Question

A private equity firm called SoLoop is considering a leveraged buyout (LBO) of a manufacturing company, MILSA, that prior to the LBO has zero net debt. MILSA generates EBITDA of $40 million, and SoLoop will need to pay a 6x EV/EBITDA multiple to buy it. SoLoop plans to finance the purchase with a $100 million loan issued to MILSA; the loan has a 10% annual interest rate and a balloon payment of $100 million due in five years, when SoLoop believes it will be able to exit its investment by selling MILSA to a larger competitor. The proceeds of the sale will first be used to make MILSA’s debt balloon payment, and the remaining proceeds will go to SoLoop. SoLoop expects to be able to grow MILSA’s EBITDA at an annual rate of 5% during these five years. At what EV/EBITDA multiple M will SoLoop need to sell MILSA in order to generate an (annual) IRR of 22% from this investment?

Answer 1

Saloop buys MILSA at EV of 6XEBIDTA.i.e He needs to pay 6 * 40 (240 million). He will take a loan of 100 and rest will be invested as equity. Hence he will get total equity of 140.

He expects an annual IRR of 22% on selling the stake.

i.e Value of investment at end of 5th Year= 140 (1+22%)^5 = 378.38 million

Over and above the investment he requires funds to pay off the debt of 100 million balloon payment also.

Hence total sales value of investment will be 478.38 (378.38 +100)

EBIDTA will grow @5% pa.

EBIDTA at end of 5th Year = 40 (1+5%)^5 = 51.05

Hence EV/EBIDTA multiple shall be 478.38 / 51.05 = 7.41

Hence EV/EBIDTA multiple expected is 7.41