CU-Sem VI-Investment Banking

["a. Synergies b. Stock Sale c. Asset Sale d. Goodwill 2. Goodwill =_________________ \u2013 Net Identifiable Assets. a. Higher price b. Lower Price c. Discount Price d. Purchase Price 4. Asset sales are pretty straightforward when it comes to ______________ a. actual price b. taxes c. discount price d. Depreciation 5. ___________ are assets that are not physical in nature. a. Goodwill b. patent c. Tangibles d. Intangibles Answers\u2019 1-a, 2-a , 3-d,4-b, 5-d 151","11.6 SUGGESTED READING AND E- RESOURCES \uf0b7 PunithavathyPandian, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, Vikas Publications Pvt. Ltd, New Delhi. 2001. \uf0b7 Kevin.S, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, PHI, Delhi, 2011 \uf0b7 YogeshMaheswari, INVESTMENT MANAGEMENT, PHI, Delhi, 2011 \uf0b7 Bhalla V K, INVESTMENT MANAGEMENT: SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, S Chand, New Delhi, 2009 \uf0b7 Prasanna Chandra, PORTFOLIO MANAGEMET, Tata McGraw Hill, New Delhi, 2008. 152","UNIT \u2013 12 INVESTMENT BANKERS 12.0Unit Objective 12.1Introduction 12.2 Concept of Investment Bankers 12.3Role of investment bankers in M&A. 12.4Summary 12.5Keywords 12.6 Learning Activity 12.7Unit end questions 12.8Suggested Reading and E- Resources 12.0 UNIT OBJECTIVES \uf0b7 To understand the concept of Investment Bankers \uf0b7 To explain the role of investment bankers in M&A. 12.1 INTRODUCTION A person who frequently works for a financial institution and is primarily concerned with generating funds for corporations, governments, or other organisations is known as an investment banker. Investment banks such as Goldman Sachs (GS), Morgan Stanley (MS), JPMorgan Chase (JPM), and Deutsche Bank employ investment bankers as well (DB). An investment banker will support large, sophisticated financial transactions whether they are related to the business or not. These can entail putting together a deal for an acquisition, merger, or sale to a business or client party. Another crucial activity is the issuance of shares as a form of capital raising. It entails creating thorough Securities and Exchange Commission (SEC) documentation, which are necessary for a company to go public. By identifying potential hazards before a company moves forward, an investment banker can help a client save time and money. In theory, the investment banker is a specialist in his 153","profession who keeps a finger on the pulse of the present investment environment.Investment bankers are frequently consulted by businesses and non-profit organisations for guidance on the best ways to finance their expansion.A banker that specialises in investments can also assist with regulatory compliance and pricing financial products. An investment bank may occasionally directly purchase all or a significant portion of the stock in a company during its Initial Public Offering (IPO), acting as an intermediary.In this case, the investment bank will then act on behalf of the company going public and sell the company's shares to the public market, creating immediate liquidity. 12.2 CONCEPT OF INVESTMENT BANKERS Companies frequently seek the guidance of investment experts when looking to raise capital. Due to their assistance in helping businesses raise cash, investment banks play a crucial role in the financial sector. The career of an investment banker may be a good fit for you if you're interested in counselling businesses on their financial dealings. What an investment banker does and the benefits and drawbacks of this financial position are covered in this article. Investment bankers are financial professionals who help institutional clients with activities like mergers and acquisitions and capital raising by drawing on their expertise in the financial services industry, analytical skills, and persuasive communication abilities. A wide range of clients, including start-up firms, well-established corporations, and in some cases even governments, are served by investment bankers' corporate financing services. Whether they work for an investment bank or the investment banking division of a firm, they are significant contributors to the financial growth and development of a company, organisation, or other corporate entity. Entry-level investment bankers and high-level executive vice presidents are both included in the broad definition of \\\"investment banker.\\\". Pro of investment banker Working as an investment banker has many advantages for people considering their career options. When determining whether to pursue this position, keep the following benefits in mind: 1. High potential for income 154","With an average annual compensation of $66,493 for investment bankers, a career in the financial sector has the potential to be financially rewarding. Successful investment bankers can make substantial commissions in addition to hefty base pay. For professionals that value their ability to generate money when choosing a career route, this can make investment banking a potentially alluring job option. 