1 Introduction
As the term suggest, a leverage buyout (LBO) is the acquisition of a company, using a significant amount of debt to pay most of the purchase price. The remaining part is equity and is usually provided by the acquirer, also called the financial sponsor, typically a private equity (PE) firm. Accordingly, this financing technique permits the sponsor to make large acquisitions without having to commit to a lot of equity capital. The idea is to use the cash flows generated by the acquired company to pay down both interest and debt. It is the reduction of debt and increase in equity over the holding period that reflects the value that is created to the PE firm in the LBO. The ultimate goal of the PE firm is to exit within a predefined timeframe, making annualized returns above 20%.
Generally, an LBO transaction falls into three stages: the acquisition stage, the holding stage, and the divestment stage: During the acquisition stage, a PE firm first screens the market for potential investment opportunities that satisfy their criteria for desirable target characteristics. Once an appropriate target has been identified, the PE firm initiates the due diligence process of the target, which involves a valuation and the formulation of a business plan for the LBO candidate. The business plan is meant to outline the possibilities for value creation that are expected to be realized in the subsequent holding stage. Last in the acquisition stage, the financial sponsor prepares a detailed structuring of the transaction and organizes the required leverage. In the following holding stage, the PE firm plays an active role in the reshaping of the company and its strategy, implementing operational as well as organizational changes. These changes are meant to generate improved earnings that will be used to pay down the debt. By the end of the predefined investment horizon, the PE firm evaluates its possibilities to exit, and the LBO transaction enters the divestment stage.
2 Target Selection Process
2.1 Defining the Target Universe Before embarking on our analysis, it is crucial to establish a set of key assumptions. First, to ensure the use of reliable data, the date of acquisition is fixed on December 31, 2022, providing a foundation built on accurate information. Second, we consider a Private Equity (PE) firm with a fund size of €1.5 billion, aligning with the average fund size of European PE firms in 2022. Third, due to limited data and literature, we choose as target market the Northern European one, more precisely the Swedish market, this will allow us to follow along with the current literature smoothening out the selection process. Fourth, we limit our analysis to companies listed on the main Swedish stock exchange, Nasdaq OMX Stockholm, reducing the possibility of unreliable information. Last as we are interested to implement operational changes on our target company, we choose to exclude purely financial companies, where such measures are difficult to carry out, as they do not have any tangible operations. Hence, subject to the assumptions and limitations, the scope of the case beholds Swedish firms, listed on the main Nasdaq OMX Stockholm stock exchange, excluding property & financials and investment companies, and with a total market capitalization ranging from EUR 100mln to EUR 500mln, or about 6% to 33% of fund’s capital.
2.2 Quantitative Screening
With these foundational elements in place, our research into the target company can commence. Again, there are many factors that contribute to the success of LBOs – one crucial factor is the choice of the right candidate, which is why the selection is of vital importance. The key metrics used by PE firms to assess the adequacy of a potential target revolves around a series of intuitive and straightforward criteria, that will be later translated into multiples and ratios and applied to potential target on a pass or fail basis. Leveraged Buyout (LBO) transactions thrive when targeting companies with specific characteristics that align with the strategic goals of Private Equity (PE) firms. Favorable LBO candidates typically hold strong market positions in attractive and non-cyclical industries, creating a foundation for stable and growing earnings essential for debt repayment. PE firms meticulously screen potential targets based on other several key criteria:
Stable and Predictable Cash Flows: Paramount to the screening process is the emphasis on stable and predictable cash flows. In LBOs, PE firms aim to repay loans over a defined period. Consequently, they seek targets with positive and stable cash flows exceeding operational needs and debt requirements. Ideal targets exhibit low sensitivity to seasonal fluctuations and macroeconomic factors, making them resilient to economic downturns and volatile commodity prices.
Attractive Purchase Price: The success of an LBO transaction hinges significantly on securing a low purchase price. A prudent purchase price enhances the potential Internal Rate of Return (IRR) for the investment.
Hard Assets: Given the high reliance on debt in LBOs, targets with abundant, valuable, and liquid tangible assets are favorable. These assets, such as plant and equipment, inventory, receivables, real estate, and cash, serve as collateral for the debt.
