What's The Big Deal?

Private Equity: Leveraged Buyouts Explained (How to Analyze Deals Like a Pro)

• Wall Street Prep • Season 1 • Episode 10

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This week Graham and Debs try something different. 

Rather than dissecting a single deal, they go back to basics with one of the most important concepts in finance — the leveraged buyout — and build up from first principles using two of the biggest real-world examples in the market right now: the $18B acquisition of Hologic and the $55B acquisition of Electronic Arts.

Graham walks through the core LBO framework using an accessible house purchase analogy, explaining how leverage turns a 1.5x equity return into a 3x return, what drives that amplification, and what the key variables in any LBO analysis actually are. 

From there the conversation covers what makes a good LBO candidate, the concept of cash conversion, how loan-to-value has evolved since the early days of private equity, and the three main value creation levers available to a private equity owner.

The second half of the episode puts theory into practice. 

Graham runs a live napkin LBO on both the Hologic and EA deals — walking through sources and uses, entry multiples, debt paydown assumptions and return calculations — and asks the central question: do the numbers actually make sense?

The episode closes with a broader conversation about the evolution of private equity — from the generalist, high-leverage model of the early 90s to today's specialist, operationally-focused landscape — and what record levels of dry powder mean for returns going forward.

Key Discussion Points:

LBO fundamentals — what a leveraged buyout is, how leverage amplifies equity returns, and the key variables that drive an LBO model. 

LBO candidates — what makes a business suitable for a leveraged buyout: cash conversion, recurring revenues, predictable cash flows. 

Sources and uses — how deals get financed, what refinancing existing debt means and why a target's cash is a legitimate source of transaction funding. 

Money multiple vs. IRR — what each metric measures and why you need both to evaluate a deal properly. 

The Hologic LBO walkthrough — entry and exit multiples, debt structure, return sensitivity and the revolving credit facility question. 

The EA deal — 30x entry multiple, $20 billion of debt, and why the base case numbers require a significant EBITDA growth story. 

Co-investment and sovereign wealth — why mega-deals increasingly rely on structures beyond the traditional GP/LP fund. 

The evolution of private equity — dry powder, multiple expansion and why operational improvement matters more than ever.

Why Wall Street Prep? 

Wall Street Prep is the trusted training provider for the world's top investment banks, private equity firms, Fortune 1000 companies and business schools. 

Our online training and instructor-led boot camps are direct adaptations of our corporate training, making Wall Street Prep the ideal choice for those looking to break into finance.

DISCLAIMER: 

The information provided in this video is for educational and entertainment purposes only and does not constitute financial, investment, tax, or legal advice. Investing involves risk, and you may lose some or all of your capital. 

Past performance is not indicative of future results. 

Please conduct your own due diligence or consult with a certified professional before making any financial decisions.

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SPEAKER_00

We're going to try more of an explainer topic today rather than talking about a deal in particular.

SPEAKER_02

So can you just explain what is an LDS?

SPEAKER_00

Anytime we're buying a company and funding a big part of the purchase price with debt, hence the name leverage buyout.

SPEAKER_02

So we started by investing 500,000 of our own money.

SPEAKER_00

All of a sudden we've made three times our money with this leverage, otherwise known as financial engineering, really, in this case.

SPEAKER_02

And that increasing of IVFC, that is my return as an investor. Welcome to all of our listeners. Welcome to this week's episode of What's the Big Deal, where we take a look under the hood of major deals in the public and private markets and explore finance industry developments. My name is Deborah Taylor, and I'm going to use my experience from my career in investment banking to bring insights from a

00:50 — Episode intro: What's the Big Deal?

SPEAKER_02

public markets perspective.

SPEAKER_00

And I'm Graham Smith. I'm going to use my career in investment banking and private credit to bring the private market perspective here.

SPEAKER_02

Fantastic. And Graham, before we dive in, uh tell us a little bit about what you've been doing this week.

SPEAKER_00

Ooh, okay, so I'm still, I'm still in Abu Dhabi. So I think I mentioned in last episode, I'm here for a pretty long, a pretty long training session, actually. So one of the, you know, one of the big sovereign wealth managers, this is a five-week program for some of their new recruits. Let's see, this week we've been doing a lot of financial statement modeling. There's an assessment tomorrow morning. So trying to make sure every everyone's ready for that. Um it's been a lot of a lot of time in the classroom, which has been a lot of fun. Uh and we're gonna talk about some LBO stuff today. I think we're gonna we're gonna kick off on some LBO content, I think, back end uh back end of next week. So we'll get a little bit of live uh live run through of some of the stuff that we do, we do in the classroom. Uh but otherwise, otherwise can't complain. It's uh it's hot here. It's probably, I mean, I think in Fahrenheit, so it's you know probably in the 90s right now, so it's not it's not too crazy. I'm coming back here in June, July, and everyone's like, get ready for that. So we'll see how that goes. But for now, for now, pretty good. It's all it's all good. How about you?

SPEAKER_02

Yeah, good. Uh and likewise, I'm still doing lots of teaching. I've been delivering more Spring Insights uh training this week. And also I've done a little bit of forensic accounting. Um I know I kind of hide it very well, but deep down I am a bit of a nerd and I do quite enjoy rolling my sleeves up and doing a bit of forensic accounting work. So I've been having lots of fun with that this week as well.

SPEAKER_00

I don't even try to hide it. Like I'm fully, fully a nerd over here. And I like but I what I don't tell what I yeah, what I don't tell everyone though is I actually did uh well, I did an accounting degree in college and I did a uh an internship my my junior year at one of the one of the big four accounting firms. And you know, everyone, everyone in school said, you know, audit, audit's way more exciting than people, people give it credit for. Just give it a try. And I I was like drinking the Kool-Aid. So, you know, I did, I did this summer internship. I show up at the job, and literally the first day I'm on the client site, the guy who's like right above me, who's I don't know, it's like first year, whatever you call first year accountant, opens up the little like plastic box with colored pencils and a ruler, and I'm like, oh my God, I I signed up for the wrong thing. Like this is this is not me. So I finished the couple of things. That's not fun times, Dan. Yeah, you know, I mean, like I had I had a fun summer. I just didn't have a fun summer in the in the work part of it. Uh so that's that's when I decided I'm like, no, I'm gonna recruit for investment banking, and then went into MA, which I think suited my my like interests and personality a little bit more.

SPEAKER_02

So I'll take your red pencils and raise you to the fact that I my first audit client when I was training as an accountant was Enron. And within the first few weeks, I was told to leave the building because I'm gonna lock the doors. So actually, my start off in accountancy was actually quite thrilling. Um, and to be honest, it was all a bit uh bit dull in comparison. Um, but yeah, so great that we've both got that background. I think that level of technical expertise um is has been really useful. It's definitely for me and my career, and I'm sure the same for you guys.

SPEAKER_00

Yeah, well, and hey, and I was at I was at Lehman Brothers. You worked on Enron, so we were both in or around places that just spectacularly blew up. So we got that as well. So yeah, I love it. Excellent.

