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Most LBOs aren’t really that interest rate sensitive, let’s say you buy a company for $100m dollars 12x EBITDA, and 15x unlevered free cash flow ($7m), you woul

Most LBOs aren’t really that interest rate sensitive, let’s say you buy a company for $100m dollars 12x EBITDA, and 15x unlevered free cash flow ($7m), you would have put $50m of non amort. debt in the business @ 3%, so had a $1.5m interest payment. Lets say that doubles to $3m, earnings would have to be cut in half to not be able to service debt…

abirch 4y ago
Correct. Many of the large private equity companies were started in the 1980's when the rates were significantly higher than they are today.
cs702 4y ago
[EDIT: the data in this paragraph is WRONG! See comment below.] 12x EBITDA? Unlikely. According to the article, the average valuation multiple for US deals to take firms private is 19.3x EBITDA. A 3% rate for a leveraged entity? Unlikely. Current high-yield spreads are in the neighborhood of 500-600bp, on top of treasury rates. So, you'd need 60% more debt (19.3/12) to keep the same capital structure [EDIT: this last sentence is WRONG! The amount of debt needed would be the same, because the correct EV/EBITDA multiple is 12.3x. See comment below.], and the debt would be 2-3x more expensive, leaving much less margin for a downside scenario, say, in the event of a prolonged recession, rising rates, and/or declining valuation multiples. If all three of those things happen at the same time, things could get... ugly.
- mbesto 4y ago
  > According to the article, the average valuation multiple for US deals to take firms private is 19.3x EBITDA. That's on a PIPE, which is a small subsection of all PE buyouts. Average multiples for ALL buyouts is 12.3x in NA: Average buyout multiples in 2021 rose 9% to 12.3x in North America, and, despite a slight decline, still stood at a lofty 11.9x in Europe (see Figure 14). https://www.bain.com/globalassets/noindex/2022/bain_report_global-private-equity-report-2022.pdf https://www.bain.com/globalassets/noindex/2022/bain_report_g...
  - cs702 4y ago
    You're absolutely right. In haste, I misread the data. I updated my comment to indicate I was wrong about this. Thank you!
    - mbesto 4y ago
      All good! It's a total nuance to this space so I can understand if someone got it wrong anyway.
- balderdash 4y ago
  With regards to your comment on the rates, most LBOs are done with floating rate loans/ bank loans/levers loans, as such they trade at a spread over libor/sofr, which chops ~3% off your interest rate…
engineeringwoke 4y ago
It trashes your IRR though. Now what does the sponsor make?
- formercoder 4y ago
  IRRs have been waning the last few years anyway, to the point folks will look at 12.5%. There is a lot of money chasing PE allocations. Of course top quartile funds will just pull further away from the pack.
- balderdash 4y ago
  Not really, that rule of thumb is that if you can grow EBITDA at higher percentage than the EBITDA multiple you bought at, thing will just work out fine (e.g. buy at 20x need 20% cagr on earning over the next 5 years)
  - engineeringwoke 4y ago
    There was a recent Economist article that said that 6% of the performance in PE is driven by earnings growth. It’s a Ponzi scheme built on debt because PE has so much money that they just trade around companies at higher multiples. Lol imagine believing in synergies, or that the trash you guys make is somewhat legitimate at all. Cutting shit to the bone and sending it to the next guy isn’t good business. Enjoy the money and the carried interest loophole while it lasts. Community Health Systems? Dex Media? I’m not one of the fools that will buy it. Maybe it helps you sleep at night or whatever but if rates continue to spike, all the trash adjusted EBITDA nonsense will all die and you guys will lose your shirts.

abirch 4y ago

Correct. Many of the large private equity companies were started in the 1980's when the rates were significantly higher than they are today.

cs702 4y ago

[EDIT: the data in this paragraph is WRONG! See comment below.] 12x EBITDA? Unlikely. According to the article, the average valuation multiple for US deals to take firms private is 19.3x EBITDA. A 3% rate for a leveraged entity? Unlikely. Current high-yield spreads are in the neighborhood of 500-600bp, on top of treasury rates. So, you'd need 60% more debt (19.3/12) to keep the same capital structure [EDIT: this last sentence is WRONG! The amount of debt needed would be the same, because the correct EV/EBITDA multiple is 12.3x. See comment below.], and the debt would be 2-3x more expensive, leaving much less margin for a downside scenario, say, in the event of a prolonged recession, rising rates, and/or declining valuation multiples. If all three of those things happen at the same time, things could get... ugly.

mbesto 4y ago
> According to the article, the average valuation multiple for US deals to take firms private is 19.3x EBITDA. That's on a PIPE, which is a small subsection of all PE buyouts. Average multiples for ALL buyouts is 12.3x in NA: Average buyout multiples in 2021 rose 9% to 12.3x in North America, and, despite a slight decline, still stood at a lofty 11.9x in Europe (see Figure 14). https://www.bain.com/globalassets/noindex/2022/bain_report_global-private-equity-report-2022.pdf https://www.bain.com/globalassets/noindex/2022/bain_report_g...
- cs702 4y ago
  You're absolutely right. In haste, I misread the data. I updated my comment to indicate I was wrong about this. Thank you!
  - mbesto 4y ago
    All good! It's a total nuance to this space so I can understand if someone got it wrong anyway.
balderdash 4y ago
With regards to your comment on the rates, most LBOs are done with floating rate loans/ bank loans/levers loans, as such they trade at a spread over libor/sofr, which chops ~3% off your interest rate…

engineeringwoke 4y ago

It trashes your IRR though. Now what does the sponsor make?

formercoder 4y ago
IRRs have been waning the last few years anyway, to the point folks will look at 12.5%. There is a lot of money chasing PE allocations. Of course top quartile funds will just pull further away from the pack.
balderdash 4y ago
Not really, that rule of thumb is that if you can grow EBITDA at higher percentage than the EBITDA multiple you bought at, thing will just work out fine (e.g. buy at 20x need 20% cagr on earning over the next 5 years)
- engineeringwoke 4y ago
  There was a recent Economist article that said that 6% of the performance in PE is driven by earnings growth. It’s a Ponzi scheme built on debt because PE has so much money that they just trade around companies at higher multiples. Lol imagine believing in synergies, or that the trash you guys make is somewhat legitimate at all. Cutting shit to the bone and sending it to the next guy isn’t good business. Enjoy the money and the carried interest loophole while it lasts. Community Health Systems? Dex Media? I’m not one of the fools that will buy it. Maybe it helps you sleep at night or whatever but if rates continue to spike, all the trash adjusted EBITDA nonsense will all die and you guys will lose your shirts.