Low Capex Requirements: Targets with low capital expenditure (Capex) requirements are preferred in LBOs. While a strong asset base is advantageous for collateral, asset-heavy companies may face challenges in repaying loans due to high ongoing Capex needs. PE firms seek targets that do not consistently require significant cash for maintaining and replacing existing assets.
Efficiency Enhancement Opportunities: PE firms value candidates with strong underlying business models but find them even more attractive if there are opportunities for further enhancements. This may include cost-cutting measures, optimizing product pricing, diversifying the customer base, or exploring new markets.
Attractive Industry: LBOs are more successful in industries characterized by high economic and technological stability, concentration, and high entry barriers. Ideally, these industries have low substitution possibilities and little dependence on customers and suppliers, with minimal exposure to general economic sentiment.
Experienced Management: A robust management team is crucial for operational improvements and strategy implementation. If the initial management lacks essential qualities, PE firms ensure a replacement is ready before acquiring the company.
Among the initial 74 companies meeting our criteria, we need to refine our selection. Firstly, we exclude companies with an EBITDA margin below 5% over the last 5 years, indicating meager and unstable cash flows. Simultaneously, we eliminate companies with an EBITDA margin above 20%, as limited room for improvement by the PE firm could result in a diminished exit value. Moving forward, we define an attractive purchase price as an EV/EBITDA ratio below 15x. This means the enterprise value should not exceed 15 times the earnings before interest, taxes, depreciation, and amortization (EBITDA). Additionally, we consider a share price return below 30% over the last 12 months as a parameter for attractiveness. Given our interest in companies with robust debt capacity, able to accommodate a significant debt load, we introduce a criterion excluding companies with a Net Debt multiple of EBITDA below 2x. This ensures that the EBITDA is at least twice the total amount of debt net cash and cash equivalents. Recognizing the PE firm's intention to implement operational improvements, it becomes imperative to consider companies with room for enhancement. Therefore, we set a criterion for an EBITDA margin below the competitor’s level. Finally, in alignment with the need for sufficient collateral for debt repayment, we exclude companies with a share of intangible assets over total assets exceeding 20%.
As a result of our quantitative screening, our target universe reduced from 74 possible target companies to 9. These companies are listed in figure 2.
2.3 Qualitative Screening
The first characteristic under consideration is "non-cyclicality," assessed through firm-specific and industry-specific betas. Firm-specific betas measure the correlation of a company's share returns with the market portfolio, while industry betas indicate the correlation between the industry and the overall economy. An ideal target should exhibit minimal correlation with the overall economy. Consequently, we eliminate companies with the highest beta, narrowing down our selection to four companies: Malmbergs, Swedol, Fenix Outdoor, and Rezidor. To evaluate industry attractiveness, we examine the degree of concentration and potential entry barriers. This assessment leads to the exclusion of Malmbergs, given its industry's high degree of private firms, making analysis challenging. Moving forward, we assess capex intensity for the remaining three firms, selecting those with the lowest capex as a percentage of sales ratio. However, all three companies display similar results, prompting us to proceed with all three. Reviewing recent market events, we note that both Swedol and Rezidor have been recently acquired by other companies, Alligo and Radisson, respectively, and have gone public, thus violating our initial criteria. By excluding both Swedol and Rezidor, we determine that Fenix Outdoor AG will be our target.
3 Fenix Outdoor AG Overview
Home to Fjällräven, Tierra, Hanwag, Royal Robbins and Frilufts Retail, Fenix Outdoor is an international group of premium outdoor brands focused on products for nature and outdoor life. The company is listed on Nasdaq Stockholm, Large Cap. Fenix Outdoor’ products range includes apparel, daypacks, back- packs, sleeping bags, tents, stoves, bags, outdoor shoes, and boots. The products are high-quality, durable, light weight and classically designed. Product development adapts to the demands of consumers and professional users. The brands are also trusted names, with considerable expertise and history in product design, materials, and production. The philosophy is to offer optimal and functional products based on functional design. In addition to continuous development of the brands’ product ranges, Fenix Outdoor focuses on investing in the brands. The main owner of Fenix Outdoor International AG is Martin Nordin, holding 53.1% of the total voting rights and 15.6% of the total capital.
