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Last week I told you my life story (part 1 of it, anyway), and this week I’m going to do something almost as unexpected: pick apart a recent, high-profile deal and show you how to analyze it with video tutorials, Excel models, and more.
This “high-profile deal,” of course, is Silver Lake’s highly controversial $24 billion leveraged buyout of Dell.
And it’s an excellent example to learn from because of all the different elements:
- Microsoft’s participation (to what end?) via the $2 billion subordinated note it’s investing in.
- It’s not an acquisition of 100% of the company since Michael Dell is rolling over his equity and contributing more cash.
- The valuation and offer price are questionable, with Southeastern Asset Management claiming that the company is worth $24.00 per share rather than $13.65 per share.
- Scenarios for revenue and expenses will be very important because it’s a quasi-turnaround: Dell needs to transition away from its declining desktop and notebook businesses and move toward tablets, software, and services. And that may or may not work out.
- Finally, post-transaction acquisitions will play a huge role here because Dell is unlikely to achieve massive growth organically.
Let’s get started with my favorite model of all: theExcel kind.
First Things First: Have I Gone Crazy?
We’ll get the most obvious question out of the way first: what if you’ve signed up for one or more of our financial modeling courses?
Have I gone crazy by releasing this case study for free on this site and in our YouTube channel, when you normally have to pay to access such in-depth case studies?
The answer is no – because I’m only releasing part of the case study on M&I for free.
We’ll be skipping over large portions of it, my explanations won’t be as detailed, and I won’t walk through everything step-by-step.
So think of this as a “preview” for the full thing more than anything else (though you’ll still learn more from this set of free tutorials than you will from many classes that cost $3,000+).
I will create a special “bonus area” inside the BIWS site and you will be able to access the full case study if you’ve signed up for the Fundamentals and Advanced courses.
There, you’ll get access to the step-by-step videos, more in-depth explanations, and new in-video quizzes so you can test yourself as you move along.
No, I don’t have an exact ETA yet, but it will certainly be done much sooner than the 5-part case study here.
Your Mission: The Case Study Itself
Here’s the PDF that lays out exactly what we’re going to cover in this leveraged buyout case study.
The short version:
- Part 1: Set up the model and the assumptions and gather data for everything.
- Part 2: Create revenue and expense scenarios.
- Part 3: Create the debt schedules, calculate interest, and link the model.(NOTE: Order swapped from what is in the PDF above)
- Part 4: Build in support for post-buyout acquisitions (bet you haven’t seen that one before…).
- Part 5: Answer the case study questions and create your presentation.
Private Equity Case Studies 101
We’re in the middle of another multi-part series on hedge fund case studies, so it’s easy to forget that I already wrote about PE case studies years ago in a 3,017-word post.
To summarize, there are 3 types of case studies in interviews: long-form (you have several days to a week and you must present a comprehensive analysis), medium-length (you have a few hours on the day of the interview), and speed test (build an LBO model in 30 minutes starting from a blank page).
This one will be an example of a long-form case study, which means that the qualitative part and your presentation are just as important as the numbers.
And yes, you must present a “Yes/No” investment recommendation and support it with solid arguments, and then explain the risks and how to mitigate them.
This is an advanced case study. It is not for the faint of heart. If you are new to modeling, you will not be able to follow along with everything here.
But you will still learn something about how to pick apart deals and analyze them, which is why you’re reading this site, right?
How to Gather All the Data: Your Video Tutorial
(I highly recommend full-screening this video in 720p so you can see everything better.)
Table of Contents:
- 0:03 – Introduction and Case Study Overview
- 6:00 – Revenue and Market Share by Business Segment
- 7:20 – Where to Find the Data
- 11:28 – Transaction Assumptions
- 15:23 – Sources & Uses Schedule
- 17:23 – Debt Assumptions
- 19:39 – Impact of Assumptions on Everything Else
- 21:39 – Summary & Recap
Here are most of the documents you need in this single ZIP file below (including the blank and completed Excel files):
Here’s a quick summary of why you need each one, or at least why you should look at the documents in each category:
- Analyst Presentations – Lots of additional facts, figures, and metrics are here; you can also get a sense of management’s wildly optimistic growth expectations by reviewing these presentations. Be skeptical, of course, but still be aware of how much they think they will grow.
