Leveraged Buyouts. Investment Banking – Valuation, Leveraged Buyouts, and Mergers & Acquisitions. Rosenbaum, J and Pearl, J (2009) by Hoboken, New Jersey, John Wiley & Sons, Inc.
1. Start with the Operational Model sheet and build the projections of each operational segment based on the historical data providedn Make the necessary assumptions for each operational segment of the Company (US, International, CPG)n Total the numbers of all operational segments and build the Net Working Capital projections by forecasting Balance Sheet items days
2. Move on to the Financial Statements to build the projections for Company's future Income Statement, Cash Flow Statement and Balance Sheetn You will be using the operational model assumptions calculated in the previous step for some key itemsn Some figures are provided to keep things simple
3. DCF Analysis follows using the NPV and APV methodologiesn Beta analysis is provided in order to calculate the unlevered beta of the Company to be used in the NPV methodn Build the NPV model following the steps that help you derive the value of the Companyn Build the APV model following the steps that help you derive the value of the Companyn A Comparables Model is also provided
4. The LBO Model presented here is irrelevant and independent from other sheetsn Start with building the Sources & Uses of funds (The capital structure is provided)n Operational assumptions are also providedn Debt pricing and schedule terms are provided; you need to build itn Project the future Financial Statements of the Company based on the operational assumptions provided (this is similar to the process in step 2 above)
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Linked with other spreadsheets GREEN
Formulas BLACK
Cells with black border indicate that their content was initially hard coded and will need to be updated at a later step
Note: Several comments have been provided inside every sheet to help you. If there is something you don't understand the respective (answer) sheet provides the solution
1. Start with the Operational Model sheet and build the projections of each operational segment based on the historical data providedMake the necessary assumptions for each operational segment of the Company (US, International, CPG)Total the numbers of all operational segments and build the Net Working Capital projections by forecasting Balance Sheet items days
2. Move on to the Financial Statements to build the projections for Company's future Income Statement, Cash Flow Statement and Balance SheetYou will be using the operational model assumptions calculated in the previous step for some key items
Beta analysis is provided in order to calculate the unlevered beta of the Company to be used in the NPV methodBuild the NPV model following the steps that help you derive the value of the CompanyBuild the APV model following the steps that help you derive the value of the Company
Project the future Financial Statements of the Company based on the operational assumptions provided (this is similar to the process in step 2 above)
Cells with black border indicate that their content was initially hard coded and will need to be updated at a later step
Several comments have been provided inside every sheet to help you. If there is something you don't understand the respective (answer) sheet provides the solution
Marios Pastellopoulos: Pricing: The pricing will be reviewed taking into the account the liquidity in the primary market, the perceived risk of the Company and the target profitability of the banks (usually lenders to TLa/b/c tranches). After reviewing the market conditions (from LCD news), the credit rating of the Company (ratings reports) and receiving an advice from the Main Lead Arranger (i.e. their syndication team), the price of the debt is decided. The PIK element of the SHL will have a higher interest than the most expensive debt instrument (i.e. in this deal Mezzanine), however this is agreed with the Management because it could affect their MSIP. In this case it was decided to stand at 14.0%.
B11
Marios Pastellopoulos: It can be provided in three tranches namely TLa, TLb, TLc with typical maturities ranging between 5-8 years respectively. Commercial banks usually provide Senior Debt, requiring strict covenants and protection features. Senior Debt is always repaid first and has the highest guarantee in the event of default. TLa is usually the most senior tranche and the only one that is amortised, TLb and TLc are repaid only at maturity (bullets) with higher interest margins.
B12
Marios Pastellopoulos: RCF and Capex Facilities will match the term and pricing of the Senior Debt.
C12
Marios Pastellopoulos: Allows the borrower to draw various amounts up to a limit and for a specified period. It provides ongoing liquidity for seasonal WC and other general needs (Same term with TLa).
F12
Marios Pastellopoulos: RCF is decided to be in the region of 10%-20% of EBITDA.
C13
Marios Pastellopoulos: It can only be used to finance a CapEx program (Same term as TLa).
C16
Marios Pastellopoulos: TLb will be 7 years. TLc will be 8 years.
B17
Marios Pastellopoulos: This is a second-priority debt, which means that it ranks after Senior Debt in the event of a liquidation or bankruptcy. Its interest charges are effectively more expensive than Senior Debt and repayments are usually a bullet payment and the term of the facility.
B18
Marios Pastellopoulos: More aggressive investors like Hedge Fund, CLO vehicles and Institutional Investors are the primary underwriters of Mezzanine Debt, requiring much higher return (and thus interest rate) by accepting higher risk (lowest seniority). Mezzanine’s interest repayments have two distinctive elements: the usual cash interest paid every year and a PIK interest that has no periodical payments but accumulates to the end of the term and repaid with the principal as a bullet. Typical tenors are around 8-10 years provided with much looser covenants and greater flexibility (headroom).
C18
Marios Pastellopoulos: Mezzanine maturity set at 9 years.
B21
Marios Pastellopoulos: This is a speculative investment grade bond. High Yield (HY) Bonds are unsecured and subordinated with usual tenors of 5-10 years, periodic interest payments and principal repayment as bullet at maturity. Cost depends on the investment grade attached to the bond (and the issuing company) and can be more or less expensive than Mezzanine.
B23
Marios Pastellopoulos: The Shareholder Loan (SHL) is equity injected into the company from the PE firm's perspective. From the company's perspective, however, this capital is regarded as a loan since it will have to pay interest (PIK only - banks do not allow a cash interest) and repay the SHL at its term (i.e. it has the same characteristics with the facilities provided by banks or institutional investors). For simplicity, this line is shown here. Nevertheless, in the model of a PE firm it would appear on a different sheet under the name "Equity schedule".
C23
Marios Pastellopoulos: The maturity is usually bigger than 10 years (our horizon). This is why, among other things (i.e. no cash interest), SHL is considered by rating agencies as equity and not debt.
B26
Marios Pastellopoulos: Cash interest, indicates the interest received for the cash on the Balance Sheet.
D29
Marios Pastellopoulos: The Debt Repayment Schedule serves to bring in the effects of the LBO financing structure in the LBO model. All the different debt instruments with their respective obligatory and optional debt repayments and interest expenses are provided here, showing the opening and closing balances of each instrument.
C32
Marios Pastellopoulos: The Forward 3-Month LIBOR Curve is used to determine the LIBOR rate every year for the purpose of interest repayments. This is the best prediction that a banker can have relating to the floating interest rate.
B33
Marios Pastellopoulos: Banks require 1/2 hedging of the interest rates. To model the interest payments (1/2 of LIBOR) + (1/2 * Swap rate). Here we assume that interest hedging is for 3 years but we expand the formula up to the end.
D34
Marios Pastellopoulos: On bank debt the standard hedging requirements are: If for 2 years hedge 66% of the debt If for 3 years hedge 50% of the debt
B38
Marios Pastellopoulos: Floating Base Rate as above.
B39
Marios Pastellopoulos: Interest Rate = Base Rate + Spread
C41
Marios Pastellopoulos: Banks want amortising debt, therefore the average life should be no more than c. 80% of the term of the facility.
B42
Marios Pastellopoulos: The amortisation of the Senior Debt is designed with incremental payments over the years, with the biggest repayment made at the term of the facility (Baloon). This is to facilitate the de-leveraging of the company, since in the early years it has higher interest payments due. The analyst must decide the amortisation schedule of TLa.
E43
Marios Pastellopoulos: Opening Balance = Closing Balance of previous year
B44
Marios Pastellopoulos: Principal Repayments = %Amortisation * Opening Balance
E44
Marios Pastellopoulos: Need to make sure that the balance is positive, otherwise the cash sweep will not work properly.
B45
Marios Pastellopoulos: Cash Sweep is provided here for simplicity. Note: Cash Sweep is explained in detail later when the LBO Model will be built
Marios Pastellopoulos: Pricing: The pricing will be reviewed taking into the account the liquidity in the primary market, the perceived risk of the Company and the target profitability of the banks (usually lenders to TLa/b/c tranches). After reviewing the market conditions (from LCD news), the credit rating of the Company (ratings reports) and receiving an advice from the Main Lead Arranger (i.e. their syndication team), the price of the debt is decided. The PIK element of the SHL will have a higher interest than the most expensive debt instrument (i.e. in this deal Mezzanine), however this is agreed with the Management because it could affect their MSIP. In this case it was decided to stand at 14.0%.
B11
Marios Pastellopoulos: It can be provided in three tranches namely TLa, TLb, TLc with typical maturities ranging between 5-8 years respectively. Commercial banks usually provide Senior Debt, requiring strict covenants and protection features. Senior Debt is always repaid first and has the highest guarantee in the event of default. TLa is usually the most senior tranche and the only one that is amortised, TLb and TLc are repaid only at maturity (bullets) with higher interest margins.
B12
Marios Pastellopoulos: RCF and Capex Facilities will match the term and pricing of the Senior Debt.
C12
Marios Pastellopoulos: Allows the borrower to draw various amounts up to a limit and for a specified period. It provides ongoing liquidity for seasonal WC and other general needs (Same term with TLa).
F12
Marios Pastellopoulos: RCF is decided to be in the region of 10%-20% of EBITDA.
C13
Marios Pastellopoulos: It can only be used to finance a CapEx program (Same term as TLa).
C16
Marios Pastellopoulos: TLb will be 7 years. TLc will be 8 years.
B17
Marios Pastellopoulos: This is a second-priority debt, which means that it ranks after Senior Debt in the event of a liquidation or bankruptcy. Its interest charges are effectively more expensive than Senior Debt and repayments are usually a bullet payment and the term of the facility.
B18
Marios Pastellopoulos: More aggressive investors like Hedge Fund, CLO vehicles and Institutional Investors are the primary underwriters of Mezzanine Debt, requiring much higher return (and thus interest rate) by accepting higher risk (lowest seniority). Mezzanine’s interest repayments have two distinctive elements: the usual cash interest paid every year and a PIK interest that has no periodical payments but accumulates to the end of the term and repaid with the principal as a bullet. Typical tenors are around 8-10 years provided with much looser covenants and greater flexibility (headroom).
C18
Marios Pastellopoulos: Mezzanine maturity set at 9 years.
B21
Marios Pastellopoulos: This is a speculative investment grade bond. High Yield (HY) Bonds are unsecured and subordinated with usual tenors of 5-10 years, periodic interest payments and principal repayment as bullet at maturity. Cost depends on the investment grade attached to the bond (and the issuing company) and can be more or less expensive than Mezzanine
B23
Marios Pastellopoulos: The SHL is equity injected into the company from the PE firm's perspective. From the company's perspective, however, this capital is regarded as a loan since it will have to pay interest (PIK only - banks do not allow a cash interest) and repay the SHL at its term (i.e. it has the same characteristics with the facilities provided by banks or institutional investors). For simplicity, this line is shown here. Nevertheless, in the model of a PE firm it would appear on a different sheet under the name "Equity schedule".
C23
Marios Pastellopoulos: The maturity is usually bigger than 10 years (our horizon). This is why, among other things (i.e. no cash interest), SHL is considered by rating agencies as equity and not debt.
B26
Marios Pastellopoulos: Cash interest, indicates the interest received for the cash on the Balance Sheet.
C29
Marios Pastellopoulos: The Debt Repayment Schedule serves to bring in the effects of the LBO financing structure in the LBO model. All the different debt instruments with their respective obligatory and optional debt repayments and interest expenses are provided here, showing the opening and closing balances of each instrument.
C32
Marios Pastellopoulos: The Forward 3-Month LIBOR Curve is used to determine the LIBOR rate every year for the purpose of interest repayments. This is the best prediction that a banker can have relating to the floating interest rate.
B33
Marios Pastellopoulos: Banks require 1/2 hedging of the interest rates. To model the interest payments (1/2 of LIBOR) + (1/2 * Swap rate). Here we assume that interest hedging is for 3 years but we expand the formula up to the end.
D34
Marios Pastellopoulos: On bank debt the standard hedging requirements are: If for 2 years hedge 66% of the debt If for 3 years hedge 50% of the debt
B37
Marios Pastellopoulos: Mezzanine is paid as a bullet at its maturity and has a PIK interest element in addition to the ordinary cash interest paid. PIK element is not paid at the agreed repayment periods but accumulates every year and paid in total at maturity.
B38
Marios Pastellopoulos: Floating Base Rate as above.
B39
Marios Pastellopoulos: PIK Element of Mezzanine debt defined in step 1.
B40
Marios Pastellopoulos: Cash Element = Base Rate + Spread
B42
Marios Pastellopoulos: Mezz makes a bullet payment at maturity.
E43
Marios Pastellopoulos: Opening Balance = Closing Balance of previous year
E44
Marios Pastellopoulos: Due to PIK, the facility amount will increase over time. Therefore need to pay 100% of Op. balance + PIK interest expense.
PIK ElementCash Element 6.5%HY Bond 10 Bullet 0.4x 1,000
Shareholder loan 15 Bullet 1.2x 2,870PIK Element
LIBORCash Interest
Step 2 – Define the HY Bond repayment schedule
2010A 2011E 2012E 2013E
HY BondInterest rate
Amortisation schedule (% of Op. balance+PIK)Opening BalancePrincipal repaymentsInterest expense
Closing Balance
Expand for the answer
Term (Years)
x EBITDA
B8
Marios Pastellopoulos: Pricing: The pricing will be reviewed taking into the account the liquidity in the primary market, the perceived risk of the Company and the target profitability of the banks (usually lenders to TLa/b/c tranches). After reviewing the market conditions (from LCD news), the credit rating of the Company (ratings reports) and receiving an advice from the Main Lead Arranger (i.e. their syndication team), the price of the debt is decided. The PIK element of the SHL will have a higher interest than the most expensive debt instrument (i.e. in this deal Mezzanine), however this is agreed with the Management because it could affect their MSIP. In this case it was decided to stand at 14.0%.
B11
Marios Pastellopoulos: It can be provided in three tranches namely TLa, TLb, TLc with typical maturities ranging between 5-8 years respectively. Commercial banks usually provide Senior Debt, requiring strict covenants and protection features. Senior Debt is always repaid first and has the highest guarantee in the event of default. TLa is usually the most senior tranche and the only one that is amortised, TLb and TLc are repaid only at maturity (bullets) with higher interest margins.
B12
Marios Pastellopoulos: RCF and Capex Facilities will match the term and pricing of the Senior Debt.
C12
Marios Pastellopoulos: Allows the borrower to draw various amounts up to a limit and for a specified period. It provides ongoing liquidity for seasonal WC and other general needs (Same term with TLa).
F12
Marios Pastellopoulos: RCF is decided to be in the region of 10%-20% of EBITDA.
C13
Marios Pastellopoulos: It can only be used to finance a CapEx program (Same term as TLa).
C16
Marios Pastellopoulos: TLb will be 7 years. TLc will be 8 years.
B17
Marios Pastellopoulos: This is a second-priority debt, which means that it ranks after Senior Debt in the event of a liquidation or bankruptcy. Its interest charges are effectively more expensive than Senior Debt and repayments are usually a bullet payment and the term of the facility.
B18
Marios Pastellopoulos: More aggressive investors like Hedge Fund, CLO vehicles and Institutional Investors are the primary underwriters of Mezzanine Debt, requiring much higher return (and thus interest rate) by accepting higher risk (lowest seniority). Mezzanine’s interest repayments have two distinctive elements: the usual cash interest paid every year and a PIK interest that has no periodical payments but accumulates to the end of the term and repaid with the principal as a bullet. Typical tenors are around 8-10 years provided with much looser covenants and greater flexibility (headroom).
C18
Marios Pastellopoulos: Mezzanine maturity set at 9 years.
B21
Marios Pastellopoulos: This is a speculative investment grade bond. High Yield (HY) Bonds are unsecured and subordinated with usual tenors of 5-10 years, periodic interest payments and principal repayment as bullet at maturity. Cost depends on the investment grade attached to the bond (and the issuing company) and can be more or less expensive than Mezzanine.
B23
Marios Pastellopoulos: The SHL is equity injected into the company from the PE firm's perspective. From the company's perspective, however, this capital is regarded as a loan since it will have to pay interest (PIK only - banks do not allow a cash interest) and repay the SHL at its term (i.e. it has the same characteristics with the facilities provided by banks or institutional investors). For simplicity, this line is shown here. Nevertheless, in the model of a PE firm it would appear on a different sheet under the name "Equity schedule".
C23
Marios Pastellopoulos: The maturity is usually bigger than 10 years (our horizon). This is why, among other things (i.e. no cash interest), SHL is considered by rating agencies as equity and not debt.
B26
Marios Pastellopoulos: Cash interest, indicates the interest received for the cash on the Balance Sheet.
C29
Marios Pastellopoulos: The Debt Repayment Schedule serves to bring in the effects of the LBO financing structure in the LBO model. All the different debt instruments with their respective obligatory and optional debt repayments and interest expenses are provided here, showing the opening and closing balances of each instrument.
B32
Marios Pastellopoulos: HY Bond is paid as a bullet at its maturity and has ordinary cash interest paid yearly.
B33
Marios Pastellopoulos: Interest rate of HY Bond defined in step 1.
B35
Marios Pastellopoulos: HY Bond makes a bullet payment at maturity.
E36
Marios Pastellopoulos: Opening Balance = Closing Balance of previous year
Marios Pastellopoulos: Pricing: The pricing will be reviewed taking into the account the liquidity in the primary market, the perceived risk of the Company and the target profitability of the banks (usually lenders to TLa/b/c tranches). After reviewing the market conditions (from LCD news), the credit rating of the Company (ratings reports) and receiving an advice from the Main Lead Arranger (i.e. their syndication team), the price of the debt is decided. The PIK element of the SHL will have a higher interest than the most expensive debt instrument (i.e. in this deal Mezzanine), however this is agreed with the Management because it could affect their MSIP. In this case it was decided to stand at 14.0%.
B11
Marios Pastellopoulos: It can be provided in three tranches namely TLa, TLb, TLc with typical maturities ranging between 5-8 years respectively. Commercial banks usually provide Senior Debt, requiring strict covenants and protection features. Senior Debt is always repaid first and has the highest guarantee in the event of default. TLa is usually the most senior tranche and the only one that is amortised, TLb and TLc are repaid only at maturity (bullets) with higher interest margins.
B12
Marios Pastellopoulos: RCF and Capex Facilities will match the term and pricing of the Senior Debt.
C12
Marios Pastellopoulos: Allows the borrower to draw various amounts up to a limit and for a specified period. It provides ongoing liquidity for seasonal WC and other general needs (Same term with TLa).
F12
Marios Pastellopoulos: RCF is decided to be in the region of 10%-20% of EBITDA.
C13
Marios Pastellopoulos: It can only be used to finance a CapEx program (Same term as TLa).
C16
Marios Pastellopoulos: TLb will be 7 years. TLc will be 8 years.
B17
Marios Pastellopoulos: This is a second-priority debt, which means that it ranks after Senior Debt in the event of a liquidation or bankruptcy. Its interest charges are effectively more expensive than Senior Debt and repayments are usually a bullet payment and the term of the facility.
B18
Marios Pastellopoulos: More aggressive investors like Hedge Fund, CLO vehicles and Institutional Investors are the primary underwriters of Mezzanine Debt, requiring much higher return (and thus interest rate) by accepting higher risk (lowest seniority). Mezzanine’s interest repayments have two distinctive elements: the usual cash interest paid every year and a PIK interest that has no periodical payments but accumulates to the end of the term and repaid with the principal as a bullet. Typical tenors are around 8-10 years provided with much looser covenants and greater flexibility (headroom).
C18
Marios Pastellopoulos: Mezzanine maturity set at 9 years.
B21
Marios Pastellopoulos: This is a speculative investment grade bond. High Yield (HY) Bonds are unsecured and subordinated with usual tenors of 5-10 years, periodic interest payments and principal repayment as bullet at maturity. Cost depends on the investment grade attached to the bond (and the issuing company) and can be more or less expensive than Mezzanine.
B23
Marios Pastellopoulos: The SHL is equity injected into the company from the PE firm's perspective. From the company's perspective, however, this capital is regarded as a loan since it will have to pay interest (PIK only - banks do not allow a cash interest) and repay the SHL at its term (i.e. it has the same characteristics with the facilities provided by banks or institutional investors). For simplicity, this line is shown here. Nevertheless, in the model of a PE firm it would appear on a different sheet under the name "Equity schedule".
C23
Marios Pastellopoulos: The maturity is usually bigger than 10 years (our horizon). This is why, among other things (i.e. no cash interest), SHL is considered by rating agencies as equity and not debt.