3.1 Business
The Fenix Outdoor Group’s business was originally based on the development and sale of products from Fjällräven, the group’s first brand. In 2001 the group acquired Naturkompaniet. In addition, the group acquired the brand Tierra, which develops and sells innovative, high-tech garments for outdoor ac- tivities. In 2002 Fenix Outdoor acquired the brand Primus, a world-leading developer and producer of outdoor stoves and accessories, and in September 2004 the group acquired the German footwear brand Hanwag. The Brand segment was in 2018 complemented with the US-based outdoor and travel apparel brand Royal Robbins.
In 2011 the retail segment Frilufts expanded with the acquisition of the Finnish retail chain Partioaitta. In 2014 the German retailer Globetrotter was acquired. The expansion of Frilufts continued in 2017 and 2021 when the Danish retailer Friluftsland and the British retailer Trekitt were acquired. In 2021 Frilufts also introduced a new market penetration strategy by expanding the Naturkompaniet brand to Norway. In addition, the group has acquired and started up distribution companies all over the world, including in Europe, Asia, and North America.
In December 2022 Fenix Outdoor signed an agreement to divest Primus to Silva Group. The closing of the agreement is planned for April 28, 2023. Fenix Outdoor believes that Primus has significant growth and development potential in the future together with Silva, a company that also operates in the technical segment of outdoor products. Silva being focused within outdoor hardware and technical equipment makes it a natural fit with the long technical legacy of the Primus brand.
The business of Fenix Outdoor is to develop and market high-quality, durable outdoor products through a selected retail network with a high level of service and professionalism, to end consumers with high expectations.
3.2 Strategies
Continued expansion within the segment Brands, through organic growth and acquisitions.
Organic growth based on a strong global retail network with strong brands. Owning and operating a retail network increases control of the value chain through close contact with the end user, which enables a faster response to trends and changing consumer demands. The retail network also showcases the brands’ assortments.
3.3 Operations
The group is organized into three business segments: Brands, Global Sales and Frilufts.
Brands include Fjällräven, Tierra, Primus, Hanwag and Royal Robbins. It also includes Brandretail (the e-com and brand retail shops) and the distribution companies concentrated in sales of only one brand.
Global Sales includes distribution companies selling more than one Fenix brand. The Global Sales segment consists of Fenix Out- door multiband distribution companies rep- resented globally, mainly buying its products from the Brands segment. The Asian distribution companies also run retail operations, primarily brand retail.
Frilufts includes the retailers Naturkompaniet AB, Naturkompaniet AS, Partioaitta Oy, Globetrotter Ausrüstung GmbH, Friluftsland A/S and Trekitt.
3.4 Risk Factors
Cyclical risks. Historically, upswings and downturns in the economy have not had any significant impact on the group’s sales or earnings trend, even though the risk may have increased by the larger retail share of the operations, including the changing retail environment.
Weather-related and seasonal risks. Certain parts of the group’s product range and sales are affected by weather conditions. Portions of the winter collection, mainly available in the markets with a colder climate, are negatively affected by warm and late winters.
Trend risks. The group does not consider itself to be a group of fashion products, but the business is affected by long-term trends such as the positive active and outdoor life trend. Some markets in warmer climates which have a different product mix are still more impacted by single product trends compared to other more traditional outdoor markets.
Pandemic risks. The group has shown that it is well prepared to handle a crisis like that.
Currency risks. The group’s net sales in different currencies are distributed as follows: SEK 12%, EUR 56% including DKK, USD 16% and other currencies 16%. A major portion of the Brand segment's purchases take place in USD, even though certain brands make a large share of purchases in EUR. The Frilufts and Global Sales companies mainly buy in local currency. The group’s policy is to hedge its short USD position from purchase orders, through forward contracts lasting up to a year.
Vendor risk. The group is not totally dependent on any major single vendor even though some brands are more exposed in the short run.
4 Strategic Analysis
In this chapter we try to assess Fenix Outdoor industry position in the outdoor apparel market as well as the market structure and concentration. Market information will be pivotal to the newly established management team to understand the extent and strategies of operational engineering upon the company.
