Understanding an LBO model

Introduction

LBO Case Study: Indax

Damián Rubianes
Associate Professor of Finance

GMIF - Corporate Finance 1

Introducing the case
Indax Laboratories Inc.
◼ You receive a teaser from an investment
bank with a buy-out opportunity in Europe.
◼ The owners are retiring and selling 100% of
the equity shareholding.
◼ They have hired an advisor which is
organising a beauty contest.
◼ You have to quickly build a simple model to
confirm if the acquisition is a profitable
investment.
◼ Based on a simple financing structure
(Senior debt, mezzanine and Seller note),
calculate the returns for the investment.

GMIF - Corporate Finance 2

Steps you have to go through
Indax Laboratories Inc.
1. Understanding the business.
Is this a suitable candidate?
2. Reviewing the financials
Is this a suitable candidate?
3. Analysing the accounts
4. Assumptions for the financial projections
5. Balance Sheet adjustments
6. Setting a price and financing structuring
7. Financial projections
8. Check if the cash flows from operations can honour the debt
9. Calculate your returns
10. Make your offer

GMIF - Corporate Finance 3

 LBO Model

Step 1: Understanding the business

GMIF - Corporate Finance 4

 Introducing the target
Indax Laboratories Inc.
◼ Experts in absorbent
products for urinary
incontinence.
◼ Sector: Personal Care
business.
◼ Segment: absorbent
hygiene products for
adults.
◼ Factory: modern
production centre.
◼ Distribution channels:
Professional (hospitals),
Commercial (pharmacies Leading company in the manufacture of sanitary and hygienic products.
and drug stores) and Retail Leading brands in their market niches.
(supermarkets). Products regarded by customers as high quality and innovative.

Note: The pictures show real products and production centres, but Indax
Laboratories, Inc. is a made up name for a non-existing company.
GMIF - Corporate Finance 5
 LBO Model

Is this a suitable candidate?

GMIF - Corporate Finance 6

 LBO Model

Step 2: Reviewing the financials

GMIF - Corporate Finance 7

Buy-out candidates

Suitable candidates Poor candidates

◼ Predictable cash flows ◼ Cash flow volatile to cyclical downturn
◼ Clean balance sheet with little debt ◼ High-tech companies
◼ Committed management ◼ Government regulated industries
◼ Mature product(s) ◼ Untried products
◼ Strong, secure market position ◼ Large turnaround risks
◼ Quality customers ◼ Environmental concerns
◼ No rapid technological change ◼ Pending litigation
◼ Low business risk
◼ Heavy asset base for loan collateral
◼ Divestible assets
◼ Potential for expense reduction or
efficiency improvements

GMIF - Corporate Finance 8

 Indax Historical P&L
Historical Financials

Actual Common Size

INCOME STATEMENT 2015 2016 2017 2015 2016 2017

Net Revenues 115.000,0 118.000,0 127.000,0 100,0% 100,0% 100,0%

Cost of Revenue 52.000,0 55.000,0 58.000,0 45,2% 46,6% 45,7%
Gross Profit 63.000,0 63.000,0 69.000,0 54,8% 53,4% 54,3%

Operating Expenses 35.000,0 36.000,0 37.000,0 30,4% 30,5% 29,1%

EBITDA 28.000,0 27.000,0 32.000,0 24,3% 22,9% 25,2%

Depreciation 5.000,0 5.500,0 6.000,0 4,3% 4,7% 4,7%

EBIT 23.000,0 21.500,0 26.000,0 20,0% 18,2% 20,5%

Interest Expense, Net 2.500,0 2.600,0 2.700,0 2,2% 2,2% 2,1%

Other Expense (Income) 0,0 0,0 0,0 0,0% 0,0% 0,0%

Profit Before Tax 20.500,0 18.900,0 23.300,0 17,8% 16,0% 18,3%

Income Tax 4.500,0 4.700,0 5.000,0 3,9% 4,0% 3,9%

Net Income 16.000,0 14.200,0 18.300,0 13,9% 12,0% 14,4%

EBITDA adjustments: € 2m per year.

