Hypothetical Leveraged Buyout Valuation: Examination of the Leveraged Buyout Transaction Process Illustrated and Applied in a Practical Context

Johan Selling & Felix Törnblom

Student thesis: Master thesis

Abstract

This study aims at providing a comprehensive examination of the leveraged buyout (LBO) transaction process. We assess the theoretical foundations and characteristics of an LBO, thereby portraying activities in the acquisition stage, holding stage and the divestment stage of the LBO. In the acquisition stage, typical characteristics of LBO targets are determined. These characteristics include stable and predictable cash flows, hard assets and low capex requirements. Furthermore, the composition of debt and equity in structuring the deal is addressed. In the holding stage, primary value creating activities in LBOs are examined, including financial, operational and governance engineering. Subsequently, main risks concerning LBO transactions are explained. Finally, in the divestment stage common return measures, e.g. IRR, are explained and exit strategies including IPOs and M&As are outlined. The thesis employs a case study methodology to illustrate how an LBO could be designed in a practical context. In doing so, we apply our theoretical framework to generate a list of the most suitable LBO candidates on the Nasdaq OMX Stockholm Stock Exchange, our assumed universe. We identify nine potential LBO targets and select Rezidor Hotel Group as our research company due to its attractive valuation, stable cash flow generation and efficiency enhancing opportunities. We further undertake a financial and strategic analysis of Rezidor, which constitutes the base for the formulation of a business plan meant to improve profitability. We establish a hypothetical deal structure composed of 64% debt and 36% equity taking Rezidor’s debt capacity, the current trends in European LBOs and the prevailing state on the debt capital markets into account. We project free cash flows and accumulated debt repayments over a holding period of five years for the purpose of estimating Rezidor’s equity value at exit. We determine the hypothetical IRR from the LBO to 21% in a conservative base case. In a scenario with more optimistic assumptions, an IRR in the region of 32% appears feasible. Finally, we address the monetization strategy for Rezidor by considering the route of an IPO or in the event of a sale to a strategic buyer. Thereby the thesis concludes that by selecting an LBO target based on a range of academically derived parameters and implementing typical value enhancing strategies, an IRR above 20% could realistically be achieved.

EducationsMSc in Applied Economics and Finance, (Graduate Programme) Final Thesis
LanguageEnglish
Publication date2016
Number of pages146
SupervisorsPoul F. Kjær