4.1 Market Analysis
The Outdoor Apparel market refers to the segment of the clothing industry that specializes in the design, production, and distribution of clothing and accessories tailored for outdoor activities and recreational pursuits. This market encompasses a wide range of outdoor clothing, footwear, and gear designed to provide protection, comfort, and performance for individuals engaged in various outdoor adventures and sports. The Outdoor Apparel market in Western Europe is characterized by a high level of concentration with major players such as Patagonia, The North Face, Dechatlon, and Columbia, detaining a relevant market share. Even though price pressure among competitors is high due to the presence of low-price range retailers, such as Decathlon and RVRC, the market has experienced robust growth after the Covid pandemic with an increase of 11.5% in revenues compared to the previous year in Western Europe. The strongest growth was recorded in footwear and accessories, up in value by 20.40% and 19.05% respectively, but there was growth in all categories, with an overall increase of 11.49% in value and 6.31% in volume. The lowest level of growth was in tents and climbing equipment. The forecasts for Western Europe show a bright picture with CAGR of 5% between 2022 to 2032. The main drivers for such robust growth have to do with:
Increasing Outdoor Activities: A rising focus on health and wellness has encouraged more people to engage in outdoor activities, leading to increased demand for outdoor apparel that supports an active lifestyle. Further, the growing popularity of outdoor activities, such as hiking, camping, running, and cycling, has led to a higher demand for specialized outdoor clothing that provides comfort, protection, and performance thus it will enhance business demand.
Health and Wellness Trends: According to McKinsey, the wellness market is growing at a fast pace, and it’ll only continue to do so in the future. Consumers intend to keep spending more on products that improve their health, fitness, nutrition, appearance, sleep, and mindfulness.
While it might seem that the trajectory to success for such companies is smooth, this industry is not without its challenges. To withstand competition, firms must continually invest in research and innovation, focusing on both materials and designs, which can impact a company’s profitability. Additionally, the market experiences seasonal demand fluctuations, with heightened demand for cold weather gear in winter and warm-weather attire in summer, necessitating efficient inventory management by companies. Lastly, given the intense competition, it is crucial for brands to establish and uphold a robust brand image and reputation for quality, durability, and authenticity, making extremely difficult for new entrant to penetrate the market.
4.2 Fenix Outdoor AG - Market Position
As illustrated in Figure 2, before the acquisition date, Fenix Outdoor AG held a market share of nearly 7%, a significant value considering the competitive landscape in the region. Fenix's market share was calculated by dividing Fenix's market capitalization by the total market capitalization of the Outdoor Apparel market in Western Europe during that period. A 7% market share is highly valuable for the PE firm, providing a substantial competitive advantage and robust cash-generating power.
4.3 Competitive Analysis
In Section 4.2, we provided an overview of the entire Outdoor Apparel Market. Now, let's delve into a comparative analysis of how Fenix Outdoor International AG stands against its competitors. It's noteworthy that Fenix has established a robust and consolidated presence in six out of thirteen counties in North-Western Europe, primarily through the Frilufts segment. This segment is managed by six subsidiaries, each operating retail shops across the Nordics, Germany, and the UK. This positioning presents an opportunity for expansion into the remaining Western European regions, thereby enhancing consumer awareness and popularity.
To assess the performance of all three segments of Fenix Outdoor in comparison to its peers, we concentrated on two crucial metrics: Inventory Turnover Rate, measuring how frequently a company replenishes its inventory relative to its cost of sales (higher ratios are favorable), and Return on Investments (ROI). Figures 3 and 4 present a comprehensive overview of these key performance indicators (KPIs) for Fenix in comparison to other sport holdings. Despite both the market and the peer group grappling to reach pre-pandemic levels in terms of return on investment, it is noteworthy that Fenix Outdoor has consistently maintained its ROI well above industry and peer group averages. This underscores Fenix's proficiency in generating positive NPV from its investments, leveraging its competitive advantages and economic rents. Additionally, Figure 4 indicates that the company has sustained a commendable level of efficiency, attributed not to a reduction in inventory stock but rather to robust sales figures
4.4 SWOT Analysis
Performing a SWOT analysis on Fenix Outdoor will the PE firm to see which criticalities could be addressed to improve the target’s operational and financial performance.