B26
Marios Pastellopoulos: Cash interest, indicates the interest received for the cash on the Balance Sheet.
E29
Marios Pastellopoulos: The Debt Repayment Schedule serves to bring in the effects of the LBO financing structure in the LBO model. All the different debt instruments with their respective obligatory and optional debt repayments and interest expenses are provided here, showing the opening and closing balances of each instrument.
C32
Marios Pastellopoulos: The Forward 3-Month LIBOR Curve is used to determine the LIBOR rate every year for the purpose of interest repayments. This is the best prediction that a banker can have relating to the floating interest rate.
B33
Marios Pastellopoulos: Banks require 1/2 hedging of the interest rates. To model the interest payments (1/2 of LIBOR) + (1/2 * Swap rate). Here we assume that interest hedging is for 3 years but we expand the formula up to the end.
D34
Marios Pastellopoulos: On bank debt the standard hedging requirements are: If for 2 years hedge 66% of the debt If for 3 years hedge 50% of the debt
B37
Marios Pastellopoulos: RCF and Capex Facilities Debt structuring includes these two credit facilities. Even though they are not an actual source of financing for an LBO deal they are typically included in the majority of the transactions (especially the RCF Facility). RCF is similar to a line of credit provided by a bank, allowing the borrower to draw various amounts up to a specified limit for a specific period, for the purpose of providing liquidity to the company for anticipated working capital needs. RCF quantum depends on Working Capital swings from year to year and on the liquidity needs of the company. Its commitment fee is typically calculated as a certain % of its interest margin. CapEx Facility is very similar to RCF, the main difference is that it can only be used to finance the capital expenditure program of the company including minor acquisitions. RCF and Capex Facilities tenors and pricing are typically matching those of the senior debt since they have similar risk and seniority, even though Capex Facility is usually tailored to the specific company need.
B39
Marios Pastellopoulos: The RCF Facility is a credit facility that the company can use for cash purposes (to maintain a desirable minimum closing cash balance that will ensure liquidity at all times). RCF Facility pays two kinds of interest. The usual interest payment and a commitment fee paid on the undrawn portion of the facility.
B40
Marios Pastellopoulos: Floating Base Rate as above.
B41
Marios Pastellopoulos: IF > facility maturity THEN "-" ELSE Interest Rate = Base Rate + Spread
B42
Marios Pastellopoulos: Annual commitment fee paid on the undrawn portion of the revolver.
E42
Marios Pastellopoulos: IF > facility maturity THEN "-" ELSE Commitment fee = 40% * RCF spread
B44
Marios Pastellopoulos: RCF Facility amount defined in step 1.
Marios Pastellopoulos: A drawdown from this facility is been made if required (i.e. the closing cash balance is less than the required minimum cash balance), otherwise there is a repayment of previously used amount or no drawdown.
E51
Marios Pastellopoulos: IF >=Maturity Prepay = - OP. Balance of RCF facility ELSE IF Closing Balance before RCF > Min. cash balance Prepay = - min (OP. RCF, CB before RCF - Min cash balance) ELSE Drawdown = min (Min. Cash balance - CB before RCF, Commitment - OP. RCF) END END
Marios Pastellopoulos: Interest Expense for RCF is assumed on the average of Op. and Cl. Balance.
E59
Marios Pastellopoulos: IF > facility maturity THEN 0 ELSE Commitment fee * Undrawn
B61
Marios Pastellopoulos: CapEx Facility works similarly but the difference is that the analyst decides the amount needed to be drawn each year depending on the CapEx needs of the Company. Interest expense and commitment fees are charged on drawn and undrawn portions respectively and the repayment is a bullet at the end of the term of the facility.
E64
Marios Pastellopoulos: IF > facility maturity THEN "-" ELSE Commitment fee = 40%*CapEx spread
B69
Marios Pastellopoulos: CapEx Facility is repaid as a bullet payment at maturity.
E72
Marios Pastellopoulos: Amount needed to be drawn each year depending on the CapEx needs of the Company.
Marios Pastellopoulos: Pricing: The pricing will be reviewed taking into the account the liquidity in the primary market, the perceived risk of the Company and the target profitability of the banks (usually lenders to TLa/b/c tranches). After reviewing the market conditions (from LCD news), the credit rating of the Company (ratings reports) and receiving an advice from the Main Lead Arranger (i.e. their syndication team), the price of the debt is decided. The PIK element of the SHL will have a higher interest than the most expensive debt instrument (i.e. in this deal Mezzanine), however this is agreed with the Management because it could affect their MSIP. In this case it was decided to stand at 14.0%.
B11
Marios Pastellopoulos: It can be provided in three tranches namely TLa, TLb, TLc with typical maturities ranging between 5-8 years respectively. Commercial banks usually provide Senior Debt, requiring strict covenants and protection features. Senior Debt is always repaid first and has the highest guarantee in the event of default. TLa is usually the most senior tranche and the only one that is amortised, TLb and TLc are repaid only at maturity (bullets) with higher interest margins.
B12
Marios Pastellopoulos: RCF and Capex Facilities will match the term and pricing of the Senior Debt.
C12
Marios Pastellopoulos: Allows the borrower to draw various amounts up to a limit and for a specified period. It provides ongoing liquidity for seasonal WC and other general needs (Same term with TLa).
F12
Marios Pastellopoulos: RCF is decided to be in the region of 10%-20% of EBITDA.
C13
Marios Pastellopoulos: It can only be used to finance a Capex program (Same term as TLa).
C16
Marios Pastellopoulos: TLb will be 7 years. TLc will be 8 years.
B17
Marios Pastellopoulos: This is a second-priority debt, which means that it ranks after Senior Debt in the event of a liquidation or bankruptcy. Its interest charges are effectively more expensive than Senior Debt and repayments are usually a bullet payment and the term of the facility.
B18
Marios Pastellopoulos: More aggressive investors like Hedge Fund, CLO vehicles and Institutional Investors are the primary underwriters of Mezzanine Debt, requiring much higher return (and thus interest rate) by accepting higher risk (lowest seniority). Mezzanine’s interest repayments have two distinctive elements: the usual cash interest paid every year and a PIK interest that has no periodical payments but accumulates to the end of the term and repaid with the principal as a bullet. Typical tenors are around 8-10 years provided with much looser covenants and greater flexibility (headroom).
C18
Marios Pastellopoulos: Mezzanine maturity set at 9 years.
B21
Marios Pastellopoulos: This is a speculative investment grade bond. High Yield (HY) Bonds are unsecured and subordinated with usual tenors of 5-10 years, periodic interest payments and principal repayment as bullet at maturity. Cost depends on the investment grade attached to the bond (and the issuing company) and can be more or less expensive than Mezzanine.
B23
Marios Pastellopoulos: The SHL is equity injected into the company from the PE firm's perspective. From the company's perspective, however, this capital is regarded as a loan since it will have to pay interest (PIK only - banks do not allow a cash interest) and repay the SHL at its term (i.e. it has the same characteristics with the facilities provided by banks or institutional investors). For simplicity, this line is shown here. Nevertheless, in the model of a PE firm it would appear on a different sheet under the name "Equity schedule".
C23
Marios Pastellopoulos: The maturity is usually bigger than 10 years (our horizon). This is why, among other things (i.e. no cash interest), SHL is considered by rating agencies as equity and not debt.
B26
Marios Pastellopoulos: Cash interest, indicates the interest received for the cash on the Balance Sheet.
D29
Marios Pastellopoulos: The Debt Repayment Schedule serves to bring in the effects of the LBO financing structure in the LBO model. All the different debt instruments with their respective obligatory and optional debt repayments and interest expenses are provided here, showing the opening and closing balances of each instrument.
C32
Marios Pastellopoulos: The Forward 3-Month LIBOR Curve is used to determine the LIBOR rate every year for the purpose of interest repayments. This is the best prediction that a banker can have relating to the floating interest rate.
B33
Marios Pastellopoulos: Banks require 1/2 hedging of the interest rates. To model the interest payments (1/2 of LIBOR) + (1/2 * Swap rate). Here we assume that interest hedging is for 3 years but we expand the formula up to the end.
D34
Marios Pastellopoulos: On bank debt the standard hedging requirements are: If for 2 years hedge 66% of the debt If for 3 years hedge 50% of the debt
B37
Marios Pastellopoulos: SHL is a form of quasi-equity but from the company’s perspective is like a loan. Its modeling simulates that of the Mezzanine debt since it is also paid as a bullet and its interest is PIK accumulating at the end. Note: Notice that the SHL does not pay cash interest like Mezz.
B38
Marios Pastellopoulos: PIK Element of SHL defined in step 1.
E41
Marios Pastellopoulos: Opening Balance = Closing Balance of previous year
E42
Marios Pastellopoulos: Due to PIK, the facility amount will increase over time. Therefore need to pay 100% of Op. balance + PIK interest expense.
n Breakdown of the Company's main Income Statement figures based on its reportable operating segments
n Revenues to grow at a 2010-14 CAGR of c. 4.7% trending to c. 3.4% in later years driven by a 14.2% CAGR of the CPG segment as well as strong growth in other segments
n Gross margins expected to decrease from c. 59% in 2010 to 57% in later years driven by an increase of COGS in the CPG segment
n Overheads to decrease as a % of sales from c. 36.4% to 34%
n EBITDA margins to remain broadly flat c. 23%
n CapEx assumed to be between 4 - 5 % of revenues
n Working Capital assumed to decrease over time leading to a positive cash impact
Note 1: Fiscal year end for Starbucks is end of September
Note 2: For modeling purposes we assumed that the transaction closes in September 2010 and that 2010 Revenues and EBITDA are Expected based on our ssumptions
Financial Modelling LABOperational Model
1A US ($M), FY End Sep-2010 2007A 2008A 2009A 2010A 2011E 2012E 2013E 2014E 2015E 2016E 2017E
Marios Pastellopoulos: The aim of the Operational Model is to provide the base on which the LBO Model will be built: We are trying to break up the main figures of the Income Statement into the core operating segments of the Company in order to determine the drivers behind its operational performance. This analysis is critical since each segment is characterised by different endogenous characteristics, which we are trying to identify in order to build prudent and liable projections.
D8
Marios Pastellopoulos: Operational Segment 1: United States - Includes Company operated retail stores and certain components of specialty operations.
H8
Marios Pastellopoulos: The historical financial performance of the Company forms the basis of the analyst's projections (usually a 3-year period is a good proxy). Historic figures can be found in the Company’s annual Financial Statements.
I8
Marios Pastellopoulos: Projections are determined by the analyst. To build up the forecasts the analyst is based on the Company's historical performance, equity research reports as well as management guidance. Task: Your aim here is to build the model yourself, using guidance and information from the historical figures provided. Sales growth rates and COGS, SG&A and EBITDA and DA % of Sales have to be decided.
D21
Marios Pastellopoulos: Gross Margin
D23
Marios Pastellopoulos: Selling General & Administrative expenses (SG&A) include Operating Expenses (store+other), G&A and Income from investments.
D33
Marios Pastellopoulos: Operational Segment 2: International - Includes company operated retail stores and certain components of specialty operations.
D48
Marios Pastellopoulos: Selling General & Administrative expenses (SG&A) include Operating Expenses (store+other), G&A and Income from investments.
D57
Marios Pastellopoulos: Operational Segment 3: Global Consumers Product (CPG) - Includes packaged coffee and tea, and other branded products sold worldwide.
D72
Marios Pastellopoulos: Selling General & Administrative expenses (SG&A) include Operating Expenses (store+other), G&A and Income from investments.
D82
Marios Pastellopoulos: Here the key figures projected for each Operational Segment above are totaled.
International (649.7) (811.4) (734.3) (851.0)CPG (66.4) (77.1) (51.1) (57.4)
Marios Pastellopoulos: Selling General & Administrative expenses (SG&A) include Operating Expenses (store+other), G&A+G&A unallocated corporate and Income from investments.
D112
Marios Pastellopoulos: Dep'n from US+In'l+CPG+Corporate
D115
Marios Pastellopoulos: Capital Expenditure (CapEx) is capital invested by the Company to purchase, improve, expand and replace its fixed assets (i.e Property, Plant & Equipment). CapEx is not an expense and is capitalised on the Balance Sheet (as an addition to the Fixed Assets). It is an actual cash outflow for the Company and they must be taken into account when calculating Free Cash Flow (FCF). Depreciation & Amortisation (DA) is a measure of how assets are being “used up” over time. A company will usually replace its assets at a rate faster than it is using them up (due to inflation it costs more to replace them), therefore CapEx will in general be higher than DA.
I115
Marios Pastellopoulos: Historical levels are used as a proxy for future CapEx forecasts. The Management of the Company also provides guidance for planned future CapEx in its Financial Statements. Management expects CapEx of 550-600m. in 2011.
D116
Marios Pastellopoulos: To forecast future levels of CapEx the analyst calculates CapEx % of Sales and builds the projections based on this margin because sales growth must be “backed up” by a relative growth in the Company’s asset base.
D118
Marios Pastellopoulos: Typically defined as non-cash current assets minus non-interest bearing current liabilities.
F120
Marios Pastellopoulos: Change in NWC = NWCt - NWCt-1
D122
Marios Pastellopoulos: Current Assets include cash and other assets that will likely be converted into cash or used to pay Current Liabilities within 12 months or one operating cycle (time needed to purchase inventory, sell it and collect the cash).
D123
Marios Pastellopoulos: Cash & Cash equivalents are short-term, highly liquid investments that are readily convertible into cash (i.e money market holdings, short-term government bonds or Treasury bills, marketable securities and commercial paper).
D128
Marios Pastellopoulos: Current Liabilities are obligations that will be satisfied within 12 months or one operating cycle.
Marios Pastellopoulos: In order to project NWC throughout the projection period, each Balance Sheet item mentioned above has to be projected with using ratios (days).
D134
Marios Pastellopoulos: Accounts Receivable is usually projected based on Days Sales Outstanding (DSO).
Marios Pastellopoulos: In an LBO Analysis the projection period typically matches the maturity of the longest-term debt instrument which usually stands between 7 to 10 years. It may also be the case that the analyst may implement a 5-year projection period so as to match the investment horizon of the LBO.
Marios Pastellopoulos: The aim of the Operational Model is to provide a base on which the LBO Model will be built: We are trying to break up the main figures of the Income Statement into the core operating segments of the Company in order to determine the drivers behind its operational performance. This analysis is critical since each segment is characterised by different endogenous characteristics that we are trying to identify in order to build prudent and liable projections.
D8
Marios Pastellopoulos: Operational Segment 1: United States - Includes company operated retail stores and certain components of specialty operations.
H8
Marios Pastellopoulos: The historical financial performance of the Company forms the basis of the analyst's projections (usually a 3-year period is a good proxy). Historic figures can be found in the Company’s annual Financial Statements.
I8
Marios Pastellopoulos: Projections are determined by the analyst. To build up the forecasts the analyst is based on the Company's historical performance, equity research reports as well as management guidance.
M11
Marios Pastellopoulos: Typically growth rates are gradually reduced and stabilised in the outer years of the projection period.
M18
Marios Pastellopoulos: Usually held constant in the outer years.
D21
Marios Pastellopoulos: Gross Margin
D23
Marios Pastellopoulos: Selling General & Administrative expenses (SG&A) include Operating Expenses (store+other), G&A and Income from investments.
D33
Marios Pastellopoulos: Operational Segment 2: International - Includes company operated retail stores and certain components of specialty operations.
M36
Marios Pastellopoulos: Typically growth rates are gradually reduced and stabilised in the outer years of the projection period.
M43
Marios Pastellopoulos: Usually held constant in the outer years.
D48
Marios Pastellopoulos: Selling General & Administrative expenses (SG&A) include Operating Expenses (store+other), G&A and Income from investments.
D57
Marios Pastellopoulos: Operational Segment 3: Global Consumers Product - Includes packaged coffee and tea, and other branded products sold worldwide.
M64
Marios Pastellopoulos: Typically growth rates are gradually reduced and stabilised in the outer years of the projection period.
M67
Marios Pastellopoulos: Usually held constant in the outer years.
D72
Marios Pastellopoulos: Selling General & Administrative expenses (SG&A) include Operating Expenses (store+other), G&A and Income from investments.
M89
Marios Pastellopoulos: Typically growth rates are gradually reduced and stabilised in the outer years of the projection period.
M95
Marios Pastellopoulos: Usually held constant in the outer years.
Marios Pastellopoulos: Selling General & Administrative expenses (SG&A) include Operating Expenses (store+other), G&A+G&A unallocated corporate and Income from investments.
D112
Marios Pastellopoulos: Dep'n from US+In'l+CPG+Corporate
D115
Marios Pastellopoulos: Capital Expenditure (CapEx) is capital invested by the Company to purchase, improve, expand and replace its fixed assets (i.e Property, Plant & Equipment). CapEx is not an expense and is capitalised on the Balance Sheet (as an addition to the Fixed Assets). It is an actual cash outflow for the Company and they must be taken into account when calculating Free Cash Flow (FCF). Depreciation & Amortisation (DA) is a measure of how assets are being “used up” over time. A company will usually replace its assets at a rate faster than it is using them up (due to inflation it costs more to replace them), therefore CapEx will in general be higher than DA.
I115
Marios Pastellopoulos: Historical levels are used as a proxy for future CapEx forecasts. The Management of the Company also provides guidance for planned future CapEx in its Financial Statements. Management expects CapEx of 550-600m. in 2011.
D116
Marios Pastellopoulos: To forecast future levels of CapEx the analyst calculates CapEx % of Sales and builds the projections based on this margin because sales growth must be “backed up” by a relative growth in the Company’s asset base.
D118
Marios Pastellopoulos: Typically defined as non-cash current assets minus non-interest bearing current liabilities.
F120
Marios Pastellopoulos: Change in NWC = NWCt - NWCt-1
D122
Marios Pastellopoulos: Current Assets include cash and other assets that will likely be converted into cash or used to pay Current Liabilities within 12 months or one operating cycle (time needed to purchase inventory, sell it and collect the cash).
D123
Marios Pastellopoulos: Cash & Cash equivalents are short-term, highly liquid investments that are readily convertible into cash (i.e money market holdings, short-term government bonds or Treasury bills, marketable securities and commercial paper).
D128
Marios Pastellopoulos: Current Liabilities are obligations that will be satisfied within 12 months or one operating cycle.
Marios Pastellopoulos: In order to project NWC throughout the projection period, each Balance Sheet item mentioned above has to be projected with using ratios (days).
D134
Marios Pastellopoulos: Accounts Receivable is usually projected based on Days Sales Outstanding (DSO).
Marios Pastellopoulos: DSO are maintained from last historical year. Going forward there is a slight decrease as the Company tries to collect its Receivalbes faster, pushing its debtors for quicker payment.
D135
Marios Pastellopoulos: Inventory is usually projected based on Days Inventory On hand (DIH).
Marios Pastellopoulos: In an LBO Analysis the projection period typically matches the maturity of the longest-term debt instrument which usually stands between 7 to 10 years. It may also be the case that the analyst may implement a 5-year projection period so as to match the investment horizon of the LBO.
Step 1 - Define Operational assumptions of the model
(%) 2011E
Sales Growth (%) 3.9%
EBITDA Margin (% Sales) 22.3%
CapEx (% Sales) 5.2%
Net Working Capital (% Sales) (7.3%)
DA (% Sales) 4.3%
Tax (% EBT) 34.5%
Step 2 – Forecast the income statement
$M 2009A 2010A 2011E
Revenue 9774.6 10707.4
EBITDA 1681.6 2444.5
Depreciation & Amortisation -486.3 -463.0
EBIT 1,195.3 1,981.5
Interest Income 0.0
Total Interest Expense (838.4)
Net Interest (838.4)
EBT
Tax 0.0
Net income
Step 3 - Calculate the cash flow & cash balance
$M 2010A 2011A
EBITDA
Adjustments:
- Change in Net Working Capital
- Tax
- CapEx
Cash flow before financing (CFBF)
FCF (% EBITDA)
D4
Marios Pastellopoulos: In this spreadsheet the main figures projected in the Operational Model are summarised and used to help the analyst build the future Financial Statements of the Company.
D8
Marios Pastellopoulos: This step is linked with the Operational Model and summarises projections for Sales growth, EBITDA Margin, CapEx (% of Sales), NWC (% of Sales), DA (% of Sales), Tax (% of EBIT).
Marios Pastellopoulos: The current tax rate (effective tax rate) is maintained according to management projections for the future. Annual Report: 34%-35%.