Note: Numbers are made up for learning purposes.

GMIF - Corporate Finance 9
 Indax Historical Balance Sheet

Historical Financials

Actual Common Size

ASSETS 2015 2016 2017 2015 2016 2017

Cash 9.000,0 11.000,0 10.000,0 6,6% 7,5% 6,5%

Accounts Receivable 45.000,0 47.000,0 50.000,0 32,8% 32,1% 32,5%
Inventory 8.000,0 8.500,0 9.000,0 5,8% 5,8% 5,8%
Other Current Assets 0,0 0,0 0,0 0,0% 0,0% 0,0%
Total Current Assets 62.000,0 66.500,0 69.000,0 45,3% 45,4% 44,8%

Fixed Assets, Gross 70.000,0 75.000,0 80.000,0 51,1% 51,2% 51,9%

Accumulated Depreciation 0,0 0,0 0,0 0,0% 0,0% 0,0%
Fixed Assets, Net 70.000,0 75.000,0 80.000,0 51,1% 51,2% 51,9%

Other Assets 5.000,0 5.000,0 5.000,0 3,6% 3,4% 3,2%

Total Assets 137.000,0 146.500,0 154.000,0 100,0% 100,0% 100,0%

Note: Numbers are made up for learning purposes.

GMIF - Corporate Finance 10
 Indax Historical Balance Sheet

Historical Financials

Actual Common Size

ASSETS 2015 2016 2017 2015 2016 2017

LIABILITIES & EQUITY

Cash 9.000,0 11.000,0 10.000,0 6,6% 7,5% 6,5%
Accounts Receivable 45.000,0 47.000,0 50.000,0 32,8% 32,1% 32,5%
Accounts Payable
Inventory 25.000,0
8.000,0 27.000,0
8.500,0 29.000,0
9.000,0 18,2%
5,8% 18,4%
5,8% 18,8%
5,8%
Short-term
Other Debt
Current Assets 5.000,0
0,0 6.000,0
0,0 7.000,0
0,0 3,6%
0,0% 4,1%
0,0% 4,5%
0,0%
Other
Total Current Liabilities
Current Assets 6.000,0
62.000,0 5.000,0
66.500,0 6.000,0
69.000,0 4,4%
45,3% 3,4%
45,4% 3,9%
44,8%
Total Current Liabilities 36.000,0 38.000,0 42.000,0 26,3% 25,9% 27,3%
Fixed Assets, Gross 70.000,0 75.000,0 80.000,0 51,1% 51,2% 51,9%
Long-term Debt
Accumulated Depreciation 35.000,0
0,0 27.000,0
0,0 27.000,0
0,0 25,5%
0,0% 18,4%
0,0% 17,5%
0,0%
Fixed Assets, NetLiabilities
Other Long-term 5.000,0
70.000,0 5.000,0
75.000,0 5.000,0
80.000,0 3,6%
51,1% 3,4%
51,2% 3,2%
51,9%

TotalAssets
Other Liabilities 76.000,0
5.000,0 70.000,0
5.000,0 74.000,0
5.000,0 55,5%
3,6% 47,8%
3,4% 48,1%
3,2%

Common
Total Equity
Assets 35.000,0
137.000,0 35.000,0
146.500,0 35.000,0
154.000,0 25,5%
100,0% 23,9%
100,0% 22,7%
100,0%
Retained Earnings 26.000,0 41.500,0 45.000,0 19,0% 28,3% 29,2%
Total Equity 61.000,0 76.500,0 80.000,0 44,5% 52,2% 51,9%

Total Liabilities and Equity 137.000,0 146.500,0 154.000,0 100,0% 100,0% 100,0%

Note: Numbers are made up for learning purposes.