STRENGHTS Fenix Outdoor AG boasts a strong market presence in six key countries within North-Western Europe, showcasing a strategic and influential position. The company's success is amplified by a diverse brand portfolio, allowing it to effectively cater to a broad range of consumer preferences. With an extensive retail network strategically positioned in key markets like the Nordics, Germany, and the UK, Fenix ensures widespread brand visibility and accessibility for consumers.
Fenix's commitment to innovation and quality in materials and design positions it as a leader in producing high-quality outdoor goods. This dedication not only meets evolving consumer demands but also distinguishes Fenix as an industry frontrunner. Additionally, the potential financial stability of Fenix Outdoor AG, marked by consistent revenues and profitability, underscores the company's resilience and effective business management.
WEAKNESSSES The company's geographical concentration primarily in North-Western Europe exposes it to potential vulnerabilities arising from regional economic fluctuations. This concentration may heighten the impact of economic changes within the specified region, necessitating a strategic approach to mitigate associated risks.
Secondly, the sales of outdoor apparel are intricately tied to weather conditions, rendering Fenix susceptible to fluctuations in demand driven by seasonal variations. This weather-dependency introduces an element of unpredictability, requiring the company to employ flexible strategies to adapt to varying consumer preferences influenced by climate changes.
Thirdly, Fenix encounters challenges in seasonal inventory management due to the inherent fluctuations in demand. Managing inventory effectively during peak seasons and ensuring adequate supply during off-peak periods can be intricate. These seasonal inventory dynamics necessitate a meticulous approach to maintain optimal supply chain efficiency and meet consumer demands throughout the year.
OPPORTUNITIES The company has the potential for global expansion, offering an avenue to diversify and extend its market presence beyond the confines of North-Western Europe. Exploring new and potentially lucrative markets aligns with Fenix's growth strategy and opens doors to fresh opportunities.
In addition, the surging growth of online shopping presents a notable opportunity for Fenix to enhance its e-commerce presence. This avenue allows the company to reach a broader customer base, adapting seamlessly to the evolving landscape of consumer preferences in the digital era.
Fenix also has the chance to align its products with the increasing emphasis on sustainability in consumer choices. Embracing eco-friendly and ethical practices not only resonates with conscientious consumers but also positions Fenix as a socially responsible brand in an environmentally conscious market.
Furthermore, the prospect of forming strategic partnerships or collaborations with other companies stands out as an opportunity. Such partnerships could unlock new avenues for product offerings, expand market reach, and facilitate shared resources, enhancing Fenix's overall competitiveness in the industry. Embracing these opportunities strategically can propel Fenix Outdoor AG towards sustained growth and success.
THREATS Firstly, the outdoor apparel market is marked by intense competition, featuring both global and local competitors. Navigating and differentiating itself within this fiercely competitive landscape is imperative for Fenix to secure and expand its market share.
Moreover, the company is susceptible to the impact of economic downturns, with uncertainties or recessions potentially dampening consumer spending on non-essential items, thereby affecting Fenix's sales and overall profitability. A robust strategy for navigating economic fluctuations is crucial to mitigate the potential repercussions on the company's financial health.
Supply chain disruptions represent another challenge for Fenix, as global events, natural disasters, or interruptions in the supply chain can significantly impact the availability of materials and disrupt production. Ensuring resilience and flexibility in the supply chain is vital to maintaining consistent operations and meeting customer demand.
Furthermore, Fenix must remain attuned to evolving consumer preferences and trends in outdoor activities. Shifts in these trends can directly influence the demand for specific types of outdoor apparel. Staying adaptive and innovative in response to changing consumer dynamics is essential for Fenix to retain its relevance and competitive edge in the dynamic market landscape.