- Earnings Call Transcripts – Sometimes they’ll disclose metrics here that are not mentioned anywhere else – in Dell’s case, for example, they give numbers for new IT services signings that do not appear in the filings. Those numbers plus their backlog will help in projecting services revenue later on.
- Equity Research – No, don’t rely on research for your own projections or investment thesis, but it is useful for finding data such as market share, units shipped, ASPs, and so on. You’ll see the key reports we’re using here. Also note that Dell actually discloses a lot of market share information in its own financials (see below).
- Filings – It’s a really bad idea to analyze a company without reviewing their annual report / 10-K first. The only issue here is that we’re going off of last year’s 10-K since the most recent one hasn’t been released yet.
- Filings Excerpts – Look how nice I am: I even extracted key portions of the 10-K that you’ll use throughout the model and made separate files here. Don’t expect this red carpet treatment in real case studies or interviews.
- Financials – The Excel version of Dell’s financial statements – a huge time-saver, unless you really want to spend time copying and pasting numbers from PDFs. Also, they include revenue and operating income by segment and market share data in here.
- Merger Docs – Helpful for reviewing the capital structure, rollover details, and anything else that might impact the deal analysis. Most of this is boilerplate and incredibly boring (corporate law is so much fun!), so only a small portion will be useful.
- Valuation, Debt Overview & Other – These are from sources like Factset, Thomson, and Capital IQ, and are useful for reviewing the transaction itself, details on the debt, and also taking a brief look at valuation multiples. These are not essential at all – they’re just another way to verify facts and figures.
You can get most of these documents from the investor relations section of Dell’s site.
Yes, it’s tricky to get equity research unless you know someone with access, but even there you can get free reports for most companies if you have a TD Ameritrade (or other brokerage) account.
What to Simplify in This Type of Case Study
You’ll always have to make judgment calls about what to simplify in models and case studies like this. Yes, you could create a model that tries to capture every last detail, but this is counter-productive in time-pressured case studies.
In this case, yes, you have 5 days to complete and present this analysis, but your time is much better spent on data gathering and even calling industry experts, partners, suppliers, customers, and so on than it is on getting small details correct:
- Close Date – Technically, the deal will probably close in Q2 of Dell’s next fiscal year. But a stub period would create extra work and add little value to the analysis, so we’re just a assuming transaction close at the end of this past fiscal year.
- Financial Statements – Take a look at my comments here (Shift + F2) and you’ll see some of my simplifications (see the Equity section and the “Existing Long-Term Debt” line item for examples).
- Existing Debt – Rather than bothering to project each tranche separately (there are over a dozen), we’re simplifying it and consolidating all the existing debt into one tranche.
In parts 2 – 5 of the case study, there will also be simplifications because of the lack of time (“5 days” is not much time when you’re already working full-time).
Unusual Assumptions and Sources & Uses
You’ll see that the setup for these sections is somewhat unusual, mostly because different parties are contributing funds for the deal – it is not like a traditional LBO where it’s just investor equity from the PE firm plus debt, and where you can make a simple assumption for the percentage of each one.
As a result, we have to factor in the excess cash (repatriated from overseas), the cash and rollover equity from Michael Dell, and make sure that we don’t end up with a negative investor equity number by linking the debt percentages to the wrong number (i.e. the equity purchase price rather than the actual amount of funding required in the deal).
The rest of these schedules are not “unusual” necessarily, but they are more complex because of the options to refinance or assume existing debt and the multiple tranches of debt.
Oh, and Dell has not yet released the 10-K for its recently-ended fiscal year, nor has it released finalized deal terms… so some of these numbers may shift around in the next parts.
The debt section, in particular, is a lot of guesswork in the absence of actual interest rates and principal repayment terms.
For now, I’m just assuming a modest increase over the interest rates on the company’s existing debt balances (see the files and video for more) since its credit rating was downgraded after the deal announcement.
Tweaking the Assumptions
Play around with the assumptions here and you’ll see some interesting trends… and points you should think about:
- How does the offer premium affect the post-deal ownership percentages? Why is that?
- What about refinancing existing debt, and the percentage of debt used?