SPEAKER_02

Right, so let's dive in then. Let's let's talk about what we're gonna discuss this week. What is the big deal, Graham?

SPEAKER_00

Hey, it's

This week's format: an LBO explainer using Logic and EA

SPEAKER_00

a big deal. We're gonna try something a little bit new, aren't we, Dubs? We're gonna try more of a more of an explainer topic today rather than talking about a deal in particular. We are gonna, we actually we are gonna use electronic arts and Hologic as a couple of kind of template LBO examples to talk through. I really wanted to have a discussion around, you know, high-level, high-level how to think about an LBO. We're gonna run through just the really when I think when both of us teach these these kind of topics in the classroom, really the the very the very first intro into this topic, kind of looking at sources, uses, just some high-level entry-exit assumptions and kind of what that means for returns, and just just the the high-level nuts and bolts of how an LBO comes together. Because I think there are a lot of there are a lot of YouTube videos, there's a lot of content on here's how you build an LBO model, but sometimes a bit less about actually if you take a step back, here's what's actually happening, here's why we build the LBO model. So we're gonna kick off with the the high level, and then maybe in another session we'll do some of the more like nuts and bolts in-depth stuff.

SPEAKER_02

Absolutely. Um Graham, this is definitely your wheelhouse. So you're gonna be front and center this week. I'm gonna sit back and just ask the questions. Um, in terms of what we'll cover, we will start off with a quick primer, as you say. We'll answer the question what is an LBO? Uh we're then gonna look at two deals, as you said, two live deals. Um, and uh they are great case studies to help explain um some of the real uh important elements of an LBO. We're gonna look at Hologic, which maybe a lot of people haven't heard of. It's a US MedTech company and is a textbook example of an LBO. Uh and then we'll touch on electronic arts, which I think most people will have heard of, um, and is a really interesting case study because it's a record-breaking deal. In fact, it's the largest LBO in history at $50 billion.

SPEAKER_00

Um and then hopefully we'll have to the biggest financing as well, right? I mean, so at 20 something, 2020. 20 billion dollars in debt.

SPEAKER_02

And we'll answer the question: why is that so important in an LBO? Um and then finally, we're gonna talk about the current LBO market. Where is it at right now? So let's kick off with you, Graeme. Uh, giving us a bit of a walkthrough of the LBO mechanics and almost a 101 on LBOs, if you like.

What is an LBO? The house purchase analogy

SPEAKER_02

Uh so can you just explain what is an LBO?

SPEAKER_00

It's a leveraged buyout, Debs.

SPEAKER_02

Oh, great. Thank you. Bit more color movie.

SPEAKER_00

It's uh it's funny because like when I don't know about you, whenever I ask these questions in the classroom, like what's an LBO, what's eBITA? The first response I always get is earnings before interest tax. I'm like, guys, that is not, that is not the answer I'm looking for. I'm like, what is it? And that what does it stand for? Uh so really, I mean, an LBO is is really anytime we're buying, we're buying a company and funding a big part of the purchase price with debt, hence the name leverage buyout. Uh, I think, and again, a way, one of the ways I talk about this a lot when I'm teaching is think about this like a house purchase, like really, really similar, similar kind of frameworks. Let's say you've got a house you buy with, you know, 100% equity, you buy that house for, I don't know, to make the to make the math easy, you buy that, you buy that house for a million dollars, you roll forward the clock, you know, five years, whatever the case may be, you sell it for $1.5 million. So if you if you think about your your returns there, we'll talk a little bit about some of the high-level return metrics we look at in this space. But cash on cash, money multiple, M O I C, you've got one and a half million that you sell it for, a million that you bought it for. You've made one and a half times your money. So great.

SPEAKER_02

We said multiple of money and multiple of invested capital, M O I C. Are those different?

How leverage turns a 1.5x return into a 3x return

SPEAKER_02

And why are we talking about that?

SPEAKER_00

All we're really talking about with the finance, in finance, we love to have a bunch of different, different terms and words that all really mean the same thing. And with these, all we're really saying is what was my initial equity value? And this is important because it's not necessarily purchase price. And this in this first example where we say purchase price equals equity value. When we talk about money multiple, we're just talking about of that, of that initial purchase price, what multiple on that initial equity investment did I make when I sell? So if I buy for a million, sell for 1.5 million, it's 1.5 over one, I've made one and a half times my money.

SPEAKER_02

Go on it.

SPEAKER_00

Let's just let's just sign out, make up, make up another example here where we buy that same million dollar house. And instead of instead of a million dollars all equity, we buy it for uh buy it for million dollars, million dollars purchase price. Think purchase price here being like enterprise value, but we split it, say, 50-50 debt equity, so half a million dollars of equity and a half million dollars of debt. Now let's say, you know, we have, we've we've got a great job, we're making a bunch of money in that job, and we in the time that we own this house are paying down, we're paying down that mortgage. Then when we go to sell that house for 1.5, $1.5 million. Now let's think about what our what our returns are. And what what are our what's our what's our numerator and what's our denominator devs in that in that equation?

SPEAKER_02

Yeah, absolutely. So we've basically we've invested $500,000 and or half a million, and we've got one and a half million uh exits. That's basically three times.

SPEAKER_00

Yeah, right. Amazing. And I'm in. Right. And nothing, nothing has changed. Right. Yeah, 100%, right? And nothing has changed in terms of the actual value of the house, right? We buy it per purchase price, aka in this case, enterprise value, buy for a million, sell for 1.5. But instead of doing one and a half times our money with all equity, all of a sudden we've made three times our money with with this leverage,

The key LBO variables: entry, exit, leverage and debt paydown

SPEAKER_00

otherwise known as financial engineering, really, in this case. And you know, one of the one of the things we'll talk about when we start looking at these deals is just when we when we think about some of the assumptions we're gonna we're gonna flex here, we don't have that many at the end of the day, right? We have what are we buying for, what are we selling for, how much leverage, i.e., how much of a mortgage are we putting on this company at entry? And then how much of that mortgage can we pay off between entry and exit? And it's that difference between the exit enterprise value, and we'll talk a lot about net debt, right? Enterprise value less net debt equals equity value. The more net debt we can pay off, so the lower that number is, the higher our exit equity value is, and therefore the higher our returns are going to be. Um, so a big, a big part of LBO modeling and LBO analysis is really just it's really just cash flow modeling. It's right. It's like in that in that house example of our of our job that's paying us, that's paying us how much money every year to pay off this $500,000 mortgage, how realistic are those assumptions? Like, can we pay off all $500,000? Is that assumption aggressive? Like that's that's that's kind of the main point of the whole LBO model is just let's take this company, let's model out what we think it's gonna do, right, in terms of revenue down to down to EBITDA, how much of that EBITDA is gonna convert to cash, how much of that cash are we gonna use to repay debt? And at the end of the day, we basically add it all up and say, okay, what's our ending equity value? Compare that to our entry equity value, and that's that's what we're gonna do in terms of our return. So it's kind of the the whistle stop tour.