1. Valuable benefits packages Your benefits package is another area where the pay in this profession might be attractive. Investment bankers frequently receive large perk packages in addition to high pay. This professional path may be interesting due to compensation like commission and bonus potential, insurance coverage, and stock options. 2. Working with driven peers Your contemporaries are probably working just as hard as you to succeed in the competitive field of investment banking. The position calls for intellect and analytical skills, and coworkers and clients might need to perform well to stay competitive. Working with other motivated individuals may help to challenge you to keep learning and give you competent coworkers when you need assistance. 3. Powerful networking Senior executives at the organisations that investment bankers deal with and analyse frequently contact with them. This offers the chance to establish personal and business ties with these powerful individuals. This can help you in your job by providing a networking opportunity. Members of your network could help you uncover new career chances, act as references for you when you apply for a job you've found or ask for a promotion. 4. Continued development Investment banking is a discipline that is continuously evolving since the markets that investment bankers study in the course of their work, as well as many businesses you may study, are continually changing. This implies that while the knowledge and skills you acquire early in your career may still be crucial, you may also discover that you need to acquire new ones in order to keep up with advancements in your area. Investment banking offers the chance 155","tocontinuously advance your knowledge and abilities in order to keep up with developments in the business sector, making it a fantastic career option. Cons of being an investment banker It's beneficial to think about the potential disadvantages of a job in investment banking, as well as strategies for lessening their influence, in order to make an informed career selection. Among the drawbacks of the work are: 1. Extended hours of employment A significant time commitment may be necessary to work as an investment banker. This might take the form of regular working hours that go beyond the standard 40-hour workweek, including working weekends and extra-long shifts during the week. Extended hours can also help investment bankers earn a high pay, offering a financial trade-off for the higher work requirements, even though this can be difficult for professionals in the sector. 2. Increased availability In addition to regular working hours, an employer or client may anticipate that an investment banker will be accessible on call during irregular working hours. This could be handling calls and emails, sending emails, answering questions, or conducting research on a subject. In these circumstances, being accessible to your employer or client can help you give them better service. This might help you make a better first impression, enhance your professional possibilities, and increase your earning power. 3. High competition levels Investment banking may be a very competitive industry due to the high pay available within the sector and the competitive nature of investments. Due to the rivalry, these professionals may experience heightened pressure to perform at a high level and find it challenging to seek out peer assistance or counsel. Being able to perform well under pressure is advantageous when working as an investment banker. Developing close bonds with your peers can provide you an advantage since they can connect you to resources that can help you achieve. 4. Highly repetitive work 156","A lot of the work an investment banker does might be rather repetitious. For instance, each organisation may respond differently to research and report-writing about them. However, the actions an investment banker takes to do this are probably the same regardless of the company. This could be a disadvantage if you like your job to be dynamic when thinking about this career. However, if you value consistency in your work, you might find the repetitive chores appealing. 12.3 ROLE OF INVESTMENT BANKERS IN M&A Depending on whether an investment bank (\\\"sell-side\\\") is representing a company's seller or providing advice to a potential buyer, the functions of the bank will change (\\\"buy-side\\\"). The obligations of the investment bank on a sell-side engagement include: \uf0b7 Keeping an eye on industry M&A trends to help our clients plan their timing and go-to- market strategies and to set expectations for valuation. \uf0b7 Using our understanding of the client's business to develop a collection of key points that constitute a convincing investment thesis, and then putting together marketing materials like the \\\"Information Memorandum\\\" to communicate these ideas. \uf0b7 Setting up an online diligence \\\"data room\\\" and acting as the main point of contact between the buyer (and\/or its advisors) and seller during due diligence. \uf0b7 Setting up an online diligence \\\"data room\\\" and acting as the main point of contact between the buyer (and\/or its advisors) and seller during due diligence. \uf0b7 Locating and contacting potential buyers, managing information flow, and holding strategic discussions with interested parties. \uf0b7 Establishing a formal bid process for the business, reviewing bids, and assisting in the selection of a buyer.Helping negotiate the final terms of the deal \uf0b7 The investment bank's duties on a buy-side engagement include: \uf0b7 Assessing the possible target and its sector to determine a rough valuation \uf0b7 Evaluating a potential target's strategic fit with the client; locating and, to the extent possible, quantifying synergy prospects \uf0b7 Formulating a bid strategy and assisting with the creation of proposed purchase conditions; 157","\uf0b7 Spotting any problems during the diligence phase and taking appropriate action;Analyzing the buyer's capital structure to determine the correct transaction financing; helping the buyer find financing. \uf0b7 Assisting in negotiating the agreement's final terms Insofar as positioning the company for potential investors, creating marketing collateral, engaging investors, and arriving at a fair value are concerned, the investment bank's duties in an IPO are quite similar to those in a sell-side M&A transaction. However, there are multiple buyers rather than just one, so management holds a \\\"road show\\\" where it meets and addresses a number of prospective investors.An IPO does not involve the extensive buyer-seller negotiations typical of an M&A deal. The shares must be distributed through the sales desk of the bank as an additional step before they can join the market. To complete the real sales and distribution phase of the IPO process, IPO applicants frequently enlist more than one bank, leveraging more investor ties. 12.4 SUMMARY \uf0b7 Investment bankers are financial professionals who help institutional clients with activities like mergers and acquisitions and capital raising by drawing on their expertise in the financial services industry, analytical skills, and persuasive communication abilities. \uf0b7 Entry-level investment bankers and high-level executive vice presidents are both included in the broad definition of \\\"investment banker.\\\". \uf0b7 Investment bankers frequently receive large perk packages in addition to high pay. \uf0b7 Investment banking is a discipline that is continuously evolving since the markets that investment bankers\u2019 study in the course of their work. \uf0b7 Investment banking may be a very competitive industry due to the high pay available within the sector and the competitive nature of investments. 12.5 KEYWORDS \uf0b7 Memorandum - To convey information of immediate importance to individuals inside a company or organisation, a memo (memo) is utilised. 158","\uf0b7 Buy side engagement - When an investment banker or M&A advisor collaborates with a buyer to find a potential acquisition target, this is known as a \\\"buy side engagement.\\\" \uf0b7 Initial public offering - A private firm can go public through an initial public offering by selling its stocks to the general public. A company that decides to list on an exchange and subsequently become public could be brand-new, young, or elderly. \uf0b7 Investment banker - An investment banker is an individual who often works as part of a financial institution and is primarily concerned with raising capital for corporations. \uf0b7 Appealing - attractive or interesting. 12.6 LEARNING ACIVITY 1. Explain the concept \u201cInvestment banking is a discipline.\u201d 2. Mention any 3obligations of the investment bank on a sell-side engagement. 12.7 UNIT END QUESTIONS A. Short questions 1. What do you mean byInvestment banker? 2. HowHigh potential for income is work in investment banker? 3. Discuss the term buy side. 4. IsIPO involving the extensive buyer-seller negotiations typical of an M&A deal? 5. Describe the term sell-side. Long questions 159","1. Write in detail Investment banker. 2. What are the advantage of investment banker? 3. What is the Role of investment bankers in M&A? 4. What is the different between dell side and buy side? 5. Explain the disadvantage of investment banker Multiple choice questions 1. _______________ could be handling calls and emails, sending emails, answering questions, or conducting research on a subject. a. High competition levels b. Increased availability c. Decreased availability d. Highly repetitive work 2. A lot of the work an investment banker does might be rather ______________ a. incomplete b. interesting c. varied d. repetitious 3.Setting up an online diligence \\\"_______________\\\" and acting as the main point of contact between the buyer and seller during due diligence. a. data room b. private room c. meeting room d. personal data 160","4. _______________- are financial professionals who help institutional clients with activities like mergers and acquisitions. a. Public bankers b. Private bankers c. Investment bankers d. Government bankers 5._____________ is representing a company's seller or providing advice to a potential buyer. a. debit side b. buy side c. sell side d. credit side Answers\u2019 1-b, 2-d ,3-a ,4-c ,5-c 12.7 SUGGESTED READING AND E- RESOURCES \uf0b7 PunithavathyPandian, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, Vikas Publications Pvt. Ltd, New Delhi. 