Hello @Mergers & Inquisitions Thank you very much for the video, it's very clear and useful! But like a few other people, I still find it difficult to understand your answer to the last question :) I'm not an LBO or financial modeling expert at all, but my reasoning is: With the equation Equity = EV - (Debt - Cash), assuming EV is fixed, the equity stake (i.e. the PE firm's stake) remains the same independently of the debt that's left after the sale (IPO or not), in my opinion. Simply because, if you want to reimburse the existing debt (or a part of it) you can 1) use cash balance in the company, i.e. the debt and cash decrease by the same amount and the value of equity remains the same. 2) and if the company does not have enough cash to do it (as in our example) they have to use external funding. So either debt (which does not make sense for what we're trying to do here) or equity. But it does not really make sense either because the PE firm won't ask its investors to put 1$ more in the company just to get exactly 1$ more the day after upon the sale. Either way, the level of debt does not change anything to the proceeds to equity holders. EV is in effect what the PE firm could get if net debt was equal to 0. But if it is positive as in our example, repaying debt with cash or anything else would not change anything to the proceeds for the PE firm For me, the minus before Net Debt in the equation does not mean that their has to be a repayment and then a cash outflow. It's just an equation to calculate the value to equity investors, taking the total company value minus the part that belongs to debt holders. I think that even in the previous questions, the assumption is not that the whole (net) debt has to be reimbursed by the PE firm at the end of year 3. It would just get its $385 million, leaving the debt as it is, and then the buyer would either stick with it or replace it by new debt (or new equity) if it had to because of the change in control. Does my reasoning make sense to you? What did I get wrong? Thanks a lot!!
Yes, the treatment of Debt upon exit here is ambiguous/arguably wrong. I don't know, I'm only human and sometimes these things happen. If you disagree with the treatment, follow whatever makes sense for you. The goal in these case studies is to get them 70-80% correct, not to get to 100% - since the mean score is often in the 40-50% range.
Ok! It’s just that I literally spent several hours thinking about that issue and felt I would not manage to fall asleep if I didn’t ask :) By the way your videos are certainly the best one can find about finance on the web, so thanks again!
@@damienkaralus Yeah I found that confusing as well. It's similar to assuming debt in an LBO vs paying it off. In either case, it's a use of funds that will cause the Purchase Price to be lower than it would have had the debt not existed in the first place. The choice of whether or not the debt is paid down on year 4 or still assumed doesn't affect the money the PE firm will get from it.
I think the last answer might be slightly off. If you don't repay the senior debt, it means that you won't get paid the full enterprise value (EV) upon exit. The EV represented by the senior debt is simply carried over after IPO. In M&A context, the consideration you receive is the assumption of debt by the buyer. All in all, you won't get paid more simply because you did not repay the debt, since net debt decreases the equity value for the buyer. The way you modeled it, the equity value on exit increased while the net debt included in the EV remained unchanged. If you think about it, given a constant EV, an increase in equity value should result in a decrease in net debt. If you add back all the debt to the equity value, suddenly you're left with an EV of 592 (ie, a 8,9x multiple), instead of 532 (ie, a 8,0x multiple). Unless I'm missing something. Other than that, great video. Do you have an idea how to answer such questions if you have circular formulas in your model?
Dawid Kędzierski In an exit value calculation in an LBO, the Exit Enterprise Value is most often determined by an EBITDA multiple applied to the final year EBITDA. If you start adjusting for the treatment of debt, then you're no longer calculating the Enterprise Value upon exit, but some other number. Put differently, why would the Exit Enterprise Value be any different regardless of how much debt or equity the company has? The whole point is that Enterprise Value is supposed to be capital-structure-neutral and that a company's value is linked to some metric that does not depend on the debt/equity split. The only difference here is that some of the debt is not repaid at the end because the company is taken public and it is no longer the PE firm's responsibility to repay it. As a result of that, the proceeds to the PE firm increase. Of course, the trade-off now is that it takes longer for the firm to realize a return on stake in the company... so the lack of responsibility for debt pay-off may or may not be worth it. I agree that perhaps in a real life situation, you could make an argument that the exit Enterprise Value may indeed be different in an IPO scenario if the treatment of debt is different because the multiple might be different. However, the instructions said to assume the same exit multiple, but simply assume that the senior debt stays in place, so that's what we're doing. So I could see your point of view here, but in this case we've chosen to follow a strict interpretation of the case study instructions. You cannot solve questions like this if your model has circular references because goal seek won't work. So you would need to remove the references or disable circular references if you have a switch to do so.