SPEAKER_02

Okay, so we're basically we're buying assets, a group of assets like a business. We're using loads of leverage. We plan to sell it on at some point in the future for a higher valuation. Whilst we've owned it, we've paid down some of the debt. And therefore, that means when we sell it, the equity, that's basically what's left over after selling the asset and paying off all the debts. That's gone up massively because both we've increased the value of the asset and we've paid down the debt. And that increase in the value of the equity, that is my return as an investor. Am I right?

SPEAKER_00

Exactly that. Exactly that. And it can be, it can be all these things, all these things at the same time. I mean, one of the one of the teaching examples I use a lot in the classroom is looking at really a hypothetical LBO where you buy and sell for the same enterprise value, there's no eBIT growth, there's no multiple expansion. The main assumption we make is that we pay down all the debt in the five years that we're looking at for our returns horizon. And it's a it's like a 3x return on your money just because you have financed so much of the day one purchase price with debt and you've paid off all that debt by the time you exit. It's these assumptions, though, that make all the difference in the in the LBO model and trying to figure out how conservative or aggressive they are. So we're gonna talk high level today. We'll talk through a couple examples, and then we can also spend a few minutes talking about okay, in the real world, when you do the job and when you're actually modeling this stuff, what are the things you think about and what are you ultimately working toward?

SPEAKER_02

Okay. I have got a few questions for you, Graham. So, first of all, in the example you gave with the house purchase, it was 50% debt, 50% equity. Is that what we also see when it comes to leverage buyouts? That's a mix of debt and equity.

SPEAKER_00

It's a mix of debt and equity and very much depends on the company, the industry, and also the competitive market or competitive landscape at that point in time. This has changed a lot kind of over the years. Like you go back to the original, original LBO days, like way back in, let's say, you know, early, early 90s, and we were seeing, we were seeing the uh the ratio of or the the composition of the capital structure is comprised of debt, you know, versus enterprise value, you know, really high,

What makes a good LBO candidate

SPEAKER_00

you know, kind of 80, 80, 90%. You know, people people worked out. That's obviously a ton of that's a ton of risk on the on the debt investment. And over the years, things have been pulled back to a much more modest level. Uh so I'd say real, real world, anywhere between say 50% to two-thirds the enterprise value is financed with leverage. And we kind of think about that in the term in this term called loan to value. So if you think about the the value, again, the value of the business or value of the house being the enterprise value, the amount of debt that you place on that house or on that business relative value, relative to value is your loan to value. The higher that ratio is, the more debt you're placing on it, the more risky it is fundamentally from a say a creditor's perspective, the lower the amount of debt, the safer it is from a creditor's perspective. And in some ways, an equity, an equity owner's perspective, because the more contractual, contractual obligations you place on a business, the more riskier it is for everyone, realistically.

SPEAKER_02

Okay. Um and then secondly, um, we use the example of buying a house, but in reality, we're talking about leverage buyouts of businesses. What sorts of businesses are usually involved in leverage buyouts? I mean, is it basically you could pretty much do this with any type of company, or there are other specific characteristics that make it more perhaps sort of attractive almost to do a leverage buyout?

SPEAKER_00

Yeah, I mean, in theory, in theory, it can work with anything, but ultimately when we're talking leverage buyout, we're talking companies that can support a degree, if not a large degree, of leverage. So if you think about what kind of what kind of companies are leverageable. Companies where you have some kind of stable, predictable cash flow. Like the more stability, the more predictability, the more, the more you can get a view on the recurring nature of cash flows, the better a candidate that company is for a leveraged buyout. Because when we're talking, we're talking, say, levered lending or, you know, kind of leveraged finance, high yields, you know, all these, all these kind of terms to go beyond just say pure investment grade. A lot of times what we're talking about is our security that we're gonna take as lenders is really around future expected cash flows of a business. It goes, it goes beyond, it goes well beyond the value of, say, the hard assets of a company. And we're talking about, we're talking about taking security over ultimately the enterprise value of this business. And the enterprise value being comprised of, you know, let's talk about the old discounted cash flow analysis where the value of this company is the value of the future cash flows. Uh so we're looking for companies where we've got some kind of visibility on these cash flows. And the more visibility, the more visibility we have, let's say the higher cash conversion we have. We'll talk about this a little bit today, but a thing we think about a lot in this world is cash conversion. In my mind, I think of cash conversion as really a bridge from EBITDA to cash flow. So for every dollar of EBITDA, how much of that dollar converts into actual cash? A lot of companies are below that. Some companies convert more than 100% of every dollar of EBITDA to cash flow. So again, when we think about businesses that have recurring contracts uh generate cash through its working cap or through their working capital cycles, like these are businesses that are really, really oftentimes highly levered and make good LBO candidates. But in theory, in theory, it can be anything. You can make the argument there's a right purchase price and there's a right level of leverage for almost any business.

SPEAKER_02

Okay. But then you also said that it's really important that we um, as part of the LBO, that there is an expectation that the valuation of the business will grow. And that's going to be through some of that's gonna be through growth in eBit DAR. So are we just looking for businesses where we have an organic expectation of EBITDA growth, or is there something else driving up that uh that eBit DAR and therefore the uh the increase in the value of the company?

SPEAKER_00

Can be can be a bunch of different factors. So we can think about this purely from a financial engineering perspective where ultimately we might not need a whole lot of eBit Dog growth to generate financial returns. Most of that financial return is coming through the use of leverage, right? The less, the less equity we can put in as an owner day one, the more that we can take on with debt. Uh, if we if we can use the operations and the cash flows of that business to pay down debt, then we will have generated perhaps a pretty interesting equity return, even if we don't do that much from an operational perspective. And say the holy grail of private equity investing is really trying to do a bunch of these things all at the same time, right? Buying, buying a business that might be undervalued, financing a decent chunk of that purchase price with debt, really pushing through operational improvements. So identifying companies that are not only leverageable day one, but hey, I think I can, I can double, I can triple EBITDA because I've got some real sector-focused knowledge in a particular space, and I just know how to increase value because I've say done it a bunch of times before. I've also got the the concept of say a a buy and build or a platform, platform opportunity. This has been a really interesting value creation opportunity for private equity in recent in recent years or decades really, where you find a you find a platform, you bolt on acquisitions, you're often buying, you're often buying companies for a much lower multiple than your group is valued at. So let's say you buy something for eight times and you bolt it onto your platform before you've even extracted any kind of synergies. The eight times EBITDA you've paid for that business is immediately worth the 13 times that your platform is valued at today. So you if you can pull all these levers at the same time, that's when you see these three, five, 10x return private equity deals. Um, you can you can really do all this stuff together.

SPEAKER_02

Okay. Um and you have referred to sort of the number, so the return on the equity in terms of multiple of money. Is that all we're focused on then? Um in terms of the sort of the targets uh

Money multiple vs. IRR: why you need both

SPEAKER_02

when we're structuring a deal?