2001. \uf0b7 Kevin.S, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, PHI, Delhi, 2011 \uf0b7 YogeshMaheswari, INVESTMENT MANAGEMENT, PHI, Delhi, 2011 \uf0b7 Bhalla V K, INVESTMENT MANAGEMENT: SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, S Chand, New Delhi, 2009 \uf0b7 Prasanna Chandra, PORTFOLIO MANAGEMET, Tata McGraw Hill, New Delhi, 2008. 161","UNIT - 13 LEVERAGED 13.0Unit Objective 13.1Introduction 13.2Leveraged Buyouts 13.3Key participants in Leveraged 13.4Characteristics of Leveraged 13.5Summary 13.6Keywords 13.7Unit end questions 13.8Suggested Reading and E- Resources 13.0 LEARNIG OBJECTIVES \uf0b7 To understand the meaning of Leveraged Buyouts \uf0b7 To discuss Key participants in Leveraged \uf0b7 To explain the characteristics of Leveraged 13.1 INTRODUCTION The act of purchasing another firm using funds from outside sources, such as loans and\/or bonds, as opposed to using corporate earnings, is known as a leveraged buyout, or LBO. In some cases, the assets of the business being acquired are also utilised as loan collateral (rather than, or in addition to, assets of the company doing the acquiring).It's known as a \\\"hostile takeover\\\" when the companies being bought are opposed to the deal. The leveraged buyout (LBO) research is to ascertain the potential price that a financial buyer might be willing to pay for a target. The highest price that could be paid for a company with financing available in the present debt markets and still provide a financial buyer with a reasonable return can be determined using this technique. 13.2 CONCEPT OF LEVERAGED BUYOUTS Corporate purchases cost a lot of money to carry out. In a leveraged buyout, the buyer only contributes a tiny amount of the necessary money; the remaining amount is made up of loans. It 162","can be useful to comprehend how a leveraged buyout can be successful if you work in corporate finance or are considering doing so. Leveraged buyouts are defined in this article, along with how, why, and when businesses employ them. We also give an example to assist you better grasp what they are. An LBO, or leveraged buyout, is an example of employing leverage to acquire a business. Leverage in business terminology refers to borrowed funds, such a bank loan. In an LBO, leverage accounts for about 90% of the purchase price. In addition to using their own assets or the assets of the purchased company as collateral, the buyer typically covers the remaining debt with their own equity. Consider, for illustration, that you acquire a business with a $2.5 million annual net income. You pay $15 million for it, with $5 million of your own money and $10 million in loans. You owe the lender $1 million a year because the interest on the loan is 10%. Because the company's net income is $2.5 million, you can anticipate an after-tax return of 20% in the first year and a total return of 100% in five years. However, you must sell the collateral assets if you are hit by a recession and are unable to satisfy the debt obligations. What are the Steps in a Leveraged Buyout (LBO)? Building a separate financial model for the operating firm is the first step in the LBO investigation. This entails creating a projection that is, on average, five years in the future and figuring out a terminal value for the last period. In order to maximise the returns on equity, the research will be presented to banks and other lenders in an effort to secure as much debt as possible. The model is updated and the final terms of the agreement are implemented once the amount and rate of debt financing have been established. After the sale closes, the job has only just begun because the PE firm and management must increase the top line, cut costs, pay down debt, and finally realise the value of the business. Steps in a Leveraged Buyout: 1. Build a financial forecast for the target company 2. Link the three financial statements and calculate the free cash flow of the business 163","3. Create the interest and debt schedules 4. Model the credit metrics to see how much leverage the transaction can handle 5. Calculate the free cash flow to the Sponsor (typically a private equity firm) 6. Determine the Internal Rate of Return (IRR) for the Sponsor 7. Perform sensitivity analysis 13.3 KEY PARTICIPANTS OF LEVERAGES BUYOUTS LBOs are an acquisition strategy that enables a company to acquire ownership of a business with the least amount of personal capital outlay and the greatest likelihood of profit. To be more precise, employing the least amount of their own stock possible