7355949 lbo modelling

8/9/2019 7355949 LBO Modelling

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Merger and Acquisition Modelling Feb 8, 2015 1

Leveraged Buyouts


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Leveraged Buyout Discussion

• A group takes over control sometimes with hostile takeovers.

• Use high level of leverage and multiple debt layers to take control

• Once in control

• Improve Operations

• Divest Unrelated Businesses

• e!sell the "ew #ompany for a $rofit


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Leveraged Buyout

• %everage ranges from &'( to ()'(

• Investors seek returns of )* to +, percent

• Average life of &.- years after which investors take the firm public

• #haracteristics

• /trong and stable cash flows

• %ow level of capital e0penditures

• /trong market position

• %ow rate of technological change

• elatively low market valuation


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Merger and Acquisition Modelling Feb 8, 2015

LB! "tatistics

• 12 to &2 of 34A activity in number of transactions

• $eak in (56,7s

• /ignificant increases in efficiency

• %ate (56,7s )- percent of %BO7s defaulted

• Opportunities to transfer wealth between groups


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LB! #$a%&le

• 3edi3edia

• evolver and senior debt

• Amount 81) million

•9erm - years

•ate %IBO : ).)*2

• 3e;;anine Debt

• Amount 8(* million

•9erm 6 years

•ate %IBO : 1.)*2

•


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Merger and Acquisition Modelling Feb 8, 2015 '

LB! #$a%&le ( )evco

/ources

• Bank 9erm %oans +**,,,

• /enior /ubordinated +,,,,,

• /ubordinated )(,,,,

• ?unior /ubordinated 5((+*

• #ommon /tock 51-*,

• =0changable $referred (1,),,

• #onvertible $referred 6*,,,

• ?unior $referred 1,,56

• Investor #ommon 1+)-&

• #ash of evco (,&**

•9otal /ources (++6-55

• Uses

• $urchase of #ommon /tock ()*11(*

• epayment of Debt ((-+6+

• @ees and =0penses -6,,,

•9otal Uses (++6-55


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Merger and Acquisition Modelling Feb 8, 2015 *

+e Deal Decade, 1-81(1-8- .te /ourt %ove%ent

• 3otivating forces

• /urge in the economy and stock market beginning in mid!(56)

• Impact of international competition on mature industries such as steel andauto

• Unwinding diversified firms

• "ew industries as a result of new technologies and managerial innovationsDecade of big deals

• 9en largest transactions

•=0ceeded 8& billion each

•/ummed to 8()&.( billion

• 9op (, deals reflected changes in the industry

•@ive involved oil companies increased price instability resulting from O$=#actions

•9wo involved drug mergers increased pressure to reduce drug prices

•9wo involved tobacco companies diversified into food industry


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1-80s LB! ave

• $rior to (56, managers wereloyal to the firm not shareholders

• %ittle managerial shareownership stockcompensation

• %ittle e0ternal threat oftakeover

• #haracteristics

• ighly levered deals' cashpayment funded byborrowing

• ostile

• Industry clusters

"on Investment Crade Bond


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LB! reed or #//iciency ains

• %BOs shifted corporate governance

• 3anagers had high e>uity stakes

• Debt disciplined manager decision making

• #lose monitoring from %BO investors stongboards

• @irst half of (56,s

• Improved operating profits

• @ew defaults• %ast half of (56,s

• (E1 defaulted

• But operating profits improved from pre!%BOlevels Fust not enough

• $rices paid in %BO deals were too high

• By the end of the (56,s corporate raidersand %BOs were despised

• /ecurities fraud

• ?unk bond market collapsed

Contested Tender Oers as ! of Total197" - 1999


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• 3anagers are more shareholder focused

• ostile takeovers not as necessary

• 3ore shares are owned by institutional investors G(56, H1, 2 to ),,,*,2J

•3ore monitoring and activism from shareholders

• 3anagement stock ownership and stock compensation has increased

• 3ore interested in creating stockholder value

• #=O option grants increased 0- from (56, K (55+

• =>uity compensation L *,2 in (55+ H),2 in (56,

• Boards are more active

Lasting )esults /ro% 1-80s +a4eovers


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alue reated by LB!6s


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7roductivity "tudy o/ LB!6s


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LB! Modelling ssues

• $erspective of Alternative $arties

• #ash @low Materfall

• /ources and Uses of @unds

• $ro!@orma Analysis• I on Alternative @inancial Instruments


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as Flo9 ater/all

• Materfall Issues

• Defaults and subse>uent repayments of defaults beforedividend distributions

• 3odel different priorities of debt

• 3odel cash flow trap mechanisms

• =valuate $re!payments from covenant violations

• #ompute Debt service reserve inFections and withdrawls

• Accumulation of debt service reserve after constructionperiod


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Merger and Acquisition Modelling Feb 8, 2015 1'

