Case study
A case study in leveraged buyout analysis

Prof. Ian Giddy, New York University


A small group of engineers and armed forces veterans is considering a leveraged buyout of the security services division of their firm. For several months they have worked closely with a private equity firm on analysing the possibilities. At last they have come up with some numbers to show the banks and potential equity investors.                                   

The idea is that they would form a new company, Mushroom Energy, to buy the division. The new company would issue  13 million shares with a par value of $10. The proposed purchase price is $400 million. In addition the new company would refinance $60 million worth of long-term lease obligations. Fees are expected to run at 3% of the purchase price. Expected new capex and restructuring costs are estimated at 10%  up front. Ongoing capex will be 10% of EBIT. The tax rate is  35%       
The company expects to have EBIT of $75 million in the 12 months prior to purchase. This is predicted to grow at 7% for the first 3 years and 3% thereafter.       

Discussions with banks suggest that for this kind of business it might be difficult to syndicate an acquisition loan unless EBIT interest coverage is at leas 1.6. At this level, the cost of funds would be quite high (see table).                               

The engineers, who would run the company, have managed to raise  $9million among themselves to invest in the company. The remainder must be raised by the private equity firm, whose partners generally look for an exit plan after 5-7 years and a return of  35%

Similar companies have been able to go public at a multiple of 7x EBITDA-Net Debt, but this group is hoping for more.                                   

Debt Coverage, Rating and Cost Estimates
If EBIT interest coverage ratio is
> Rating is Spread is
-100000 0.50 D 14.00%
0.5 0.80 C 12.70%
0.8 1.25 CC 11.50%
1.25 1.50 CCC 10.00%
1.5 2.00 B- 8.00%
2 2.50 B 6.50%
2.5 3.00 B+ 4.75%
3 3.50 BB 3.50%
3.5 4.50 BBB 2.25%
4.5 6.00 A- 2.00%
6 7.50 A 1.80%
7.5 9.50 A+ 1.50%
9.5 12.5 AA 1.00%
12.5 100000 AAA 0.75%

  1. What is the company's debt capacity, and how much additional financing is needed?                               
  2. What forms of financing could fill the funding gap?                               
  3. What kind of rate of return can the engineers expect to make if the predictions work out? | | | | contact
Copyright ©2006 Ian Giddy. All rights reserved.