SPEAKER_00

Certainly not the only thing we're focused on. We've got we've got money multiple, which which I mean, I think money multiple is the is kind of the metric that that people focus on, I'd say the most, the most in this world. But money multiple and IRR together are really the things that we look at. Because of course, money multiple, we just talked through the calculation. There's no there's no time component to this. So if I buy something today and I generate three times my money, that's an amazing deal. If I generate three times my money in the span of two years, it looks a little bit less amazing if I generate a three times return over 30 years. So money multiple and IRR together really give us a good feel of like just just how successful a private equity deal has been.

SPEAKER_02

And when you're talking about IRR, so that's internal rate of return, isn't it? So that's kind of the annualized return that we're generating. I know if I invest in the stock market, I can expect a return of around, I don't know, nine, ten percent on you know, on US. Equities, let's say. What kind of return are we talking about for private equity?

SPEAKER_00

Well, it really, I mean, this really runs the spectrum. I'd say you kind of have to, you also have to look at the different, the different types of private equity. And I said different types. You've got you know kind of small cap, mid-cap, large cap. Generally speaking, it's harder, it's harder to make the the kind of really, really high IRR money multiples when you're talking the mega, mega large cap private equity. But let's say, let's say, I don't know, you're kind of your your base case hurdle rate, you need, you really need and want to clear at least, at least say 15%. You're really targeting more like 20, 25. And then you've got the really successful, successful private equity deals that are 30, 40, 50% IRR. Right. So generally speaking, you've got, you've got this, you've got this huge range, but you know, let's say, let's say we're in this, we're in this overall world of, I don't know, about 20%, something like that.

SPEAKER_02

Okay. Well, I guess because also, you know, you know that if you're buying a private company or taking a company private, you take buying a public company and taking it private, you take on quite a lot of risk, aren't you? Because you're locking your money away. You've then got potentially operational improvements that you've got to execute on. That's actually quite a lot of risk. So definitely you'd want more of a return than you get in the public markets for sure.

SPEAKER_00

100%. And you're getting, you're also getting really involved. Like think about your role as a private equity investor. It's not like, it's not like one of us just investing in shares in in the public market where you buy a share of stock and then you don't really do anything, right? You just let it sit there and see what happens. Maybe you maybe you submit a proxy vote every once in a while if you really care about it. If you're a if you're a private equity investor, you are, to your point, you're investing for control. You own the business. So you have to, you have to like do you gotta do the work, right? You are you are now the owner, you buy, you buy the whole company, and you're usually buying it because you think you can do something better or different than say the person who owned it before. So you don't buy it and just sit back. You buy it, you already, before you, before you buy it, you've already got a plan, right? A big, a big, I mean, we'll talk, I'm sure, in future, in future episodes about the whole diligence process that you go into before you even execute a transaction like this. But you don't, you don't just buy it, right? You got to do a bunch of work and say, okay, this is, I'm interested in this sector overall. I'm interested in this company because of X, Y, and Z. I've done, say, six months of diligence, really identifying areas of say operational improvement, of say new business lines that I can open up, acquisitions I want to make. Like I've got, before I even buy this thing, I've got a really good idea of what I want to do. And then you buy it and you gotta do it. Right. So you gotta, you gotta roll up your sleeves and do the work. And you know, that takes that takes some time, that takes some time to pull together. It's not, you know, most most of the time when we're when we're looking at deals in this space, we're also not talking about a quick flip. Like it tends, it's not, it's not that that never happens or hasn't happened before, but generally speaking, we're we're buying to hold, we're buying to roll up our sleeves, do a bunch of work, make these improvements, and then sell, you know, five, seven years down the line.

SPEAKER_02

Okay. Um, so we've talked through the mechanics. I think we're now ready to sort of dip into a couple of real deals. Uh let's start off with our first one, uh, Hologic, which um I introduced it as kind of the classic or textbook leverage buyouts. Um I think I mentioned a lot of people won't have necessarily have heard of this company. They

The Hologic deal: sources, uses and the napkin LBO walkthrough

SPEAKER_02

are a med tech business. They sell um, they're focused on women's health, they sell diagnostic tools and systems, lots of RD uh behind their uh products, lots of proprietary technology, which does give it a big competitive advantage. This was quite a big deal, wasn't it? About $18 billion purchase price. Um talk us through the numbers. What do we know?

SPEAKER_00

This is in that kind of mega, mega large cap deal kind of space. Like this is uh this is a big one. Um, so if we're by the way, if you're listening, if you're listening on on a platform that's not YouTube, right? If you're listening rather than watching, we're gonna do a quick screen share. If you have time later, maybe just give the YouTube video a watch. The YouTube is gonna have a couple of files linked to it so you can play around with some of these numbers yourself as well. Um, but really what I've got on my screen here is just the the most basic private equity analysis. So when I'm teaching, we call this the the napkin LBO. You can do on the back of a cocktail napkin, where all you're basically saying is, okay, I know, I know what I'm buying, I know how I'm financing it. So I'm gonna back solve into how much equity I need to buy it, and then I'm gonna make some assumptions about my exit valuation. So here, because we're talking, we're talking a public LBO, a P2P, we've got a buyout, a buyout price per share, number of shares outstanding, and that gives us our entry equity value. Now, most of the time when we're talking valuation for say private companies, you know, mid-market LBOs, we're usually talking, we're usually talking enterprise value. But in a in a public LBO, when we've got a we've got an offer value, that's that's the equity value. So we kind of know, we know what we're buying. So our our uses of funds here, they're really, they're really simple in this in this analysis. We're basically saying what we what we've got to fund is the purchase price of the equity. We need to refinance the debt, and then we got to pay the fees.

SPEAKER_02

And what does that mean? Refinance the target's debt? Why is that important?

