Investment Banking: Valuation, LBOs, M&A, and IPOs, 3rd Edition

Additional Resources xiii

About the Authors xv

Foreword xvii

Acknowledgments xix

INTRODUCTION 1

Structure of the Book 3

Part One: Valuation (Chapters 1–3) 3

Part Two: Leveraged Buyouts (Chapters 4 & 5) 5

Part Three: Mergers & Acquisitions (Chapters 6 & 7) 6

ValueCo Summary Financial Information 8

PART ONE: Valuation 11

CHAPTER 1: Comparable Companies Analysis 13

Summary of Comparable Companies Analysis Steps 14

Step I. Select The Universe of Comparable Companies 17

Study the Target 17

Identify Key Characteristics of the Target for Comparison Purposes 18

Screen for Comparable Companies 22

Step II. Locate The Necessary Financial Information 23

SEC Filings: 10-K, 10-Q, 8-K, and Proxy Statements 24

Equity Research 25

Press Releases and News Runs 26

Financial Information Services 26

Summary of Financial Data Primary Sources 27

Step III. Spread Key Statistics, Ratios, and Trading Multiples 28

Calculation of Key Financial Statistics and Ratios 28

Supplemental Financial Concepts and Calculations 42

Calculation of Key Trading Multiples 47

Step IV. Benchmark the Comparable Companies 50

Benchmark the Financial Statistics and Ratios 50

Benchmark the Trading Multiples 50

Step V. Determine Valuation 51

Valuation Implied by EV/EBITDA 52

Valuation Implied by P/E 52

Key Pros and Cons 54

Illustrative Comparable Companies Analysis for ValueCo 55

Step I. Select the Universe of Comparable Companies 55

Step II. Locate the Necessary Financial Information 56

Step III. Spread Key Statistics, Ratios, and Trading Multiples 57

Step IV. Benchmark the Comparable Companies 69

Step V. Determine Valuation 74

Bloomberg Appendix 75

Chapter 2: Precedent Transactions Analysis 83

Summary of Precedent Transactions Analysis Steps 84

Step I. Select the Universe of Comparable Acquisitions 87

Screen for Comparable Acquisitions 87

Examine Other Considerations 88

Step II. Locate the Necessary Deal-Related and Financial Information 90

Public Targets 90

Private Targets 93

Summary of Primary SEC Filings in M&A Transactions 93

Step III. Spread Key Statistics, Ratios, and Transaction Multiples 96

Calculation of Key Financial Statistics and Ratios 96

Calculationof Key Transaction Multiples 102

Step IV. Benchmark the Comparable Acquisitions 106

Step V. Determine Valuation 106

Key Pros And Cons 107

Illustrative Precedent Transaction Analysis for ValueCo 108

Step I. Select the Universe of Comparable Acquisitions 108

Step II. Locate the Necessary Deal-Related and Financial Information 108

Step III. Spread Key Statistics, Ratios, and Transaction Multiples 111

Step IV. Benchmark the Comparable Acquisitions 119

Step V. Determine Valuation 121

Bloomberg Appendix 122

Chapter 3: Discounted Cash Flow Analysis 125

Summary of Discounted Cash Flow Analysis Steps 126

Step I. Study the Target and Determine Key Performance Drivers 130

Study the Target 130

Determine Key Performance Drivers 130

Step II. Project Free Cash Flow 131

Considerations for Projecting Free Cash Flow 131

Projection of Sales, EBITDA, and EBIT 133

Projection of Free Cash Flow 135

Step III. Calculate Weighted Average Cost of Capital 141

Step III(a): Determine Target Capital Structure 142

Step III(b): Estimate Cost of Debt (rd) 143

Step III(c): Estimate Cost of Equity (re) 144

Step III(d): Calculate WACC 148

Step IV. Determine Terminal Value 148

Exit Multiple Method 149

Perpetuity Growth Method 149

Step V. Calculate Present Value and Determine Valuation 151

Calculate Present Value 151

Determine Valuation 153

Perform Sensitivity Analysis 155

Key Pros and Cons 156

Illustrative Discounted Cash Flow Analysis for ValueCo 157

Step I. Study the Target and Determine Key Performance Drivers 157

Step II. Project Free Cash Flow 157

Step III. Calculate Weighted Average Cost of Capital 164

Step IV. Determine Terminal Value 169

Step V. Calculate Present Value and Determine Valuation 171

Bloomberg Appendix 176

PART TWO: Leveraged Buyouts 183

Chapter 4: Leveraged Buyouts 185

Key Participants 187

Financial Sponsors 187

Investment Banks 188

Bank and Institutional Lenders 190

Bond Investors 191

Target Management 191

Characteristics of a Strong LBO Candidate 192

Strong Cash Flow Generation 193

Leading and Defensible Market Positions 193

Growth Opportunities 194

Efficiency Enhancement Opportunities 194

Low Capex Requirements 194

Strong Asset Base 195

Proven Management Team 195

Economics of LBOs 196

Returns Analysis—Internal Rate of Return 196

Returns Analysis—Cash Return 197

How LBOs Generate Returns 197

How Leverage Is Used to Enhance Returns 198

Primary Exit/Monetization Strategies 202

Sale of Business 202

Initial Public Offering 203

Dividend Recapitalization 203

Below Par Debt Repurchase 203

LBO Financing: Structure 204

LBO Financing: Primary Sources 207

Bank Debt 207

High Yield Bonds 211

Mezzanine Debt 213

Equity Contribution 214

LBO Financing: Selected Key Terms 217