4.5 Operational Engineering
In addition to their financing expertise, PE firms implement operational changes in the target, enhancing its efficiency by either developing or refining the existing business plan and evaluating resource allocation within different business areas. A primary step in this process involves appointing a new management team, as the current leadership may struggle to break through the existing status quo. Introducing a fresh management team to Fenix will infuse new perspectives into the company's operations, fostering a critical examination of established practices. This need for management renewal is particularly pronounced in Fenix's case, given its current CEO, Martin Nordin, has familial ties to the founders of Fjällräven, the company that later evolved into Fenix Outdoor AG. A suggested new management team could include Erik Ahlström, a former Fjällräven CEO known for adept brand management, as Chief Executive Officer, overseeing Fenix's strategic vision. Maria Lundberg, a seasoned finance executive with a background in multinational retail, is a strong candidate for Chief Financial Officer, ensuring the financial health of the organization. Anders Larsson, an operations expert with a track record in supply chain optimization within the outdoor and sportswear industry, could take on the role of Chief Operating Officer. The substantial leverage burdening on the company could serve as a powerful incentive for the management team to exert extra effort, considering their jobs and reputations are at stake.
Turning our attention to the operating side, Fenix Outdoor AG, comprising the Frilufts, Brands, and Other segments, can strategically enhance its operational performance and boost profits through targeted measures. To mitigate the risk of geographical concentration in the Frilufts segment, the company should focus on global expansion, establishing a presence in untapped regions through localized partnerships. For Brands, optimizing e-commerce integration, implementing brand-specific sustainability initiatives, and negotiating favorable terms with suppliers can fuel growth. Within the Other segment, market-specific expansion, product portfolio diversification, and tailoring sustainability and CSR initiatives to each market's unique demands are crucial. Embracing advanced data analytics, adopting flexible inventory strategies, and exploring opportunities for vertical integration across all segments can improve overall supply chain efficiency. Implementing comprehensive digital marketing strategies, including e-commerce and sustainability-focused initiatives, can enhance Fenix Outdoor's brand visibility, market reach, and profitability, positioning the company as a leader in the outdoor and sporting goods market. We assumed that the implementation of such strategies will let Fenix Outdoor achieve higher, although fairly conservative, revenue growth in its three core segments than industry average.
5 Leverage Buyout Valuation
In this paragraph we developed the deal structure and performed the LBO valuation. We’ll first begin with the computation of the target price. Second, we’ll describe how the capital structure will be composed, describing the uses and sources. Third, we’ll identify the company free cash flows that will be then used to repay the debt. Fourth, we’ll build the repayment schedule and finally we’ll look at the return conditioned upon different scenarios and discuss the exit options.
5.1 Acquisition Price
The literature extensively covers the multiples utilized in the decision-making process of PE firms during the capital allocation phase of target acquisitions. Throughout this deal, we will rely on EBITDA multiples, a widely used measure in the finance industry. EBITDA is favored for its ability to provide a representative snapshot of operating cash flows, crucial in evaluating the target's capacity to service debt payments.
Determining the target purchase price necessitates establishing an appropriate share acquisition premium that the PE firm must pay to attain full control of the target. Existing literature suggests that acquisition premiums for leverage buyout transactions typically range between 15% to 50%, with a narrower interval of 28.5% to 32%. Considering this, we opt for a reasonable 30% acquisition premium to proceed with the target price determination.
As of the valuation date on 31/12/2022, Fenix Outdoor International AG's share price was EUR 76.21, with a total of 13,330,000 shares outstanding. This computes the market capitalization to be EUR 1,016m. Adding the 30% share premium to the market capitalization results in a purchase price of EUR 1,321m. Adjusting for Fenix's negative net debt, the enterprise value is calculated to be EUR 1,325m. Consequently, dividing Fenix's enterprise value by its EBITDA at acquisition, the PE firm will be paying a 9.5x Enterprise Value Multiple of EBITDA. Additionally, the computed Fenix Equity Value stands at EUR 1,016m.
5.1 Deal Financing
The PE firm choose among the nature of the funding sources as well as their composition. The best source of funding for a LBO transaction is debt finance as the serviceable debt will generate interests that will be used as tax shields given the deductible nature of interest expenses. The amount of debt that lenders are wiling to concede depends on several factors, company specific factors, such as the quality of the target company and the company’s track record, case specific factors, such as the amount of equity contributed by the PE fund as well as the current economic environment and the prevailing willingness among banks to take risk. In a traditional LBO debt level as a percentage of the purchase price typically comprise between 60% to 70%. For the purpose of determining an appropriate debt multiple for our LBO, we have collected the average debt multiples of European LBOs between 2002 and 2015.