enables higher profitability and a higher anticipated yearly growth rate from an investment. LBOs also raise risk, especially if the buyer utilises the assets of the acquired company as security. The purchased business might file for bankruptcy if the buyer is unable to pay the loan. Before starting an LBO, the buying company must assess their financial situation to make sure they can handle the risk involved in taking on significant debt. There are various ways to finance an LBO: Private equity companies: A private equity firm is an investing corporation that makes investments using either its own money or money that it borrows from investors. They typically want a high rate of return or may desire management control over the purchased business. Banks: Bank loans are an option for both the buyer and the private equity firm. Banks employ a revolving credit line, which the borrower repays and may use once more as necessary. Subordinated debt It is a means to get a loan without putting up any security. The lender may take over a portion of the property in proportion to the loan balance if the borrower is unable to make payments on the debt. Bonds: 164","With a bond, the borrower obtains funding from a shareholder for a predetermined period of time. Until the bond matures or expires, the investor receives interest on the loan. The purchasing organisation must also locate a target business. Some businesses don't lend themselves to an LBO because they pose too much risk. The company you want to buy should ideally be reliable and able to benefit the company doing the buying. For instance, a competitor or the manufacturer of a necessary ingredient may be the best candidate for acquisition if the buyer is a cosmetics firm. These options can aid in vertical or horizontal integration. 13.4 CHARACTERISTICS OF LEVERAGES BUYOUTS \uf0b7 Strong free cash flow (FCF) generation is essential for the company to be able to adequately meet all debt obligations and reinvest in growth plans\u2014as well as raising enough financing from debt lenders at advantageous terms\u2014given the significant debt burden placed on the post-LBO company's capital structure. \uf0b7 Recurring Revenue: If revenue is recurring, the company's cash flows are more predictable, which directly raises a borrower's loan limit and suggests a lower risk of default for the business, such as with multi-year client contracts and planned product\/service customer orders. \uf0b7 \\\"Economic Moat\\\": Businesses with a \\\"moat\\\" have a differentiator that has the potential to develop a long- term competitive edge, allowing them to maintain their current market share and safeguard their profit margins from outside threats (i.e. barrier against competition). \uf0b7 Favorable unit economics and an effective cost structure, which may be enhanced by following operational best practises and taking advantage of economies of scale, result in a constant, industry-leading margin profile (and scope). \uf0b7 Minimal CapEx and Working Capital Needs: When there are fewer capital expenditures (CapEx) requirements and fewer working capital needs (i.e., when there is less cash invested in operations), there are more free cash flows (FCFs), which can be used to pay down debt principal and service interest payments, both required and optional. \uf0b7 Operational Improvements: 165","Upon acquiring a majority ownership in the post-LBO company, sponsors work with management right away to streamline the business model and increase operational efficiency by eliminating redundancies and saving costs. \uf0b7 Strategic Value-Add Opportunities: PE firms frequently target companies that are performing well, but there are opportunities that could unlock significant value, such as expansion into adjacent markets, adoption of alternative pricing strategies, and improvement of weak marketing and sales teams, that are not being pursued. \uf0b7 Asset Sales \/ Divestitures: If the target holds assets or a business division that is out of sync with its core business model or doing poorly, the PE firm may divest the assets in order to use the sale proceeds to fund operations or pay off debt.Low Purchase Multiple (Undervalued): Businesses in industries that have lost market favour or that have been negatively impacted by transient macro conditions or short-term headwinds may be underpriced; however, these opportunities are becoming increasingly rare due to the influx of capital into the private markets and high competition in sale processes, particularly auction-based sales with strategic acquirers on the buyer list. \u2022 \\\"Buy-and-Build\\\": An alternative to paying less for a business is to purchase smaller firms, or \\\"add-ons,\\\" which may increase the sale price through increased scale, diversified revenue sources, etc. This increases the likelihood of multiple expansion (exiting at a higher exit multiple than the entry multiple). 