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Ferdinand petra - introduction to LBO and Private Equity

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Extract of Financial training on LBO and Private Equity

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Ferdinand petra - introduction to LBO and Private Equity

  1. 1. 1Ferdinand Petra – www.Ferdinand-petra.com – All rights reserved 2018 © Financial Training Extract on LBO www.ferdinand-petra.com Prof: Ferdinand Petra (contact@ferdinand-petra.com) Any reproduction, copy of this document is strictly forbidden without prior consent of the author
  2. 2. 2Ferdinand Petra – www.Ferdinand-petra.com – All rights reserved 2018 © Introduction
  3. 3. 3Ferdinand Petra – www.Ferdinand-petra.com – All rights reserved 2018 © What Is a LBO?  A financing technique for acquiring a Target company − Primarily funded with debt − Proportionally small amount of equity  Investors in LBO are called “Financial Sponsors” (important players in the M&A market)  Their goal is to purchase assets, which they plan to sell in the short/medium term for a substantial profit − Their time frame is typically 3 / 5 years − Trade buyers, on the other hand, have a much longer time horizon  Focus on cash flows generated by the Target company during the investment period − Used to pay down debt − Provides the financial buyers with leveraged returns  The credit crunch (post subprime) has reduced significantly the amount of debt available and therefore transaction values (and leverage) − Since last year, we began to witness leverages coming back to pre-crisis levels!  Sponsors evaluate investments with two metrics − Internal Rate of Return which measures return on equity invested (Excel IRR() or XIRR() functions) − Cash on Cash multiples (aka Money multiple) Introduction
  4. 4. 4Ferdinand Petra – www.Ferdinand-petra.com – All rights reserved 2018 © Structuring NewCo 100% Mezzanine Funds Cash Management Investment Fund Corporate Banks Mezzanine Funds NewCo Selling shareholders Target Capital Cash “Debt push-down” Introduction
  5. 5. 5Ferdinand Petra – www.Ferdinand-petra.com – All rights reserved 2018 © Financial Sponsors  Investment or financial sponsors are professional financial investors (for instance insurance companies or pension funds) who bring the rarest and most expensive resource, since it is the most risky: equity…  … whose objective is to create value by: − Using the leverage effect − Improving the profitability and accelerating organic growth − Increasing external growth (build-up) − Developing profit-sharing schemes for managers (MBO)  Value creation: − Materializes at the exit − Is computed thanks to the IRR, generally in the region of 15 to 25%  Financial sponsors became key players on the market and they now account for an estimated 20% of the European M&A market Introduction
  6. 6. 6Ferdinand Petra – www.Ferdinand-petra.com – All rights reserved 2018 © PE basics LP Reporting Governance Fund Money COC IRR Team control Management fees ( 2%) Management contract GP Carried interest (20%) Hurdle (8%) Fees of GPs are increasingly under pressure from reluctant LPs Introduction
  7. 7. 7Ferdinand Petra – www.Ferdinand-petra.com – All rights reserved 2018 © Value Creation And Transfer In LBOs
  8. 8. 8Ferdinand Petra – www.Ferdinand-petra.com – All rights reserved 2018 © How Can a LBO Create Value (For Shareholders)?  Deleveraging − Using available free cash flow to repay debt  Enhancing Top line growth − Market expansion − Market share gains − Consolidation: bolt-on acquisitions  Operational improvements − Margin improvements and higher efficiency  Fiscal advantages − Tax payments to the government are reduced by the tax shield on interest  Multiple expansion? − Can be a result of operating improvements or business turnaround − Typically assume entry and exit at same multiple (iso-multiple)  Some historical statistics (Jin and Wang 2002) – For all LBO’s from 1996 to 2000, value created came from 43% operating improvement (incl. top line), 24% Leverage and 22% multiple expansion (industry-wide expansion), 11% multiple arbitrage (higher multiple at exit due to better business) Value Creation And Transfer In LBOs
  9. 9. 9Ferdinand Petra – www.Ferdinand-petra.com – All rights reserved 2018 © How Can a LBO Create Value? – Corporate Finance Vision  Change in market valuation  Private information (MBO)  Superior market information  Superior deal making  Sale of noncore or underperforming assets Financial Arbitrage  Cutting costs  Reducing WCR  Removing inefficient managers Increasing Operational Effectiveness Financial engineering  Optimizing capital structure  Reducing corporate tax  Optimization of corporate scope  No conglomerate cross-subsidy Increasing Strategic Distinctiveness  Debt discipline  Improving incentive alignment (strategic value accountability)  Monitoring and controlling Reducing Agency Costs  Restoring entrepreneurial spirit  Advising and enabling Mentoring Source: Berg and Gottschalg, Jensen Value Creation And Transfer In LBOs

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