In this lesson, LBO Candidates - Criteria and How to Pick Them, you’ll learn what make an “ideal” leveraged buyout candidate, and how you can do a quick 1-2-minute financial screen of a company to see how suitable it would be for a leveraged buyout. http://breakingintowallstreet.com/ "Financial Modeling Training And Career Resources For Aspiring Investment Bankers" Table of Contents: 1:36 Criteria for Ideal LBO Candidates 6:48 Foot Locker – Analysis 10:07 Finish Line – Analysis 11:38 Burberry – Analysis 12:49 Michael Kors – Analysis 13:51 The Winner Lesson Outline: The criteria for leveraged buyout (LBO) candidates varies a bit depending on the private equity firm, but *in general* most firms seek the following qualities: • Financials: Low fixed costs, high(er) EBITDA margins, minimal debt, lots of excess cash, stable cash flows, and lower valuation multiples. • Industry: Fragmented, barriers to entry, leadership position, strong management team, lots of M&A; activity and/or IPOs so you can exit the investment. In terms of specific numbers, 2-3x Debt / EBITDA or less is ideal, since much of the IRR in an LBO comes from adding additional debt to the company’s capital structure and repaying it over time. If the company is already leveraged at 5-6x Debt / EBITDA, it’s tough to add any new debt and the PE firm will have to earn returns from other sources. EBITDA / Net Interest Expense should also ideally be above 2x so that the company has some additional cushion for higher interest expense resulting from more debt. The company’s margins should also be on the higher end for the industry you’re in: if the average EBITDA margin is 15%, don’t acquire a company with 5% margins. If you use Google Finance, you can use these criteria to rapidly judge each company in your set in 1-2 minutes. Foot Locker • Balance Sheet: ~$1000M of cash, and $132M of debt • EBITDA: ~$950M; 13% margin • Cash Flows: Grown steadily from ~$350M FCF to ~$500M FCF over 3 years • Valuation: 18x P / E multiple, 9.5x EV / EBITDA Foot Locker seems “decent”: very little debt, lots of excess cash, and good FCF generation and growth, though its valuation multiples seem a bit high. Finish Line • Balance Sheet: ~$100M of cash, and $0 of debt • EBITDA: ~$160M; 9% margin • Cash Flows: Fallen from ~$65M FCF to ~$14M FCF over 3 years • Valuation: 11x P / E multiple, 5x EV / EBITDA Finish Line is a worse candidate than Foot Locker because its excess cash and EBITDA margins are lower, and its FCF has actually declined in recent years. Burberry • Balance Sheet: ~$925M of cash, and ~$100M debt • EBITDA: ~$870M; 23% margin • Cash Flows: Increased from $371M FCF to $491M over 3 years • Valuation: 19x P / E multiple, 10x EV / EBITDA Burberry is better than both of the previous companies because it has even higher margins, it has also increased its cash flow significantly, and its valuation multiples are almost the same as Foot Locker’s. Michael Kors • Balance Sheet: ~$800M of cash, and $0 of debt • EBITDA: ~$1400M; 32% margin • Cash Flows: Increased from $27M FCF to $473M over 3 years • Valuation: 10x P / E multiple, 5x EV / EBITDA Michael Kors seems even better because it has about the same amount of excess cash, the highest EBITDA margins and best FCF growth, and amazingly it trades at the lowest multiples of any company in the set. The Clear Winner Michael Kors is the clear winner here because it has the highest margins, the lowest valuation multiples, the most excess cash, no debt, and the strongest FCF growth. The ranking would be: 1) Michael Kors 2) Burberry 3) Foot Locker 4) Finish Line. It’s also worth thinking about what might happen in a recession – there, the luxury retailers could be hurt far more than the mid-range/lower-end ones. RESOURCES: http://youtube-breakingintowallstreet-com.s3.amazonaws.com/109-10-LBO-Candidates-How-to-Pick.pdf

• published: 13 Oct 2015
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