13.5 SUMMARY \uf0b7 The act of purchasing another firm using funds from outside sources, such as loans and\/or bonds, as opposed to using corporate earnings, is known as a leveraged buyout, or LBO. \uf0b7 In a leveraged buyout, the buyer only contributes a tiny amount of the necessary money; the remaining amount is made up of loans. \uf0b7 Leverage in business terminology refers to borrowed funds, such a bank loan. \uf0b7 LBOs are an acquisition strategy that enables a company to acquire ownership of a business with the least amount of personal capital outlay and the greatest likelihood of profit. 166","\uf0b7 An alternative to paying less for a business is to purchase smaller firms, or \\\"add-ons,\\\" which may increase the sale price through increased scale, diversified revenue sources, etc. 13.6 KEYWORDS \uf0b7 Bank Debt - A company incurs a long-term burden known as bank debt when it borrows money from its bank. \uf0b7 Finance metrics - Key performance indicators (KPIs) for finances are measurements that businesses use to monitor, assess, and evaluate their financial well-being. \uf0b7 Leveraged buyout: A leveraged buyout (LBO) is the acquisition of another company using a significant amount of borrowed money (bonds or loans) to meet the cost of acquisition. \uf0b7 Credit metrics: Credit Metrics, is based on the analysis of credit migration, i.e., the probability of moving from one credit quality to another, including default, within a given time horizon. \uf0b7 Private equity firm: A private-equity firm is an investment management company that provides financial backing and makes investments in the private equity of start-up or operating companies through a variety of loosely affiliated investment strategies including leveraged buyout, venture capital, and growth capital. 13.7LEARNING ACIVITY 1. What do you mean by Internal Rate of Return? 2. Explain the meaning of financial risk. 167","13.8 Unit end questions A. Short questions 1. What do you mean by Leveraged? 2. Explain the concept of Leveraged Buyouts 3. Name the participants of Leverages Buyouts, 4. What is theEconomic Moat? 5. Describe the feature Buy-and-Build Long questions 1. Explain Private equity companies. 2. What are the Key participants of Leverages Buyouts? 3. Explain are the Characteristics of Leverages Buyouts. 4. Explain Asset Sales \/ Divestitures in Leverages Buyouts. 5. What are the important of Leverages Buyouts? B. Multiple choice questions 1.___________debt is a means to get a loan without putting up any security. a. secured b. unsecured c. Bad d. Subordinated 2.A _____________firm is an investing corporation that makes investments using either its own money or money that it borrows from investors. a. private equity b. bonds 168","c. preference d. debenture 3. __________________ the buyer only contributes a tiny amount of the necessary money; the remaining amount is made up of loans. a. FCF b. leveraged buyout c. Investment banking d. Mergers and Acquisitions 4. FCF stands for ______________ a. financial cash flow b. fixed cash flow c. free cash flow d. favorable cash flow 5. ______________are an option for both the buyer and the private equity firm. a. Bonds b. Bank loans c. Private equity d. FCF Answers\u2019 1-d, 2-a ,3-b ,4-c ,5-b 13.9 SUGGESTED READING AND E- RESOURCES \uf0b7 PunithavathyPandian, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, Vikas Publications Pvt. Ltd, New Delhi. 2001. 169","\uf0b7 Kevin.S, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, PHI, Delhi, 2011 \uf0b7 YogeshMaheswari, INVESTMENT MANAGEMENT, PHI, Delhi, 2011 \uf0b7 Bhalla V K, INVESTMENT MANAGEMENT: SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, S Chand, New Delhi, 2009 \uf0b7 Prasanna Chandra, PORTFOLIO MANAGEMET, Tata McGraw Hill, New Delhi, 2008. 170","UNIT \u2013 14 LBO analysis 14.0Unit Objective 14.1Introduction 14.2LBO analysis 14.3Assessing financial structure, 14.4Investment returns and valuation 14.5Summary 14.6Keywords 14.7Unit end questions 14.8Suggested Reading and E- Resources 14.0 LEARNIG OBJECTIVES \uf0b7 To discuss LBO analysis \uf0b7 To analyses Assessing financial structure \uf0b7 To understand Investment returns and valuation 14.1 INTRODUCTION The leveraged buyout (LBO) research is to ascertain the potential price that a financial buyer might be willing to pay for a target. The highest price that could be paid for a company with financing available in the present debt markets and still provide a financial buyer with a reasonable return can be determined using this technique. The following factors will essentially determine the greatest acquisition price that can be justified in an LBO: \uf0b7 the existing and anticipated free cash flows of the target company; \uf0b7 the hurdle rate necessary for equity investors; and \uf0b7 the terms of the loan, including the interest rate and any covenants imposed by the bank. 171","14.2 CONCEPT OF LBO ANALYSIS A financial tool called an LBO model is often created in Excel to assess a leveraged buyout (LBO) deal, which is the purchase of a business that is financed with a sizable amount of debt. The assets of the purchasing