Mergers & Inquisitions / Breaking Into Wall Street Thanks for the quick reply. I guess that with circular references one would take a trial and error approach. As regards the exit: my point was that the way you modeled the exit, the exit multiple is no longer 8.0x. If you carefully calculate the whole EV the way you modeled it, you get: 445 equity value 20 term loan A 20 term loan B 20 term loan C 50 second lien 37 PIK = 592 In other words, the EV you propose on exit is now (592 / 67) = 8.9x of Year 3 EBITDA (67), and not 8.0x. You cannot say that since the senior debt stays in place, it is not part of the EV. Any sane buyer will take that debt into account when subtracting debt from EV to arrive at the equity value. The subtraction in this case will not come from repayment or refinancing of the senior debt, but rather as assumption of that debt by the buyer. If my calculation of the EV is wrong please do let me know. But to me it seems that the model either: 1) changed the exit multiple or 2) moved the value of senior debt to the equity value, essentially wiping the senior debt off the capital structure and EV.
Dawid Kędzierski I think the easiest way to explain this is that we are not really calculating the traditional "Enterprise Value" at the end: we are attempting to figure out the proceeds that a PE firm can claim upon selling their stake in the company. Normally, if the PE firm sells the company 100% to another company, it must repay all debt. Therefore, we subtract debt when calculating proceeds at the end. In an IPO, however, the debt may not necessarily have to be repaid by the PE firm because the company is being sold to public markets investors, not another company or another firm, and therefore the "change of control" clause may not apply. As a result, the PE firm can claim a higher amount of proceeds because it does not have to repay as much debt at the end. That is the point of this question. Yes, I agree that if you back into Enterprise Value the way you have suggested, you get different multiples. However, you would not back into Enterprise Value like that because the number we calculate at the end is more like "Proceeds Available to PE Firm Before Debt Repayment" as opposed to traditional Enterprise Value. You're right that no sane buyer would ignore the debt... but in this case we do not have a single buyer. We have thousands or tens of thousands public markets investors buying the company's stock once it goes public. So yes, they do note the debt, but it is not their responsibility to repay the debt. Yes, effectively we have moved the value of the senior debt to equity value in this calculation. But that is because it's not a traditional sale to another buyer - it's an IPO scenario. I could see your point of view that perhaps it should not be done this way, but we are just following the case study instructions here, which tell us to keep everything else the same but to assume no senior debt repayment at the end. That's about all we can say regarding this issue on UA-cam - feel free to ask any additional questions within our courses. Otherwise, we'll have to agree to disagree on this point (and yes, I agree that perhaps it would not happen like this in real life). Thanks for your feedback.
Mergers & Inquisitions / Breaking Into Wall Street Personally I have never modeled an IPO exit so I can't speak from experience, but I certainly can see your point. I agree that this is probably not the best place to have such a discussion. Thanks for the swift replies.
I thought the "senior debt stays in place" part was to clarify that we needn't take the debt repayments in Year 4 into account and we can use the same equity value we arrived at in Year 3 (based on debt balances in Year 3) to calculate the value in Year 4.
Great video. For the last question, if you assume the senior debt stays in place, shouldn't you also put to "zero" any amortisation related to the term loans A B C in order to reflect the correct cash balance?
I'm having trouble understanding your answer to the last question (60% equity sold at IPO, 40% deferred): Why do you substract only junior debt from EV to get to EqV? The way I see it, if you ignore senior debt (because it is not repaid at IPO) you should also deduct it from the EV, right? Otherwise the EqV attributable to the sponsor would increase just because debt is not repaid/refinanced, which doesn't seem right conceptually.