GMIF - Corporate Finance 11
 LBO Model

Is this a suitable candidate?

GMIF - Corporate Finance 12

 LBO Model

Step 3: Analyzing the accounts

GMIF - Corporate Finance 13

 Indax Historical Ratio Analysis
Historical Financials

Actual
RATIOS 2015 2016 2017

Revenue Growth N/A 2,6% 7,6%

Cost of Revenue / Net Revenues 45,2% 46,6% 45,7%
Gross Margin 54,8% 53,4% 54,3%
Operating Expenses / Net Revenues 30,4% 30,5% 29,1%
EBITDA Margin 24,3% 22,9% 25,2%
Depreciation / Net Revenues 4,3% 4,7% 4,7%
EBIT Margin 20,0% 18,2% 20,5%
Net Income Margin 13,9% 12,0% 14,4%

Quick Ratio 1,5 1,5 1,4

Current Ratio 1,7 1,8 1,6

Days Receivable (1) N/A 142,3 139,4

Days Inventory (2) N/A 54,8 55,1
Days Payable (2) N/A 172,5 176,2

Receivable Turnover (1) N/A 2,6 2,6

Inventory Turnover (2) N/A 6,7 6,6
Payables Turnover (2) N/A 2,1 2,1

(1) Based on Net Revenues

(2) Based on Cost of Revenue
Note: Numbers are made up for learning purposes.
GMIF - Corporate Finance 14
 LBO Model

Step 4: Assumptions for the financial projections

GMIF - Corporate Finance 15

 Indax: Assumptions
Assumptions

2015 2016 2017 2018 2019 2020 2021 2022

Revenue Growth N/A 2,6% 7,6% 0,0% 0,0% 0,0% 0,0% 0,0%
Cost of Revenue / Net Revenues 45,2% 46,6% 45,7% 0,0% 0,0% 0,0% 0,0% 0,0%
Gross Margin 54,8% 53,4% 54,3% 100,0% 100,0% 100,0% 100,0% 100,0%
Operating Expenses / Net Revenues 30,4% 30,5% 29,1% 0,0% 0,0% 0,0% 0,0% 0,0%
Depreciation / Net Revenues 4,3% 4,7% 4,7% 0,0% 0,0% 0,0% 0,0% 0,0%
Other Expense / Net Revenues 0,0% 0,0% 0,0% 0,0% 0,0% 0,0% 0,0% 0,0%

Days Receivable (1) N/A 142,3 139,4 0,0 0,0 0,0 0,0 0,0
Days Inventory (2) N/A 54,8 55,1 0,0 0,0 0,0 0,0 0,0
Days Payable (2) N/A 172,5 176,2 0,0 0,0 0,0 0,0 0,0

Other Current Assets / Net Revenues 0,0% 0,0% 0,0% 0,0% 0,0% 0,0% 0,0% 0,0%
Other Assets / Net Revenues 4,3% 4,2% 3,9% 0,0% 0,0% 0,0% 0,0% 0,0%
Short-term Debt / Net Revenues 4,3% 5,1% 5,5% 0,0% 0,0% 0,0% 0,0% 0,0%
Other Current Liabilities / Net Revenues 5,2% 4,2% 4,7% 0,0% 0,0% 0,0% 0,0% 0,0%
Other Long-term Liabilities / Net Revenues 4,3% 4,2% 3,9% 0,0% 0,0% 0,0% 0,0% 0,0%

Capital Expenditures / Net Revenues N/A 4,2% 3,9% 0,0% 0,0% 0,0% 0,0% 0,0%

(1) Based on Net Revenues

(2) Based on Cost of Revenue

Note: Numbers are made up for learning purposes.

