A Leveraged Buyout Story

A LEVERAGED BUYOUT STORY

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LEVERAGED BUYOUTS: INTRODUCTION Why Tabletops Global was an ideal LBO Candidate

Undervalued

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Tabletops Global is a distributor of bespoke dining furniture and was established over 20 years ago. The current CEO, Jeremy Firth joined Tabletops three years ago and implemented a number of strategic turnaround initiatives, lowering transportation costs, increasing cash flow conversion and expanding the product range. Despite these successes, the company still traded at a substantial discount to its peers in the specialty retail sector. Investors did not value the stable lower growth cash flow profile of the business. Firth believed the company, valued at £200 million was materially undervalued by investors. With the company out of favour with investors, the management team still believed strongly in the company’s prospects and pursued a buyout of the owner's equity stake and control of the company.

Strong Management

Stable Cash Flows Low Capex & Working Capital

Viable Exit Strategy

Management examined the potential for funding the acquisition mostly with debt. Tabletops was an ideal candidate for this type of transaction as it had stable operating margins, minimal working capital needs and had disciplined management to ensure interest payments on the debt would be met. Management invested 40% equity and took a bank loan to fund the remaining £120m. Management had a five-year time horizon before they looked to sell the company on the stock market or to a competitor. As such, Firth developed a leveraged buyout (LBO) analysis for Tabletops to determine what management could afford to pay for the company in order to earn a sufficient return on its equity investment.

LEVERAGED BUYOUTS: OPERATING ASSUMPTIONS

To start, Firth developed a number of operating assumptions (listed to the left) for Tabletops over the 5 year investment period to project the cash flows available to repay the bank loan.

Tabletops - Operating Assumptions Sales - Year 1 Projected Annual Revenue Growth (%) EBITDA Margin (%) Annual Operating Working Capital (£m)

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100.0 5% 40% 3.0

Depreciation (£m)

20.0

Tax Rate (%)

30%

EBITDA Entry Multiple (x)

5.0x

Capital Expenditure / Sales (%)

10%

Interest Rate on Debt (%)

5%

Tabletops expected to hit £100 million in revenues in its first year after the buyout. Revenues were forecast to grow by 5% each year. Thanks to the CEOs initiatives over the last few years, Tabletop’s EBITDA margin had steadily increased to 40% and this was expected to remain flat over the next five years. The interest rate negotiated on the loan was 5.0% and all the debt would be paid down at the point of sale in Year 5. Spending on property and equipment (capital expenditures) was forecast at 10% of sales. Operating working capital was forecast to increase by £3 million annually. Depreciation on property and equipment was expected to account for £20 million annually. Tabletops would pay corporate tax rate at 30%. Management planned to exit the business after 5 years at the same EBITDA valuation multiple used at entry (£200m Valuation / £40m EBITDA) = 5.0x EBITDA.

LEVERAGED BUYOUTS: CASH FLOWS

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Tabletops Earnings Projections Tabletops - Earnings Projections

Year 1

Year 2

Year 3

Year 4

Year 5

Year 6

Sales

100.0

105.0

110.3

115.8

121.6

127.6

EBITDA

40.0

42.0

44.1

46.3

48.6

51.1

Depreciation & Amortisation

20.0

20.0

20.0

20.0

20.0

20.0

Operating Profit

20.0

22.0

24.1

26.3

28.6

31.1

Net Interest

6.0

6.0

6.0

6.0

6.0

6.0

Profit Before Tax

14.0

16.0

18.1

20.3

22.6

25.1

Tax

(4.2)

(4.8)

(5.4)

(6.1)

(6.8)

(7.5)

Net Profit

9.8

11.2

12.7

14.2

15.8

17.5

Tabletops Levered Free Cash Flows Levered Free Cash Flows (FCF)

Year 1

Year 2

Year 3

Year 4

Year 5

9.8

11.2

12.7

14.2

15.8

Capex

(10.0)

(10.5)

(11.0)

(11.6)

(12.2)

Depreciation & Amortisation

20.0

20.0

20.0

20.0

20.0

Operating Working Capital

(3.0)

(3.0)

(3.0)

(3.0)

(3.0)

Free Cash Flow

16.8

17.7

18.6

19.6

20.7

Net Profit

To forecast the cash flows available to repay the lenders on exit, Firth projected the income statement for the next 5 years. Using the above assumptions for EBITDA margin (40%), depreciation & amortisation of £20m annually, interest payments on debt (£120m x 5% = £6m) and corporate tax rate of 30%, he calculated the company’s forecast net profits over the period. Firth then deducted the cash outflows from capital expenditures and increases in working capital (needed to operate the business). He added back depreciation and amortisation to reflect the fact that these were non-cash deductions that were made from net profit. From this he arrived at the free cash flows available for debt repayment. The projections showed the company generated a sum total of £93.5m (16.8+17.7+18.6+19.6+20.7) in free cash flows over the period to pay down the £120m loan for the acquisition.

LEVERAGED BUYOUTS: THE EXIT STRATEGY

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Tabletops Exit Valuation & Returns

Year 6 EBITDA (£m)

51.05

Exit Multiple

5.0x

Enterprise Value (£m) Less Net Debt (£m)

Equity Value (£m)

255 27

229

Assuming the company’s valuation in five years time was based on the same 5.0x entry EBITDA multiple as exit, as this is a forward looking multiple (based on next year’s financials), Firth used Year 6 EBITDA of £51.05m x 5.0x to yield an enterprise value of £255m. With the remaining debt left in the business after paying down the £20m loan with £93.5m free cash flows, the company had £26.5m net debt. Deducting the remaining debt from enterprise value implied a £205m (£255 - £27m) equity valuation. From management’s initial £80m equity investment, the annual rate of return (IRR) the investors achieved over the 5 years was:

IRR: (£229m / £80m)^

-1 = 23.4%

(1/5)

IRR (%) Money Multiple (x)

23.4% 2.9x

Money Multiple: (£229m / £80m) = 2.9x