SPEAKER_00

So think about this from a well, let's let's talk some high-level numbers first, and then and then we'll we'll talk about why. Because it really, it really relates to, you know, let's say, well, we can talk about the numbers now. Let's say we've got we've got an equity purchase price of $18 billion. Hologic had $2.5 billion of debt on their balance sheet at the time of this deal. And we're gonna assume transaction fees of three hundred and seventy million dollars. If you're if you're one of the the financing parties here, the bankers, like it's a pretty that's a pretty healthy, healthy fee check. Uh so we kind of know what our our total uses are. Now, thinking about this, this refinancing of the target debt, ultimately when we're when we're buying, when we're buying a business, when we're when we are a financial sponsor and we are we're we are undertaking a leverage buyout, one of the things we're doing is we're going to banks are going to credit funds and we're sourcing, we're sourcing new leverage for this business. So in this case, we've got on our on our source of funds, we've got a $9.5 billion term loan, a $2 billion term loan, and we've got a an RCF or revolving credit facility of $750 million. Now, I Debs, I don't know if we know, I mean, more of a more of a detail point. It's not going to make a huge difference for the returns here. I don't know if this revolver was drawn or undrawn at close, if this is really part of the the transaction, transaction funding here. Kind of talk about that in a second. But let's just look at the the term debt here. So we've got $11.5 billion of term debt that we're bringing with us as the new, as the new owners. We're buying, we're buying this business. Now put yourself in the shoes of one of the lenders of this $2.5 billion, $2.5 billion bank loan, I assume, which is what Hologic had outstanding at that point in time. You're one of the lenders there, you're happy, you're happy with your position. So EBITDA, if we're talking LTM, EBITDA is $1.4, $1.4 billion. So you are sitting at 1.8 times leverage. Less than that, that's gross leverage, by the way, because they've got 2.2 billion, sorry, $2.2 billion of cash on the balance sheet. So you're basically, you're basically at zero times net leverage. So your risk profile is just incredibly safe from that perspective. All of a sudden someone comes along and says, hey, I'm going to put $11.5 billion more debt on this business, your risk profile changes materially. So you're, you're unlikely to say, yeah, okay, just put it on. So usually, usually what happens in the real world is you've got all kinds of change of control provisions, which mean if the if the equity, if the equity changes hands, the the debt that's outstanding on the existing business just needs to get repaid. Because if you're if you're sitting in that facility, you're zero times net leverage, and then all of a sudden new owners come along and they're saying, oh, actually, if we just look at this from a term debt perspective, I think we've got what nine, nine point four times debt to EBITDA. Let's let's say, let's say the RCF wasn't drawn at close. So we're looking at our $11.5 billion of debt over our EBITDA 1.4 times. We're now 8.6 times levered. We're gone from zero to 8.6. That's a that's a pretty big change overnight. So you basically say, no, you gotta, you gotta take me out.

SPEAKER_02

Okay. So is it pretty normal, therefore, that when you're doing an LBO, you wipe the slate cleaning, you basically clear out the capital structure before loading up with absolutely loads of debt. That sounds like a big number. 100% eight times even. Um okay, great. So we've got our sources uh and use of funds there for the deal. Okay, what's the next thing we need to sort of walk through then, Graham?

SPEAKER_00

Yeah, well, one thing one thing that I also think is useful to point out really quick is just the fact that we've got the existing cash of this company as a source of funds. Because I think sometimes, especially, I don't know about you, especially when when I'm kind of teaching this in the classroom, people always say, wait, hang on a second. Why, why can we, that that 2.2 billion of existing cash, that's hologics, right? So why why can we use that as a source of transaction funding? And that really comes down to the the relationship between enterprise value and equity value. And you think about you think about enterprise value being equity value plus net debt, you really flip that around and you're like, okay, my equity value is my enterprise value less net debt. So baked into the value of Hologics equity is also the value of the cash, right? So as soon as you, as soon as you buy it, you get access to that cash. And actually going back to that that house example, one one way I find is really useful to just to just understand this really quickly is we've got these two houses. They they're both, yeah, let's say not two houses, not the one house we bought before. We're looking to buy a house. We've got two houses that are both valued at a million dollars enterprise value. It's like the value of the actual house, right? In our diligence of the house, we find that one of the houses has a half a million dollars of cash sitting on its kitchen counter. And when you buy these houses, you get everything, you get everything in it. So if you're buying a house that's got half a million dollars of cash sitting on the kitchen counter, how much think you gotta pay for it?

SPEAKER_02

I'm definitely gonna pay half a million dollars more.

SPEAKER_00

Right? You gotta, you gotta buy the cash in essence, right? So the the offer value and the purchase price of the equity in the sources and uses has already got the value of that cash included. So the second we take the keys to the business, we can use that as a source of transaction funding. Okay. And really it's it on the the last step on our sources and uses, really, is just back solving into what we think the, not what we think, what the what the equity check is gonna be based on what we think we can raise in terms of debt.

SPEAKER_02

I was gonna say I can see that the equity number in that table, for those of you who are listening, uh, it's not a blue number, it's a black uh font in there, which means it's a calculated number. So that must mean it's basically a plug, is how I would refer to it. It's basically you need to send that cash to do funding to do the deal.

SPEAKER_00

So yeah, exactly. We know the way the way we're doing this, we know what our uses of funds are, we know the equity that we've got to buy, we know the debt we've got to refinance, and then we know what we're what we're bringing with us as in what the what the debt we're raising for this transaction is. And then the balancing item is just the equity that we gotta that we gotta raise or put into our pocket, raise from our raise from our LPs or call from our LPs, rather. It's kind of the balancing, balancing figure. Now, I think realistically, if we want to be intellectually honest with ourselves, we should probably delete this $750 on the RCF. I don't know if this was

What is a revolving credit facility?

SPEAKER_00

drawn at close or not. So, Debs, what's a what's a revolving credit facility?

SPEAKER_02

Uh so I like to think of it as like an overdraft for a company. It's something you can dip into uh when you're, you know, you need a bit of extra cash for things like inventory purchases or you know, to pay off some of your suppliers, for example. Am I right?

SPEAKER_00

Yeah, 100%. I kind of think of it as like a it's like a corporate credit card almost. And you know, one of the to your point, you you pay suppliers and whatnot. You know, working it's also called a working capital facility, kind of gets you through working capital swings. Really common in in European RCFs, or at least it was anyway, where you have what's called a clean down provision, which means for a certain amount of time every year it's actually got to be paid down to zero just to prove that it's really a temporary source of funds. So usually in a transaction like this or undrawn at close, sometimes, sometimes part of it is drawn to fund the transaction, but it's not really, not really supposed to be that way. So let's delete, let's delete the RCF from the the the source of funds here. What does that mean our equity check is gonna do, Debs?

SPEAKER_02

We're gonna have to put in more equity.

SPEAKER_00

So let's let's run with this for the time being. Um okay, so Debs, what's what's next?

SPEAKER_02

I don't know. You tell me. You're teaching me.

