Chapter 5: Value Creation
Channel 1
Make management sweat with sweet equity
Effect of Interest Alignment
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Example of a Management Buy-Out / Buy-In
Private company: BoringMe Inc.
• Company’s net debt: $400
• Selling shareholders want $600 for the company
• Company’s LTM EBITDA: $125 => EV/EBITDA multiple: 8.0x
• D&A/Capex margin: 10%
• Tax rate: 35%
Forecast
• Intended holding period: 6 years
• EBITDA CAGR: 3.1%
• EV/EBITDA multiple after 6 years: 10x
Financing
• Senior debt: 3.2x EBITDA ($400) at 4.35% interest
• Junior debt: 2.4x EBITDA ($300) at 8.0% interest
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LBO modelling
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Spicing it up
Equity split between management and PE fund at inception:
PE fund has got: Management invested:
$250 million of shareholder loan (with $10 million of common stock
rolled-up interest payment of 12% (half their wealth?)
p.a.)
$40 million of common stock
Questions: Calculate how much management will earn if the company is sold at 12x,
at 10x, at 8x, and if EBITDA had not grown? Provide commentary
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Governance: Private Equity vs Public Equity (I/II)
Top 3 Board Priorities (%)
Value creation 89 Governance, compliance
& risk mngmt.
45
Exit strategy 56 Strategic initiatvies 45
Strategic initiatives PE
11 Org. design &
(inc. M&A) succession planning
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PLC
Boards Role In Strategy (%)
Following 0 29
Accompanying 14 71
Leading 86 0
Type of Board Information (%)
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Cash focused 89
More diverse 11 80
Source: McKinsey. Interviews with ex-members of PE and plc boards
Governance: Private Equity vs Public Equity (II/II)
In private equity, we observe:
Less perks
Less cash
More debt
Less taxes paid
Smaller boards
Less politics
Sense of urgency, focus
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8
Channel 2 (I/II)
Add stuff
Buy and Build Strategies
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Channel 2 (II/II)
Add stuff
Buy and Build Strategies
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Channel 3
Be there
Multi-service provider: liquidity, executives…
Petco was born in 1988 when an L.A. based investor Andrew Galen approached TH Lee* to
acquire a ‘small, down and dirty’ pet store. Immediately, they purchased two more pet chains
(Pet Department Stores and Well Pet) to merge with Petco - a classic ‘buy and build’ strategy.
In 1990, they reached out to no less than a Toys R Us executive, Brian Devine: ‘I had never
heard of Petco’ Devine says, ‘I visited about thirty stores and they were all very bad (…) but
all I saw was a giant opportunity.’ He joined Petco in August 1990, bringing with him 20
years of specialty retail experience.
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Channel 4 (I/II)
Operational engineering
Doing it better
Source: Bain & Company
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Channel 4 (I/II)
Operational engineering
Doing it better
Source: Bain & Company
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Networking
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Unique assets, expertise and capabilities
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Channel 5
Buy Low
Proprietary deals?
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Channel 6
Think Exit
Keeping a close and constant eye on exit options
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Channel 7
Buy Low and Sell High
© Ludovic Phalippou 18
Measuring Value Creation Correctly (I/II)
• Careful about inorganic growth!
• May focus on the ratio EBITDA
over assets (or EBITDA over TEV if
that is available). Variations on
return on assets are probably the
best metric one can use to
compare value creation across
companies.
• Warning:
In September 2014, Bloomberg published a story that called • EBITDA is not a GAAP figure;
the Hilton LBO ‘The Best Leveraged Buyout Ever.’ it is better to work with
Bloomberg wrote in glowing terms about the smart
adjusted EBITDA (which you
management and extraordinary growth. From 2010 to 2013,
Hilton’s revenues and EBITDA grew by 21% and 48%, may compute yourself on a
respectively. But the corresponding figures for Marriott are case-by-case basis as it is
similar: 24% and 46% respectively, as long as you account for easy to cook it).
the 2011 spin off of MVW by Marriott. From 2008 to 2013, • EBITDA over assets is
Hilton generated an average return on tangible assets of 10.4%
while Marriott’s equivalent figure was 12.2%. influenced by M&A activity.
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Measuring Value Creation Correctly
(II/II)
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Some Takeaways
There are many ways to add value
The usual split leverage (financial engineering), operational engineering, multiple arbitrage is not helpful
o Value bridge, one of the of tools to do this exercise, is garbage
Leverage is not a separate channel, it levers what you do as long as you paid too little
o Can you pay too little, and get away with it?
Management in PE is different
o More cash focused and thus act differently
o Sense of urgency
o Professional approach to everything