GMIF - Corporate Finance 16
 LBO Model

Step 5: Balance Sheet Adjustments

GMIF - Corporate Finance 17

 Indax: Balance Sheet Adjustments

Balance Sheet Adjustments

Target Closing Financing Accounting Newco Opening

Balance Sheet Adjustments Adjustments Balance Sheet
ASSETS

Cash 10.000,0 0,0 0,0 10.000,0

Accounts Receivable 50.000,0 50.000,0
Inventory 9.000,0 9.000,0
Other Current Assets 0,0 0,0
Total Current Assets 69.000,0 0,0 0,0 69.000,0

Fixed Assets, Gross 80.000,0 80.000,0

Accumulated Depreciation 0,0 0,0
Fixed Assets, Net 80.000,0 0,0 0,0 80.000,0

Other Assets 5.000,0 5.000,0

Goodwill (80.000,0) (80.000,0)

Total Assets 154.000,0 0,0 (80.000,0) 74.000,0

Note: Numbers are made up for learning purposes.

GMIF - Corporate Finance 18
 Indax: Balance Sheet Adjustments

Balance Sheet Adjustments

Target Closing Financing Accounting Newco Opening

Balance Sheet Adjustments Adjustments Balance Sheet
ASSETS
LIABILITIES & EQUITY

Cash
Accounts Payable 10.000,0
29.000,0 275.000,0 (260.000,0) 25.000,0
29.000,0
Short-termReceivable
Accounts Debt 50.000,0
7.000,0 50.000,0
7.000,0
Inventory
Other Current Liabilities 9.000,0
6.000,0 9.000,0
6.000,0
Other
Total Current
Current Assets
Liabilities 0,0
42.000,0 0,0 0,0 0,0
42.000,0
Total Current Assets 69.000,0 275.000,0 (260.000,0) 84.000,0
Senior Debt 27.000,0 0,0 27.000,0
Fixed Assets,
Mezzanine DebtGross 80.000,0 0,0 80.000,0
0,0
Accumulated
Seller Note Depreciation 0,0 0,0 0,0
0,0
Fixed Long-term
Other Assets, Net
Liabilities 80.000,0
5.000,0 0,0 0,0 80.000,0
5.000,0

Other
Total Assets
Liabilities 5.000,0
74.000,0 0,0 0,0 5.000,0
74.000,0
Goodwill 180.000,0 180.000,0
Common Equity 35.000,0 0,0 (35.000,0) 0,0
Total Assets
Retained Earnings 154.000,0
45.000,0 275.000,0 (80.000,0)
(45.000,0) 349.000,0
0,0
Total Equity 80.000,0 0,0 (80.000,0) 0,0

Total Liabilities and Equity 154.000,0 0,0 (80.000,0) 74.000,0

Note: Numbers are made up for learning purposes.

GMIF - Corporate Finance 19
 LBO Model

Step 6: Setting a price and financial structuring

GMIF - Corporate Finance 20

 Indax buyout: Major Inputs
Major Inputs

Target
Company Name Indax Laboratories Inc.

Transaction ($000) Financing Amounts ($000)

Equity Purchase Price 0,0 PE Sponsor Equity 0,0
Transaction Costs 0,0 Seller Note 0,0
Working Capital Need 0,0 Mezzanine Debt 0,0
Senior Debt 0,0
Total 0,0 Total 0,0

Exit Valuation Interest Rates (%)

Exit EBITDA Multiple 0,0x Senior Debt Interest 0,00%
Multiple Increase/Decrease for Scenarios 0,0x Mezzanine Debt Interest 0,00%
Seller Note Interest 0,00%

Tax Rate Debt Maturity (Years)

Income Tax Rate 0,00% Senior Debt Maturity 0
Mezzanine Debt Maturity 0
Seller Note Maturity 0