Modelling De/aults on Debt

• 3odelling defaults on debt is important in credit analysis. 9hroughmodelling defaults the probability of default and the loss givendefault can be evaluated through break!even analysis and through3onte #arlo simulation.

• 9he following process shows how to model defaults'

• /et up the debt balance to incorporate defaults and re!payment of defaults

• 9he default comes from an if statement in the cash flowstatement

• 9he re!payment of default is the previous year default

amount. 9his means the model attempts to fully repay thedefault in the year immediately following the default. If thereis no cash flow to repay the default the default increases bythe amount of the default.


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Merger and Acquisition Modelling Feb 8, 2015 1*

Modelling De/aults on Debt ( 7rocedure

• 9he following illustrates the modelling process for defaults.

• "ote how the default comes from the cash flow statement

• 9he if statement in the cash flow statement

• 9he repayment of default from the prior default


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Ma$i%u% De/ault

• Mhen modelling the defaults on debt it is possible that the cashflow is less than the total debt service.

• In this case the default is only the debt service that was notcovered not the negative of the cash flow.

• 9herefore the default formula should be'

• IfGcashH,minG!cashdebt serviceJ,J

• "otes'

•#ash is cash flow to tranche

•Debt service includes the repayment of defaults


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Merger and Acquisition Modelling Feb 8, 2015 1-

Analysis 9it De/aults

• Once defaults are modeled one can evaluate the I earnedon debt instruments and the amount of debt outstanding.

• 9he amount of debt outstanding is the loss given default.

• 9he I allows you to compute a probability distribution

for the loan facility


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o%&uting as Flo9 /or te ater/all

• 9o model priorities in a cash flow waterfall the first step is setting up a the cash flowstatement in a model that reflects the actual ordering of cash flow'

• Begin with the cash flow after capital e0penditures and after all new financingand ac>uisitions

• Add back interest e0pense that was deducted because the interest will beaccounted for on an issue by issue basis

• Add the beginning balance of cash. =ven though it seems odd to add thecash balances these cash balances are available to pay off debt.

• 9he sum of these items gives the cash flow for the waterfall as illustratedbelow.

•#ash @low After #apital =0penditures

K Add' "ew Debt Issues K Add' "ew =>uity Issues

•#ash @low before waterfall adFustments K Add' 9otal Interest =0pense K Add' Beginning #ash Balance

•#ash @low for Materfall


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as Flo9 7riorities

• Once the cash flow for the waterfall is computed you can compute the defaults on senior and Funior debt.

• /ubtract scheduled interest payments and maturities from the cash flow for waterfall

• Also subtract attempts to re!pay earlier defaults

• 9he difference is cash flow after senior debt that determines default K defaults are the driven by anif statement driven by whether there is negative cash flow.

• Any defaults are added to cash flow to determine the cash flow to Funior debt

• 9his step of the waterfall is illustrated below'

•#ash @low for Materfall

K%ess' /cheduled epayment K%ess' Interest on /enior K%ess' epayment of earlier defaults

•#ash @low after /enior Debt

K Add' Default on /enior Debt•#ash @low to ?unior Debt

K%ess' /cheduled epayment K%ess' Interest on ?unior K%ess' epayment of earlier default


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as Flo9 +ra&s and Dividends

• After Funior debt is evaluated traps on cash and distributions can beevaluated.

• Nou must subtract the cash balance that was added at the beginning of thewaterfall

• #ash 9raps can be evaluated at this point that prevent e0cess cash goingdividends before debt is paid

• 9his step of the waterfall is illustrated below'

•#ash @low after ?unior Debt

K Add' Default on ?unior Debt K%ess' #ash Balance Added Above

•"et #ash @low

K/witch for 9rapping #ash K%ess' #ash 9rapped K Add' #ash Mithdrawn from Account

•Dividend Distributions

7355949 lbo modelling

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