Immerse yourself in the intricate details of a leveraged buyout (LBO) and learn how to construct an LBO model in Excel. Understand the nuances of transaction summaries, funding sources, capital structures, and internal rate of return calculations, as they play out in real-world scenarios such as the acquisition of Dave and Buster's by global investment company, Kohlberg Kravis Roberts.
Key Insights
- A leveraged buyout (LBO) involves the acquisition of a company using a significant amount of borrowed money to meet acquisition costs.
- An LBO model typically includes three main steps: LBO transaction summary, capital structure formulation, and net cash flow and IRR calculation.
- The 'Sources and Uses' table in an LBO transaction summary details the total cost of acquiring the target and the structure of the transaction.
- Capital structure refers to the specific mix of debt and equity used to finance an LBO transaction, with the interest coverage ratio determining how easily the company can pay interest on the outstanding debt.
- Net cash flow is used to calculate the internal rate of return (IRR), a metric that estimates the profitability of potential investments, such as the LBO transaction.
- The equity multiple, calculated by dividing total cash distributions received from an investment by total equity invested, is utilized to assess the investment's overall profitability.
LBO Model Build
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Sources & Uses
Map purchase price funded by senior debt, mezz, and sponsor equity.
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Operating Model
Revenue, costs, and EBITDA projections during hold period.
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Debt Schedule
Track interest expense and principal paydowns each year.
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Exit & Returns
Exit multiple × terminal EBITDA. IRR and MoIC calculations.
A leveraged buyout is the acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition.
You can watch the video on the LBO overview and theory in another section. In this video, we will build an LBO model in Excel.
In our example, Kohlberg Kravis Roberts, an American global investment company that includes private equity management, acquires Dave and Buster’s at 25% premium to its current valuation.
Our model will include three main steps:
Step 1: LBO Transaction Summary and Sources and Uses of Funds
The Sources and Uses table is a summary of the amount of funding required to complete a M&A transaction.
The sources & uses section lists the total cost of acquiring the target in a hypothetical transaction structure.
The “Uses” side calculates the total amount of capital required to make the acquisition (i.e., the purchase price and transaction fees), whereas the “Sources” side details how exactly the deal is going to be funded, including the required amount of debt and equity financing.
Step 2: Capital Structure
Capital structure refers to the specific mix of debt and equity used to finance an LBO transaction.
The interest coverage ratio is a debt and profitability ratio used to determine how easily a company can pay interest on its outstanding debt. The interest coverage ratio is calculated by dividing a company's EBIT by its interest expense during a given period.
Generally, a higher coverage ratio is better, although the ideal ratio may vary by industry.
Step 3: Model – Net Cash Flow and IRR calculation
Net cash flow is calculated and used to find out the internal rate of return (IRR), which is a metric used in financial analysis to estimate the profitability of potential investments, in our case scenario – the profitability of the LBO transaction.
The key difference between IRR and XIRR is the way each formula handles cash flows. IRR doesn't take into account when the actual cash flow takes place, so it rolls them up into annual periods. By contrast, the XIRR formula considers the dates when the cash flow actually happens.
Equity multiple is defined as the total cash distributions received from an investment, divided by the total equity invested.