SPEAKER_00

Okay. All right. So the so one of the one of the examples that I tend to run through in the classroom is, you know, this this it's actually not a hypothetical, not a hypothetical company. It's a hypothetical example of a real LBO where we enter and exit at the same the same multiple. So we're we're now gonna look at this on a multiple of enterprise value to Ebita, kind of how we tend to think about valuation in this world. We're gonna say, okay, we backed into our into our entry multiple. We're saying that's 14, that's 14 times. We've got our enterprise value, which is our equity value plus uh plus net debt in this case. Um so we've got our and our entry enterprise value, by the way, when we're talking equity value, we know our equity value. The net debt that we're gonna calculate is the entry net debt. Now, broadly speaking, because we're we're basically zero net debt, enterprise bio and equity value basically the same for this company on entry. We've got LTM EBITDA of 1.4 billion. So we think our entry, our entry enterprise value multiple is 13.7 times. On a base case, like base case in in this world, we're usually gonna assume no multiple expansion. Multiple expansion just means your multiple goes up. What you really want is both EBITDA and multiple expansion, right? Grow EBITDA and sell at a higher, at a higher multiple. So in our really base case analysis here, we're just gonna assume no multiple expansion. We exit at the same, the same value. In this base case example, we also assume no EBITDA growth. Highly, highly not a realistic assumption for this business. And we'll talk about, we'll talk about why. Like you would never, you would never do this deal with zero, with zero EBITDA growth. So then we work out our exit EV, which lo and behold, is the same as our entry EV, and then we assume some kind of some kind of net debt position at exit. So we we buy this business with $11.5 billion of term debt. Although we talked about that mortgage example where we we have a job, we have a salary, we use that salary to pay down the mortgage. Here we basically do the same thing. We're just using the the cash flow from this company to pay off its debt. Now, a big, a big part, I mean, the main part of an actual LBO model is basically just to model the cash flows of a company, make some assumptions for what you think revenue EBITDA is gonna be. You have some assumptions for cash conversion, you know, what's your capex, your working capital, whatever else. How much cash are you ultimately gonna generate? And how much of that cash can you use to repay debt? The more debt that you can repay, the more you grow your exit equity value. And the more you grow your exit equity value, the higher return is gonna be. That's kind of that's kind of it. So with a company like this, now devs, I don't, I actually don't know the company, the company very well. Like I haven't, I haven't looked at their at their actual financials. But if we're saying, if if I go back to my uh, let's let's go back to our base case example that we always talk to in the classroom, where we say we pay down to $0, $0 net debt. You know, one of the things I like to, I like to kind of tee the class up and talk about is how reasonable of an assumption is that for a business like this? And what what what do you think, Debs? We've got $1.4 billion of EBITDA at entry. We've got $11.5 billion of term debt on this business. And we're saying we're gonna exit in five years. So in five years, do you think we can pay down $11.5 billion of term debt with this this kind of EBITDA profile? And and what and what information are we lacking and what do we need to really figure this out? Because we don't know everything right now.

SPEAKER_02

So I say no way. Um, but uh I think we would probably want to know a little bit more information about how EBITDA converts to cash because it could be no way, or it could be no way jose if it is a very low cash conversion.

SPEAKER_00

Yeah, and look, I don't, again, I don't know, I don't know too much about this business, but you know, medical devices, I'm thinking big capex bill, probably a big maintenance capex cycle. This might be a business that you tend to look at on instead of an EV to EBITDA basis, an EV to EBITDA less maintenance capex basis, you know, really typical for businesses that have a big, you know, big kind of regular maintenance capex cycle. Because ultimately, by the way, when we're talking, when we're talking EBITDA, we're talking some kind of proxy for cash flow. At the end of the day, things come down to actual cold hard cash. Right. So we're look really looking at things on a multiple of actual cash flow. So I kind of think about this as all right, we've got five years, five years to generate enough cash to pay off 11.5 billion. I mean, we'd have to, we'd have to convert a lot of this $1.4 billion of EBITDA cash to get anywhere close to that.

SPEAKER_02

And what about interest, right? Because we're ignoring the fact that you're gonna have

Stress-testing the deal: $4.6 billion in interest over five years

SPEAKER_02

to pay not just the debt. 100% of the interest. 100%.

SPEAKER_00

Yeah, yeah, right. So let's like let's just let's just think about this really, really high level, right? So we've got our $11.5 billion of debt. So let's just, I don't know. I'm gonna not great Excel modeling practice, but we're gonna make some notes, notes here as we go. This is our this is our just total, total debt. We'll make some assumptions for interest. Uh what do you think the blended interest rate across these two facilities is?

SPEAKER_02

Well, I'm gonna go for about eight percent.

SPEAKER_00

That that's kind of what I was gonna go. I don't really know. I mean, it's gonna be it's gonna be close, it's gonna be close enough. So we're gonna say, okay, of this 11.5 billion, we're gonna pay 8% interest per year for five years. Five years, that's $4.6 billion of interest. Like that's that's a lot. Right. So in our five-year hold, if we want to get this down to debt-free, cash-free, we got to come up with $16 billion of cash and our entry EBITDA is $1.4 billion. I think that's that's probably a stretch.

SPEAKER_02

Okay.

SPEAKER_00

But it's not that we have to pay this all the way down to zero to make the returns work. It's it's it's highly unlikely that that this would ever happen. Most LBOs don't pay all their debt down to zero at exit in order to in order to make things work. What are some things that could that could make this interesting, Debs? Like what do you think, what do you think is on the owner's mind here?

SPEAKER_02

Um well, I mean, I don't know Hologic as a business very well, but I would expect that there would be some operational improvements in there. I mean, it's uh we've very conservatively assumed no change to eBid dollar, but I reckon that they are banking on eBid DA improvements and therefore, as you mentioned earlier, some multiple expansion.

SPEAKER_00

There I there has to be, right? Like you basically, if you let let's say, let's say more conservatively, I don't know, let's say, let's say 100% of this eBITDA converts to cash flow, which I think is pretty is pretty unlikely, right? I think it's probably it's probably likely to be a lot less than that. So you say 100% of this EBITDA converts to cash flow, that's what, almost $7 billion of cumulative cash flow over this five year period. You know, but let's let's let's ignore the fact that we are going to repay, you know, pay down potentially Not equally, but in some in some fashion, that's not just all at the at the end of this projection period here. But let's say, okay, we've got $6.7 billion of cumulative free cash flow. We've paid $4.6 billion in total interest. So we've got $2 billion left to make actual principal repayments on our debt. We started off with $11.5 billion of debt. We paid down $2 billion. So I don't know, let's be generous and say we found some extra cash and we paid our debt balance down to $10 from $11.5 billion. Right. All of a sudden, if I if I plug in $9 billion of debt at exit, then my returns just don't make any sense. Like negative 46% IRR, zero times cash on cash. Like you just, you just would not do this deal. So you absolutely have to be assuming that you've got you've got some real some real operational plans for this business. You know, but there's there's a good, by the way, there's a good argument to say that the EBITDA that everyone was backing when they bought this business and when they financed this business was actually quite a bit higher than this 1.4 billion anyway. You're saying, okay, based on based on everything that I know about this company, based on all the stuff I'm going to do really quickly, you know, potentially based on, based on some of the operational improvements that I can do basically overnight, I think my my true entry EBITDA is probably quite a bit higher than that. So I think I've got a higher entry EBITDA than I'm reporting here. And I've probably got some pretty interesting growth plans for this business, which means there's there's there's like no way they're gonna exit still at $1.4 billion EBITDA. So the whole point, by the way, of the actual LBO model is to model this out and say, okay, in this five-year period, I think I can get EBITDA to X. I'm gonna do the actual cash flow model and say, I think of this EBITDA so much is gonna convert to cash flow. Again, add it all up, figure out how much debt you can repay, solve for your equity value at the end. And that's at the at the highest, most basic level, that's that's kind of the LBO model. That's that's basically it.