A core expertise among PE funds is their ability to access cheap financing through their excellent relationships with investments banks. Banks are very much interested to provide PE firms with founding as the interest rate they pocket from such transactions is much higher than the one earned for corporate lending. Therefore, bank loans normally form the majority of the debt structure.
We are confident to have chosen a strong candidate with solid fundamentals. However, as at acquisition date the interbank market was facing the consequences of increasing interest rates with 3-month STIBOR increasing from negative values to 2.56%, we decided to get a multiple taking into account the increase cost of borrowing, therefore choosing a Net Debt Multiple of EBITDA of 5.5x. Therefore, the amount of serviceable debt will correspond to almost half of the purchase price, or to EUR 819m. The remaining part of company’s enterprise value will be financed through equity contributions from the PE firm directly. Therefore, as shown in figure 8, 78% of total debt and 45% of the total capitalization will be financed through Senior Debt while the remaining part of debt, 22% of total debt and 13% of the total capitalization will be financed through Subordinated Debt.
Further, the overall amount of debt financing will be divided into different types and tranches. The debt provided by banks and financial institutions will be of two kinds: Senior and Subordinated debt. Senior debt will have the priority over the subordinated one and therefore will yield a lower interest payment. We’ll further divide Senior Debt in two different tranches, amortization term loan A (TLA) and institutional term loan B (TLB) and both will be collateralized against Fenix’s receivables, inventory, and property, plant, and equipment in order to get the lowest interest rates. TLAs are considered to be less flexible than TLBs due to stricter amortization schedules and larger shares of mandatory repayments during its maturity. For this reason, TLBs typically constitute a larger share of the debt structure in LBOs. Accordingly, we will assume a relationship where the TLB constitutes 70% of the senior debt and where the TLA accounts for the remaining 30%. TLAs are usually priced based on a floating interest rate, made up by a base rate plus a spread depending on the borrower’s credit ratings. According to Vernimmen et al. (2014, p.844) the average spread on senior debt used in LBOs between 2008 and 2014 has been between 400 to 600 basis points (bps). Given the stricter nature of TLA amortization schedule, the interest rate for TLA will be lower than the one for TLB. We assumed a TLA interest rate being defined as the three-month Swedish interbank rate (STIBOR) plus 400bp and TLB as STIBOR plus 600bp. The interest rate on Subordinated debt as the literature suggests will be 10%.
The TLA will have maturity 5 years with the following annual amortization schedule: 5%, 10%, 20%, 30%, 35%. As already said, the TLA is embedded with a stricter amortization schedule and will be repaid prior maturity. The TLB instead, given the subordinated nature compared to TLA, will have a longer maturity of 8 years and will be structured of a 1% annual amortization schedule. The loan will then be repaid at maturity or with a bullet payment at exit. The subordinated debt instead will be considered as a bullet term loan with 10 years of maturity with no mandatory repayment.
5.2. Sources and Uses
In summary, the PE firm will predominantly rely on bank loans, composing the Senior Debt, along with subordinated notes and/or junk bonds, constituting the Subordinated Debt, for its funding needs. The total debt will be equivalent to 5.5 times EBITDA, totaling EUR 763.1 million, constituting 57.6% of the company’s enterprise value. Within this, 45% of the capitalization, equivalent to 4.3x EBITDA Multiple, will be attributed to Senior Debt, comprised of TLA and TLB. The remaining 12.6% of the capitalization, or 1.2x EBITDA Multiple, will be sourced from Subordinated Debt. The PE firm will contribute the remaining 42% of the capitalization, amounting to 4 times EBITDA or EUR 561 million.
Upon acquisition, the PE firm will utilize these funding sources to acquire the target, settling the company’s purchase price. Due to the negative net debt, the enterprise value will be higher than the target purchase price, additionally, the PE firm will use part of the sources to ensure a minimum cash balance to meet the company’s operational needs. This minimum cash balance is assumed to be 10% of the average cash amount in the company.
5.3. Free Cash Flows
Now it’s time to estimate the future free cash flows the company will generate in the future given the changes in business plan and competitive position implemented by the PE firm. Free cash flows will be paramount in determining the actual amount available for debt repayment.