B20
Marios Pastellopoulos: In this step we calculate Company’s future Income Statements based on the Operational Model analysis. You should use the assumptions made (interest expense is provided for simplicity). The tax paid will be used in the cash flow statement. The interest income will be calculated in step 3, hence at this stage the analyst should put zero in all cells in this line.
E23
Marios Pastellopoulos: Based on forecasts provided in step 1.
E24
Marios Pastellopoulos: Based on forecasts provided in step 1.
E25
Marios Pastellopoulos: Based on forecasts provided in step 1.
B28
Marios Pastellopoulos: Interest Income Calculation Steps: 1. Interest Income will be calculated in Step 3, hence at this stage the analyst should put zero in all cells in this line. 2. When implementing Step 3, Interest Income is again hard coded as zero and not calculated due to circularity. 3. When the Step 4 is finished bo back to Step 3 and calculate Interest Income as explained. 4. Finally link Interest Income line in Step 2 with the calculated figure in Step 3.
E28
Marios Pastellopoulos: ISERROR function is used to make it easier to revert an accidentally introduced mistake with a circular reference.
B29
Marios Pastellopoulos: Interest Expense paid on Company's outstanding debt. This is based on the debt structure of the LBO financing. Note: This item is totaled and provided for simplicity.
E29
Marios Pastellopoulos: Total Interest Expense is provided for simplicity.
B32
Marios Pastellopoulos: Earnings Before Taxes = EBIT - Net Interest
E33
Marios Pastellopoulos: If the company has a negative taxable income it will not pay taxes.
B34
Marios Pastellopoulos: Net Income = EBT - Tax
E34
Marios Pastellopoulos: In some situations, if the company performs very well, the PE firm will be able to receive dividends. The dividends payments would decrease the Free cash flow and appear on the Balance Sheet under an extra line called "Dividends", i.e. they would increase the Total Stockholders Equity. In this model it was considered that the company never pays dividends.
B38
Marios Pastellopoulos: In this step the Company’s future Cash Flows are calculated. To calculate the Cash Flow available to amortise debt and pay interest (i.e. service debt), adjustments have to be made to EBITDA. 1. Start with EBITDA and subtract the change in NWC, CapEx (using previous steps) and Tax paid (from Step 2). This will give you the Cash flow Before Financing (CFBF) or Free cash flow (FCF). Since the Balance Sheet has not yet been calculated, put zero in all cells for the change in WC; the Opening Cash Balance is zero. 2. The Interest Income will be calculated as the average balance between the Opening and Closing Cash Balance, and therefore it will make the model circular (because the closing cash balance will depend on the interest income). At this stage put zero in all cells in this line and update it only at the end when you finish implementing all the steps in the model. 3. Then subtract the cash Interest Expense (from Step 2) to obtain the Cash flow available for debt repayment. 4. Calculate the Excess Cash after Debt Repayments (Note: Debt Repayments are provided for simplicity). 5. Finally, use the Cash Increase/(Decrease) (equals Excess Cash from above) and the Opening Cash Balance to calculate the Closing Cash Balance. Make sure it is positive, otherwise the capital structure should be updated since the company will not be able to support this level of gearing (leverage).
B43
Marios Pastellopoulos: At this stage hard code 0 in this line. When NWC is calculated in Step 4, come back and link this line.
B46
Marios Pastellopoulos: Cash flow Before Financing (CFBF) = EBITDA – Change in NWC – Tax – CapEx
Interest Expense
Interest Income
Cash flow available for debt repayment (Free cash flow - FCF)
Debt Repayments (185.0)
Excess Cash
Opening Cash Balance
Cash Increase/(Decrease)
Closing Cash Balance 0.0
Cash balance check NOK
Step 4 -Calculate balance sheet and calculate the future balance sheets
Marios Pastellopoulos: The interest income depends on the opening and closing cash position. The closing cash position depends, among other things, on the interest income, therefore this calculation introduces a circular reference in the model. If an error is introduced somewhere (e.g. accidentally introduce text in the revenue cell), the model will enter into a #Value! error state, that will not be corrected even if you undo the error introduced. There are two solutions to correct this problem: 1) undo the error and then go the this line, delete everything (breaks circularity) and introduce the formula again. (time consuming) 2) use the ISERROR function in this line with an IF function: If there is an error, return 0, otherwise return the interest income. This way is better because when you undo the error, the model will automatically return to its normal state.
B51
Marios Pastellopoulos: Cash flow available for debt repayment = CFBF – Interest Expense + Interest Income
E53
Marios Pastellopoulos: Total Interest Expense is provided for simplicity.
B54
Marios Pastellopoulos: Excess Cash = Cash flow available for debt repayment - Debt Repayments
E57
Marios Pastellopoulos: Equals the Excess Cash (EC) for the year after all obligations (interest and debt repayments) have been paid.
D58
Marios Pastellopoulos: Assumed that acquisition is cash free. All money is drawn from Balance Sheet, therefore the Opening Cash Balance is zero.
E58
Marios Pastellopoulos: If the closing cash balance is negative it means that the company will not be able to support this gearing level.
B62
Marios Pastellopoulos: To build an integrated BS, the following steps should be followed: 1. Link the Cash & Equivalents entry with the respective Closing Cash position from the Cash flow statement calculated in Step 3. 2. Link the Net Working Capital (using NWC margin from Step 1 and Revenues from Step 2). 3. Go back to Step 3 and update the hard coded line for the change in NWC; a decrease in NWC translates in a cash inflow (i.e. CL increase more than CA), hence make sure you calculate this correctly: – (NWC1 – NWC0). 4. Gross Property Plant & Equipment (PPE) will be calculated as PPE from the previous year plus the (absolute value of) CapEx from the Cash Flow statement (the starting value is provided for simplicity). 5. Accumulated Depreciation will be equal to the previous year one plus the Depreciation from the Income Statement (the starting value is provided for simplicity). 6. Total (other) Fixed Assets and Goodwill will remain constant over the years. 7. Mezzanine debt is provided and Senior Debt is calculated such that the BS is balanced for simplicity. 8. Common stock is assumed to remain constant over the years. 9. Retained earnings will be calculated as the sum of the previous year one with the Net Income from Income Statement. 10. Include a line at the end to check that the BS is in balance.
D70
Marios Pastellopoulos: Starting value is provided for simplicity.
Marios Pastellopoulos: (the starting value is provided for simplicity).
D75
Marios Pastellopoulos: Provided for simplicity and remains constant throughout forecasted period.
D76
Marios Pastellopoulos: Provided for simplicity and remains constant throughout forecasted period.
D81
Marios Pastellopoulos: This line serves to balance the Balance Sheet. Our aim in this step is not explain the finance instruments used by the Company but rather to understand how Financial Statements are built. Finance instruments are explained in detail later,
D82
Marios Pastellopoulos: Amount of Mezzanine debt is provided for all the years in the forecasted period.
D85
Marios Pastellopoulos: Provided for simplicity and remains constant.
E86
Marios Pastellopoulos: There would be an extra line, linked to the cash flow statement if dividends were paid.
Step 1 - Define Operational assumptions of the model
(%) 2011E
Sales Growth (%) 3.9%
EBITDA Margin (% Sales) 22.3%
CapEx (% Sales) 5.2%
Net Working Capital (% Sales) (7.3%)
DA (% Sales) 4.3%
Tax (% EBT) 34.5%
Step 2 – Forecast the income statement
$M 2009A 2010A 2011E
Revenue 9774.6 10707.4 11,129.0
EBITDA 1681.6 2444.5 2,479.7
Depreciation & Amortisation -486.3 -463.0 (484.1)
EBIT 1,195.3 1,981.5 1,995.6
Interest Income 2.6
Total Interest Expense (838.4)
Net Interest (835.8)
EBT 1,159.8
Tax (400.1)
Net income 759.6
Step 3 - Calculate the cash flow & cash balance
$M 2010A 2011A
EBITDA 2,479.7
Adjustments:
- Change in Net Working Capital 39.6
- Tax (400.1)
- CapEx (580.5)
Cash flow before financing (CFBF) 1,538.6
FCF (% EBITDA) 62.1%
Interest Expense (838.4)
D4
Marios Pastellopoulos: In this spreadsheet the main figures projected in the Operational Model are summarised and used to help the analyst build the future Financial Statements of the Company.
D8
Marios Pastellopoulos: This step is linked with the Operational Model and summarises projections for Sales growth, EBITDA Margin, CapEx (% of Sales), NWC (% of Sales), DA (% of Sales), Tax (% of EBIT).
Marios Pastellopoulos: The current tax rate (effective tax rate) is maintained according to management projections for the future. Annual Report: 34%-35%
B20
Marios Pastellopoulos: In this step we calculate Company’s future Income Statements based on the Operational Model analysis. You should use the assumptions made (interest expense is provided for simplicity). The tax paid will be used in the cash flow statement.
E28
Marios Pastellopoulos: ISERROR function is used to make it easier to revert an accidentally introduced mistake with a circular reference.
B29
Marios Pastellopoulos: Interest Expense paid on Company's outstanding debt. This is based on the debt structure of the LBO financing. Note: This item is totaled and provided for simplicity.
B32
Marios Pastellopoulos: Earnings Before Taxes
E33
Marios Pastellopoulos: If the company has a negative taxable income it will not pay taxes.
B38
Marios Pastellopoulos: In this step the Company’s future Cash Flows are calculated. To calculate the Cash Flow available to amortise debt and pay interest (i.e. service debt), adjustments have to be made to EBITDA. 1. Start with EBITDA and subtract the change in NWC, CapEx (using previous steps) and Tax paid (from Step 2). This will give you the Cash flow Before Financing (CFBF) or Free cash flow (FCF). Since the Balance Sheet has not yet been calculated, put zero in all cells for the change in WC; the Opening Cash Balance is zero. 2. The Interest Income will be calculated as the average balance between the Opening and Closing Cash Balance, and therefore it will make the model circular (because the closing cash balance will depend on the interest income). At this stage put zero in all cells in this line and update it only at the end when you finish implementing all the steps in the model. 3. Subtract the cash Interest Expense (from Step 2) to obtain the Cash flow available for debt repayment. 4. Calculate the Excess Cash after Debt Repayments (Note: Debt Repayments are provided for simplicity). 5. Finally, use the Cash Increase/(Decrease) (equals Excess Cash from above) and the Opening Cash Balance to calculate the Closing Cash Balance. Make sure it is positive, otherwise the capital structure should be updated since the company will not be able to support this level of gearing (leverage).
Interest Income 2.6
Cash flow available for debt repayment (Free cash flow - FCF) 702.8
Debt Repayments (185.0)
Excess Cash 517.8
Opening Cash Balance 0.0
Cash Increase/(Decrease) 517.8
Closing Cash Balance 0.0 517.8
Cash balance check OK
Step 4 -Calculate balance sheet and calculate the future balance sheets
$M 2010A 2011A
Current Working Capital
Cash & Equivalents 0.0 517.8
Net Working Capital (776.6) (816.2)
Total Working Capital (776.6) (298.4)
Gross Property, Plant & Equipment 6,141.6 6,722.1
Less Accumulated Depreciation (3,725.1) (4,209.2)
Net Property, Plant & Equipment 2,416.5 2,512.9
Other Assets
Total fixed assets 711.8 711.8
Goodwill 14,938.3 14,938.3
Total assets 17,290.0 17,864.6
Long term debt
Senior Debt 10,270.0 9,905.0
Mezzanine 3,000.0 3,180.0
Equity
Common Stock 4,020.0 4,020.0
Retained Earnings 0.0 759.6
Total Stockholders' Equity 4,020.0 4,779.6
Total Liabilities & Equity 17,290.0 17,864.6
Balance check OK OK
E50
Marios Pastellopoulos: The interest income depends on the opening and closing cash position. The closing cash position depends, among other things, on the interest income, therefore this calculation introduces a circular reference in the model. If an error is introduced somewhere (e.g. accidentally introduce text in the revenue cell), the model will enter into a #Value! error state, that will not be corrected even if you undo the error introduced. There are two solutions to correct this problem: 1) undo the error and then go the this line, delete everything (breaks circularity) and introduce the formula again. (time consuming) 2) use the ISERROR function in this line with an IF function: If there is an error, return 0, otherwise return the interest income. This way is better because when you undo the error, the model will automatically return to its normal state.
E57
Marios Pastellopoulos: Equals the Excess Cash (EC) for the year after all obligations (interest and debt repayments) have been paid.
D58
Marios Pastellopoulos: Assumed that acquisition is cash free. All money is drawn from Balance Sheet, therefore the Opening Cash Balance is zero.
E58
Marios Pastellopoulos: If the closing cash balance is negative it means that the company will not be able to support this gearing level.
B62
Marios Pastellopoulos: To build an integrated BS, the following steps should be followed: 1. Link the Cash & Equivalents entry with the respective Closing Cash position from the Cash flow statement calculated in Step 3. 2. Link the Net Working Capital (using NWC margin from Step 1 and Revenues from Step 2). 3. Go back to Step 3 and update the hard coded line for the change in NWC; a decrease in NWC translates in a cash inflow (i.e. CL increase more than CA), hence make sure you calculate this correctly: – (NWC1 – NWC0). 4. Gross Property Plant & Equipment (PPE) will be calculated as PPE from the previous year plus the (absolute value of) CapEx from the Cash Flow statement (the starting value is provided for simplicity). 5. Accumulated Depreciation will be equal to the previous year one plus the Depreciation from the Income Statement (the starting value is provided for simplicity). 6. Total (other) Fixed Assets and Goodwill will remain constant over the years. 7. Mezzanine debt is provided and Senior Debt is calculated such that the BS is balanced for simplicity. 8. Common stock is assumed to remain constant over the years. 9. Retained earnings will be calculated as the sum of the previous year one with the Net Income from Income Statement. 10. Include a line at the end to check that the BS is in balance.
E86
Marios Pastellopoulos: There would be an extra line, linked to the cash flow statement if dividends were paid.
Marios Pastellopoulos: Comparable Companies (Comps) analysis is based on the idea that similar companies have equivalent business characteristics, performance drivers and risks such that they can provide a helpful foundation to value a company. It is highlighted that Comps analysis reflects a market valuation of the target since the derived multiples valuation are based on the current prevailing conditions and outlook. Methodology: The essence of this analysis is to select the best comparables from a universe of comparable companies that are found to match the business and financial profile of the target very closely. The analyst must calculate the valuation ratios of these companies (or trading multiples) which are then used to reach a valuation range for the target company. This analysis provides a market benchmark for the target valuation.
Marios Pastellopoulos: Trading multiples may vary based on the company's sector. The ones presented and calculated here are the most widely used by experts.
D30
Marios Pastellopoulos: Price-Earnigns ratio = Market Capitalisation / Net Income
E30
Marios Pastellopoulos: Price-Sales ratio = Market Capitalisation / Revenues
B49
Marios Pastellopoulos: Mean and Median of the comparables’ valuation ratios are used as a starting point to determine the valuation range of the target.
B51
Marios Pastellopoulos: The high and low ends of these ratios also serve as a reference point and outline the dispersion and variance of the multiple range.
Starbucks Corporation Valuation ($M) Average ratio
PE ratio 17.36x 945.6 P/Sales 1.69x 10,707.4 P/EBITDA 7.98x 2,444.5 P/Book Value 6.39x 3,674.7 EV/EBITDA 10.54x 2,444.5 EV/Sales 2.11x 10,707.4
* Subtracted Net Debt on EV ratios
Starbucks Corporation indicator
Balance sheet LTM Financial Statistics
Equity Book Value LTM Revenues EBITDA Net income3,674.7 10,707.4 2,444.5 945.6
No. of shares (m) Share price ($) Specific Value Driver (m) Market Capitalisation742.6 30.78 - 22,78 bil.
-
1,010.0 - 102,455.4 455.9 - 28,529.2 48.3 - 106.2
154.9 - 7,665.3 129.0 - 6,833.8 29.6 - 2,677.5
56.7 - 1,474.2 390.7 - 2,096.0 53.7 - 1,269.8
N9
Marios Pastellopoulos: Here we can input a decided value driver which is specific and relevant to Starbucks.
P9
Marios Pastellopoulos: Market value of the Equity (usually higher than the Book Value or Balance sheet value).
Market Valuation
Enterprise Value (Equity + Net debt) Predicted Beta3,060.1
89,992.6 0.7125,545.5 0.876,262.4 0.91
6,910.4 0.777,474.2 0.892,874.7 1.05
2,363.4 12,992.8 0.991,763.4 1.04
3B. Discounted Cash Flow (DCF)
Financial Modelling LABBeta Analysis
Company Country Net Debt EV
% %
Company 1 1,088 714 1,803 60.4% 152.4%
Company 2 601 1,662 2,263 26.5% 36.1%
Company 3 147 97 244 60.2% 151.3%
Company 4 183 226 409 44.7% 81.0%
Company 5 312 210 522 59.7% 148.3%
Company 6 114 218 332 34.3% 52.3%
Company 7 95 137 233 40.9% 69.3%
Company 8 691 512 1,203 57.4% 134.8%
Company 9 139 127 266 52.1% 108.8%
Company 10 1,127 949 2,076 54.3% 118.7%
High 60.4% 152.4%
Low 26.5% 36.1%
Mean 49.1% 105.3%
Median 53.2% 113.7%
Equity Value
Gearing (D / D+E)
Debt-to-Equity (D/E)
D4
Marios Pastellopoulos: In the Beta analysis we aim to determine and calculate the unlevered beta that we will use in the DCF Analysis forward. If the target company is public, its beta can be easily found by financial databases and resources (i.e Bloomberg). This is although a historic representation of the company's beta and may not indicate reliable company's future returns. This can be mitigated with the use of a forward looking or predicted beta. If the traget is a private company though, the beta can only be estimated using a group of publicly traded comparable companies (where beta is available). Due to differences in the capital structure of each firm (reflected in each individual beta) the analyst must unlever the beta of each company to derive the unlevered beta that will be consequently relevered using the target company's capital structure (this is done in the DCF analysis). From the universe of peer companies identified and used as comparables to the Company high, low, mean and median indicators are calculated. Usually the mean unlevered beta of the peer group will be used in the DCF analysis.
%
33.3% 1.64 0.81
25.0% 1.00 0.79
25.0% 1.27 0.59
25.0% 1.84 1.14
25.0% 1.77 0.84
25.0% 0.85 0.61
28.0% 0.81 0.54
33.3% 1.90 1.00
25.0% 1.33 0.73
33.3% 1.30 0.72
1.90 1.14
0.81 0.54
1.37 0.78
1.31 0.76
Effective tax rate
Levered Beta
Unleveredbeta
K8
Marios Pastellopoulos: or otherwise asset beta.
K22
Marios Pastellopoulos: The mean unlevered beta of the peer group will be used in the DCF analysis.
Financial Modelling LABAPV Model
Step 1 - Study the target, define key growth drivers and project the Income Statement
Income Statement ($M) 2010A 2011E 2012E 2013E 2014E
Revenues% Growth
COGS
Gross Profit
SG&A
EBITDA
Depreciation & Amortisation
EBIT
Taxes
EBIAT
Step 2 - Calculate the discount rate, used to discount the CF and Terminal Value (TV) to the present using:Only the unlevered cost of equity (CAPM)
Discount Rate Calculation Unlevering Beta Cost of Equity Levered BetaRisk-free Rate 5.0% Debt-to-Equity ratio (D/E)Market Risk Premium 8.1% Tax RateUnlevered Beta - Unlevered Beta Cost of Equity (CAPM)
Step 3 - Project the target’s Cash Flows ignoring the capital structure and discount them with the cost of equity
FCF ($M) 2010A 2011E 2012E 2013E 2014E
EBITDA
Depreciation & Amortisation
EBIT
B4
Marios Pastellopoulos: Adjusted Present Value (APV) Methodology differs from NPV method previously analysed. The main difference between the two methodologies is that the APV model assumes that the Company is financed only with equity while the effects of value added from debt interest tax shields and other loan subsidies are considered separately. The analyst again calculates target's future Unlevered Cash Flows but the appropriate discount rate is now the cost of equity (not WACC). The future tax benefits associated with its capital structure, in the form of interest tax shields are then added to derive the total value of the Company Note: In the NPV model, tax shields are incorporated indirectly in the WACC calculation where the analyst accommodates the after tax cost of debt. APV with bankruptcy costs: The methodology analysed above is arguably flawed since potential bankruptcy costs are not taken into account (cost of debt is not considered here). The APV approach should theoretically include not only the benefits from using debt in the capital structure of the Company in the form of interest tax shields but also bankruptcy costs which is a function of the default risk of the Company (which depends on the magnitude of leverage used). Calculating bankruptcy costs though is complicated and usually not straightforward. It would make more sense to calculate bankruptcy costs when the Company employs very high debt ratios, where the probability of default is clearly important. Note: In the analysis presented below bankruptcy costs are ignored to keep things simple.
