Leveraged Financing
Ian Giddy
1
Four Applications of Valuation
Business restructuring: breakup value of public
companies
Financial restructuring: before and after
Mergers and acquisitions
Valuing a private company
2
What Does Value Mean? Public vs. Private
Public Company Valuation
maximum share price
Private Company Valuation
maximize after-tax personal income
build personal wealth
protect wealth from taxes
3
“Enhance Shareholder Value?”
Depends on Corporate Life Cycle
BUSINESS
Start-Up Growth Early Maturity Late Maturity
Creation Growth Preservation Transfer
PERSONAL
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Managing Value
Maximize corporate expenses
Shift income to low-tax bracket family
tradeoff payroll taxes if employed
better to make family S-corp holders or limited partners
Own assets privately, lease to company
Lever company to finance new investments
Multiple corporations:
distribute income and value
lower tax bracket
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Uses of Private Company Valuation
Estate planning
Merger & acquisition
IPO
ESOP
Phantom stock options
Stock repurchase (buy/sell agreements)
First right of refusal
Shareholder disputes
Private equity investments
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Private Valuation Concepts
Corporate value
¾ Value of company if acquired whole
Controlling interest premium
Marketability (illiquidity) discount
Minority interest discount
¾ “Swing vote”: a minority share that effectively controls the
company
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Private Companies: Typical Valuation Methods
Book value
Market comparables
¾ earnings multiples
weighted averages of recent earnings
earnings adjusted for recurring operations
earnings normalized for related party transactions
Prices of prior arm’s-length stock sales
Discounted cash flow/VC method/LBO
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Marketability Discounts
No market for shares versus public company
Lacks liquidity unless:
do an IPO
sell or merge the business
sell shares to company or other shareholders
Flotation costs must be incurred to sell
Typical range: 15-35%
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Minority Interest Discounts
Cannot influence dividends
insecure income stream
Shareholders have no control
can be squeezed-out
no influence on Board of Directors
Typical discount range: 35-50%
degree of discount affected by buy/sell agreements,
preemptive rights, appraisal rights, employment agreements,
etc
as specified in shareholders’ agreement
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Relationships Between Discounts
Issue 1 Issue 2
Controlling Interest
Private Company?
or Minority Interest?
Marketability
Control Minority
Discount
15-35%
Control Minority
Premium Discount
20-25% 35-50%
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M&A and Leverage
Takeover?
Company
has
unused Leveraged buyout?
debt
capacity
Leveraged
recapitalization?
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Private Pitfalls
Methods: same
Problems:
No market price
No history of reported information
Data provided can be distorted
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Private Pitfalls
Revenue overstated?
Costs understated? Overstated?
New costs that will be incurred?
Intangible value?
14
LBO: A Temporary Capital Structure
Stage 1: Pre-LBO
Stage 2: LBO
financing
Stage 3: LBO
refinancing
Stage 4: Debt
paydown
COST
OF
CAPITAL
DEBT
RATIO
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12-Step Method
Evaluating cost of deal
Estimating borrowing capacity
Estimating cash costs of funding
Estimating growth rates of sales, expenses, etc
Projecting cash flows (FCFF and FCFE)
Projecting debt amortization
Calculating terminal value of FCFE and FCFF
Estimating costs of capital to find PV
Making sense of the deal
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Cost of the Deal
Estimating cost of deal
Shares 10
Price $ 45
Premium 15%
Equity cost $ 518
Debt cost $ 55
Fees 5% $ 29
Capex & restructuring 10% $ 57
Total cost of deal $ 658
[Link] on [Link]
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Borrowing Capacity
Estimating borrowing capacity
Given:
EBIT $ 95
Min EBIT int coverage ratio 1.3
Interest capacity $ 73 From table
Interest rate 16.00%
Debt capacity $ 457
[Link] on [Link]
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Capital Structure
Preliminary capital structure
Debt $ 457
Missing $ 177
Mgt equity $ 25
Total financing $ 658
[Link] on [Link]
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LBO Financing
NEWCO
Senior
Cost of debt $457 What securities?
purchasing What returns?
Mezzanine
the What investors?
business
Equity $25
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Cash Flows and Debt Repayment
Cash Flows and debt repayment
1 2 3 4 5
NOI 95 5% $ 99.75 105 110 115 121
Principal $ 457
Interest 16% 73 55 51 46 40
Tax 35% 9 17 21 24 28
Add depr of 57 11.4 11.4 11.4 11.4 11.4
Less capex 10% $ 10.0 $ 10.5 $ 11.0 $ 11.5 $ 12.1
Cash avail to repay debt 19 33 39 45 52
Remaining debt 438 405 366 321 269
[Link] on [Link]
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Exit
Company gets bloated or slack IPO or sale of
and stock price falls company
LBO financing lined up
Rates of return LBO offer made
IPO @ NOIx 6 727
VCs 87.6% $ (177)LBO completed
0 0 0 0 637
Managers 12.4% $ (25) 0 0 0 0 90
$ (202)
IRR 29%
Restructuring
Efficiencies
Divestitures
Financial
? years 3-9 months 5-7 years
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Case Study
Photronics
Flexics
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Flexics
Using what you have learned about M&A valuation,
private company valuation and leverage capacity,
estimate a range of values for the company
What should Flexics’ owners do?
What should the LBO team offer?
What should Photronics offer?
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