Security 217

Seniority 217

Maturity 219

Coupon 219

Call Protection 220

Covenants 221

Term Sheets 224

LBO Financing: Determining Financing Structure 227

Bloomberg Appendix 232

Chapter 5: LBO Analysis 235

Financing Structure 235

Valuation 235

Step I. Locate and Analyze the Necessary Information 238

Step II. Build the Pre-LBO Model 238

Step II(a): Build Historical and Projected Income Statement through EBIT 239

Step II(b): Input Opening Balance Sheet and Project Balance Sheet Items 242

Step II(c): Build Cash Flow Statement through Investing Activities 244

Step III. Input Transaction Structure 247

Step III(a): Enter Purchase Price Assumptions 247

Step III(b): Enter Financing Structure into Sources and Uses 249

Step III(c): Link Sources and Uses to Balance Sheet Adjustments Columns 251

Step IV. Complete the Post-LBO Model 256

Step IV(a): Build Debt Schedule 256

Step IV(b): Complete Pro Forma Income Statement from EBIT to Net Income 265

Step IV(c): Complete Pro Forma Balance Sheet 268

Step IV(d): Complete Pro Forma Cash Flow Statement 270

Step V. Perform LBO Analysis 272

Step V(a): Analyze Financing Structure 272

Step V(b): Perform Returns Analysis 274

Step V(c): Determine Valuation 278

Step V(d): Create Transaction Summary Page 279

Illustrative LBO Analysis for ValueCo 280

Bloomberg Appendix 290

PART THREE: Mergers & Acquisitions 293

Chapter 6: Sell-Side M&A 295

Auctions 296

Auction Structure 299

Organization and Preparation 299

Identify Seller Objectives and Determine Appropriate Sale Process 299

Perform Sell-Side Advisor Due Diligence and Preliminary Valuation Analysis 301 

Select Buyer Universe 301

Prepare Marketing Materials 302

Prepare Confidentiality Agreement 305

First Round 306

Contact Prospective Buyers 306

Negotiate and Execute Confidentiality Agreement with Interested Parties 306

Distribute Confidential Information Memorandum and Initial Bid Procedures Letter 306

Prepare Management Presentation 308

Set up Data Room 309

Prepare Stapled Financing Package 311

Receive Initial Bids and Select Buyers to Proceed to Second Round 311

Valuation Perspectives—Strategic Buyers vs. Finacial Sponsors 312

Second Round 313

Conduct Management Presentations 313

Facilitate Site Visits 314

Provide Data Room Access 314

Distribute Final Bid Procedures Letter and Draft Definitive Agreement 315

Receive Final Bids 316

Negotiations 320

Evaluate Final Bids 320

Negotiate with Preferred Buyer(s) 320

Select Winning Bidder 320

Render Fairness Opinion 321

Receive Board Approval and Execute Definitive Agreement 321

Closing 322

Obtain Necessary Approvals 322

Shareholder Approval 322

Financing and Closing 324

Negotiated Sale 325

Bloomberg Appendix 327

Chapter 7: Buy-Side M&A 331

Buyer Motivation 332

Synergies 333

Cost Synergies 334

Revenue Synergies 334

Acquisition Strategies 335

Horizontal Integration 335

Vertical Integration 335

Conglomeration 336

Form of Financing 337

Cash on Hand 338

Debt Financing 338

Equity Financing 339

Debt vs. Equity Financing Summary—Acquirer Perspective 340

Deal Structure 340

Stock Sale 340

Asset Sale 343

Stock Sales Treated as Asset Sales for Tax Purposes 346

Section 338 Election 346

338(h)(10) Election 346

Buy-Side Valuation 348

Football Field 349

Analysis at Various Prices 352

Contribution Analysis 353

Merger Consequences Analysis 355

Purchase Price Assumptions 355

Balance Sheet Effects 360

Accretion/(Dilution) Analysis 365

Acquisition Scenarios—I) 50% Stock / 50% Cash; II) 100% Cash; and III) 100% Stock 368

Illustrative Merger Consequences Analysis for the BuyerCo / ValueCo Transaction 373

Bloomberg Appendix 394

Afterword 397

Bibliography and Recommended Reading 399

Index 405

JOSHUA ROSENBAUM is a Managing Director and Head of the Industrials & Diversified Services Group at RBC Capital Markets, where he also serves on the Management Committee for the U.S. Investment Bank. He originates, structures, and advises on M&A, corporate finance, and capital markets transactions. Previously, he worked at UBS Investment Bank and the International Finance Corporation, the direct investment division of the World Bank. He received his AB from Harvard and his MBA with Baker Scholar honors from Harvard Business School. He is also the co-author of The Little Book of Investing Like the Pros.

JOSHUA PEARL is the Founder and Chief Investment Officer of Hickory Lane Capital Management, a long/short equity asset manager. He focuses on public equity investments and special situations utilizing a fundamentals-based approach. From 2011-2020, he served as a Managing Director and Partner at Brahman Capital. Previously, he structured high yield financings, leveraged buyouts, and restructurings as a Director at UBS Investment Bank. Prior to UBS, he worked at Moelis & Company and Deutsche Bank. He received his BS in Business from Indiana University’s Kelley School of Business. He is also the co-author of The Little Book of Investing Like the Pros.