- What accounts for the fact that Michael Dell goes from 14-15% ownership pre-deal to over 75% post-deal?
- Would it even be possible to do this deal without funding from Michael Dell, his rollover, and the excess cash? Why or why not?
I’m not going to “answer” these questions – they’re for you to think about and draw your own conclusions on.
What to Do Next
Download the model and files and practice it yourself, or at least tweak the version I have and see if you can answer those questions above.
Then, subscribe to our new YouTube channel – who knows, I may not even release 100% of the rest of this case study on M&I – but it will definitely be on YouTube.
And I can guarantee there will be many new YouTube tutorials over the next year that will NOT appear on this site.
So it’s in your best interest to subscribe, unless you want to miss out on all of that.
And yes, this tutorial series and the rest of the upcoming YouTube videos will be added to BIWS in a “bonus area” on the site.
As AJ would say, “Just give it a few hours” (OK, maybe a bit more than that…).
The Rest of the Series:
About the Author
Brian DeChesare is the Founder of Mergers & Inquisitions and Breaking Into Wall Street. In his spare time, he enjoys memorizing obscure Excel functions, editing resumes, obsessing over TV shows, traveling like a drug dealer, and defeating Sauron.
Acquisitions or takeovers are a transaction or process wherein one company (commonly called as acquirer) or an investor acquires another company (known as target). Acquisition can be done in a number of ways that can range from one firm merging with another firm to create a new firm or managers of a firm acquiring the firm from its stockholders and creating a private firm.
Briefly the transactions can be classified as follows:
If a firm is acquired by another firm, the various distinctions are:
Merger: Target firm becomes part of acquiring firm; stockholder approval is needed from both firms
Consolidation: Target firm and acquiring firm become new firm; stockholder approval needed from both firms
Tender offer: Target firm continues to exist, as long as there are dissident stockholders holding out. Successful tender offers ultimately become mergers. No shareholder approval is needed
Acquisition of assets: Target firm remains as a shell company, but its assets are transferred to the acquiring firm. Ultimately, target firm is liquidated.
If the company is acquired by its own manager or/and outside investors
Buyout: Target firm continues to exist, but as a private business. It is usually accomplished with a tender offer.
Here, we will discuss Buyout only with particular reference to the Leveraged Buyout case of DELL which is in the news nowadays.
Leveraged Buy Out (LBO)
Any type of acquisition aims at creating synergy by acquisitions or takeover of another company. Some companies use these transactions to create strategic synergies wherein the acquirer target the companies in same sector and thus profit by increasing economies of scale and capturing market share and expertise of target company. This type of buyer is a strategic buyer and finances the purchase through company cash, company stock as well as some percentage of debt.
On the other hand LBO is the purchase or the acquisition of the company using significant amount of debt and some amount of sponsor’s equity. Ratio of Debt to Equity is generally 70 to 30.
LBO is often undertaken by financial buyers or investors who seek to generate high returns on the equity and increase their potential returns by using financial leverage (debt) and implementation of cost cutting strategies in operations of the company.
Acquisition of HCA Inc. in 2006 by Kohlberg Kravis Roberts & Co. (KKR), Bain & Co., and Merrill Lynch is the largest LBO transaction in recent times. The three companies paid around $33 billion for the acquisition.
While looking for a company for a leveraged buyout, an acquirer looks for company which:
Has very little or no debt on its balance sheet
Is a non-cyclical and mature company with a well established brand, products, and industry position
Has a strong management team
Has non-core assets which can be liquidated to generate cash flows
Has an operating cash flow which is predictable and strong enough to service the debt raised for LBO
Has limited Working capital requirements
Has a viable exit strategy.
It is essential for an acquirer to perform a detailed analysis while determining the Purchase value to be paid for buying out a company.
Most important parameters in the valuation of a company are EBITDA and Free Cash Flow (FCF). Projections for these two have to be drawn out for the investment horizon (typically 3 to 7 years)
Exit Multiple: Valuation Multiples such as EV/EBIDTA and EV/FCF are used to determine the value of the company at time of acquisition. An acquirer aims at multiples which are similar or higher at the time of exit then at the time of acquisition
Key Leverage levels and Capital structure (senior and subordinated debt, mezzanine financing, etc.) which has to be managed for the achievement of required results
Determining equity returns (IRRs) to the financial sponsor and performing sensitivity analysis of the results across range of leverage and exit multiples, as well as investment horizons
Reaching a value which can be paid to acquire the company.
