Question

Currence Capitalization (Millions of USD) Currency Share Price Shares Outstanding USD $40.43 4553 184097.2 5500 111989 Market Capitalization - Cash & Short Term Investments + Total Debt + Pref. Equity + Total Minority Interest = Total Enterprise Value (TEV) 2520 293088.2 82726 Book Value of Common Equity + Pref. Equity + Total Minority Interest + Total Debt =Total Capital 2520 111989 197235

a) Given the data above, what is your guess for the value of the offer that an acquirer would have to make in order to buy Company Z?

b) If the deal is paid in cash, how much debt would the acquirer need for the deal?

c) How would you expect this deal to be financed?

d) Would an LBO (Leveraged Buy Out)deal be feasible in this case?

Answer 1

1) The value of the offer that an acquirer would have to make in order to buy Company would be 2,93,088.2 Million USD as the Enterprise Value reflects the true value of the Company,

2) In order to make it a deal in cash, the acquirer would require a debt of 2,93,088 - 1,11,989 = 1,81,099,

3) A leveraged buyout (LBO) is a type of acquisition whereby the cost of buying a company is financed primarily with borrowed funds or external capital. LBOs are often executed by private equity firms who raise the fund using various types of debt to get the deal completed

4) In order to determine if LBO is feasible in this case, following factors need to be considered:

• Mature industry and/or company: If the stock price of the target company is trading at a lower multiple to free cash flow than new companies in high-growth industries. It would enable the LBO purchaser to buy the company at a relatively low cost compared to the annual cash flow it produces; this cash flow will be a key ingredient in generating an attractive return for the investors.
• Clean balance sheet with no or low amount of outstanding debt: Buyers need the ability to be able to use new debt, or “leverage” as the name suggests, as part of the acquisition consideration. Companies with high levels of pre-existing debt limit the amount of new debt that it can withstand, and new debt is crucial for the LBO. (Note that if a company has existing debt, that existing debt will often need to be refinanced in an LBO, because the financial sponsor will need to remove pre-existing financial covenants and limitations to fit the new capital structure.)
• Strong management team and potential business improvement measures: Management is capable of running the company effectively, and capable of creating a more efficient company (lower costs) or expanding into new profitable markets or products.
• Strong competitive advantages and market position: It is ideal if the company is in a good position within its market space (relative to current and potential competitors)—this will help shield the company from competitive pressures that might reduce profit margins (and therefore cash flows) and will help provide possible growth opportunities for the business.
• Steady cash flows: Stable, recurring cash flows are necessary, as that cash flow is needed every year to service the large debt burden for the LBO (especially in the first several years post-acquisition). Cyclical or highly seasonal companies, therefore, can run into trouble quickly if a downturn occurs. Debt pay-down is also important in that it increases the equity/total assets ratio of the company, boosting investor returns.
• Low future capital expenditure and working capital requirements: Part of the return LBO investors seek will be generated from growing the business, and growth costs cash in the short-term: growth must be used to finance new capital expenditures and new working capital requirements for the business. Therefore businesses that have relatively high capital expenditure and working capital requirements will be less attractive for an LBO.
• Possible sale of underperforming/non-core assets: Some companies that are purchased via LBO will have divisions or side businesses that are performing weakly or are a distraction to management. Often, these businesses can be sold to raise cash to pay off outstanding debt that is used in the purchase of the company. Note that these assets should not represent a significant portion of the company’s current cash flow: selling the business means losing that future cash flow, and cash flow is needed to pay off debt and interest.
• Feasible exit options: Once the business has been improved and some of the debt used to purchase the business has been paid off, an LBO investor would generally like to exit—that is, sell—the company fairly quickly (a typical timeframe is 3-5 years after purchase). Holding the company beyond the optimal selling point will reduce the expected annual return on the investment, because leverage decreases every year. Therefore an analyst considering an LBO opportunity might want to consider how the company can be sold (typically via strategic sale to another company, an Initial Public Offering, or sale to another LBO investor). Any historical LBO, M&A, or IPO precedents in the LBO candidate’s industry might give an indicator as to how easily the company can be sold when it is ready for sale.