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13. Valuing our Investment Part 1
In this lesson, we calculate the Money-on-Money multiple and IRR for the ToolCo buyout. We also examine the impact that high entry multiples can have on LBOs.
The problem of High Multiples
- Currently ToolCo is trading at a very high EV / EBITDA multiple
- Consequently, Dealer Partners will need a high exit multiple to generate a return
- Dealer Partners wants to assume an exit EV / EBITDA multiple of 12.5x
Why is ToolCo trading at such a high multiple?
- An unusually high multiple is often speculation over a strategic buyer in the market
- A strategic buyer (in this case another retailer) can often generate more value than PE fund
- This is due to the potential for synergies, benefits generated from merging two similar companies
These benefits will often include (but not be limited to) the following:
- Increased buying power
- Cost savings
- Cross-selling of products
In this lesson, we're going to calculate the Internal Rate of Return and the Money-on-Money Multiple for Dealer Partners' proposed investment in ToolCo. Dealer Partners would like to use an EBITDA multiple to value the business. I would prefer to use EBITDA minus CAPEX multiple, but the company believes that the EBITDA multiple will ultimately be what a potential buyer in the future will use to value ToolCo. Historically, Dealer Partners has achieved an EBITDA exit multiple of 7.3x and that's what we have as our Baseline EBITDA Exit Multiple.
In the past, Dealer Partners has achieved, on average, a baseline EBITDA exit multiple of 7.3x.
However, there's a problem here. The price being paid for ToolCo at the current share price is 12.5x. And if we include the premium, it's 14.5x. As a consequence, the company will need to achieve a higher EBITDA exit multiple than 7.3x to achieve a favorable return on this particular investment.
When we mentioned this to Dealer Partners, they're confident that they can achieve a 12.5x EBITDA multiple on exit.
I'm quite skeptical of this, but have agreed to enter it for ToolCo to begin with. So I'll enter 12.5.
I'll now skip to the bottom to perform my calculations.
Off-camera, I have entered the EBITDA Exit Multiple and the EBITDA figure projected for the next five years.
You might be asking yourself at this stage, "Why does ToolCo trade at such a high multiple "when its growth prospects are not stellar?" There may be a couple of reason for this, but the most obvious is that a strategic buyer, i.e. another retailer, is in the market to buy ToolCo and, as a result, the price may have spiked. A strategic buyer can often extract more value from a target than a private equity firm by utilizing synergies to increase profits. For example, if ToolCo's biggest competitor decides to bid for the company, it's more likely that the combined entity could close down competing stores in some locations, saving cash on capital expenditure and operating expenses while maintaining the same revenue. In this scenario, the private equity firm will struggle to compete. Instead, Dealer Partners might be better waiting until the price drops to a lower level and a more manageable EBITDA multiple. Anyhow, let's complete our valuation for now. To calculate the Exit Enterprise Value, I'll simply take EBITDA and multiply by the Exit Multiple.
And I'll copy across for the remaining cells.
To get the Equity Value on Exit, I'll need to subtract Net Debt excluding Capital Leases. This is a pretty easy calculation. I'll simply take Net Debt, which I calculated earlier in my key metrics, and subtract Leases, which I can find in the balance sheet.
Here we go. I'd like this number to be negative, so I'll jump back in the formula, put a minus sign, and close the brackets.
And I'll copy across.
To calculate the Equity Value on Exit, I'll add these values together.
And to calculate the Investor Equity on Exit, I need to make sure that I only include the percentage ownership of the business that Dealer Partners holds. And to do this, I'll take the Equity Value on Exit and I'll multiply by the number of shares held by Dealer Partners, divided by the number of shares held by Dealer Partners plus the rollover.
And because no shares are rolling over, this number is the same as the total equity value. I'll need to anchor my cells before I copy across this formula.
Now I need to calculate the Returns to Investors.
And to do this, I need to compare the Initial Investment, which I'll enter here, to the Investor Equity, which will be determined by the exit year. So again, I'll scroll up to the top to capture the Initial Investment, which can be found in Sources and Uses.
And I'll put a negative sign behind this for the IRR calculation.
For the Investor Equity, I'm going to need to use an IF function.
And the IF function will simply check if the current year is equal to the exit year, which I'll find at the very top.
And I'll anchor this here and, if it is equal to the exit year, I want to return the investor equity. And if it's not, I'll simply return zero.
And I'll copy across for the remaining cells. As you can see, the Investor Equity in 2020 now appears.
To calculate the Total Cash Flows, I'll simply sum these cells.
And to calculate the Money-on-Money Multiple, I can simply take Total Cash Flow and divide by the Initial Investment. And for the Internal Rate of Return, I can simply feed the cash flows into my formula.
And as you can see, the IRR is 10% and the Money-on-Money multiple is 1.5.
However, my calculation only works when the exit year is 2020. I want to calculate the Money-on-Money Multiple and the Internal Rate of Return for various exit years. Let's find out how to do this in the next lesson.