G8
Marios Pastellopoulos: Identical with Step 1 in NPV methodology.
G35
Marios Pastellopoulos: The levered beta is the current equity beta of the Company as calculated in the NPV methodology previously.
B36
Marios Pastellopoulos: Should match the maturity of the investment project. Typically we use the 10-year rate on US-Treasury.
D36
Marios Pastellopoulos: Provided for simplicity.
B37
Marios Pastellopoulos: Estimates of the market risk premium vary according to the local market.
Repayment (End of Year) (200.0) (200.0) (200.0) (200.0)
Ending Debt 1,000.0 800.0 600.0 400.0 200.0
Cost of Debt 7.0%
Interest Expense
Interest Tax Shield
Discount Factor
Present Value
Cumulative PV of Tax Shields
B75
Marios Pastellopoulos: Perpetuity Growth Method: Calculates Terminal Value assuming the that the terminal year FCF will grow at a steady perpetual rate (perpetuity). Terminal Value = [FCFn * (1+g)] / (r-g)
E83
Marios Pastellopoulos: Apart from the different discount rate the difference between the NPV and APV methodologies is the calculation of the expected tax benefits. This cash flow is of course a function of the tax rate of the Company. These tax benefits are created due to the tax deductibility of interest expenses paid by the Company. The appropriate discount rate must be used to best capture the risk associated with these interest tax shields. If one assumes that the ability to use the tax shield is as risky as the cash flows to an all-equity firm, then the unlevered cost of equity should be used (RE). If you assume that the tax shield is as risky as the ability to repay the debt, then the discount rate should be the cost of debt (which is usually the case).
C91
Marios Pastellopoulos: Provided for simplicity.
B97
Marios Pastellopoulos: These tax benefits are created due to the tax deductibility of interest expenses paid by the Company.
B99
Marios Pastellopoulos: Using the discount rate that best captures the risk associated with the TS. If you assume that the ability to use the tax shield is as risky as the cash flows to an all-equity firm, we would use the rE(unlevered). If you assume that the tax shield is as risky as the ability to repay the debt, then the discount rate should be the cost of debt. The discount rate used to calculate the NPV of the tax benefits here is the pre-tax rate of return on debt.
Step 6 - Determine the Valuation:a) the PV of FCF, PV of TV and PV of Tax shields b) Enterprise (EV)
2010A
PV of FCFPV of TVPV of Tax ShieldsEnterprise Value
Implied Equity Value and Share Price Implied EV/EBITDAEnterprise Value Enterprise ValueLess: Total Debt (932.1) LTM EBITDALess: Preferred SecuritiesLess: Noncontrolling Interest Implied EV/EBITDAPlus: Cash and Cash Equivalents 1,164.0
Implied Equity Value
Fully Diluted Shares Outstanding 764.2
Implied Share Price
Step 7 - Implement a Sensitivity Analysis on the discount rate and Exit Multiple of Terminal Value
Marios Pastellopoulos: The procedure for implementing the above step is very similar with Step 5 in NPV methodology. The cumulative CF from the tax shields created due to the Company's outstanding debt will be added to value of the unlevered Company to derive the value of the levered Company.
Marios Pastellopoulos: Implied Equity Value and Share Price are calculated identically with Step 5 in NPV methodology.
G129
Marios Pastellopoulos: Identical with Step 6 in NPV methodology.
WA
CC
10.6% 0.00 0.00 0.00 0.00 0.00
CAGR
2015E 2016E 2017E 2018E 2019E 2020E 10A-15E
#DIV/0!
#DIV/0!
#DIV/0!
#DIV/0!
#DIV/0!
Step 2 - Calculate the discount rate, used to discount the CF and Terminal Value (TV) to the present using:
Unlevering Beta Levered Beta
Debt-to-Equity ratio (D/E)
Unlevered Beta
Step 3 - Project the target’s Cash Flows ignoring the capital structure and discount them with the cost of equity
2015E 2016E 2017E 2018E 2019E 2020E
H31
Marios Pastellopoulos: The appropriate discount rate to discount the future Unlevered CFs of the target is the unlevered Cost of Equity using the CAPM methodology.
G34
Marios Pastellopoulos: Since we are trying to estimate the value of the targer with no leverage the beta used in the cost of equity calculation is the unlevered beta.
I42
Marios Pastellopoulos: Identical with Step 2 in NPV methodology.
Step 4 - Determine the Terminal Value (TV), to quantify the remaining value of the target after the projection period
1
Exit Multiple MethodTerminal Year EBITDA (2020E)
7.0x
2015E 2016E 2017E 2018E 2019E 2020E
200.0 0.0 0.0 0.0 0.0 0.0
(200.0) (0.0) (0.0) (0.0) (0.0) (0.0)
0.0 0.0 0.0 0.0 0.0 0.0
I71
Marios Pastellopoulos: Identical with Step 4 in NPV methodology, except the discount rate is different.
F75
Marios Pastellopoulos: Exit Multiple Method: Calculates Terminal Value using a multiple of the Company’s terminal year EBITDA. Terminal Value = EBITDAn * Exit Multiple
Marios Pastellopoulos: Adjusted Present Value (APV) Methodology differs from NPV method previously analysed. The main difference between the two methodologies is that the APV model assumes that the Company is financed only with equity while the effects of value added from debt interest tax shields and other loan subsidies are considered separately. The analyst again calculates target's future Unlevered Cash Flows but the appropriate discount rate is now the cost of equity (not WACC). The future tax benefits associated with its capital structure, in the form of interest tax shields are then added to derive the total value of the Company Note: In the NPV model, tax shields are incorporated indirectly in the WACC calculation where the analyst accommodates the after tax cost of debt. APV with bankruptcy costs: The methodology analysed above is arguably flawed since potential bankruptcy costs are not taken into account (cost of debt is not considered here). The APV approach should theoretically include not only the benefits from using debt in the capital structure of the Company in the form of interest tax shields but also bankruptcy costs which is a function of the default risk of the Company (which depends on the magnitude of leverage used). Calculating bankruptcy costs though is complicated and usually not straightforward. It would make more sense to calculate bankruptcy costs when the Company employs very high debt ratios, where the probability of default is clearly important. Note: In the analysis presented below bankruptcy costs are ignored to keep things simple.
G8
Marios Pastellopoulos: Identical with Step 1 in NPV methodology.
G35
Marios Pastellopoulos: The levered beta is the current equity beta of the Company as calculated in the NPV methodology previously.
B36
Marios Pastellopoulos: Should match the maturity of the investment project. Typically we use the 10-year rate on US-Treasury.
B37
Marios Pastellopoulos: Estimates of the market risk premium vary according to the local market.
Repayment (End of Year) (200.0) (200.0) (200.0) (200.0)
Ending Debt 1,000.0 800.0 600.0 400.0 200.0
Cost of Debt 7.0%
Interest Expense (56.0) (42.0) (28.0) (14.0)
Interest Tax Shield 19.3 14.5 9.7 4.8
Discount Factor 0.935 0.873 0.816 0.763
Present Value 18.1 12.7 7.9 3.7
Cumulative PV of Tax Shields $42.3
B75
Marios Pastellopoulos: Perpetuity Growth Method: Calculates Terminal Value assuming the that the terminal year FCF will grow at a steady perpetual rate (perpetuity). Terminal Value = [FCFn * (1+g)] / (r-g)
E83
Marios Pastellopoulos: Apart from the different discount rate the difference between the NPV and APV methodologies is the calculation of the expected tax benefits. This cash flow is of course a function of the tax rate of the Company. These tax benefits are created due to the tax deductibility of interest expenses paid by the Company. The appropriate discount rate must be used to best capture the risk associated with these interest tax shields. If one assumes that the ability to use the tax shield is as risky as the cash flows to an all-equity firm, then the unlevered cost of equity should be used (RE). If you assume that the tax shield is as risky as the ability to repay the debt, then the discount rate should be the cost of debt (which is usually the case).
B97
Marios Pastellopoulos: These tax benefits are created due to the tax deductibility of interest expenses paid by the Company.
B99
Marios Pastellopoulos: Using the discount rate that best captures the risk associated with the TS. If you assume that the ability to use the tax shield is as risky as the cash flows to an all-equity firm, we would use the rE(unlevered). If you assume that the tax shield is as risky as the ability to repay the debt, then the discount rate should be the cost of debt. The discount rate used to calculate the NPV of the tax benefits here is the pre-tax rate of return on debt.
Step 6 - Determine the Valuation:a) the PV of FCF, PV of TV and PV of Tax shields b) Enterprise (EV)
2010A
PV of FCF 9504.6PV of TV 8902.4PV of Tax Shields 42.3Enterprise Value $18,449.2
Implied Equity Value and Share Price Implied EV/EBITDAEnterprise Value $18,449.2 Enterprise ValueLess: Total Debt ### LTM EBITDALess: Preferred Securities - Less: Noncontrolling Interest - Implied EV/EBITDAPlus: Cash and Cash Equivalents 1,164.0
Implied Equity Value $18,681.1
Fully Diluted Shares Outstanding 764.2
Implied Share Price $24.4
Step 7 - Implement a Sensitivity Analysis on the discount rate and Exit Multiple of Terminal Value
Marios Pastellopoulos: The procedure for implementing the above step is very similar with Step 5 in NPV methodology. The cumulative CF from the tax shields created due to the Company's outstanding debt will be added to value of the unlevered Company to derive the value of the levered Company.
B115
Marios Pastellopoulos: Implied Equity Value and Share Price are calculated identically with Step 5 in NPV methodology.
G129
Marios Pastellopoulos: Identical with Step 6 in NPV methodology.
Step 2 - Calculate the discount rate, used to discount the CF and Terminal Value (TV) to the present using:
Unlevering Beta Levered Beta 0.84
Debt-to-Equity ratio (D/E) ######
Unlevered Beta 0.78
Step 3 - Project the target’s Cash Flows ignoring the capital structure and discount them with the cost of equity
2015E 2016E 2017E 2018E 2019E 2020E
3,067.0 3,173.2 3,283.2 3,397.2 3,515.3 3,637.7
(351.3) (362.6) (374.4) (386.5) (399.0) (412.0)
2,715.7 2,810.5 2,908.8 3,010.7 3,116.3 3,225.8
H31
Marios Pastellopoulos: The appropriate discount rate to discount the future Unlevered CFs of the target is the unlevered Cost of Equity using the CAPM methodology.
G34
Marios Pastellopoulos: Since we are trying to estimate the value of the targer with no leverage the beta used in the cost of equity calculation is the unlevered beta.
I42
Marios Pastellopoulos: Identical with Step 2 in NPV methodology.
Step 4 - Determine the Terminal Value (TV), to quantify the remaining value of the target after the projection period
1
Exit Multiple MethodTerminal Year EBITDA (2020E) $3,637.7
7.0x$25,464.2
0.34 $8,723.1
2015E 2016E 2017E 2018E 2019E 2020E
200.0 0.0 0.0 0.0 0.0 0.0
(200.0) (0.0) (0.0) (0.0) (0.0) (0.0)
0.0 0.0 0.0 0.0 0.0 0.0
(0.0) (0.0) (0.0) (0.0) (0.0) (0.0)
0.0 0.0 0.0 0.0 0.0 0.0
0.713 0.666 0.623 0.582 0.544 0.508
0.0 0.0 0.0 0.0 0.0 0.0
I71
Marios Pastellopoulos: Identical with Step 4 in NPV methodology, except the discount rate is different.
F75
Marios Pastellopoulos: Exit Multiple Method: Calculates Terminal Value using a multiple of the Company’s terminal year EBITDA. Terminal Value = EBITDAn * Exit Multiple
Implied EV/EBITDAEnterprise Value $18,449.2LTM EBITDA $2,444.5
tmd07: An X (colored in white so that it does not show in the layout) was introduced at the start of each step. This was done in order to flick more quickly between steps using Ctrl + [UP] or [DOWN]. This means that rather than scrolling through a sheet to a certain section one can flick to column A,and then using Control and the up/down arrows flick to each step easily. In a simple model like this, it does not make a big difference, but when working on large sheets with a lot of data it will make the model easier to work with.
B10
Marios Pastellopoulos: In an LBO transaction, a Sources and Uses of Funds table is used to demonstrate the flow of funds required to consummate the transaction and summarise the instruments used to finance the deal and their uses. Uses of funds: A historical analysis of comparable transactions in the industry showed that the usual multiples are in the range of 5x - 7x EBITDA. Recent transaction multiples that were taken from Leveraged Commentary News (LCD News) were used as a check for the 6x multiple. Consequently 6x EBITDA - 07 multiple was used, yielding an Enterprise Value, EV (EV = Equity + Debt – Cash on Balance sheet) of £1,384.1 M. A further £69.2 M (i.e. 5% of the EV) are considered to be paid for the transaction fees and therefore the total uses of funds will be £1,453.3 M. Sources of funds: Historically, debt to equity ratios have changed cyclically between 50-80% in the industry. A recent loan review from LCD News, indicates that investors in the primary market (first time the loan is syndicated to banks and institutional investors), are currently demanding a maximum gearing level of around 55-65%. Consequently, it was decided to finance the acquisition with 55% of debt and 45% of equity. This level of gearing was considered to be a good trade-off between ensuring a full subscription of the syndicated loan and a good Internal Rate of Return (IRR) for the fund. LCD news indicates that current transaction structures have c. 2:1 relation between senior and mezzanine debt hence a breakdown of 40% for senior debt and 15% for mezzanine was used.
C13
Marios Pastellopoulos: Senior Debt = %Senior Debt * Total Uses
C14
Marios Pastellopoulos: Mezzanine = %Mezzanine * Total Uses
G14
Marios Pastellopoulos: Entry multiple of the PE firm.
C15
Marios Pastellopoulos: Total Debt = Senior Debt + Mezzanine
C17
Marios Pastellopoulos: Equity = %Equity * Total Uses
I17
Marios Pastellopoulos: EV = EBITDA * Multiple
G18
Marios Pastellopoulos: Transaction fees are be capitalised, i.e. put in the BS and amortised over the years. For simplicity we will assume that the assumptions from the DA include the amortisation of these fees.
I18
Marios Pastellopoulos: Fees = EV * %Fees
C20
Marios Pastellopoulos: Total Sources = Total Debt + Total Equity
I20
Marios Pastellopoulos: Total Uses = EV + Fees
B23
Marios Pastellopoulos: The economy/market is expected to continue to grow in the next years at 12-18% a year, hence, it was assumed a growth in revenues of 16% for the first three years (down to 5% in 2013-2014). A detailed analysis of industry peers and historical values for the companies took place to support the assumptions regarding the EBITDA margin, which is expected to increase in 2-3 years, after the operational improvements and costs cutting measures start to kick-in. Other operational models were used, to derive the assumptions for the change in WC, CapEx (assumed to be only 4% of sales since historically this industry has had low CapEx requirements) and DA (Depreciation and Amortisation assumed to be 3% ). Finally a tax rate of 24% and cash sweep of 75% of the Excess Cash was assumed. Broker consensus from equity research reports were used to support/improve the above assumptions.
B31
Marios Pastellopoulos: The current tax rate (effective tax rate) is usually maintained but Management projections are also taken into account in case where fluctuations are expected.
B32
Marios Pastellopoulos: A certain percentage of the Excess Cash (EC), i.e. EC = Free cash flow - cash interest expense - debt repayments, is used to prepay the senior debt (only).
B35
Marios Pastellopoulos: Pricing: Taking into account the market conditions (i.e. liquidity), the credit rating of the company (ratings reports) and after receiving the advice of the Bookrunner (bank in charge of advising the fund on the syndication), the price of the senior debt will be at LIBOR+325 bps (basis points) with a term of 5 years and the Mezzanine at 500 bps for the PIK and LIBOR+400 bps for the cash pay, with a term of 7 years. LIBOR at that time was 4.3%.
B36
Marios Pastellopoulos: Debt Structure: Taking into account the market conditions (i.e. liquidity), the credit rating of the company (ratings reports) and the advice of the Bookrunner (bank in charge of advising the PE fund on the syndication), the structure, price and terms of the different debt structures are decided (Senior and Mezzanine debt in this case).
I38
Marios Pastellopoulos: As defined in step 1.
I39
Marios Pastellopoulos: As defined in step 1.
B42
Marios Pastellopoulos: London Interbank Offered Rate (LIBOR) is the interest rate used by the banks to borrow/lend funds in the interbank market. LIBOR is usually used as the reference rate in floating-rate loans.
B44
Marios Pastellopoulos: Debt Repayment schedule: The amortisation of the Senior debt usually increases over the years, with the biggest repayment to be made at the end of the term of the facility (Baloon). This is done to facilitate the de-leveraging ability of the company, since in higher interest payments are payable in the first years (due to higher debt levels). When the model is completely built, the analyst should come back to this step and adjust the amortisation profile of the senior debt so that the fixed charges cover is maintained greater than c. 1.0x. For the moment the analyst should hard code the fixed charges cover line to zero and put an increasing percentage for the amortisation. The Mezzanine is paid as a bullet at the end of the term of the facility. Interest expense calculations and debt balance at the end of the year will be used in the Income Statement and credit statistics (Steps 4 and 6) respectively.
E48
Marios Pastellopoulos: The fixed charges covers gives a measure of the Company's ability to service its debt, i.e. the principal repayments and the cash interest expense.It is calculated as: Free cash flow/(interest + debt repayments). It should be greater than 1.0x for all the years before the term of the facility.
E50
Marios Pastellopoulos: Closing balance of previous year.
E51
Marios Pastellopoulos: Need to make sure that the balance is positive, otherwise the cash sweep will not work properly.
B52
Marios Pastellopoulos: The Cash Sweep (is the % of the excess cash flow available to prepay senior debt) is obtained using the Cash Flow statement from step 5, hence at this stage you should put zero in this row. After performing step 5, you should come back and update this entry with the corresponding CS. Because of the CS, it might happen at some stage in the future, that the scheduled amortisation is greater than the opening balance. Therefore to avoid having a negative closing balance (in which case the CS calculations in step 5 would not work properly) you should use the minimum between these two amounts when calculating the principal repayment.
E52
Marios Pastellopoulos: A certain percentage of the Excess Cash (EC) is used to prepay the senior debt (only). EC = Free cash flow - cash interest expense - debt repayments Linked with step 5, where Cash Sweep is calculated.
D54
Marios Pastellopoulos: Equals the Senior Debt amount defined in step 1.
Marios Pastellopoulos: Closing balance of previous year.
E62
Marios Pastellopoulos: Due to PIK, the facility amount will increase over time. Therefore need to pay 100% of Opening Balance + PIK interest expense.
D65
Marios Pastellopoulos: Equals the Mezzanine amount defined in step 1.
x Step 4 – Forecast the Income Statement
£ M 2009A 2010A 2011E 2012E 2013E 2014E 2015E
Revenue 627.4 769.0 EBITDA 188.2 230.7
Depreciation&AmortisationEBIT 65.1 76.4
InterestSenior debtMezzanine PIKMezzanine Cash
Total Cash interest (Senior debt + Mezzanine cash)Total Interest (Cash interest + Mezzanine PIK)Interest check OK OK OK OK OK
EBTTax 0.0 0.0 0.0 0.0 0.0 Net income
x Step 5 - Calculate the cash flow & cash balance
£ M 2009A 2010A 2011E 2012E 2013E 2014E 2015E
EBITDAAdjustments:
- Change in Working Capital- Tax- CapExCash flow before financing (CFBF)FCF (% EBITDA) #DIV/0! #DIV/0! #DIV/0! #DIV/0! #DIV/0!
Total Cash interest (Senior debt + Mezzanine cash)Cash flow available for debt repayment (Free cash flow - FCF)
Debt RepaymentsExcess Cash
Cash Sweep 0.0 0.0 0.0 0.0 0.0
Opening Cash Balance 0.0Cash Increase/(Decrease)
Closing Cash BalanceCash balance check NOK NOK NOK NOK NOK
B71
Marios Pastellopoulos: This step is practically similar with Step 2 of Financial Statements section of the Operational Model. The difference here is that interest expense in not grouped as a single item but reported differently based on the different debt instruments of the financing structure of the LBO. The operational assumptions devised in Step 2 and Interest expenses from Step 3 are used to form the forecasted Income Statement of the target Company.