firm and the target company are both utilised as security for the financing. Typically, the buyer wants to contribute the least amount of equity and pay the remaining balance of the acquisition price using debt or other non-equity sources. The LBO model aims to give investors the tools they need to evaluate the transaction correctly and generate the highest potential risk-adjusted internal rate of return (IRR). The investing business or buyer's objective in an LBO is to maximise potential returns while generating high returns on their equity investment. The purchasing company calculates the projected internal rate of return (IRR), where the minimum is commonly regarded as 30% and above, to decide whether an investment is worthwhile to pursue. When the economy is adverse or for larger deals, the IRR rate may occasionally be as low as 20%. Since debt often accounts for 50\u201390% of the purchase price after the acquisition, the debt\/equity ratio is typically higher than 1-2x. The remaining debt is settled using the company's cash flow. 14.3 ASSESSING FINANCIAL STRUCTURE In a leveraged buyout, the investors (private equity or LBO Firm) create a new entity to be used in the acquisition of the target business. Following a buyout, the target either becomes a subsidiary of the new business or the two organisations combine to establish a single business. Capital Structure in the Model of an LBO In a leveraged buyout (LBO), capital structure refers to the various sources of funding that are utilised to acquire a target company. Although each LBO is structured differently, the capital structure is usually similar in most newly-purchased companies, with the largest percentage of LBO financing being debt. In a normal capital structure, the cheapest and lowest-risk financing is used initially, followed by other viable possibilities. A capital structure for an LBO might contain the following: 172","Bank Debt In a leveraged buyout, bank debt, also known as senior debt, makes up 50% to 80% of the capital structure and is the least expensive financing option utilised to acquire the target firm. Investors prefer it the most since it offers a cheaper interest rate than other forms of financing. However, bank debts have restrictions and covenants that prevent a business from issuing dividends to shareholders, obtaining more bank debt, and purchasing other businesses while the debt is in effect. Bank loans often have a 5-to-10-year payback period. Bank debts are paid off first in the event of a corporate liquidation before all debts have been settled. Subordinated debt and high yield debt High yield debt often has an unsecured nature and a high interest rate to make up for the investors' financial risk. They have less stringent restrictions or covenants than bank debts do. In the case of a liquidation, high yield debt is paid out after the bank debt but before equity holders. The public debt market or the private institutional market may be used to raise the debt. The normal payback time is 8 to 10 years, with options for early and bullet repayment. Mezzanine Debt Mezzanine debt, which is a combination of debt and equity and is junior or subordinate to other debt financing choices, is a modest middle tier of the LBO capital structure. In comparison to bank debt and high-yield debt, it has a higher interest rate and is frequently financed by hedge funds and private equity investors. Mezzanine financing increases investor returns in line with the risk involved by taking the form of high yield debt with an option to buy a stock at a particular price in the future. Similar to high yield loans, it permits early repayment alternatives and bullet payments. Mezzanine debt is settled during a liquidation after all other obligations have been paid, but before equity stockholders are compensated. Equity Depending on the arrangement, 20\u201330% of LBO financing is made up of equity. Due to the risk involved, it fetches a high interest rate and serves as the private equity fund's capital. The equity 173","stockholders are compensated last in a liquidation, after all debts have been paid. Equity shareholders may not see a return on their money if the company fails to make payments. Finance Metrics Making ensuring the credit metrics and debt covenants are appropriate for the deal is one of the cornerstones to developing an LBO model. 