Debt Amortization
Senior Debt Amortization Yes
Mezzanine Debt Amortization Yes
Seller Note Amortization Yes
Note: Numbers are made up for learning purposes.
GMIF - Corporate Finance 21
 Indax buyout: Major Inputs
Instructions Legend
* Input major inputs on Summary worksheet (all inputs in blue). Blue = Inpu
* Input company historical financial information on Historical Financials worksheet (all inputs in blue). Green = P
* Input assumptions for future periods on Assumptions worksheet (all inputs in blue). Black = Ca
* Optional assumptions on Projected Financials worksheet (all inputs in blue).
* Optional assumptions on Return Analysis worksheet (all inputs in blue).
* Model assumes 100% acquisition of target company.
* Model assumes most recent year-end balance sheet is closing balance sheet for transaction.
* Model assumes no step-up in asset values.
* Model assumes no amortization of goodwill from acquisition.
* Transaction amount (Uses of Funds) is expected to equal Financing Amounts (Sources of Funds).
* Debt amortization = "Yes" results in equal annual amortization.
* Debt amortization = "No" results in balloon repayment.
* Short-term debt is not amortized in model.
* Model assumes investment exit in 5th year following acquisition.

Legend
Blue = Inputs
Green = Primary Links
Black = Calculated Fields

Note: Numbers are made up for learning purposes.

GMIF - Corporate Finance 22
 Indax buyout: Major Inputs
Summary Summary

Transaction Summary Transaction Summary

Uses of Funds
Enterprise Value 34.000,0 Enterprise Value 34.000,0
Enterprise Value / Adjusted EBITDA 1,0x Enterprise Value /Price
Equity Purchase Adjusted EBITDA 0,0 1,0x
N/A
Senior Debt / Adjusted EBITDA 0,8x Senior Debt /Costs
Transaction Adjusted EBITDA 0,0 0,8x
N/A
Mezzanine Debt / Adjusted EBITDA 0,0x Mezzanine Debt / Adjusted EBITDA
Working Capital 0,0 0,0x
N/A
Total Uses of Funds 0,0 0,0%
Sources of Funds Sources of Funds
Check -
Senior Debt 0,0 N/A Senior Debt 0,0 N/A
Mezzanine Debt 0,0 N/A Mezzanine Debt Investment Return Summary0,0 N/A
Seller Note 0,0 N/A Seller
EquityNote
Exit Value 0,0 N/A
635.000,0
PE Sponsor Equity 0,0 N/A PE Sponsor
Total Equity Equity
IRR 0,0 N/A
N/A
PE Sponsor IRR N/A
Total Sources 0,0 0,0% Total Sources 0,0 0,0%
EBITDA Exit Multiple Total Equity IRR
Uses of Funds 0,0x Uses of Funds N/A
0,0x N/A
Equity Purchase Price 0,0 N/A Equity
0,0x Purchase Price 0,0 N/A
N/A
Transaction Costs 0,0 N/A Transaction Costs 0,0 N/A
Working Capital 0,0 N/A Working Capital 0,0 N/A
Total Uses of Funds 0,0 0,0% Total Uses of Funds 0,0 0,0%
Check - Check -

Investment Return Summary Investment Return Summary

Equity Exit Value 635.000,0 Equity Exit Value 635.000,0
Total Equity IRR N/A Total Equity IRR N/A
PE Sponsor IRR N/A PE Sponsor IRR N/A

Note:
EBITDANumbers are made up for learning purposes.
Exit Multiple Total Equity IRR EBITDA Exit Multiple Total Equity IRR
GMIF
0,0x
- Corporate Finance N/A 23 0,0x N/A
 LBO Model

Step 7: Financial projections

See “Projected Financials” sheet

GMIF - Corporate Finance 24

 LBO Model

Step 8: Check if the cash flows from operations

can honour the debt

See “Projected Financials” sheet

GMIF - Corporate Finance 25

 LBO Model

Step 9: Calculate your returns

See “Return Analysis” sheet

GMIF - Corporate Finance 26

 LBO Model

Step 10: Make your offer

GMIF - Corporate Finance 27

Thank you!
Any questions, please email me:
drubianes@faculty.ie.edu
GMIF - Corporate Finance 28