E74
Marios Pastellopoulos: Based on forecasts provided in step 2.
E75
Marios Pastellopoulos: Based on forecasts provided in step 2.
E76
Marios Pastellopoulos: Based on forecasts provided in step 2.
E80
Marios Pastellopoulos: Linked with interest expense calculated in step 3.
E81
Marios Pastellopoulos: Linked with interest expense calculated in step 3.
E82
Marios Pastellopoulos: Linked with interest expense calculated in step 3.
E83
Marios Pastellopoulos: Sum only cash interest expenses paid, not PIK.
B86
Marios Pastellopoulos: Earnings Before Taxes (EBT).
E86
Marios Pastellopoulos: EBT = EBIT - Total Interest
B87
Marios Pastellopoulos: Tax paid is determined from EBT and the tax rate defined in Step 2. Tax amount calculated here will be used in the cash flow statement.
E87
Marios Pastellopoulos: If the company has a negative EBT it will not pay taxes.
E88
Marios Pastellopoulos: Net Income = EBT - Tax
B91
Marios Pastellopoulos: To calculate the cash flow available to amortise debt and pay interest (i.e. service debt), adjustments have to be made to EBITDA. 1. Start with EBITDA and subtract the change in WC and CapEx (from the assumptions in step 2) and the tax paid (from the Income Statement). This will give you the Cash flow before financing (CFBF) or Free cash flow (FCF). 2. Subtract the Cash Interest Expense to obtain the Cash flow available for debt repayment. 3. The next step is to calculate the Excess Cash after the Debt Repayments defined in the debt schedule. 4. Use the assumption from step 2 (in this case 75%) to calculate the Cash Sweep (CS). If the Excess Cash is negative, there will be no CS; if it is positive, take the minimum between the (Opening Balance + Principal Repayments of the Senior Debt) and (the percentage of CS times the excess cash). You should take the negative of this amount. Finally go back to Step 3, and update the CS entry. 5. Finally, use the Cash Increase/(Decrease) and the Opening Cash Balance to calculate the Closing Cash Balance. Make sure it is positive, otherwise the capital structure should be updated since the company will not be able to support this level of gearing (leverage).
E94
Marios Pastellopoulos: Linked with step 4.
E96
Marios Pastellopoulos: Based on forecasts provided in step 2.
E97
Marios Pastellopoulos: Linked with step 4.
E98
Marios Pastellopoulos: Based on forecasts provided in step 2.
E102
Marios Pastellopoulos: Linked with step 4.
E103
Marios Pastellopoulos: Cash flow available for debt repayment = FCF - Total Cash interest
E105
Marios Pastellopoulos: Principal repayments of Senior Debt + Mezzanine
Marios Pastellopoulos: IF Excess Cash (EC) < 0 THEN zero ELSE MIN (EC * %Cash Sweep, Senior Debt outstanding). This is to guarantee that the closing senior debt balance is never negative (otherwise the Cash Sweep will not work).
E109
Marios Pastellopoulos: Assumed that acquisition is cash free. All money is drawn from Balance sheet, therefore the Opening Cash Balance is zero.
E110
Marios Pastellopoulos: Whatever is left from the Excess Cash, after the Cash sweep is paid.
E112
Marios Pastellopoulos: If the closing cash balance is negative it means that the company will not be able to support this gearing level.
Marios Pastellopoulos: Credit statistics or covenants are certain provisions included in the credit agreements between the issuers of the various debt instruments and the lenders and serve to protect the latter from a worsening credit quality of the former. Credit Statistics are typically agreed on an individual basis in every transaction based on the business plan provided. A potential breach of these covenants might be considered as an event of default. The 3 primary and most common credit ratios (covenants) in a Senior Facilities Agreement (SFA) are: 1. Leverage ratios (maximum level for covenants) 2. Interest cover ratios (minimum) 3. Cash cover of fixed charges cover (minimum) Headroom: Covenants’ Headroom is the flexibility between the Company’s calculated figure and the covenant set by the bank. The desired headroom (Assumed Headroom) is decided between the counterparties, and adjusted EBITDA is calculated to reflect how much EBITDA has to drop to reach headroom on an EBITDA level. The adjusted EBITDA is used to recalculate the corresponding credit ratio to find the covenant level which will then be rounded to find the proposed covenant. The headroom level is found by comparing the corresponding ratio of interest with the proposed covenant found earlier.
E119
Marios Pastellopoulos: Net Senior Debt = Total Senior Debt - Closing Cash Balance
E120
Marios Pastellopoulos: Net Total Debt = Total Debt - Closing Cash Balance
E121
Marios Pastellopoulos: Linked with step 4.
E122
Marios Pastellopoulos: Linked with step 5.
B124
Marios Pastellopoulos: Leverage: Leverage covenants are usually with a headroom of 20-25% (for the final years, where the debt is almost zero, the covenants levels are kept constant). These values will later be included in the Senior Facilities Agreement (SFA). If the Net Total (senior) Debt is greater than zero at the end term (maturity) of the total (senior) debt, there is a debt refinancing risk, which is seen as a negative credit statistic for the lenders.
B125
Marios Pastellopoulos: Net Senior Debt = Total Senior Debt – Closing Cash Balance
B126
Marios Pastellopoulos: The desired headroom has to be decided between the counterparties, and then the adjusted EBITDA is calculated to reflect how much EBITDA has to drop to reach headroom on an EBITDA level. The adjusted EBITDA is used to recalculate the corresponding ratio (i.e. Net Senior Debt/Adjusted EBITDA) to find the covenant level which will then be rounded to find the proposed covenant. The headroom level is found by comparing the corresponding ratio of interest with the proposed covenant found earlier.
Marios Pastellopoulos: Conditional formatting can be used so that the cell turns red when there is negative headroom on any of the covenants: 1. Start by selecting all the headroom cells as indicated in the figure below. 2. Go to Format menu, then Conditional Formatting (shortcut sequence: Alt, [O] ,[D]) and define it to be red when a covenant is breached. Using conditional formatting will enable to detect more quickly a breach of covenants.
B132
Marios Pastellopoulos: Net Total Debt = Total Debt – Closing Cash Balance
B133
Marios Pastellopoulos: Same as above.
B135
Marios Pastellopoulos: The lower the ratio, the better in this case, as the Proposed Covenant level should not be exceeded.
E135
Marios Pastellopoulos: Covenant Level = Adj. EBITDA / Net Total Debt
E137
Marios Pastellopoulos: Conditional formatting in this line.
B139
Marios Pastellopoulos: Interest cover: You should calculate the ratios EBITDA/Cash interest and (EBITDA-CapEx)/Cash interest. These ratios should be significantly higher than 1x to make sure that the company is generating enough cash to pay its financial obligations. The second ratio (EBITDA-CapEx) gives us a better measure of this ability, since the cash spent on CapEx will not be available to pay the interest.
B141
Marios Pastellopoulos: Interest cover covenants are also set with a headroom of 20-25%.
B143
Marios Pastellopoulos: The higher the ratio, the better in this case, as the corresponding interest coverage ratio must not be lower than the Proposed Covenant level.
Marios Pastellopoulos: Conditional formatting in this line.
B148
Marios Pastellopoulos: Interest cover covenants are also set with a headroom of 20-25%.
B150
Marios Pastellopoulos: The higher the ratio, the better in this case, as the corresponding interest coverage ratio must not be lower than the Proposed Covenant level.
E152
Marios Pastellopoulos: Conditional formatting in this line.
B154
Marios Pastellopoulos: Cash cover: Calculate the ratio FCF/(Cash interest+Debt repayments). Cash cover ratio must be higher than c. 1.0x in order to ensure that a safety margin exists and the Company is able to service the required gearing level in case its operations underperform (i.e. lower revenues and/or margins). Usually the covenants are set between 1.0x-1.1x. You should go back to adjust step 3 and link the fixed charges cover line to the cash cover ratio calculated here. If necessary, adjust Senior Debt amortisation to reach a cover ratio greater than c. 1.0x. If necessary change the capital structure (i.e. put more equity) so that the target cover ratio is achieved.
B155
Marios Pastellopoulos: The higher the ratio the better (Company can service its debt).
E155
Marios Pastellopoulos: If the Cash interest is positive such that the ratio becomes negative, then it should no longer calculated.
E157
Marios Pastellopoulos: Conditional formatting in this line.
B161
Marios Pastellopoulos: The final step is the calculation of the IRR Returns provided by the investment and a sensitivity analysis on how these returns are altered when different years of exit and EBITDA exit multiples are considered. The following steps are recommended: 1. First the analyst must decide the appropriate exit year of the investment. In LBO analysis an exit of the fund after five years is typical. 2. The equity proceeds to the sponsor at the time of exit (equity at exit) must then be calculated. 3. Finally, the IRR of the investment must be calculated If the forecasted IRR is below the target set by the Fund, the Fund should adjust either its valuation of the company (i.e. pay less) or the equity contribution (i.e. use less/more equity/debt), until it achieves an acceptable minimum return (if at the end this is not possible then the fund will cancel the deal). Note: As a rule of thumb, Funds typically consider returns in excess of 20% as acceptable.
I164
Marios Pastellopoulos: Total equity at entry = Total Equity (calculated in step 1).
C165
Marios Pastellopoulos: Rows is used to calculate the index number, because should there be a row added/deleted inside the referenced array, the reference will no longer be correct. This way the model is more robust to errors.
tmd07: An X (colored in white so that it does not show in the layout) was introduced at the start of each step. This was done in order to flick more quickly between steps using Ctrl + [UP] or [DOWN]. This means that rather than scrolling through a sheet to a certain section one can flick to column A,and then using Control and the up/down arrows flick to each step easily. In a simple model like this, it does not make a big difference, but when working on large sheets with a lot of data it will make the model easier to work with.
B10
Marios Pastellopoulos: In an LBO transaction, a Sources and Uses of Funds table is used to demonstrate the flow of funds required to consummate the transaction and summarise the instruments used to finance the deal and their uses. Uses of funds: A historical analysis of comparable transactions in the industry showed that the usual multiples are in the range of 5x - 7x EBITDA. Recent transaction multiples that were taken from Leveraged Commentary News (LCD News) were used as a check for the 6x multiple. Consequently 6x EBITDA - 07 multiple was used, yielding an Enterprise Value, EV (EV = Equity + Debt – Cash on Balance sheet) of £1,384.1 M. A further £69.2 M (i.e. 5% of the EV) are considered to be paid for the transaction fees and therefore the total uses of funds will be £1,453.3 M. Sources of funds: Historically, debt to equity ratios have changed cyclically between 50-80% in the industry. A recent loan review from LCD News, indicates that investors in the primary market (first time the loan is syndicated to banks and institutional investors), are currently demanding a maximum gearing level of around 55-65%. Consequently, it was decided to finance the acquisition with 55% of debt and 45% of equity. This level of gearing was considered to be a good trade-off between ensuring a full subscription of the syndicated loan and a good Internal Rate of Return (IRR) for the fund. LCD news indicates that current transaction structures have c. 2:1 relation between senior and mezzanine debt hence a breakdown of 40% for senior debt and 15% for mezzanine was used.
G14
Marios Pastellopoulos: Entry multiple of the PE firm.
B23
Marios Pastellopoulos: The economy/market is expected to continue to grow in the next years at 12-18% a year, hence, it was assumed a growth in revenues of 16% for the first three years (down to 5% in 2013-2014). A detailed analysis of industry peers and historical values for the companies took place to support the assumptions regarding the EBITDA margin, which is expected to increase in 2-3 years, after the operational improvements and costs cutting measures start to kick-in. Other operational models were used, to derive the assumptions for the change in WC, CapEx (assumed to be only 4% of sales since historically this industry has had low CapEx requirements) and DA (Depreciation and Amortisation assumed to be 3% ). Finally a tax rate of 24% and cash sweep of 75% of the Excess Cash was assumed. Broker consensus from equity research reports were used to support/improve the above assumptions.
B31
Marios Pastellopoulos: The current tax rate (effective tax rate) is usually maintained but Management projections are also taken into account in case where fluctuations are expected.
B32
Marios Pastellopoulos: A certain percentage of the Excess Cash (EC), i.e. EC = Free cash flow - cash interest expense - debt repayments, is used to prepay the senior debt (only).
B35
Marios Pastellopoulos: Pricing: Taking into account the market conditions (i.e. liquidity), the credit rating of the company (ratings reports) and after receiving the advice of the Bookrunner (bank in charge of advising the fund on the syndication), the price of the senior debt will be at LIBOR+325 bps (basis points) with a term of 5 years and the Mezzanine at 500 bps for the PIK and LIBOR+400 bps for the cash pay, with a term of 7 years. LIBOR at that time was 4.3%.
B36
Marios Pastellopoulos: Debt Structure: Taking into account the market conditions (i.e. liquidity), the credit rating of the company (ratings reports) and the advice of the Bookrunner (bank in charge of advising the PE fund on the syndication), the structure, price and terms of the different debt structures are decided (Senior and Mezzanine debt in this case).
B42
Marios Pastellopoulos: London Interbank Offered Rate (LIBOR) is the interest rate used by the banks to borrow/lend funds in the interbank market. LIBOR is usually used as the reference rate in floating-rate loans.
B44
Marios Pastellopoulos: Debt Repayment schedule: The amortisation of the Senior debt usually increases over the years, with the biggest repayment to be made at the end of the term of the facility (Baloon). This is done to facilitate the de-leveraging ability of the company, since in higher interest payments are payable in the first years (due to higher debt levels). When the model is completely built, the analyst should come back to this step and adjust the amortisation profile of the senior debt so that the fixed charges cover is maintained greater than c. 1.0x. For the moment the analyst should hard code the fixed charges cover line to zero and put an increasing percentage for the amortisation. The Mezzanine is paid as a bullet at the end of the term of the facility. Interest expense calculations and debt balance at the end of the year will be used in the Income Statement and credit statistics (Steps 4 and 6) respectively.
E48
Marios Pastellopoulos: The fixed charges covers gives a measure of the Company's ability to service its debt, i.e. the principal repayments and the cash interest expense.It is calculated as: Free cash flow/(interest + debt repayments). It should be greater than 1.0x for all the years before the term of the facility.
E51
Marios Pastellopoulos: Need to make sure that the balance is positive, otherwise the cash sweep will not work properly.
B52
Marios Pastellopoulos: The Cash Sweep (is the % of the excess cash flow available to prepay senior debt) is obtained using the Cash Flow statement from step 5, hence at this stage you should put zero in this row. After performing step 5, you should come back and update this entry with the corresponding CS. Because of the CS, it might happen at some stage in the future, that the scheduled amortisation is greater than the opening balance. Therefore to avoid having a negative closing balance (in which case the CS calculations in step 5 would not work properly) you should use the minimum between these two amounts when calculating the principal repayment.
E52
Marios Pastellopoulos: A certain percentage of the Excess Cash (EC) is used to prepay the senior debt (only). EC = Free cash flow - cash interest expense - debt repayments
E62
Marios Pastellopoulos: Due to PIK, the facility amount will increase over time. Therefore need to pay 100% of Opening Balance + PIK interest expense.
Total Cash interest (Senior debt + Mezzanine cash) (62.0) (55.7) (47.3) (34.5) (22.0)Total Interest (Cash interest + Mezzanine PIK) (72.9) (67.2) (59.3) (47.1) (35.2)Interest check OK OK OK OK OK
Closing Cash Balance 12.3 24.7 46.8 115.8 375.2 Cash balance check OK OK OK OK OK
B71
Marios Pastellopoulos: This step is practically similar with Step 2 of Financial Statements section of the Operational Model. The difference here is that interest expense in not grouped as a single item but reported differently based on the different debt instruments of the financing structure of the LBO. The operational assumptions devised in Step 2 and Interest expenses from Step 3 are used to form the forecasted Income Statement of the target Company.
B86
Marios Pastellopoulos: Earning Before Taxes (EBT).
B87
Marios Pastellopoulos: Tax paid is determined from EBT and the tax rate defined in Step 2. Tax amount calculated here will be used in the cash flow statement.
E87
Marios Pastellopoulos: If the company has a negative EBT it will not pay taxes.
B91
Marios Pastellopoulos: To calculate the cash flow available to amortise debt and pay interest (i.e. service debt), adjustments have to be made to EBITDA. 1. Start with EBITDA and subtract the change in WC and CapEx (from the assumptions in step 2) and the tax paid (from the Income Statement). This will give you the Cash flow before financing (CFBF) or Free cash flow (FCF). 2. Subtract the Cash Interest Expense to obtain the Cash flow available for debt repayment. 3. The next step is to calculate the Excess Cash after the Debt Repayments defined in the debt schedule. 4. Use the assumption from step 2 (in this case 75%) to calculate the Cash Sweep (CS). If the Excess Cash is negative, there will be no CS; if it is positive, take the minimum between the (Opening Balance + Principal Repayments of the Senior Debt) and (the percentage of CS times the excess cash). You should take the negative of this amount. Finally go back to Step 3, and update the CS entry. 5. Finally, use the Cash Increase/(Decrease) and the Opening Cash Balance to calculate the Closing Cash Balance. Make sure it is positive, otherwise the capital structure should be updated since the company will not be able to support this level of gearing (leverage).
E107
Marios Pastellopoulos: IF Excess Cash (EC) < 0 THEN zero ELSE MIN (EC * %Cash Sweep, Senior Debt outstanding). This is to guarantee that the closing senior debt balance is never negative (otherwise the Cash Sweep will not work).
E109
Marios Pastellopoulos: Assumed that acquisition is cash free. All money is drawn from Balance sheet, therefore the Opening Cash Balance is zero.
E110
Marios Pastellopoulos: Whatever is left from the Excess Cash, after the Cash sweep is paid.
E112
Marios Pastellopoulos: If the closing cash balance is negative it means that the company will not be able to support this gearing level.
Marios Pastellopoulos: Credit statistics or covenants are certain provisions included in the credit agreements between the issuers of the various debt instruments and the lenders and serve to protect the latter from a worsening credit quality of the former. Credit Statistics are typically agreed on an individual basis in every transaction based on the business plan provided. A potential breach of these covenants might be considered as an event of default. The 3 primary and most common credit ratios (covenants) in a Senior Facilities Agreement (SFA) are: 1. Leverage ratios (maximum level for covenants) 2. Interest cover ratios (minimum) 3. Cash cover of fixed charges cover (minimum) Headroom: Covenants’ Headroom is the flexibility between the Company’s calculated figure and the covenant set by the bank. The desired headroom (Assumed Headroom) is decided between the counterparties, and adjusted EBITDA is calculated to reflect how much EBITDA has to drop to reach headroom on an EBITDA level. The adjusted EBITDA is used to recalculate the corresponding credit ratio to find the covenant level which will then be rounded to find the proposed covenant. The headroom level is found by comparing the corresponding ratio of interest with the proposed covenant found earlier.
B124
Marios Pastellopoulos: Leverage: Leverage covenants are usually with a headroom of 20-25% (for the final years, where the debt is almost zero, the covenants levels are kept constant). These values will later be included in the Senior Facilities Agreement (SFA). If the Net Total (senior) Debt is greater than zero at the end term (maturity) of the total (senior) debt, there is a debt refinancing risk, which is seen as a negative credit statistic for the lenders.
B126
Marios Pastellopoulos: The desired headroom has to be decided between the counterparties, and then the adjusted EBITDA is calculated to reflect how much EBITDA has to drop to reach headroom on an EBITDA level. The adjusted EBITDA is used to recalculate the corresponding ratio (i.e. Net Senior Debt/Adjusted EBITDA) to find the covenant level which will then be rounded to find the proposed covenant. The headroom level is found by comparing the corresponding ratio of interest with the proposed covenant found earlier.
B128
Marios Pastellopoulos: The lower the ratio, the better in this case, as the Proposed Covenant level should not be exceeded.
E130
Marios Pastellopoulos: Conditional formatting can be used so that the cell turns red when there is negative headroom on any of the covenants: 1. Start by selecting all the headroom cells as indicated in the figure below. 2. Go to Format menu, then Conditional Formatting (shortcut sequence: Alt, [O] ,[D]) and define it to be red when a covenant is breached. Using conditional formatting will enable to detect more quickly a breach of covenants.
B135
Marios Pastellopoulos: The lower the ratio, the better in this case, as the Proposed Covenant level should not be exceeded.
E137
Marios Pastellopoulos: Conditional formatting in this line.
B139
Marios Pastellopoulos: Interest cover: You should calculate the ratios EBITDA/Cash interest and (EBITDA-CapEx)/Cash interest. These ratios should be significantly higher than 1x to make sure that the company is generating enough cash to pay its financial obligations. The second ratio (EBITDA-CapEx) gives us a better measure of this ability, since the cash spent on CapEx will not be available to pay the interest.