+pl89 Please see our response to Dawid K below - it's better to think of this calculation not as traditional Enterprise Value, but the proceeds that a PE firm can claim at the end. If you deduct senior debt from Enterprise Value, it yields the same result (Investor Equity) as if you subtracted it as you normally do when going from Enterprise Value to Equity Value. So there's no point in specifying that condition in the question if you treat it that way. The point of the question is that there's a trade-off to not repaying the debt: it takes the PE firm longer to sell its stake in the company. That benefited us here, but it could easily go the other way if it takes much longer to sell or if the company's share price declines.
Great video. Quick question regarding the last question - what is the meaning that the senior loan stays in place? it means that the company or the private equity company does'nt repay it in the exit, right? but if the PE firm does'nt pay the senior debt and it's equity gets bigger because of it? what reason should it have to pay it all?
Loans typically have to be repaid upon "change of control" i.e. someone else acquires over 50% ownership in another company. But that doesn't happen here because it's an IPO, which is more favorable for the PE firm in some ways (though the loan would have to be repaid eventually).
We have a few other examples for merger models and LBO models elsewhere on the channel if you do a search or look through the playlists, and hope to add more examples in the future.
It seems like the goal seek function would not work unless we turned all of our interest expense calcs into values? is there a more elegant way to do it?
It does work, but you need to disable circular references or remove them in the interest calculations in the model. It's always best to make interest calculations based on beginning cash and debt balances anyway, as there's very little benefit to using the average balance in most cases.
Hi, perfect video, thanks! Was there a particular reason, however, for not accounting for cash on the company's balance when calculating entry equity (you basically multiplied LTM EBITDA by entry multiple, and did not subtract cash balance)?
Entry equity is always based on Investor Equity, i.e., the cash the PE firm contributes, not the company's Balance Sheet, if you're referring to row 87 in the model. The company's BS is irrelevant for the entry in a deal like this because you're measuring the cash the *PE firm* must pay to do the deal. And since the price is Enterprise Value-based, the Uses side already subtracts out the Cash.
Yes, it might not be available and you have to know how it works and what the constraints are to use it properly... also, it's not that useful in a scenario like this where we're just constraining one variable to solve for another.
Quick question on the last part when you assume the share price increases, yet you are not assuming any additional debt is paid down? I would assume you are making the 30% increase in share price simplifying assumption so you do not have to recalculate the proceeds from the 40% left over equity ownership using the exit multiple method less existing debt/the cash balance that would be available then. Is this correct?
In year 4, you calculate proceeds by applying +30% to your "doctored equity value". In reality, they would only be selling shares based on market share price. This number should not be affected by additional bonus proceeds resulting from Senior Debt staying in place.
Thanks for this video, it is much appreciated. I agree with almost everything you said (and you are extremely good at teaching), but my interpretation of Question #3 is different. I think it's more reasonable to assume an EBITDA margin "increase in each year", as the question says: "By how much would the EBITDA margin need to increase in each year...". That is, the margin is slightly increasing each year (as the PE firm gets a better understanding of the company and changes culture and strategy), which is different than simply assuming a different fixed ebitda margin. Thus, to answer the question we need to allow for a new 'Ebitda mg growth p.y.' cell, and make the ebitda margin each year equal to last year's * (1+EBITDA_g). The answer would then be around 7% per year, or +1.8% in Y2 and +1.9% in Y3.
Ok. Feel free to interpret the question however you wish - I would advise not over-thinking these types of questions, as the point is to finish in the allotted time and to be able to explain your answers with as little effort as possible.
+Lorenzo Tsai It is the same in Mac Excel, but most of the shortcuts are missing or don't work, so you have to go to the ribbon menu and do it manually instead.
Hello @Mergers & Inquisitions
Thank you very much for the video, it's very clear and useful! But like a few other people, I still find it difficult to understand your answer to the last question :) I'm not an LBO or financial modeling expert at all, but my reasoning is:
With the equation Equity = EV - (Debt - Cash), assuming EV is fixed, the equity stake (i.e. the PE firm's stake) remains the same independently of the debt that's left after the sale (IPO or not), in my opinion.