For a successful LBO generating positive returns, three factors are most essential:
De-levering (paying down debt): Company is generating cash flow sufficient to pay off the debt raised to buy it
Operational improvement (e.g. margin expansion, revenue growth): Cost cutting measures and sale of non-core assets result in lean structure thereby generating higher profits
Multiple expansions (buying low and selling high): EV/EBIDTA increasing or remaining similar.
Risks in LBOs for Equity and Debt Holders
Along with operating risk, there is risk associated with financial leverage. High Interest costs which are also “fixed costs” are a huge burden on company. It is a risk for both debt as well as equity holders. Small changes in the enterprise value (EV) of a company can have a significant effect on the equity value since the company is highly levered and the value of the debt remains constant.
Exiting from a LBO
Financial buyers can use many exit strategies to realize the profits made on their investments. A financial buyer typically expects to realize a return on its LBO investment within 3 to 7 years via one of these strategies.
Outright sale of the company to a strategic buyer or another financial sponsor
IPO: Initial Public offering , that is, issuing new equity to the public
Recapitalization: By paying off the debt over the time thereby converting debt into Equity and optimizing capital structure of the company.
LBO of DELL
Let us have a look at the LBO of computer manufacturer DELL Inc. (DELL.O) which was completed in October 2013.
On September 12, 2013, the buyout by founder and CEO Michael DELL and private equity firm Silver Lake Partners of DELL for $25 billion had been approved by DELL stockholders. The merger transaction closed on October 29, 2013, and the delisting from NASDAQ Stock Market commenced. DELL shareholders received $13.75 in cash, in addition to a special dividend of $0.13 per common share.
LBO of DELL faced stiff opposition from minority stake controllers Southeastern Asset Management, second largest shareholder after Mr. DELL and T. Rowe Price, third largest holder. As per an analysis by Southeastern Asset Management, share price of DELL was determined at $23.72 per share.
“Go Shop” period
It allows DELL to solicit alternative takeover proposals for 45 days. It is an exercise to promote level playing field. Blackstone and Carl Icahn emerged as the two interested parties offering $14.25 per share and $15 per share.
Offer was withdrawn due to DELL’s deteriorating business.
Financing the LBO
A debt of $7.5 billion has been issued which is the second-largest institutional LBO loan this year, behind Heinz’s $9.5 billion institutional issuance for Heinz’s $28 billion buyout by Berkshire Hathaway and 3G Capital.
DELL has proposed to raise the first-lien secured debt totaling $7.5 billion and the company has proposed $1.25 billion second-lien notes due in 2021.
Once the deal closes, DELL will have a debt load of about $18 billion, including a $2 billion loan provided by Microsoft Corp. (MSFT), up from $6.8 billion in debt before the LBO, according to data compiled by Bloomberg.
It will take DELL at least three years to repay its debt if it continues to generate cash flow of $2 billi4on to $3 billion a year. Also, reduction of workforce by a number 108,800 is also in the pipeline in order to make DELL more efficient.
The business of laptops and workstations is decreasing and thus there is an immediate requirement for DELL to grow by acquisitions in upcoming technologies such as Tablets and Pads.
The company has a strong brand name, broad customer base and good market position.
The deal is expected to close before the end of the second quarter of DELL’s fiscal 2014 year.
Leveraged Buyout has emerged as most preferred way to acquire in recent times. DELL’s CEO and co-founder Michael DELL believes that as a private entity DELL has conquered horizons and will continue to do so. He quotes that:
“DELL has made solid progress executing this strategy over the past four years, but we recognize that it will still take more time, investment and patience, and I believe our efforts will be better supported by partnering with Silver Lake in our shared vision. I am committed to this journey and I have put a substantial amount of my own capital at risk together with Silver Lake, a world-class investor with an outstanding reputation. We are committed to delivering an unmatched customer experience and excited to pursue the path ahead”
If you have any comments, questions or queries, post them below!
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