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(TableofContents)1.(OverviewofLeveragedBuyouts)2.(MechanicsofanLBOAnalysis)3.LBO(LBOBestPractices)4.TXU(TXUCaseStudy)5.LBO(LBOModeling)6.(HomeworkAssignment)(Appendix)1.OverviewofLeveragedBuyouts(LBO)OverviewofLeveragedBuyoutsAnLBOistheacquisitionofacompanyordivisionofacompanyusingdebtforamajorityofthepurchasepriceandequityfortheremainder.zThebuyer(theLBOSponsororEquitySponsor)borrowsthedebtportionofthepurchaseprice,typicallythroughpublicorprivatebondsandbankloansissuedbythecompany,andcontributestheequityportiontypicallythroughaprivatefundzDebtisservicedandrepaidwiththecompany’soperatingcashflowsz-abThebuyerlatersellsalloraportionofthecompanyandrealizesareturnonitsinitialequityinvestment–SaleofSponsorequitytypicallythrougha)aninitialpublicofferingorb)asaletoastrategicbuyeroranotherLBOfirmzTheLBOtransactionfocusisoncashflowsgeneratedbyoperationsandtheuseofthecashtopaydowndebt,therebyincreasingequityvaluezAdditionally,improvementsinoperatingperformancecanincreasevaluezAssumingtheenterprisevalueremainsunchanged,asdebtisrepaid,valuerevertstotheequityholders,therebygeneratingequityreturnsReturnonEquity:APracticalExamplez1,000,000250,000750,000500,0001,000,000750,000Assumeahomeispurchasedtodayfor$1,000,000.Thepurchaseisfinancedwith$250,000ofequityand$750,000ofdebt.Overthenextfiveyears,enoughrentisgeneratedtorepay$500,000ofdebt,inadditiontopayinginterestexpense.Assumingthevalueofthehomeremainsat$1,000,000fiveyearslater,theequitystakeinthehomehasgrownto$750,000z51,000,000250,000750,000Assumingthishomeissoldattheendofthefifthyearfor$1,000,000,$250,000oftheproceedsmustbeusedtorepaytheremainingdebt,whichleavestheownerwith$750,000.ThereturnontheequityinvestmentcanthenbecalculatedusingthefollowingIRRformula:GoalsofLBOAnalysisLBOanalysisisprimarilydesignedtoaddressthreefundamentalgoalszDeterminingtheenterprisevalueofacompanybymeasuringacompany’sabilitytogeneratesufficientcashflowstomeetrequiredequityreturnswhilecomplyingwithleverageparameters--DeterminingwhatpriceapotentialbuyercouldpayforacompanyzCalculatingfinancialratiosandothermeasurementstodeterminethebalancesheetandcreditimpactofanLBO--Ratiosandcurrentcreditconditionswilldeterminemixofdebt/equityandfinancingtermszEvaluatingthefeasibilityofanLBOgiventhecreditcharacteristicsofabusinessandunderstandinghowmuchdebtacompany’scashflowscanservice-“”=-“Doseitwork”=WillabuyergetreasonablereturnsgivenfinancialprojectionsandleverageassumptioninthemodelLBOCharacteristicsofaGoodLBOCandidateLBOAgoodLBOcandidatewilldemonstratemany,ifnotall,ofthefollowingcharacteristics(BusinessSpecific)z(Strongmanagementteam)zSteadyandpredictablecashflow(moderategrowthcanbeanticipated)zOpportunitiesforimmediaterationalization(e.g.,workingcapital,synergieswithotherportfoliocompanies,hiddenassets)z(Minimalrequiredcapitalexpenditures)z(Limitedworkingcapitalrequirements)z(Divestibleassetsovertime)(IndustrySpecific)z(Highmarketshare)z(Marginswillnotlikelybepressured)z(Industrywithhighbarrierstoentry)z(Lowcyclicalityofindustry)z(Viableexitstrategy)Citigroup’sRoleInTheProcess(CitigroupViewpoint)z(Createanaggressivefinancingstructurethatcanbeeffectivelysyndicatedtothemarket)z(Limitdownside)-(SomefinancingremainsonCitigroup’sbalancesheet)z(Otherrolesinprocess)-(M&Aadvisor)-(Otherdealswithclient)z(LeadstoIBopportunities)-(Refinancings)-(Add-onacquisitions)-(Sellsides)-IPO(IPOs/SecondaryOfferings)(PrivateEquityViewpoint)z(Createequityvalue)-(Lookingforupsidetothebusiness)-(Findadd-onacquisitions)z(Useasmuchleverageaspossibletominimizeinitialequitycheck)-(Strong/stablefreecashflow)LeveragedLoanMarketConditionsInstitutionalSpreadsAnnualNewIssuanceVolumeLeveragedLoanMarket•2007YTDvolumeof$407billionisup33%yearoveryear,andhasbarelymovedsinceJune20074,07033%,6•Primarymarketactivityhasslowedasaccountswatchtheimpedingsyndicationofthe$14billiontermloanforfirstDataFirstData140·AccountsviewtheFirstDatadealasamajorindicatorofsuccessoflargeLBOfinancinginthepipelineFirstData·Noprimarysyndicationshavesuccessfullypricedinthepastthreeweeks•Sponsoredloanvolumereachedanewhighof$127billioninQ2,upfrom$91billionduringtheQ1.Thisbroughtfirst-halfsponsor-drivenloanvolumeto$218billion,upfrom$111billionduringthefirstsixmonthsof2006.Givenallthat’sonthecalendar,privateequity-relatedloanvolumewillhandilyexceed2006’srecordfigureof$234billionbytheendofJuly.9101,2702,18020061,11020062,340•Secondlienvolumehasseena70%increaseyear-over-year.2007YTDvolumetotaled$27.3billionwiththerollingfourweekaverageofsecondlienspreadsat696bps,versus704bpsinAugust.Thefirst/secondliengapwidenedto352bpsthisweek,andistighterthanthe363bpsseeninAugust.70%20072736.96%7.04%3.52%3.63%ProRataMarketInstitutionalTermLoanMarket•Thenumberofbanksthatwereactiveintheretailprimarymarketremainedat77duringtheQ22007,matchingthe77seenduringQ1,butdownfromthe81seenattheendof2006.200777200681•2007YTDproratavolumeof$103.8billionisslightlylessthan2006YTDvolume.20071,0382006•2007YTDinstitutionalvolumeof$303billionisup50%overlastyear.20073,03050%•Thenumberofactiveinvestorsintheinstitut