14.4 Investment returns and valuation In private equity investments, an LBO Returns Attribution Analysis measures the contribution made by each of the major value creators.There are three primary components that make up the framework for measuring the sources of value generation from a leveraged buyout (LBO) transaction: 1. EBITDA Growth \u2192 Change in Initial EBITDA to Exit Year EBITDA 2. Multiple Expansion \u2192 Change in Purchase Multiple to Exit Multiple 3. Debt Paydown \u2192 Change in Initial Net Debt to Ending Net Debt EBITDA Growth Strong revenue (\\\"top line\\\") growth and operational enhancements that favourably impact a company's profit profile can both contribute to EBITDA growth (e.g. cost-cutting, raising prices). Multiple Expansion Private equity firm serving as the financial sponsor aims to sell the investment at a higher exit multiple than the buy multiple. Positive macroeconomic conditions, enhanced investor perception of a particular industry or specific trends, and advantageous transaction dynamics, such as a competitive auction headed by strategic bidders, can all increase the exit multiple. Debt Paydown Deleveraging is the process of gradually reducing net debt throughout the holding period (net debt is total debt less cash). As more debt principal is retired using the acquired LBO target's free 174","cash flows, the sponsor's equity gains value as the company's net debt carrying balance decreases (FCFs). 14.4 SUMMARY \uf0b7 The LBO model aims to give investors the tools they need to evaluate the transaction correctly and generate the highest potential risk-adjusted internal rate of return (IRR). \uf0b7 High yield debt often has an unsecured nature and a high interest rate to make up for the investors' financial risk. \uf0b7 Strong free cash flow (FCF) generation is essential for the company to be able to adequately meet all debt obligations and reinvest in growth plans. \uf0b7 High yield debt often has an unsecured nature and a high interest rate to make up for the investors' financial risk. \uf0b7 The equity stockholders are compensated last in a liquidation, after all debts have been paid. \uf0b7 Private equity firm serving as the financial sponsor aims to sell the investment at a higher exit multiple than the buy multiple. 14.5 KEYWORDS \uf0b7 EBITDA \u2013 It stands for Earnings Before Interest, Taxes, Depreciation, and Amortization. EBITDA measures the company's overall financial performance. It is often used as an alternative to other metrics, including earnings, revenue, and income. \uf0b7 Debt paydown - A paydown is a reduction in the loan or other debt's principal balance. Companies pay down their debt by issuing a fresh round of debt that is less than the old round that has matured. \uf0b7 Subordinated debt - Any debt that follows or is lower than senior debt is referred to as subordinated debt. Subordinated debt does, however, take precedence over preferred and common stock. \uf0b7 Deleveraging: Deleveraging is when a company or individual attempts to decrease its total financial leverage. \uf0b7 Initial Net Debt: To calculate net debt, we must first total all debt and total all cash and cash equivalents. Next, we subtract the total cash or liquid assets from the total debt amount. 175","14.6 LEARNING ACTIVITY 1. What does LBO model aim at? ---------------------------------------------------------------------------------------------------------------- --------------------------------------------------------------------------------------------------------------- 2. What is EBITDA? ------------------------------------------------------------------------------------------------------------ ------------------------------------------------------------------------------------------------------------ 14.7 UNIT END QUESTIONS Short questions 1. 1.What is Bad debts? 2. 2.Write note on Mezzanine Debt. 3. Explain difference between EBITDA Growth and Debt Paydown. 4. Explain LBO Returns Attribution Analysis. 5. Discuss Capital Structure in the Model of an LBO. Long questions 1. What is the LBO analysis? 2. Describe the Assessing financial structure in LBO. 3. Explain Investment returns and valuation. 4. Discuss three primary components framework for measuring the sources of value generation from a leveraged buyout. 5. Analyse the difference between Mezzanine Debt and Bank Debt. B. Multiple choice questions 1. \u2026\u2026\u2026\u2026\u2026.is the process of gradually reducing net debt throughout the holding period. a. a.Stock sale b. b.Buy back 176","c. c.Leverage d. Deleveraging 2. Depending on the arrangement, 20\u201330% of \u2026..financing is made up of equity. a. LBO b. b.JIT c. c.MIS d. d.ABC 3. Mezzanine debt, which is a combination of debt and \u2026\u2026\u2026\u2026\u2026\u2026. a. a.reserves b. b.inventory c. equity d. d.None of these 4. High yield debt often has an unsecured nature and a \u2026\u2026\u2026\u2026\u2026interest rate. a. a.static b. b.Low c. high d. d.rigid 5. \u2026\u2026\u2026\u2026\u2026..are paid off first in the event of a corporate liquidation. a. Bank debts b. b.Bad debts c. c.Capital d. d.None of these Answers\u2019 1-d, 2-a ,3-c ,4-c ,5-a 177","14.7 SUGGESTED READING AND E- RESOURCES 1. PunithavathyPandian, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, Vikas Publications Pvt. Ltd, New Delhi. 2001. 2. Kevin.S, SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, PHI, Delhi, 2011 3. YogeshMaheswari, INVESTMENT MANAGEMENT, PHI, Delhi, 2011 4. Bhalla V K, INVESTMENT MANAGEMENT: SECURITY ANALYSIS AND PORTFOLIO MANAGEMENT, S Chand, New Delhi, 2009 5. Prasanna Chandra, PORTFOLIO MANAGEMET, Tata McGraw Hill, New Delhi, 2008. 178","179"]