Simply because, if you want to reimburse the existing debt (or a part of it) you can
1) use cash balance in the company, i.e. the debt and cash decrease by the same amount and the value of equity remains the same.
2) and if the company does not have enough cash to do it (as in our example) they have to use external funding. So either debt (which does not make sense for what we're trying to do here) or equity. But it does not really make sense either because the PE firm won't ask its investors to put 1$ more in the company just to get exactly 1$ more the day after upon the sale.
Either way, the level of debt does not change anything to the proceeds to equity holders. EV is in effect what the PE firm could get if net debt was equal to 0. But if it is positive as in our example, repaying debt with cash or anything else would not change anything to the proceeds for the PE firm
For me, the minus before Net Debt in the equation does not mean that their has to be a repayment and then a cash outflow. It's just an equation to calculate the value to equity investors, taking the total company value minus the part that belongs to debt holders.
I think that even in the previous questions, the assumption is not that the whole (net) debt has to be reimbursed by the PE firm at the end of year 3. It would just get its $385 million, leaving the debt as it is, and then the buyer would either stick with it or replace it by new debt (or new equity) if it had to because of the change in control.
Does my reasoning make sense to you? What did I get wrong?
Thanks a lot!!
Yes, the treatment of Debt upon exit here is ambiguous/arguably wrong. I don't know, I'm only human and sometimes these things happen. If you disagree with the treatment, follow whatever makes sense for you. The goal in these case studies is to get them 70-80% correct, not to get to 100% - since the mean score is often in the 40-50% range.
Ok! It’s just that I literally spent several hours thinking about that issue and felt I would not manage to fall asleep if I didn’t ask :)
By the way your videos are certainly the best one can find about finance on the web, so thanks again!
@@damienkaralus Yeah I found that confusing as well. It's similar to assuming debt in an LBO vs paying it off. In either case, it's a use of funds that will cause the Purchase Price to be lower than it would have had the debt not existed in the first place. The choice of whether or not the debt is paid down on year 4 or still assumed doesn't affect the money the PE firm will get from it.
I think the last answer might be slightly off. If you don't repay the senior debt, it means that you won't get paid the full enterprise value (EV) upon exit. The EV represented by the senior debt is simply carried over after IPO. In M&A context, the consideration you receive is the assumption of debt by the buyer. All in all, you won't get paid more simply because you did not repay the debt, since net debt decreases the equity value for the buyer.
The way you modeled it, the equity value on exit increased while the net debt included in the EV remained unchanged. If you think about it, given a constant EV, an increase in equity value should result in a decrease in net debt.
If you add back all the debt to the equity value, suddenly you're left with an EV of 592 (ie, a 8,9x multiple), instead of 532 (ie, a 8,0x multiple).
Unless I'm missing something.
Other than that, great video. Do you have an idea how to answer such questions if you have circular formulas in your model?
Dawid Kędzierski In an exit value calculation in an LBO, the Exit Enterprise Value is most often determined by an EBITDA multiple applied to the final year EBITDA. If you start adjusting for the treatment of debt, then you're no longer calculating the Enterprise Value upon exit, but some other number.
Put differently, why would the Exit Enterprise Value be any different regardless of how much debt or equity the company has? The whole point is that Enterprise Value is supposed to be capital-structure-neutral and that a company's value is linked to some metric that does not depend on the debt/equity split.
The only difference here is that some of the debt is not repaid at the end because the company is taken public and it is no longer the PE firm's responsibility to repay it. As a result of that, the proceeds to the PE firm increase.
Of course, the trade-off now is that it takes longer for the firm to realize a return on stake in the company... so the lack of responsibility for debt pay-off may or may not be worth it.
I agree that perhaps in a real life situation, you could make an argument that the exit Enterprise Value may indeed be different in an IPO scenario if the treatment of debt is different because the multiple might be different.
However, the instructions said to assume the same exit multiple, but simply assume that the senior debt stays in place, so that's what we're doing.
So I could see your point of view here, but in this case we've chosen to follow a strict interpretation of the case study instructions.