B141
Marios Pastellopoulos: Interest cover covenants are also set with a headroom of 20-25%.
B143
Marios Pastellopoulos: The higher the ratio, the better in this case, as the corresponding interest coverage ratio must not be lower than the Proposed Covenant level.
E145
Marios Pastellopoulos: Conditional formatting in this line.
B148
Marios Pastellopoulos: Interest cover covenants are also set with a headroom of 20-25%.
B150
Marios Pastellopoulos: The higher the ratio, the better in this case, as the corresponding interest coverage ratio must not be lower than the Proposed Covenant level.
E152
Marios Pastellopoulos: Conditional formatting in this line.
B154
Marios Pastellopoulos: Cash cover: Calculate the ratio FCF/(Cash interest+Debt repayments). Cash cover ratio must be higher than c. 1.0x in order to ensure that a safety margin exists and the Company is able to service the required gearing level in case its operations underperform (i.e. lower revenues and/or margins). Usually the covenants are set between 1.0x - 1.1x.
B155
Marios Pastellopoulos: The higher the ratio the better (Company can service its debt).
E155
Marios Pastellopoulos: If the Cash interest is positive such that the ratio becomes negative, then it should no longer calculated.
E157
Marios Pastellopoulos: Conditional formatting in this line.
B161
Marios Pastellopoulos: The final step is the calculation of the IRR Returns provided by the investment and a sensitivity analysis on how these returns are altered when different years of exit and EBITDA exit multiples are considered. The following steps are recommended: 1. First the analyst must decide the appropriate exit year of the investment. In LBO analysis an exit of the fund after five years is typical. 2. The equity proceeds to the sponsor at the time of exit (equity at exit) must then be calculated. 3. Finally, the IRR of the investment must be calculated If the forecasted IRR is below the target set by the Fund, the Fund should adjust either its valuation of the company (i.e. pay less) or the equity contribution (i.e. use less/more equity/debt), until it achieves an acceptable minimum return (if at the end this is not possible then the fund will cancel the deal). Note: As a rule of thumb, Funds typically consider returns in excess of 20% as acceptable.
C165
Marios Pastellopoulos: Rows is used to calculate the index number, because should there be a row added/deleted inside the referenced array, the reference will no longer be correct. This way the model is more robust to errors.
Current Assets Current Assets 2,756.4 Working CapitalCash & Cash Equivalents 1,164.0 Current Liabilities (1,779.1) Cash & Cash Equivalents 1,753.9 Short-Term Investments 285.7 Working Capital 977.3 Accounts Receivable 302.7 Net working Capital (776.6)Inventories 543.3Deferred Income Taxes, Net 304.2Other current assets 156.5
Total Current Assets 2,756.4
Fixed (non-current) Assets Fixed (non-current) Assets Fixed (non-current) AssetsGross PPE 6,141.6 Gross PPE 6,141.6 Gross PPE 6,141.6
Accumulated Depreciation (3,725.1) Accumulated Depreciation (3,725.1) Accumulated Depreciation (3,725.1)Net PPE 2,416.5 Net PPE 2,416.5 Net PPE 2,416.5
Other Long term assets Other Long term assets Other Long term assetsTotal Fixed Assets 533.3 Total Fixed Assets 533.3 Total Fixed Assets 533.3 Goodwill and other 679.7 Goodwill 679.7 Goodwill 679.7
Total Assets 6,385.9 Total Assets 4,606.8 Total Assets 4,606.8
Current Liabilities Long Term debt 932.1 Long Term debtAccounts Payable 282.6 Term Loan A 0.0Accrued Expenses & Other 1,082.4 Term Loan B 0.0Deferred Revenue 414.1 Term Loan C 0.0
Total Current Liabilities 1,779.1Mezzanine 0.0
Long Term debt 549.4 Existing debt (to be refinanced) 932.1 Other Long Term Liabilities 382.7
Total Liabilities 2,711.2
Equity Equity EquityCommon stock 146.3 Common stock 146.3 Common stock 146.3 Retained Earnings 3,528.4 Retained Earnings 3,528.4 Retained Earnings 3,528.4
Total Liabilities & Equity 6,385.9 Total Liabilities & Equity 4,606.8 Total Liabilities & Equity 4,606.8
* Note: Balance Sheet as of September 2010
Last fiscal year
Last fiscal year
Last fiscal year
D4
Marios Pastellopoulos: For the purposes of this model the usual BS as appeared in the Financial Statements of the Company is revised in order to be able reach a simplified Pro-Forma Balance Sheet that will not depend on assumptions for every figure. This is done to simplify the model and the assumptions. The process used to adjust the BS to a simpler format is exhibited in this sheet. This makes the model simpler as only one assumption has to be implemented, that of Net WC.
B8
Marios Pastellopoulos: The Initial form of the Company's BS is presented here. Should this BS were used, it would be necessary to make assumptions regarding almost every BS line in the Current Assets (CA) and Current Liabilities (CL).
F8
Marios Pastellopoulos: In the adaptation of the Company's initial BS, CA and CL are shown as a group while CL are shown on the Assets’ side in order to calculate Working Capital (CA-CL). Company's Long-term debt is also grouped and shown as a single line in the Liabilities side.
I8
Marios Pastellopoulos: Finally, in the Final Balance sheet that will be transferred to the LBO model, the WC is breaks down as Net WC = WC - Cash. The proposed LBO debt structure is presented in the Liabilities side (without the respective amounts as it is not need for now), while Company's existing Long-term debt is to be refinanced.
B21
Marios Pastellopoulos: Gross PPE = Last year's Gross PPE + Additions to PPE for 2010
B26
Marios Pastellopoulos: Total Fixed Assets = Long-term investments (available-for-sale securities) + Equity and other investments
B27
Marios Pastellopoulos: Goodwill and other = Other assets + Other Intangible Assets + Goodwill
C45
Marios Pastellopoulos: Accumulated other comprehensive income ($57,2 m.) is added in Retained Earnings item.
Step 1 - Determine the Sources and Uses of funds Pro Forma Capitalisation Capital Structure Selected
Sources of Funds $ M x EBITDA % Uses $ M Post Crisis Bank and Mezz
Senior debt EBITDATerm Loan A 3,700.0 #DIV/0! #DIV/0! Multiple 7.0x Term Loan A 3,700.0 1Term Loan B 3,700.0 #DIV/0! #DIV/0! Term Loan B 3,700.0 2Term Loan C 0.0 #DIV/0! #DIV/0! Term Loan C 0.0 3
Marios Pastellopoulos: In this Advanced LBO Model four different Capital Structures are proposed. Each structure uses different financing (both debt and equity) instruments that will help you understand how debt and equity structure, quantum and pricing may be proposed in a LBO deal.
K9
Marios Pastellopoulos: Four Capital Structures are available using different debt structuring and quantum. Use toggle below to select.
B10
Marios Pastellopoulos: Sources of Funds is linked with the Capital Structures developed on the side. It changes according to which structure is selected (pre-determined)
G12
Marios Pastellopoulos: Purchase price is based on Company's Last-Twelve-Months (LTM) EBITDA.
I13
Marios Pastellopoulos: Purchase multiple depends on the Capital Structure selected.
B16
Marios Pastellopoulos: Subordinated Debt is a second-priority debt, which means that it ranks after Senior Debt in the event of a liquidation or bankruptcy. Its interest charges are effectively more expensive than Senior Debt and Repayments are usually a bullet payment and the term of the facility. Note: In this case we group Mezzanine Debt under Subordinated Debt, even though Mezzanine might be considered a distinctive class of debt instrument due to its specific charecteristics.
B22
Marios Pastellopoulos: Ordinary Equity is provided by the PE fund and the Management Team (Sweet Equity). The equity split will usually be 20% for the Management Team and 80% for the Fund.
I23
Marios Pastellopoulos: EV = EBITDA * Multiple
B24
Marios Pastellopoulos: The Sweet Equity will depend on the financial strength of the Management. Hence, as the deal value increases, it will be a decreasing percentage of the overall value (in various cases performance ratchet structures or MSIP could be structured to reward the management for meeting specific milestones).
I26
Marios Pastellopoulos: Equity Acquisition Cost = EV - Existing Net Debt
I27
Marios Pastellopoulos: At this stage the analyst should hard code the existing Net Debt. In Step 9 when Company's BS is built, come back and link this cell to its respective number in the BS.
B29
Marios Pastellopoulos: Equity contribution is in the form of SHL and Ordinary Equity from the management (Sweet Equity) and the PE fund.
H29
Marios Pastellopoulos: On larger deals the execution/underwriting fee as a % is smaller.
B32
Marios Pastellopoulos: Checks if Sources = Uses of Funds
D35
Marios Pastellopoulos: This step is linked with the Operational Model tab and is similar to Step 2 of the Simple LBO model. Sales Growth (%), EBITDA Margin (% Sales), CapEx (% Sales), NWC (% Sales) and DA (% Sales) are all linked with the Operational Model developed for Starbucks.
B38
Marios Pastellopoulos: Given the uncertainty about the future, Banks/Funds usually will consider a Base case and a Stress case. The Base case is the expected performance of the Company as it was projected in the Operational Model built previously. The Stress case tests the resilience of the business in a worst case scenario (downturn e.g. decline in sales growth or in EBITDA margins). In this model the stress case is only testing the sales growth, EBITDA margins and Capex, but in general the process could be extended to other items in the financial statements or the business plan.
C38
Marios Pastellopoulos: To create a combo box go to View menu, then toolbars and finally select "Forms". To link it up, right click on the box (after you've drawn it), go to "Format Controls and then to the Control Sheet. You can select which cell it links to (Cell link), what drop-down options are there (Input range) and how many options are presented (Drop down lines).
B45
Marios Pastellopoulos: Linked with the Operational Model.
B46
Marios Pastellopoulos: Linked with the Operational Model.
B47
Marios Pastellopoulos: The current tax rate is maintained according to management projections for the future. Annual Report: 34%-35%.
B48
Marios Pastellopoulos: According to the respective country tax rules, only a percentage of the PIK interest of the shareholder loan (SHL) is tax deductible (depending of the jurisdiction it can be deducted up to 100%). The higher the tax deductibility, the less the tax paid and therefore the higher the cash flow available to service debt. Given that is getting harder to get any tax deduction for the SHL, it was assumed a conservative level of deductibility of only 3% (could be 0% if someone wants to be even more conservative); this is the reason that covenants on step 11 are not based on a tax benefit that is uncertain.
B49
Marios Pastellopoulos: A certain percentage of the Excess Cash (EC), i.e. EC = Free cash flow - cash interest expense - debt repayments, is used to prepay the senior debt (only).
D52
Marios Pastellopoulos: Pre-crisis "adjustments" to growth rates/margins (increase) due to investors and banks being more bullish. Note: This adjustment in only used with the pre-crisis structure.
B53
Marios Pastellopoulos: Linked with the Operational Model.
B57
Marios Pastellopoulos: Linked with the Operational Model.
B61
Marios Pastellopoulos: Linked with the Operational Model.
E62
Marios Pastellopoulos: In case of a downturn, the Company will try to preserve cash generation by spending less on CapEx.
B65
Marios Pastellopoulos: As noted above, debt structuring and pricing takes into account prevailing conidtions in debt capital markets. The perceived risk of the Company and the target profitability of the banks (usually lenders to TLa/b/c tranches) are also of great importance. After reviewing the market conditions (from LCD news), the credit rating of the Company (ratings reports) and receiving an advice from the Main Lead Arranger (i.e. their syndication team), the price of the debt is been decided. Note: Debt Structure changes according to Capital Structure selected with the toggle buttons.
B68
Marios Pastellopoulos: TLa is being amortized throughout a period of 6 years, while TLb and TLc have longer tenors of 7 and 8 years respectively. Maturity and pricing of RCF and CapEx Facilities is matching TLa trance of Senior debt (as explained earlier).
C73
Marios Pastellopoulos: TLC term = 8 years. Senior Secured Bond termm = 7 years.
C75
Marios Pastellopoulos: Mezzanine term = 9 years. Unsecured bond term = 8 years.
C78
Marios Pastellopoulos: The maturity is usually bigger than 10 years (our horizon). This is why, among other things (i.e. no cash interest), SHL is considered to be equity and not debt, by rating agencies.
H79
Marios Pastellopoulos: It should be noted that the PIK element of the SHL will have higher interest rate than the most expensive debt tranche (i.e. in this deal the mezzanine), however it should be agreed with the management (because it could affect their MSIP).
B83
Marios Pastellopoulos: Forward LIBOR Curve and Interest Rate Hedging: Using the current LIBOR rate for the floating rate payments of each debt instrument, is an overly simplistic assumption since it is assumed that LIBOR rate will remain constant for the next 10 years (term of the longest lived instrument). This is unrealistic though, given the faster business cycles and financial crises and is even less applicable when LIBOR rate is very low. The effect on the projected interest payments would be an ample over/underestimation (depending on economy cycle and its effects on LIBOR) which would have a significant impact on the valuation. To correct this we are using the Forward LIBOR Curve provided by Bloomberg. This curve represents the market’s estimates for the future prevailing LIBOR rates and it is the best prediction that we can have for our future interest payments. In addition, banks typically require the borrower to hedge 1/2 or 2/3 of the debt for at least 3 years. Note: This method is technically the most precise and gives the most accurate estimate for the interest payments over the years as opposed to other methods that under or overestimate them.
B85
Marios Pastellopoulos: Typically the 3 month LIBOR is considered.
E85
Marios Pastellopoulos: Taken from Implied Forward Curve (Bloomberg).
B86
Marios Pastellopoulos: Swap Rate is the current 3 Year Swap rate at which the hedge will be typically locked. Taken from USD Swap Rates (Bloomberg).
D87
Marios Pastellopoulos: The standard hedging requirements on bank debt are: If for 2 years hedge 66% of the debt If for 3 years hedge 50% of the debt
Marios Pastellopoulos: Fixed Base Rate is used when the Capital Structure includes a fixed rate bond.
C91
Marios Pastellopoulos: The Debt Repayment Schedule serves to bring in the effects of the LBO financing structure in the LBO model. All the different debt instruments with their respective obligatory and optional debt repayments and interest expenses are provided here, showing the opening and closing balances of each instrument. This step includes repayment schedules for RCF and CapEx facilities and all senior debt structures depending on the capital structure selected (TLa, TLb, TLc, Senior Secured Bond).
B92
Marios Pastellopoulos: Similar with Debt Repayment Schedule provided in the Finance Instruments section earlier. Note 1: Remember that Interest expense calculations, principal repayments and debt balance at the end of the year will be used in the Income Statement, Cash Flow Statement and Credit Statistics (Steps 6, 7 and 11) respectively. Note 2: Cash Sweep is available to repay Senior Debt only (in this case TLa, TLb and TLc). Note 3: Hard code 0 in the respective entries in Opening Cash Balance on Balance Sheet, Cash Increase/Decrease as these entries will be linked with Step 7 when its finalised Note 4: Cash Sweep available for each senior tranche is linked with Step 8. Hard code 0 for now.
B94
Marios Pastellopoulos: Same with RCF-CapEx facilities explained in the Finance Instruments section earlier.
B97
Marios Pastellopoulos: Annual commitment fee paid on the undrawn portion of the revolver.
E97
Marios Pastellopoulos: ISERROR function is included in case the user puts an invalid character in the % of interest margin. Commitment fee = 40% * RCF spread
E102
Marios Pastellopoulos: Linked with Op.Cash Balance from the calculation of CF and Cash balance.
E103
Marios Pastellopoulos: Linked with the Cash Inc/Dec from the same step as above.
E106
Marios Pastellopoulos: IF >=Maturity Prepay = - OP. Balance of RCF facility ELSE IF Closing Balance before RCF > Min. cash balance Prepay = - min (OP. RCF, CB before RCF - Min cash balance) ELSE Drawdown = min (Min. Cash balance - CB before RCF, Commitment - OP. RCF) END END
D107
Marios Pastellopoulos: The Minimum closing cash balance has to be decided based on the required cash balance of the firm.
D111
Marios Pastellopoulos: Acquisition is Cash free thus this should always be 0.
B116
Marios Pastellopoulos: Same with RCF-CapEx facilities explained in the Finance Instruments section earlier.
E119
Marios Pastellopoulos: ISERROR function is used to make the model more robust to user-errors. Commitment fee = 40% * CapEx spread
Marios Pastellopoulos: Same with Senior Debt explained in the Finance Instruments section earlier.
B135
Marios Pastellopoulos: Hard code 0 in the Fixed charges cover. When Step 11 is done, come back and adjust the amortisation, so that fixed charges cover is greater than c. 1.0x.
C136
Marios Pastellopoulos: The average life of TLa should be no more than c. 80% of the term of the facility (i.e. 4.8 years for a 6 year term).
B137
Marios Pastellopoulos: After the model is completely built, the analyst should come back to this step and adjust the amortisation profile of the senior debt so that the fixed charges cover (to be defined on Step 11) is greater than c. 1.0x.
E139
Marios Pastellopoulos: Need to make sure that the balance is positive, otherwise the Cash Sweep will not work properly.
E150
Marios Pastellopoulos: Need to make sure that the balance is positive, otherwise the Cash Sweep will not work properly.
C156
Marios Pastellopoulos: If this is not a Loan instrument (but a bond) then the Base Rate should be 0 (interest rate is not calculated as a spread over a base rate but as a fixed base rate).
E161
Tiago Dias: Need to make sure that the balance is positive, otherwise the cash sweep will not work properly.
B168
Marios Pastellopoulos: Mezzanine Debt Repayment Schedule is explained and modelled in the Finance Instruments (Mezz sheet) section. Unsecured Bond Repayment Schedule is modelled exactly like the HY Bond in the Finance Instruments (HY Bond) section. For the Shareholder loan advice Equity Instruments section of this worksheet. Note: Remember that SHL will be paid as a bullet at the term of the facility with its PIK Element accumulating every year and paid only at the end.
C171
Marios Pastellopoulos: If this is not a Loan instrument (but a bond) then the Base Rate should be 0 (interest rate is not calculated as a spread over a base rate but as a fixed base rate).
Marios Pastellopoulos: The SHL is not included in the calculation of the total debt because it is quasi-equity injected by the fund. Total Debt = Total Senior Debt + Closing Balance(Mezzanine/Unsecured Bond)
Marios Pastellopoulos: This step is explained in the Financial Statements section and is also modelled in Step 4 of the Simple LBO Model. The different interest expenses calculated in Steps 4 and 5 are linked with this step, namely Senior debt (TLa, TLb, TLc or Senior Secured Bond, RCF and CapEx facilites, Mezzanine PIK and Cash and Shareholder Loan PIK. Also note tax treatment due to SHL tax deductibility.
B203
Marios Pastellopoulos: Interest Income will be calculated in Step 7 below, hence at this stage the analyst should put zero in all cells in this line.
E203
Marios Pastellopoulos: ISERROR function is used to make it easier to revert an accidentally introduced mistake with a circular reference.
B216
Marios Pastellopoulos: Only a certain % of the SHL's PIK Interest is tax deductible (3% in this case). Therefore Taxable Income will be different from the Earnings before Tax (EBT). To arrive at this number, simply add back the non-deductible interest % the percentage to EBT.
Marios Pastellopoulos: If the Company has a negative taxable income it will not pay taxes.
E218
Marios Pastellopoulos: In some situations, if the Company performs very well, the PE firm will be able to receive dividends. The dividend payments would decrease the Free cash flow and appear on the Balance Sheet under an extra line called "Dividends" (i.e. they would increase the Total Stockholders Equity). In this model it is assumed that the Company will not pay dividends in any case.
