Quantifying value creation in an LBO

Many people get caught up in the term LBO (Leveraged Buy Out) when it comes to modelling.

​Plain terms

An LBO is nothing more than a buyout of a business that is heavily funded by debt, usually 65% or more. In contrast to traditional LBO deals in the US, the concept and structure of harnessing leverage in Asia are relatively simpler, sometimes involving a couple of debt tranches.

From a capital budgeting point of view, most buyers will seek to use debt funding as it is less costly than using (or raising) equity, but more importantly, financing an acquisition using more debt means that the amount of cash outlay can potentially be lower i.e. enhancing the returns to equity.

Cash flows are critical.

The choice and structure of debt funding used in an acquisition is largely predicated on the nature and quality of underlying cash flows. This is the most critical and fundamental aspect of all LBOs.

Ultimately, the increase in equity value from a buyout comes down to essentially three factors:

  1. Growth

  2. Multiple expansion

  3. Deleveraging

Consider this illustrative scenario:

A company valued at 6.0x EBITDA at the point of acquisition based on a $100m EBITDA results in a deal value of $600m. Assuming the buyout was financed with 80% debt, the corresponding value of equity is $120m.

Profitability growth

Upon exit, let's assume that the EBITDA has grown by 20% to $120 and the company is valued higher at 7.0x, the resulting EV would be $840m. Because part of the acquisition debt has been repaid over the investment period, the net debt on exit has been reduced to 30% or $252m, giving an exit equity value of $588m.

From the above, we can easily observe that we have increased the value of equity from $120m to $588m, which translates to a nearly 5-fold return. To break this down, let's first look at EBITDA. The value we've created here from improving the operating cash profits can be quantified as:

Multiple expansion

Secondly, in the process of driving the top and bottom-lines i.e. size and profitability, the financial sponsors have also changed the overall "risk profile" of the business, such as: expanding to new markets, developing proprietary technology in new products, institutionalizing sales processes and improving the overall quality of customers, etc. These enhancement initiatives make the business better, or what bankers commonly call: equity positioning or equity re-rating. The idea behind this is to re-position the company more favourably amongst its competitors so as to justify a valuation multiple premium. In this case, we had assumed that on exit, the company will be valued at 7.0x EBITDA. The uplift in equity based on this can be calculated as:


Lastly, it's the additional value created from financial engineering. This is nothing more than just the reduction in net debt of the company from entry to exit. The value created is simply the difference between the net debt amounts:

Putting it all together, we have:

We have therefore effectively quantified the three sources of value creation to be a total of $468m. Although deleveraging drives most the value here, collectively, both improvements to the EBITDA and re-rating of the business post investment is also significant.

Feel free to play around with the parameters using the below spreadsheet:



Monday, December 14, 2020

Three "epic fails" nearly wiped me clean this year. Here are five things I’d learned from these painful lessons: 1) Despair and greed...

Sunday, October 18, 2020

In 1990, a psychologist quoted in the New York Times reported that people “turn on the TV when they feel sad, lonely, upset or worried,...

Sunday, July 26, 2020

Good investors are first and formost by nature: business people. They should be entrepreneurs, owners of businesses or have been placed...

Thursday, July 23, 2020

IB isn't only about late nights & number crunching, but also the toxic & condescending environment one has to put up for many years to come.

Saturday, July 4, 2020

There’s nothing you should regret in life - all the good things that you have today are a result of everything that has happened....

Wednesday, March 4, 2020

Money is the one thing that you can always replace any time or at some point of time in the future - money is just money.

Friday, August 2, 2019

More than three years since I started out, I discovered a new-found respect for the many areas of businesses which are presumably...

Wednesday, December 31, 2003

Learning, knowledge and staying up to date with the news and what's going on in the world is your own personal responsibility. The same...


  • My LinkedIn Page
  • My Twitter
  • Instagram