SPEAKER_02

Awesome. Awesome. So I feel like we've kind of explored the Hilogic uh example there. Should we look at another example? We just touch very lightly, I think, on our second one.

SPEAKER_00

Yeah, let's do it quick. I think we've we probably we probably uh we always say we're

The EA deal: $55 billion enterprise value, 30x entry multiple

SPEAKER_00

gonna do these episodes in like 10 minutes and then and then they wind up being like 45 minutes long. So really, really quickly on on EA, we've got we've got the same setup. Um so we've got, you know, the again, biggest, biggest LBO basically in history at 50, I'll call it $55 billion equity value. Um the the debt, the debt that was that was brought with this business is what kind of adding all this up. What basically close to $20 billion of debt to finance to finance this buyout. Now, if you look at the at these base case returns, again, acknowledging these returns for a high growth business just don't don't make any sense like this. These really, really don't make sense, right? Because you look at you look at this, uh, you look at the the enterprise value here, $55 billion. If we think LTM EBITDA really was $1.8 billion, that's a 30 times, 30 times entry multiple. That just seems kind of it just seems kind of nuts. I'm sure, I'm sure that on the way into this deal, there was a lot of there was a lot of analysis done to really bolster that EBITDA number and support something quite a bit higher to bring down that effective, that effective entry multiple. But if we just take the numbers as given and say, okay, $55 billion EV, $1.8 billion LTM EBITDA, 30 times, 30 times purchase price. Roll that 30 times purchase price forward. Assume you can sell for 30 times. Like that's a pretty aggressive assumption. Again, we've got this, we've got this base case assumption here that we've paid down to zero dollars, you know, zero dollars net debt. Again, highly, highly unlikely, right? We've got both principal and interest repayments again, $1.8 billion of EBITDA over five years. Like we're not going to get close to paying anywhere near that much debt down. But even if we do, right? Even if we make this assumption that somehow we find the cash to pay down, to pay down this much debt. I mean, by the way, I have to assume EA is a lot more cash generative than a medical devices company, but still, it's crazy. We're at an 8% IRR and a one and a half times money multiple. Like there's there's obviously there's obviously a lot more going on here that is not not reflected in the numbers you read in the press release. Right.

What investors must be backing: EBITDA growth assumptions

SPEAKER_00

So obviously people are backing a much, a much higher EBITDA. This is a high growth business. You know, there's there's some kind of assumption that, you know, we can sell that maybe our maybe our exit multiple isn't 30 times, maybe it's, I don't know, 18 times, but we're gonna sell it doing $10 billion of EBITDA, something like that. Now we're at, oh, yeah, we're at five times, five times our money. Again, there's no way we're gonna, we're gonna pay down that much, pay on that much debt at this point. I mean, maybe if we do get EBITDA to $10 billion, but it's probably not gonna happen in five years. So I don't know. This one, this one requires a little bit, a little bit more thought and analysis, because just based off the based off the headline numbers, it's hard to it's hard to see. Well, no one's no one's backing, I'm just gonna control Z and undo, like no one, no one's really backing this deal at an 8% return or a one and a half times money multiple. No, for sure.

SPEAKER_02

I mean as you said, I said at the beginning, you know, you can get more in the stock market. Um I think Exactly. A couple of things that make me a little bit surprised about you know this being a leverage buyout. We've got the debt to equity mix here, 20 billion of debt versus a market cap around 50, 55 billion dollars. That's not that leverage. As you said, it's a really high acquisition multiple. So you're buying a business on about 30 times its E-Bit DA. Whereas when we think about leverage buyouts, I often think about you know quite cheap businesses, you know, where you can, you know, leverage is much more effective if you're buying a company, you know, on maybe 10 times its E-Bit DAR and the debt is six times its E-Bit D. That kind of sounds a little bit more like a traditional kind of LBO. So what do you think is going on here? What is kind of, you know, I know it was a consortium uh of financiers. We've got Saudi's public investment fund, Silver Lake and Affinity Partners, or acting as a consortium. So this doesn't feel like a traditional um LBO. So what is going on? What is this this deal all about, do you think?

SPEAKER_00

I mean, the honest answer is I don't, I don't know 100%. I think you're right. When you look at the when you look at the investor base here, it's not it's not a traditional, just normal, kind of regular, regular buyout. So, you know, maybe I can see, yeah, I can see the the overall return hurdle here being being a little bit lower on the basis it's not, again, it's not your your traditional buyout where you're using a lot more leverage. I mean, even though the numbers are big, to your point, in terms of in terms of the total, the total capital structure, the leverage here isn't, isn't crazy. I mean, it isn't crazy. Well, we say we say eight times cash EBITDA, which is still crazy in in my world, right? But when you're when you're looking at at loan to value and your valuation is 30 times EBITDA, doesn't feel that crazy. Um I don't know. I need to I actually need to do a little bit more digging into some of the financials to the extent you can that they're even available here and see if we can get a better view on what's going on. But yeah, I think maybe you know people are just you've got to have probably a much, a much longer-term investment horizon here than you do for a for a standard buyout. Um, you know, probably probably a lower, lower return threshold. Because yeah, it doesn't this one it's a leverage buyout in the sense there's a there's the the the absolute leverage number is big, but in terms of the rest of characteristics that we think about for a traditional LBO, it doesn't doesn't quite feel feel like the normal the normal kind of transaction.

SPEAKER_02

And so I've been reading about about the sovereign wealth funds have been increasingly participating in in this kind of deal through co-investing. And you know, you're teaching at the moment in Abu Dhabi. So what is driving, do you think, that kind of increased participation from wealth funds in this type of deal?

SPEAKER_00

Uh I mean, you know, certainly if you think about the the the kind of reason for for some of these, uh for some of these investors to co-invest rather than, you know, rather than just make commitments to the actual the actual funds. A few different reasons. One, a deal this big just needs a bunch of capital. So you're gonna need to find pockets of capital that sit outside just the just the traditional kind of co-mingled GPLP style funds. I think a lot of a lot of co-investors also like these kind of arrangements because they tend to be a little bit more advantageous in terms of economics and fees. If you're investing straight in the deal, you're not paying all the same fees you would if you're investing through the through the actual private equity fund. So it's kind of a combination, combination of factors. Like also what we're finding now is you know, I think if you look at how a lot of these big sovereign wealth managers have developed over the last really couple decades, they've got much more, much more built-out infrastructure in terms of their own investment teams. They have the people, the knowledge to be able to make the direct investments, whereas probably didn't have as many, as many resources on the uh the kind of human capital side, you know, 10, 20 years ago. Um so I think a bunch of different reasons for for this for this being a lot more common. And certainly not just EA. You find this a lot, a lot in the private equity space these days.

SPEAKER_02

Yeah. And we've certainly been hearing about sort of more um sorry, fewer deals in total, but more more big deals, these kind of mega deals. And this is certainly an example of that. And maybe this co-investment reflects kind of that sort of search for this more um more large-scale deals uh in the private equity space.