C221
Marios Pastellopoulos: In Advanced LBO Modelling this step is slightly different and thus an analytical methodology on how to build it is provided. To calculate the cash flow available to amortise debt and pay interest (i.e. service debt), adjustments have to be made to EBITDA: 1. Start with EBITDA and subtract the change in Net WC, tax paid (from the Income Statement step above) and CapEx (from the assumptions in Step 2). Since Balance Sheet has not yet been calculated, put zero in all cells for the change in WC and hard code the cash on BS (closing balance for 2010 - link with the respective entry in the Balance sheet once built). Add back the facility funded CapEx (which is basically the yearly drawdown of the CapEx facility). This will give you the Cash flow before financing (CFBF). 2. The interest income will be calculated as the average balance between the opening and closing cash balance, and therefore it will make the model circular (because the closing cash balance will depend on the interest income). For the reasons explained in detailed before, put zero in all cells in this line and update it only at the end when you finishing implementing all the steps in the model. 3. Subtract the Cash Interest Expense to obtain the Cash flow available for debt repayment. 4. Calculate the Excess Cash after all Debt Repayments are summed up from Steps 4 and 5. 5. Use the assumption from Step 2 (in this case 75%) to calculate the Cash Sweep (CS). If the Excess Cash is negative, there will be no CS; if it is positive, take the minimum between the (Opening Balance + Principal Repayments of Senior Debt) and (the percentage of CS times the excess cash). You should take the negative of this amount. . 6. Finally, use the Cash Increase/(Decrease) and the Opening Cash Balance to calculate the Closing Cash Balance. Remember to add/subtract any RCF drawdown/repayment. Make sure it is positive, otherwise the capital structure must change since the company will not be able to support this level of gearing (leverage).
E228
Marios Pastellopoulos: There would be an extra line here, if dividends were paid.
B229
Marios Pastellopoulos: This is the yearly drawdown from the CapEx facility modelled in Step 4.
E234
Marios Pastellopoulos: The interest income depends on the opening and closing cash position. The closing cash position depends, among other things, on the interest income, therefore this calculation introduces a circular reference in the model. If an error is introduced somewhere (e.g. accidentally introduce text in the revenue cell), the model will enter into a #Value! error state, that will not be corrected even if you undo the error introduced. There are two solutions to correct this problem: 1) undo the error and then go the this line, delete everything (breaks circularity) and introduce the formula again. (time consuming) 2) use the ISERROR function in this line with an IF function: If there is an error, return 0, otherwise return the interest income. This way is better because when you undo the error, the model will automatically return to its normal state.
E239
Marios Pastellopoulos: IF Excess Cash (EC) < 0 THEN zero ELSE -MIN (EC * %cash sweep, senior debt outstanding). This is to guarantee that the closing Senior Debt balance is never negative (otherwise the Cash sweep will not work).
E242
Marios Pastellopoulos: Whatever is left from the Excess Cash, after the Cash Sweep is paid.
D244
Marios Pastellopoulos: Closing Cash Balance (2010) = Opening Cash Balance (2011). Link with the respective entry in the Balance sheet once built.
E244
Marios Pastellopoulos: If the closing cash balance is negative it means that the company will not be able to support this gearing level.
C247
Marios Pastellopoulos: For simplicity, Cash Sweep is considered to be sequential (pro-rata cash sweep is more complex). This means that any available Cash Sweep is used to prepay debt in order of seniority (i.e. TLa is entitled to any available Cash Sweep first, TLb second and TLc third). Note: When this step is finalised go back to Step 4, and update the CS entries for each facility.
E251
Marios Pastellopoulos: Linked with Step 7 above.
B252
Marios Pastellopoulos: Outstanding debt before sweep = TLa Opening balance - Principal Repayments
B253
Marios Pastellopoulos: Effective sweep to TLa will be the minimum between the TLa debt outstanding after any principal repayments and the sweep available. Effective sweep to TLa = MIN(TLa Outstanding debt before sweep, Cash Sweep available)
B255
Marios Pastellopoulos: The cash sweep to TLb is whatever is left after the Effective sweep to TLa.
B256
Marios Pastellopoulos: Cash Sweep available = Effective sweep to Tla - Cash Sweep available
B260
Marios Pastellopoulos: The cash sweep to TLc is whatever is left after the Effective sweep to TLb.
D260
Marios Pastellopoulos: When Capital Structure 4 (All Bond) is selected this line will be a Senior Secured Bond. This debt is not entitled to any Cash Sweep and thus with this feature any available Cash Sweep is not paid towards the Senior Secured Bond.
E263
Marios Pastellopoulos: IF Senior Secured Bond = 0
D266
Marios Pastellopoulos: Go to BS example sheet before moving to this step. The process used to adjust the BS to a simpler format is exhibited in the BS example sheet. As explained, Company's BS is revised in order to be able reach a simplified Pro-Forma Balance Sheet that will not require assumptions for every BS figure. Steps: 1. The final Balance Sheet (before adjustments) format is transferred in this spreadsheet. 2. Adjustments need to be made to the BS to show the impact of the LBO. The Balance Sheet is adjusted to reach a cash-free Pro-Forma Balance Sheet (since the acquisition is assumed to be cash-free) that future Balance Sheets will be built on. The Goodwill created is derived from the premium paid by the sponsor (Equity Acquisition Cost – Book Value of Equity), while transaction fees are capitalised. Company's new capital structure is linked from Step 1 (both Debt and Equity). 3. The PF Balance Sheet will be the base of Step 10, on which Company's future Balance Sheets will be built. Note: Remember to go back to Step 1 and update the hard coded number for the refinancing of existing net debt. Do the same for the hard coded number for the closing cash position in Step 7.
E267
Marios Pastellopoulos: On the Assets side the only adjustment will be on the Goodwill and the Transaction Fees. On the Liabilities side, adjustments will be made to the capital structure so that it matches the sources of funds table from Step 1. The Existing debt will be refinanced and the debt will be updated. Finally, Company's Equity must be adjusted to equal with the equity provided by the Sponsor.
F267
Marios Pastellopoulos: This column is simply the sum of the previous 2 columns. This is the Pro-Forma Balance Sheet of the Company and is transferred in Step 10 as the base on which future Balance Sheets are built.
E270
Marios Pastellopoulos: Assumed that acquisition is cash free. All money is drawn from BS, therefore the Opening cash balance is 0.
B280
Marios Pastellopoulos: Goodwill is created from premium paid for the equity. This is the excess of purchase price paid over the identifiable Net Assets (Shareholders Equity) of the Company. Under accounting rules, Goodwill is not amortised but must be tested for impairment.
Marios Pastellopoulos: Transaction fees must be capitalised, (i.e. recorded in the BS and amortised over the years). For simplicity we will assume that the assumptions from the DA include the amortisation of these fees.
E281
Marios Pastellopoulos: Link with Step 1.
E286
Marios Pastellopoulos: Link with the respective amount in Step 1.
E287
Marios Pastellopoulos: Link with the respective amount in Step 1.
E288
Marios Pastellopoulos: Link with the respective amount in Step 1.
E289
Marios Pastellopoulos: Link with the respective amount in Step 1.
E296
Marios Pastellopoulos: Under the new capital structure there will be only common stock.
F302
Marios Pastellopoulos: This step is the same with Step 4 (Balance sheet) of the FS sheet developed before. To build an integrated BS, the following steps should be followed: 1. PF BS is linked with the PF BS in Step 9.The Pro-Forma Balance Sheet from above is linked here to form base on which future Balance Sheets of the Company will be built. 2. Link Cash & Equivalents entries with the respective Closing Cash position from the Cash flow statement calculated in Step 7. 3. Link the Net Working Capital (using NWC margin from Step 2 and Revenues from Step 6). 4. Go back to Step 7 and update the hard coded line for the change in NWC; a decrease in NWC translates in a cash inflow (i.e. CL increase more than CA), hence make sure you calculate this correctly: – (NWC1 – NWC0). 5. Gross Property Plant & Equipment (PPE) will be calculated as PPE from the previous year plus the (absolute value of) CapEx from the Cash Flow statement. 6. Accumulated Depreciation will be equal to the previous year one plus the Depreciation from the Income Statement. 7. Total Fixed Assets and Goodwill will remain constant over the years. 8. Link the closing balances of each debt instrument in the capital structure from the respective repayment schedules in Steps 4 and 5. 9. Link the closing balance of the Shareholder Loan from Step 5. 10. Common stock will remain constant over the years. 11. Retained earnings will be calculated as the sum of the previous year Retained Earnings plus the yearly Net Income from the Income Statement (Step 6). 12. Include a line at the end to check that the BS is in balance. Note: Remember to go back to Step 7 and update the hard coded number for the Closing Cash position.
D316
Marios Pastellopoulos: As already mentioned Goodwill is not amortised, hence it will remain constant throughout the years. Transaction fees are amortised over a certain period (e.g. 10 years), but for simplicity it was considered that this amortisation is included in the DA assumptions.
Total assets
Long term debtRCF FacilityCapex FacilityTerm Loan ATerm Loan BTerm Loan CMezzanine
(EV-Net debt) Proceeds to equity Proceeds to equity
(EV-Net debt-SHL) Proceeds to ordinary equity Proceeds to ordinary equity
(take into account sweet equity split) Proceeds to institutional equity Proceeds to institutional equity
(add back the SHL) Total proceeds to fund Total proceeds to fund
B338
Marios Pastellopoulos: Same with Step 6 of the Simple LBO Model. A toggle is provided so that the analyst can change the Capital Structure in this step.
B347
Marios Pastellopoulos: Total Debt / Total Capitalization
E356
Marios Pastellopoulos: Conditional formatting in this line.
E363
Marios Pastellopoulos: Conditional formatting in this line.
E366
Marios Pastellopoulos: Due to the Interest Income it might happen that the cash Interest expense is positive (extreme case).
B367
Marios Pastellopoulos: Interest cover covenants are also set with a headroom of 20-25%.
E371
Marios Pastellopoulos: Conditional formatting in this line.
B374
Marios Pastellopoulos: Interest cover covenants are also set with a headroom of 20-25%.
E378
Marios Pastellopoulos: Conditional formatting in this line.
E383
Marios Pastellopoulos: Conditional formatting in this line.
C387
Marios Pastellopoulos: The final step is the calculation of the IRR Returns provided by the investment and a sensitivity analysis on how these returns are altered when different years of exit and EBITDA exit multiples are considered. Steps: 1. Calculate the Proceeds to Equity at exit. To do this, calculate the Enterprise Value at exit, by multiplying the Exit multiple times the EBITDA at exit (scaled in the upside and downside case). Afterwards, subtract the Total Debt and add back the Closing Cash balance to obtain the equity proceeds. 2. Calculate the Proceeds to ordinary equity. To do this, simply subtract the SHL from the Proceeds to Equity calculated above. 3. Calculate the Proceeds to institutional equity, which takes into account sweet equity split. 4. Calculate the Total proceeds to the fund, by adding back SHL to the Proceeds to institutional equity calculated in the previous step. 5. Calculate Money Multiples which is the Total proceeds to the fund to Institutional Equity at entry. 6. Finally, calculate IRR Returns of the investment Important Note: Should the forecasted IRR appears to be below the target set by the fund (funds typically consider returns in excess of 20% as acceptable), the sponsor might adjust either its valuation of the Company (pay less) or the equity contribution (use less/more equity/debt), until it achieves an acceptable minimum return (if this is not possible it will cancel the deal). Note: Do not forget to go back to Step 7 and insert the formula to calculate the interest income.
H391
Marios Pastellopoulos: In LBO analysis an exit of the fund after five years is normal practice.
C402
Marios Pastellopoulos: Proceeds to Equity at Exit = EBITDA * EBITDA Exit multiple – (Total Debt – Closing cash balance)
C408
Marios Pastellopoulos: Proceeds to ordinary Equity = Proceeds to Equity - SHL
C414
Marios Pastellopoulos: Proceeds to institutional equity = Proceeds to ordinary equity * Ordinary equity split
C420
Marios Pastellopoulos: Total proceeds to fund = Proceeds to institutional equity + SHL
Step 1 - Determine the Sources and Uses of funds Pro Forma Capitalisation Capital Structure Selected
Sources of Funds $ M x EBITDA % Uses $ M Pre Crisis Bank and Mezz
Senior debt EBITDA 2,444.5Term Loan A 4,500.0 1.8x 20.22% Multiple 9.0x Term Loan A 4,500.0 1Term Loan B 4,000.0 1.6x 17.97% Term Loan B 4,000.0 2Term Loan C 4,000.0 1.6x 17.97% Term Loan C 4,000.0 3
Marios Pastellopoulos: In this Advanced LBO Model four different Capital Structures are proposed. Each structure uses different financing (both debt and equity) instruments that will help you understand how debt and equity structure, quantum and pricing may be proposed in a LBO deal.
K9
Marios Pastellopoulos: Four Capital Structures are available using different debt structuring and quantum. Use toggle below to select.
G12
Marios Pastellopoulos: Purchase price is based on Company's Last-Twelve-Months (LTM) EBITDA.
I13
Marios Pastellopoulos: Purchase multiple depends on the Capital Structure selected.
B16
Marios Pastellopoulos: Subordinated Debt is a second-priority debt, which means that it ranks after Senior Debt in the event of a liquidation or bankruptcy. Its interest charges are effectively more expensive than Senior Debt and Repayments are usually a bullet payment and the term of the facility. Note: In this case we group Mezzanine Debt under Subordinated Debt, even though Mezzanine might be considered a distinctive class of debt instrument due to its specific charecteristics.
B22
Marios Pastellopoulos: Ordinary Equity is provided by the PE fund and the Management Team (Sweet Equity). The equity split will usually be 20% for the Management Team and 80% for the Fund.
B24
Marios Pastellopoulos: The Sweet Equity will depend on the financial strength of the Management. Hence, as the deal value increases, it will be a decreasing percentage of the overall value (in various cases performance ratchet structures or MSIP could be structured to reward the management for meeting specific milestones).
I27
Marios Pastellopoulos: At this stage the analyst should hard code the existing Net Debt. In Step 9 when Company's BS is built, come back and link this cell to its respective number in the BS.
B29
Marios Pastellopoulos: Equity contribution is in the form of SHL and Ordinary Equity from the management (Sweet Equity) and the PE fund.
H29
Marios Pastellopoulos: On larger deals the execution/underwriting fee as a % is smaller.
B32
Marios Pastellopoulos: Checks if Sources = Uses of Funds
D35
Marios Pastellopoulos: This step is linked with the Operational Model tab and is similar to Step 2 of the Simple LBO model. Sales Growth (%), EBITDA Margin (% Sales), CapEx (% Sales), NWC (% Sales) and DA (% Sales) are all linked with the Operational Model developed for Starbucks.
B38
Marios Pastellopoulos: Given the uncertainty about the future, Banks/Funds usually will consider a Base case and a Stress case. The Base case is the expected performance of the Company as it was projected in the Operational Model built previously. The Stress case tests the resilience of the business in a worst case scenario (downturn e.g. decline in sales growth or in EBITDA margins). In this model the stress case is only testing the sales growth, EBITDA margins and Capex, but in general the process could be extended to other items in the financial statements or the business plan.
C38
Marios Pastellopoulos: To create a combo box go to View menu, then toolbars and finally select "Forms". To link it up, right click on the box (after you've drawn it), go to "Format Controls and then to the Control Sheet. You can select which cell it links to (Cell link), what drop-down options are there (Input range) and how many options are presented (Drop down lines).
B47
Marios Pastellopoulos: The current tax rate is maintained according to management projections for the future. Annual Report: 34%-35%
B48
Marios Pastellopoulos: According to the respective country tax rules, only a percentage of the PIK interest of the shareholder loan (SHL) is tax deductible (depending of the jurisdiction it can be deducted up to 100%). The higher the tax deductibility, the less the tax paid and therefore the higher the cash flow available to service debt. Given that is getting harder to get any tax deduction for the SHL, it was assumed a conservative level of deductibility of only 3% (could be 0% if someone wants to be even more conservative); this is the reason that covenants on step 11 are not based on a tax benefit that is uncertain.
B49
Marios Pastellopoulos: A certain percentage of the Excess Cash (EC), i.e. EC = Free cash flow - cash interest expense - debt repayments, is used to prepay the senior debt (only).
D52
Marios Pastellopoulos: Pre-crisis "adjustments" to growth rates/margins (increase) due to investors and banks being more bullish. Note: This adjustment in only used with the pre-crisis structure.
E62
Marios Pastellopoulos: In case of a downturn, the Company will try to preserve cash generation by spending less on CapEx.
B65
Marios Pastellopoulos: As noted above, debt structuring and pricing takes into account prevailing conidtions in debt capital markets. The perceived risk of the Company and the target profitability of the banks (usually lenders to TLa/b/c tranches) are also of great importance. After reviewing the market conditions (from LCD news), the credit rating of the Company (ratings reports) and receiving an advice from the Main Lead Arranger (i.e. their syndication team), the price of the debt is been decided. Note: Debt Structure changes according to Capital Structure selected with the toggle buttons.
B68
Marios Pastellopoulos: TLa is being amortized throughout a period of 6 years, while TLb and TLc have longer tenors of 7 and 8 years respectively. Maturity and pricing of RCF and CapEx Facilities is matching TLa trance of Senior debt (as explained earlier).
C73
Marios Pastellopoulos: TLC term = 8 years. Senior Secured Bond termm = 7 years.
C75
Marios Pastellopoulos: Mezzanine term = 9 years. Unsecured bond term = 8 years.
C78
Marios Pastellopoulos: The maturity is usually bigger than 10 years (our horizon). This is why, among other things (i.e. no cash interest), SHL is considered to be equity and not debt, by rating agencies.
H79
Marios Pastellopoulos: It should be noted that the PIK element of the SHL will have higher interest rate than the most expensive debt tranche (i.e. in this deal the mezzanine), however it should be agreed with the management (because it could affect their MSIP).
B83
Marios Pastellopoulos: Forward LIBOR Curve and Interest Rate Hedging: Using the current LIBOR rate for the floating rate payments of each debt instrument, is an overly simplistic assumption since it is assumed that LIBOR rate will remain constant for the next 10 years (term of the longest lived instrument). This is unrealistic though, given the faster business cycles and financial crises and is even less applicable when LIBOR rate is very low. The effect on the projected interest payments would be an ample over/underestimation (depending on economy cycle and its effects on LIBOR) which would have a significant impact on the valuation. To correct this we are using the Forward LIBOR Curve provided by Bloomberg. This curve represents the market’s estimates for the future prevailing LIBOR rates and it is the best prediction that we can have for our future interest payments. In addition, banks typically require the borrower to hedge 1/2 or 2/3 of the debt for at least 3 years. Note: This method is technically the most precise and gives the most accurate estimate for the interest payments over the years as opposed to other methods that under or overestimate them.
B85
Marios Pastellopoulos: Typically the 3 month LIBOR is considered.
E85
Marios Pastellopoulos: Taken from Implied Forward Curve (Bloomberg).
B86
Marios Pastellopoulos: Swap Rate is the current 3 Year Swap rate at which the hedge will be typically locked. Taken from USD Swap Rates (Bloomberg).
D87
Marios Pastellopoulos: The standard hedging requirements on bank debt are: If for 2 years hedge 66% of the debt If for 3 years hedge 50% of the debt
Marios Pastellopoulos: Fixed Base Rate is used when the Capital Structure includes a fixed rate bond.
C91
Marios Pastellopoulos: The Debt Repayment Schedule serves to bring in the effects of the LBO financing structure in the LBO model. All the different debt instruments with their respective obligatory and optional debt repayments and interest expenses are provided here, showing the opening and closing balances of each instrument. This step includes repayment schedules for RCF and CapEx facilities and all senior debt structures depending on the capital structure selected (TLa, TLb, TLc, Senior Secured Bond).
B92
Marios Pastellopoulos: Similar with Debt Repayment Schedule provided in the Finance Instruments section earlier. Note 1: Remember that Interest expense calculations, principal repayments and debt balance at the end of the year will be used in the Income Statement, Cash Flow Statement and Credit Statistics (Steps 6, 7 and 11) respectively. Note 2: Cash Sweep is available to repay Senior Debt only (in this case TLa, TLb and TLc). Note 3: Hard code 0 in the respective entries in Opening Cash Balance on Balance Sheet, Cash Increase/Decrease as these entries will be linked with Step 7 when its finalised Note 4: Cash Sweep available for each senior tranche is linked with Step 8. Hard code 0 for now.
B94
Marios Pastellopoulos: Same with RCF-CapEx facilities explained in the Finance Instruments section earlier.
B97
Marios Pastellopoulos: Annual commitment fee paid on the undrawn portion of the revolver.
E97
Marios Pastellopoulos: ISERROR function is included in case the user puts an invalid character in the % of interest margin. Commitment fee = 40% * RCF spread
E102
Marios Pastellopoulos: Linked with Op.Cash Balance from the calculation of CF and Cash balance.
E103
Marios Pastellopoulos: Linked with the Cash Inc/Dec from the same step as above.
E106
Marios Pastellopoulos: IF >=Maturity Prepay = - OP. Balance of RCF facility ELSE IF Closing Balance before RCF > Min. cash balance Prepay = - min (OP. RCF, CB before RCF - Min cash balance) ELSE Drawdown = min (Min. Cash balance - CB before RCF, Commitment - OP. RCF) END END
D107
Marios Pastellopoulos: The Minimum closing cash balance has to be decided based on the required cash balance of the firm.