You cannot solve questions like this if your model has circular references because goal seek won't work. So you would need to remove the references or disable circular references if you have a switch to do so.
Mergers & Inquisitions / Breaking Into Wall Street Thanks for the quick reply. I guess that with circular references one would take a trial and error approach.
As regards the exit: my point was that the way you modeled the exit, the exit multiple is no longer 8.0x. If you carefully calculate the whole EV the way you modeled it, you get:
445 equity value
20 term loan A
20 term loan B
20 term loan C
50 second lien
37 PIK
= 592
In other words, the EV you propose on exit is now (592 / 67) = 8.9x of Year 3 EBITDA (67), and not 8.0x.
You cannot say that since the senior debt stays in place, it is not part of the EV. Any sane buyer will take that debt into account when subtracting debt from EV to arrive at the equity value. The subtraction in this case will not come from repayment or refinancing of the senior debt, but rather as assumption of that debt by the buyer.
If my calculation of the EV is wrong please do let me know. But to me it seems that the model either:
1) changed the exit multiple or
2) moved the value of senior debt to the equity value, essentially wiping the senior debt off the capital structure and EV.
Dawid Kędzierski I think the easiest way to explain this is that we are not really calculating the traditional "Enterprise Value" at the end: we are attempting to figure out the proceeds that a PE firm can claim upon selling their stake in the company.
Normally, if the PE firm sells the company 100% to another company, it must repay all debt. Therefore, we subtract debt when calculating proceeds at the end.
In an IPO, however, the debt may not necessarily have to be repaid by the PE firm because the company is being sold to public markets investors, not another company or another firm, and therefore the "change of control" clause may not apply.
As a result, the PE firm can claim a higher amount of proceeds because it does not have to repay as much debt at the end. That is the point of this question.
Yes, I agree that if you back into Enterprise Value the way you have suggested, you get different multiples.
However, you would not back into Enterprise Value like that because the number we calculate at the end is more like "Proceeds Available to PE Firm Before Debt Repayment" as opposed to traditional Enterprise Value.
You're right that no sane buyer would ignore the debt... but in this case we do not have a single buyer. We have thousands or tens of thousands public markets investors buying the company's stock once it goes public.
So yes, they do note the debt, but it is not their responsibility to repay the debt.
Yes, effectively we have moved the value of the senior debt to equity value in this calculation. But that is because it's not a traditional sale to another buyer - it's an IPO scenario.
I could see your point of view that perhaps it should not be done this way, but we are just following the case study instructions here, which tell us to keep everything else the same but to assume no senior debt repayment at the end.
That's about all we can say regarding this issue on UA-cam - feel free to ask any additional questions within our courses.
Otherwise, we'll have to agree to disagree on this point (and yes, I agree that perhaps it would not happen like this in real life). Thanks for your feedback.
Mergers & Inquisitions / Breaking Into Wall Street
Personally I have never modeled an IPO exit so I can't speak from experience, but I certainly can see your point.
I agree that this is probably not the best place to have such a discussion. Thanks for the swift replies.
I thought the "senior debt stays in place" part was to clarify that we needn't take the debt repayments in Year 4 into account and we can use the same equity value we arrived at in Year 3 (based on debt balances in Year 3) to calculate the value in Year 4.
Great video. For the last question, if you assume the senior debt stays in place, shouldn't you also put to "zero" any amortisation related to the term loans A B C in order to reflect the correct cash balance?
??? Not really sure what you mean. If the existing debt stays in place, the amortization associated with it should also stay in place.
I'm having trouble understanding your answer to the last question (60% equity sold at IPO, 40% deferred): Why do you substract only junior debt from EV to get to EqV?
The way I see it, if you ignore senior debt (because it is not repaid at IPO) you should also deduct it from the EV, right? Otherwise the EqV attributable to the sponsor would increase just because debt is not repaid/refinanced, which doesn't seem right conceptually.