SPEAKER_00

Maybe so. And definitely, I mean, to the the point we've been talking about the last the last few weeks, this does seem to be the year of the mega deal, the quarter of the mega deal. So more of this to come, quite possibly. I don't I don't have a crystal ball and know exactly what's coming down the pipe for the the mega, the other mega private equity deals. But will we see more stuff that looks like this? Quite possibly.

SPEAKER_02

And what about the exits uh from these transactions? We talked about the fact that, you know, you can generate a really nice return uh after five, seven years, but you actually have to be able to exit. Um and we've certainly heard some news flow around exits becoming a little bit more challenging. And certainly if you want to exit to the public markets. And so now we're increasingly seeing exits to other strategic buyers, uh, that's other other corporates, or even to other financial sponsors. So can you talk us through a little bit about kind of what's going on there?

SPEAKER_00

Yeah, I mean, it's and you know, here very much depends as well on

The evolution of private equity: generalist to specialist

SPEAKER_00

what part of the market we're talking about, you know, kind of mid-cap, mid-cap, large cap. It's actually interesting. I mean, I worked in mid-cap private equity in Europe for for a long time. And what you actually tended to find there was the same companies that kept getting passed round and around the market. And what the what the general the general kind of philosophy was you have an owner that extracts some value and then tries to sell it to a new financial sponsor with something, you know, some kind of carrot to say, oh, you can, there's there's this other stuff we haven't done yet. So if you buy this from us, there's a lot more value to extract, create still. Um so that's that's certainly one, you know, one aspect of of this world that that I've seen a lot of firsthand. To your point around some public exits becoming a little bit more tick, a little bit more tricky. I mean, obviously with public, with public listings, you've got you've got the IPO market and whether that's open shut to deal with. Um, but certainly for for companies that are say this big, uh, you know, you can make the argument, you know, both Hologic and certainly EA. I don't know how many strategic buyers you're gonna find to uh to undertake a transaction of this size. You know, maybe. I mean, let's look at the, we've been talking a lot about, you know, Warner Brothers, Paramount, Skydance, all this, all this kind of stuff. There are there are some mega some mega strategic deals. Um, but when EA ultimately comes to list, will it be strategic or or IPO? I'd kind of guess one of those two rather than a sale to another another private equity shop or consortium, but but who knows? We'll see.

SPEAKER_02

Okay. Um and then I guess my final question about the current market. Um we talked about some of the ways that you can drive value in this kind of deal in terms of debt pay down, um increasing the valuation through operational improvements, through multiple expansion. Um what how has that kind of evolved over time? I know that sort of historically you're in the early days of leverage buyouts, there's accusations of asset stripping. That's where you sell off the assets to pay down debt. And there was definitely that in the early days. But do you think the kind of the private equity market has really moved on from that approach that we're sort of much more focused on things like operational improvements?

SPEAKER_00

Yeah, I would I would say in terms of things like comparing, say, asset stripping for debt pay down versus real operational improvement value creation. If you look at like look at how a lot of the private equity world is structured these days, you find far fewer, say, true generalist private equity firms. Like we roll back the clock, I don't know, 20 years, you can find private equity firms that just did private equity, right? You can just buy any old company finance with a lot of debt, and that was that was kind of what you did. I think right now you've got one, you've got a lot of capital competing for for the same assets. I mean, I forget the I think we've talked about it in previous episodes, just the amount of dry powder that's that's out in the private equity world right now. I want to say is what, about a trillion dollars.

SPEAKER_02

About 900 billion. It has come down a little bit,

Why financial engineering alone no longer works

SPEAKER_02

but it is a huge amount. It's just sitting idle, waiting for the deals.

SPEAKER_00

And ultimately, like think about the way these funds are structured. You have to, you have to invest this money. You can't sit on it forever. You can sit on it for a period of time, but ultimately your investors are backing you because they think you're gonna go out and invest this money and earn a return. So you've got all of this dry powder sitting out in the market right now, chasing a finite number of deals. What does that do? You've got an abundance of capital and scarcity of scarcity of companies that's gonna drive up your purchase price multiples. So if your purchase price multiple is getting driven up, you really need to do, you really need to be able to do something interesting on the operational side in order to generate those same private equity style returns that used to be a lot easier, you know, 15, 15, 20 years ago. So if you look at the overall space right now, I think it's fair to say you find a lot more specialist private equity these days than you do generalists. You find people that focus on, you know, healthcare, tech, software, services, manufacturing, whatever, whatever the case may be. You know, people that have got real operational and sector experience and and know what they're doing in a particular industry and know how to how to create value in a particular company. You know, much, much different. It's much, I think it's it's it's harder, I think, to do private equity well, probably more interesting because you're you're you're really you're really kind of performing some interesting, not just turnarounds, but you know, operational improvements, you know, doing some cool stuff at a lot of these portfolio companies, but it's also not easy. You can't just buy it, put a bunch of debt on, and then and then go home and chill and expect to make a 3x to your money deal in like five years. Like that's that's just not gonna happen. And I think like these deals are great examples of that, right? It's actually interesting. Like the the teaching example that I use a lot for the buy and sell for the same price, pay your debt down, where it almost pencils out. I think that was from like 2000, 2012, right? Look at what's happening now. It just does not does not work the same way.

SPEAKER_02

And that I think that's a really important point that you know the private equity has moved on. And it isn't just about having financial smarts, the ability to use this kind of the financial engineering just to create value, that you need to have that operate, those operational smarts, the ability to improve a business. And you therefore need that kind of industry expertise, you need that playbook of how you can go in and improve that particular type of business. Um, and that is you know, and as we said, you know, that is a huge amount of risk as well, that you need to be able to, you know, have confidence that you can go in and execute those improvements. It's not just a plan, you've got to be able to execute that plan.

SPEAKER_00

Exactly.

SPEAKER_02

Well, I think it's it sounds like uh it's an interesting space. Uh definitely um we're seeing, as I said, uh some very big deals coming through. We'll keep tracking. Uh now we've got basic uh knowledge of how to do those calculations. So hopefully we can reuse that uh in further episodes when we're talking about LBO deals.

SPEAKER_00

I I mean there's there's so much more we can talk about. I'm I've just got this running list of kind of episode ideas as we as we get a bit farther down the line. So uh I think we've probably been probably been uh chewing each other's ears off for for long enough. So um we'll uh we'll save some of that for for future episodes. But there's there's a ton we can talk about in this space. So yeah, more more more to come. So stay tuned.

SPEAKER_02

Okay, well, thanks so much. And that's it for this week's episode of What's the Big Deal? Uh if you enjoyed our dive into the world of leverage buyouts, including Hologic and Electronic Arts, then please do follow us and leave a rating. And if you're watching us on YouTube, please do like, subscribe, and of course leave us a comment. Um so until next week, uh, where we're gonna look at a new deal with some fresh insights. Thanks so much from myself and also thanks from Graham.