D111
Marios Pastellopoulos: Acquisition is Cash free thus this should always be 0.
B116
Marios Pastellopoulos: Same with RCF-CapEx facilities explained in the Finance Instruments section earlier.
E119
Marios Pastellopoulos: ISERROR function is used to make the model more robust to user-errors. Commitment fee = 40% * CapEx spread
Marios Pastellopoulos: Same with Senior Debt explained in the Finance Instruments section earlier.
B135
Marios Pastellopoulos: Hard code 0 in the Fixed charges cover. When Step 11 is done, come back and adjust the amortisation, so that fixed charges cover is greater than c. 1.0x.
C136
Marios Pastellopoulos: The average life of TLa should be no more than c. 80% of the term of the facility (i.e. 4.8 years for a 6 year term).
B137
Marios Pastellopoulos: After the model is completely built, the analyst should come back to this step and adjust the amortisation profile of the senior debt so that the fixed charges cover (to be defined on Step 11) is greater than c. 1.0x.
E139
Marios Pastellopoulos: Need to make sure that the balance is positive, otherwise the Cash Sweep will not work properly.
E150
Marios Pastellopoulos: Need to make sure that the balance is positive, otherwise the Cash Sweep will not work properly.
C156
Marios Pastellopoulos: If this is not a Loan instrument (but a bond) then the Base Rate should be 0 (interest rate is not calculated as a spread over a base rate but as a fixed base rate).
E161
Tiago Dias: Need to make sure that the balance is positive, otherwise the cash sweep will not work properly.
B168
Marios Pastellopoulos: Mezzanine Debt Repayment Schedule is explained and modelled in the Finance Instruments (Mezz sheet) section. Unsecured Bond Repayment Schedule is modelled exactly like the HY Bond in the Finance Instruments (HY Bond) section. For the Shareholder loan advice Equity Instruments section of this worksheet. Note: Remember that SHL will be paid as a bullet at the term of the facility with its PIK Element accumulating every year and paid only at the end.
C171
Marios Pastellopoulos: If this is not a Loan instrument (but a bond) then the Base Rate should be 0 (interest rate is not calculated as a spread over a base rate but as a fixed base rate).
B192
Marios Pastellopoulos: The SHL is not included in the calculation of the total debt because it is quasi-equity injected by the fund.
RCF Drawdown/Repayment 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 0.0 Closing Cash Balance 0.0 576.1 1,220.6 1,944.5 2,715.0 4,007.5 5,363.9 6,543.0 7,281.5 6,432.2 10,545.1 Cash balance check OK OK OK OK OK OK OK OK OK OK
Other Long Term AssetsTotal fixed assets 533.3 0.0 533.3 Goodwill 679.7 19,147.6 19,827.3 Fees 0.0 255.0 255.0
Total assets 4,606.8 17,648.7 22,255.5
Long term debtTerm Loan A 0.0 4,500.0 4,500.0 Term Loan B 0.0 4,000.0 4,000.0 Term Loan C 0.0 4,000.0 4,000.0 Mezzanine 0.0 3,000.0 3,000.0 Existing debt (to be refinanced) 932.1 (932.1) 0.0
Marios Pastellopoulos: This step is explained in the Financial Statements section and is also modelled in Step 4 of the Simple LBO Model. The different interest expenses calculated in Steps 4 and 5 are linked with this step, namely Senior debt (TLa, TLb, TLc or Senior Secured Bond, RCF and CapEx facilites, Mezzanine PIK and Cash and Shareholder Loan PIK. Also note tax treatment due to SHL tax deductibility.
B203
Marios Pastellopoulos: Interest Income will be calculated in Step 7 below, hence at this stage the analyst should put zero in all cells in this line.
E203
Marios Pastellopoulos: ISERROR function is used to make it easier to revert an accidentally introduced mistake with a circular reference.
B216
Marios Pastellopoulos: Only a certain % of the SHL's PIK Interest is tax deductible (3% in this case). Therefore Taxable Income will be different from the Earnings before Tax (EBT). To arrive at this number, simply add back the non-deductible interest % the percentage to EBT.
E217
Marios Pastellopoulos: If the Company has a negative taxable income it will not pay taxes.
E218
Marios Pastellopoulos: In some situations, if the Company performs very well, the PE firm will be able to receive dividends. The dividend payments would decrease the Free cash flow and appear on the Balance Sheet under an extra line called "Dividends" (i.e. they would increase the Total Stockholders Equity). In this model it is assumed that the Company will not pay dividends in any case.
C221
Marios Pastellopoulos: In Advanced LBO Modelling this step is slightly different and thus an analytical methodology on how to build it is provided. To calculate the cash flow available to amortise debt and pay interest (i.e. service debt), adjustments have to be made to EBITDA: 1. Start with EBITDA and subtract the change in Net WC, tax paid (from the Income Statement step above) and CapEx (from the assumptions in Step 2). Since Balance Sheet has not yet been calculated, put zero in all cells for the change in WC and hard code the cash on BS (closing balance for 2010 - link with the respective entry in the Balance sheet once built). Add back the facility funded CapEx (which is basically the yearly drawdown of the CapEx facility). This will give you the Cash flow before financing (CFBF). 2. The interest income will be calculated as the average balance between the opening and closing cash balance, and therefore it will make the model circular (because the closing cash balance will depend on the interest income). For the reasons explained in detailed before, put zero in all cells in this line and update it only at the end when you finishing implementing all the steps in the model. 3. Subtract the Cash Interest Expense to obtain the Cash flow available for debt repayment. 4. Calculate the Excess Cash after all Debt Repayments are summed up from Steps 4 and 5. 5. Use the assumption from Step 2 (in this case 75%) to calculate the Cash Sweep (CS). If the Excess Cash is negative, there will be no CS; if it is positive, take the minimum between the (Opening Balance + Principal Repayments of Senior Debt) and (the percentage of CS times the excess cash). You should take the negative of this amount. . 6. Finally, use the Cash Increase/(Decrease) and the Opening Cash Balance to calculate the Closing Cash Balance. Remember to add/subtract any RCF drawdown/repayment. Make sure it is positive, otherwise the capital structure must change since the company will not be able to support this level of gearing (leverage).
E228
Marios Pastellopoulos: There would be an extra line here, if dividends were paid.
B229
Marios Pastellopoulos: This is the yearly drawdown from the CapEx facility modelled in Step 4.
E234
Marios Pastellopoulos: The interest income depends on the opening and closing cash position. The closing cash position depends, among other things, on the interest income, therefore this calculation introduces a circular reference in the model. If an error is introduced somewhere (e.g. accidentally introduce text in the revenue cell), the model will enter into a #Value! error state, that will not be corrected even if you undo the error introduced. There are two solutions to correct this problem: 1) undo the error and then go the this line, delete everything (breaks circularity) and introduce the formula again. (time consuming) 2) use the ISERROR function in this line with an IF function: If there is an error, return 0, otherwise return the interest income. This way is better because when you undo the error, the model will automatically return to its normal state.
E239
Marios Pastellopoulos: IF Excess Cash (EC) < 0 THEN zero ELSE -MIN (EC * %cash sweep, senior debt outstanding). This is to guarantee that the closing Senior Debt balance is never negative (otherwise the Cash sweep will not work).
E242
Marios Pastellopoulos: Whatever is left from the Excess Cash, after the Cash Sweep is paid.
D244
Marios Pastellopoulos: Closing Cash Balance (2010) = Opening Cash Balance (2011). Link with the respective entry in the Balance sheet once built.
E244
Marios Pastellopoulos: If the closing cash balance is negative it means that the company will not be able to support this gearing level.
C247
Marios Pastellopoulos: For simplicity, Cash Sweep is considered to be sequential (pro-rata cash sweep is more complex). This means that any available Cash Sweep is used to prepay debt in order of seniority (i.e. TLa is entitled to any available Cash Sweep first, TLb second and TLc third). Note: When this step is finalised go back to Step 4, and update the CS entries for each facility.
E251
Marios Pastellopoulos: Linked with Step 7 above.
B252
Marios Pastellopoulos: Outstanding debt before sweep = TLa Opening balance - Principal Repayments
B253
Marios Pastellopoulos: Effective sweep to TLa will be the minimum between the TLa debt outstanding after any principal repayments and the sweep available. Effective sweep to TLa = MIN(TLa Outstanding debt before sweep, Cash Sweep available)
B255
Marios Pastellopoulos: The cash sweep to TLb is whatever is left after the Effective sweep to TLa.
B256
Marios Pastellopoulos: Cash Sweep available = Effective sweep to Tla - Cash Sweep available
B260
Marios Pastellopoulos: The cash sweep to TLc is whatever is left after the Effective sweep to TLb.
D260
Marios Pastellopoulos: When Capital Structure 4 (All Bond) is selected this line will be a Senior Secured Bond. This debt is not entitled to any Cash Sweep and thus with this feature any available Cash Sweep is not paid towards the Senior Secured Bond.
E263
Marios Pastellopoulos: IF Senior Secured Bond = 0
D266
Marios Pastellopoulos: Go to BS example sheet before moving to this step. The process used to adjust the BS to a simpler format is exhibited in the BS example sheet. As explained, Company's BS is revised in order to be able reach a simplified Pro-Forma Balance Sheet that will not require assumptions for every BS figure. Steps: 1. The final Balance Sheet (before adjustments) format is transferred in this spreadsheet. 2. Adjustments need to be made to the BS to show the impact of the LBO. The Balance Sheet is adjusted to reach a cash-free Pro-Forma Balance Sheet (since the acquisition is assumed to be cash-free) that future Balance Sheets will be built on. The Goodwill created is derived from the premium paid by the sponsor (Equity Acquisition Cost – Book Value of Equity), while transaction fees are capitalised. Company's new capital structure is linked from Step 1 (both Debt and Equity). 3. The PF Balance Sheet will be the base of Step 10, on which Company's future Balance Sheets will be built. Note: Remember to go back to Step 1 and update the hard coded number for the refinancing of existing net debt. Do the same for the hard coded number for the closing cash position in Step 7.
E267
Marios Pastellopoulos: On the Assets side the only adjustment will be on the Goodwill and the Transaction Fees. On the Liabilities side, adjustments will be made to the capital structure so that it matches the sources of funds table from Step 1. The Existing debt will be refinanced and the debt will be updated. Finally, Company's Equity must be adjusted to equal with the equity provided by the Sponsor.
F267
Marios Pastellopoulos: This column is simply the sum of the previous 2 columns. This is the Pro-Forma Balance Sheet of the Company and is transferred in Step 10 as the base on which future Balance Sheets are built.
E270
Marios Pastellopoulos: Assumed that acquisition is cash free. All money is drawn from BS, therefore the Opening cash balance is 0.
B280
Marios Pastellopoulos: Goodwill is created from premium paid for the equity. This is the excess of purchase price paid over the identifiable Net Assets (Shareholders Equity) of the Company. Under accounting rules, Goodwill is not amortised but must be tested for impairment.
Marios Pastellopoulos: Transaction fees must be capitalised, (i.e. recorded in the BS and amortised over the years). For simplicity we will assume that the assumptions from the DA include the amortisation of these fees.
E296
Marios Pastellopoulos: Under the new capital structure there will be only common stock.
F302
Marios Pastellopoulos: This step is the same with Step 4 (Balance sheet) of the FS sheet developed before. To build an integrated BS, the following steps should be followed: 1. PF BS is linked with the PF BS in Step 9.The Pro-Forma Balance Sheet from above is linked here to form base on which future Balance Sheets of the Company will be built. 2. Link Cash & Equivalents entries with the respective Closing Cash position from the Cash flow statement calculated in Step 7. 3. Link the Net Working Capital (using NWC margin from Step 2 and Revenues from Step 6). 4. Go back to Step 7 and update the hard coded line for the change in NWC; a decrease in NWC translates in a cash inflow (i.e. CL increase more than CA), hence make sure you calculate this correctly: – (NWC1 – NWC0). 5. Gross Property Plant & Equipment (PPE) will be calculated as PPE from the previous year plus the (absolute value of) CapEx from the Cash Flow statement. 6. Accumulated Depreciation will be equal to the previous year one plus the Depreciation from the Income Statement. 7. Total Fixed Assets and Goodwill will remain constant over the years. 8. Link the closing balances of each debt instrument in the capital structure from the respective repayment schedules in Steps 4 and 5. 9. Link the closing balance of the Shareholder Loan from Step 5. 10. Common stock will remain constant over the years. 11. Retained earnings will be calculated as the sum of the previous year Retained Earnings plus the yearly Net Income from the Income Statement (Step 6). 12. Include a line at the end to check that the BS is in balance. Note: Remember to go back to Step 7 and update the hard coded number for the Closing Cash position.
D316
Marios Pastellopoulos: As already mentioned Goodwill is not amortised, hence it will remain constant throughout the years. Transaction fees are amortised over a certain period (e.g. 10 years), but for simplicity it was considered that this amortisation is included in the DA assumptions.
Total Liabilities & Equity 22,255.5 22,697.2 23,140.9 23,860.2 24,637.0 25,851.4 26,979.2 27,915.9 28,397.5 27,316.5 31,188.6 Balance check OK OK OK OK OK OK OK OK OK OK OK
E331
Marios Pastellopoulos: There would be an extra line, linked to the cash flow statement if dividends were paid.
Marios Pastellopoulos: Same with Step 6 of the Simple LBO Model. A toggle is provided so that the analyst can change the Capital Structure in this step.
B347
Marios Pastellopoulos: Total Debt / Total Capitalization
E356
Marios Pastellopoulos: Conditional formatting in this line.
E363
Marios Pastellopoulos: Conditional formatting in this line.
E366
Marios Pastellopoulos: Due to the Interest Income it might happen that the cash Interest expense is positive (extreme case).
B367
Marios Pastellopoulos: Interest cover covenants are also set with a headroom of 20-25%.
E371
Marios Pastellopoulos: Conditional formatting in this line.
B374
Marios Pastellopoulos: Interest cover covenants are also set with a headroom of 20-25%.
E378
Marios Pastellopoulos: Conditional formatting in this line.
E383
Marios Pastellopoulos: Conditional formatting in this line.
C387
Marios Pastellopoulos: The final step is the calculation of the IRR Returns provided by the investment and a sensitivity analysis on how these returns are altered when different years of exit and EBITDA exit multiples are considered. Steps: 1. Calculate the Proceeds to Equity at exit. To do this, calculate the Enterprise Value at exit, by multiplying the Exit multiple times the EBITDA at exit (scaled in the upside and downside case). Afterwards, subtract the Total Debt and add back the Closing Cash balance to obtain the equity proceeds. 2. Calculate the Proceeds to ordinary equity. To do this, simply subtract the SHL from the Proceeds to Equity calculated above. 3. Calculate the Proceeds to institutional equity, which takes into account sweet equity split. 4. Calculate the Total proceeds to the fund, by adding back SHL to the Proceeds to institutional equity calculated in the previous step. 5. Calculate Money Multiples which is the Total proceeds to the fund to Institutional Equity at entry. 6. Finally, calculate IRR Returns of the investment Important Note: Should the forecasted IRR appears to be below the target set by the fund (funds typically consider returns in excess of 20% as acceptable), the sponsor might adjust either its valuation of the Company (pay less) or the equity contribution (use less/more equity/debt), until it achieves an acceptable minimum return (if this is not possible it will cancel the deal). Note: Do not forget to go back to Step 7 and insert the formula to calculate the interest income.
H391
Marios Pastellopoulos: In LBO analysis an exit of the fund after five years is normal practice.
C402
Marios Pastellopoulos: Proceeds to Equity at Exit = EBITDA * EBITDA Exit multiple – (Total Debt – Closing cash balance)
C408
Marios Pastellopoulos: Proceeds to ordinary Equity = Proceeds to Equity - SHL
C414
Marios Pastellopoulos: Proceeds to institutional equity = Proceeds to ordinary equity * Ordinary equity split
C420
Marios Pastellopoulos: Total proceeds to fund = Proceeds to institutional equity + SHL
Financial Modelling LABModel Outputs
Pre Crisis Bank and Mezz Pro Forma Capital Structure2010PF Base Cash PIK
$ M Amount Cum. % xEBITDA xE-C Rate Margin Margin All In Maturity
Term Loan A 4,500.0 20.2% 1.8x 2.3x 1.08% 3.25% - 4.33% 2016
Term Loan B 4,000.0 38.2% 3.5x 4.3x 1.08% 3.50% - 4.58% 2017
Term Loan C 4,000.0 56.2% 5.1x 6.3x 1.08% 3.75% - 4.83% 2018
Total Senior Debt 12,500.0 56.2% 5.1x 6.3x Avg. Cost 5.63%
Previous Year Net Total Leverage - - - - - - - - - -
F36
Marios Pastellopoulos: CapEx: An increase in Capex should not be accounted as a debt repayment PIK PIK repayment is not just the difference between year end balance since it is necessary to account for the accrued interest over the year.
Project PEVCECharts
Chart 1Sourses of Funds $ MSenior debtTerm Loan A 4,500.0 0.2021972097Term Loan B 4,000.0 0.179730853Term Loan C 4,000.0 0.179730853Subordinated debtMezzanine 3,000.0 0.1347981398
Chart 3Breakdown of Proceeds at 9x Multiple and Exit Yr 2015
Total Proceeds 48,293.7Total Debt 37,972.3 10,321.4Shareholder Loan 33,151.4 4,820.9Proceeds to PE Fund 6,630.3 26,521.1Proceeds to Management 0.0 6,630.3
RETURNS BREAKDOWNNOTE: THIS CALCULATES THE VALUE CREATION AT A GIVEN EV LEVELPLEASE NOTE: THESE CALCULATIONS ONLY WORK FOR EBITDA margins and will need to be amended to reflect the use of EBIT margins
RevenueEBITDA at entry marginDifference in EBITDAValue from Revenue growth
RevenueNew RevenueRevenue at acquisition - INSERT LAST FULL YEAR REVENUESActual EBITDA mgEBITDA mg at acquisitionIncrease in EBITDAValue from Revenue growthTOTAL VALUE FROM REVENUE GROWTH
EBITDA actualEBITDA mgEBITDA at entry RevenuesDifference in EBITDAValue from margin improvement
FURTHER REPRODUCTION AND DISTRIBUTION OF THESE MODEL AND MATERIALS CONTAINED HEREIN IS PROHIBITED WITHOUT FURTHER WRITTEN PERMISSION BY ANDREAS ANGELOPOULOS.
CASES, MODELS, GUIDELINES AND ANY OTHER MATERIALS PROVIDED BY ANDREAS ANGELOPOULOS ARE PROPERTY OF ANDREAS ANGELOPOULOS WHO RETAINS SOLE OWNERSHIP OF THESE MATERIALS.
THESE CASES, FINANCIAL MODELS IN EXCEL AND OTHER MATERIALS ARE AVAILABLE ONLY FOR THE REGISTERED STUDENTS IN THIS CLASS AND STRICTLY FOR CLASS DISCUSSION. THE MATERIALS SHOULD NOT BE USED FOR COMMERCIAL OR PROFESSIONAL USE, SOLD, TRADED OR LENT, HIRED OUT, COPIED, PRESENTED OR CIRCULATED, ALL OR PARTS, WITHOUT THE PRIOR WRITTEN CONSENT OF ANDREAS ANGELOPOULOS.
FURTHER REPRODUCTION AND DISTRIBUTION OF THESE MODEL AND MATERIALS CONTAINED HEREIN IS PROHIBITED WITHOUT FURTHER WRITTEN PERMISSION BY ANDREAS ANGELOPOULOS.
CASES, MODELS, GUIDELINES AND ANY OTHER MATERIALS PROVIDED BY ANDREAS ANGELOPOULOS ARE PROPERTY OF ANDREAS ANGELOPOULOS WHO RETAINS SOLE OWNERSHIP OF THESE MATERIALS.
THESE CASES, FINANCIAL MODELS IN EXCEL AND OTHER MATERIALS ARE AVAILABLE ONLY FOR THE REGISTERED STUDENTS IN THIS CLASS AND STRICTLY FOR CLASS DISCUSSION. THE MATERIALS SHOULD NOT BE USED FOR COMMERCIAL OR PROFESSIONAL USE, SOLD, TRADED OR LENT, HIRED OUT, COPIED, PRESENTED OR CIRCULATED, ALL OR PARTS, WITHOUT THE PRIOR WRITTEN CONSENT OF ANDREAS ANGELOPOULOS.