+pl89 Please see our response to Dawid K below - it's better to think of this calculation not as traditional Enterprise Value, but the proceeds that a PE firm can claim at the end. If you deduct senior debt from Enterprise Value, it yields the same result (Investor Equity) as if you subtracted it as you normally do when going from Enterprise Value to Equity Value. So there's no point in specifying that condition in the question if you treat it that way.
The point of the question is that there's a trade-off to not repaying the debt: it takes the PE firm longer to sell its stake in the company. That benefited us here, but it could easily go the other way if it takes much longer to sell or if the company's share price declines.
Great video. Quick question regarding the last question - what is the meaning that the senior loan stays in place? it means that the company or the private equity company does'nt repay it in the exit, right? but if the PE firm does'nt pay the senior debt and it's equity gets bigger because of it? what reason should it have to pay it all?
Loans typically have to be repaid upon "change of control" i.e. someone else acquires over 50% ownership in another company. But that doesn't happen here because it's an IPO, which is more favorable for the PE firm in some ways (though the loan would have to be repaid eventually).
Excellent
Thanks for watching!
Thanks a lot! This is really helpful! Could you share some similar exercises for practice (30-45 min cases)?
We have a few other examples for merger models and LBO models elsewhere on the channel if you do a search or look through the playlists, and hope to add more examples in the future.
I am unable to download the excel sheet. Can someone please comment down below
Click "more" under the video and scroll down.
It seems like the goal seek function would not work unless we turned all of our interest expense calcs into values? is there a more elegant way to do it?
It does work, but you need to disable circular references or remove them in the interest calculations in the model. It's always best to make interest calculations based on beginning cash and debt balances anyway, as there's very little benefit to using the average balance in most cases.
Hi, perfect video, thanks! Was there a particular reason, however, for not accounting for cash on the company's balance when calculating entry equity (you basically multiplied LTM EBITDA by entry multiple, and did not subtract cash balance)?
Entry equity is always based on Investor Equity, i.e., the cash the PE firm contributes, not the company's Balance Sheet, if you're referring to row 87 in the model. The company's BS is irrelevant for the entry in a deal like this because you're measuring the cash the *PE firm* must pay to do the deal. And since the price is Enterprise Value-based, the Uses side already subtracts out the Cash.
I suppose you do not use the Solver here because it might not be available in an actual assessment center or because it may be more time consuming?
Yes, it might not be available and you have to know how it works and what the constraints are to use it properly... also, it's not that useful in a scenario like this where we're just constraining one variable to solve for another.
Quick question on the last part when you assume the share price increases, yet you are not assuming any additional debt is paid down? I would assume you are making the 30% increase in share price simplifying assumption so you do not have to recalculate the proceeds from the 40% left over equity ownership using the exit multiple method less existing debt/the cash balance that would be available then. Is this correct?
Yes, this is just a simplification. The instructions say to assume that the senior debt stays in place, so that is what we do here.
In year 4, you calculate proceeds by applying +30% to your "doctored equity value". In reality, they would only be selling shares based on market share price. This number should not be affected by additional bonus proceeds resulting from Senior Debt staying in place.
Please see the comment threads below... this point has already been asked and addressed.
Thanks for this video, it is much appreciated. I agree with almost everything you said (and you are extremely good at teaching), but my interpretation of Question #3 is different. I think it's more reasonable to assume an EBITDA margin "increase in each year", as the question says: "By how much would the EBITDA margin need to increase in each year...". That is, the margin is slightly increasing each year (as the PE firm gets a better understanding of the company and changes culture and strategy), which is different than simply assuming a different fixed ebitda margin.
Thus, to answer the question we need to allow for a new 'Ebitda mg growth p.y.' cell, and make the ebitda margin each year equal to last year's * (1+EBITDA_g). The answer would then be around 7% per year, or +1.8% in Y2 and +1.9% in Y3.
Ok. Feel free to interpret the question however you wish - I would advise not over-thinking these types of questions, as the point is to finish in the allotted time and to be able to explain your answers with as little effort as possible.
anyone who tells me how to built up data table on Mac excel???????
+Lorenzo Tsai It is the same in Mac Excel, but most of the shortcuts are missing or don't work, so you have to go to the ribbon menu and do it manually instead.