We start the computation from EBIT, which stands for earnings before interest and taxes, then subtract taxes and interest expenses, obtaining net income. Next, we add back non-cash expenditures such as D&A, subtract capital expenditure and change in net working capital. Doing that we obtain the levered free cash flows for the period. We considered levered free cash flows rather than the unlevered ones given the substantial amount of interest expenses. Disregarding that entry would provide a blurred representation of the company’s debt repayment capacity. This calculation is summarized by Figure 11.
5.4. Debt Schedule
The primary entry in the table, denoted as the "Beginning Cash Balance," represents the liquid reserves necessary for immediate expenses during the LBO process. These funds will be replenished annually through the "Ending Cash Balance" at the table's bottom. Following is the total projected "Free Cash Flows," derived earlier, which will be utilized for repaying existing debt. The "Minimum Cash Balance" item signifies reserves for operational needs during the LBO, increasing gradually to match sales growth.
"Mandatory Debt Repayments (TLA and TLB)" represent compulsory amortization of senior debt loans. Subsequently, "Cash Flows Available for Optional Debt Repayments" will be directed toward further debt reduction, prioritizing the TLA due to its higher seniority. In 2025, after fully amortizing the TLA, the remaining cash flows will target repaying TLB. The outstanding TLB balance in 2027 is assumed to be repaid as a bullet at exit. No subordinated loan repayments are expected during the holding period.
Figure 12 indicates the use of available cash flows annually for debt repayment. The debt schedule's bottom line reflects the "Ending Cash Balance," mirroring the "Minimum Cash Balance" and becoming the "Opening Cash Balance" in the subsequent year. The debt schedule summary at the exhibit's bottom outlines the expectations: Fenix aims to decrease total debt from EUR 763 million in 2023 to EUR 493 million in 2027, with an estimated net debt at exit of EUR 483 million, considering an "Ending Cash Balance" of EUR 10 million in 2027.
5.5 Return Analysis
Having projected Fenix's statement of comprehensive income, financial position, and cash flows, we can now evaluate the proceeds the PE firm will generate upon selling its stake (exit) in Fenix Outdoor AG and explore various exit opportunities. Thanks to the PE firm's adept management and financing strategies, Fenix's EBITDA surged impressively to 219 million. Commonly, literature suggests maintaining the same Enterprise Multiple of EBITDA at exit as the one at entry, which, in this instance, is 9.5x. Making assumptions about how much investors would pay beyond the entry multiple appears speculative. Consequently, multiplying the 2027 EBITDA by the exit multiple yields an Enterprise Value of nearly EUR 2.1 billion. Deducting net debt at exit results in an exit equity value of EUR 1.6 billion.
To calculate the IRR, we identify the interest rate that equalizes the cash outflow paid at the acquisition date with the cash inflow received at maturity. Utilizing Excel, we swiftly obtain an IRR of 23%, surpassing the 20% threshold typically required for LBO transactions. The Multiple on Invested Capital (MOIC) signifies that the amount received at exit is two and a half times the amount initially spent by the PE firm at entry.
5.6 Sensitivity
The next step involves conducting a sensitivity analysis to evaluate variations in the Internal Rate of Return (IRR) based on different input scenarios, encompassing changes in entry/exit multiples and fluctuations in sales growth rates. This analysis is crucial for a comprehensive assessment of the potential Leveraged Buyout (LBO). By examining the impact of alterations in assumptions and key value drivers, the sensitivity analysis provides valuable insights into the resilience of the IRR under diverse conditions.
Figure 14 sensitivity analysis investigates how modifications in entry and exit multiples influence the IRR. The second analysis, detailed in figure 15, explores the repercussions on various parameters resulting from changes in revenue growth. The third analysis, detailed in figure 16, delves into the influence on IRR when adjusting the entry multiple and exit EBITDA multiple, challenging the assumption of equality between entry and exit multiples. This holistic sensitivity analysis ensures a robust evaluation of the LBO's viability under varying scenarios. The first sensitivity analysis considers how a change in the exit and entry multiple will affect the IRR.
5.6 Exit Alternatives
There’re different ways in which a PE firm can disinvest, both partially or fully in the target. The most common ones are: Initial Public Offering (IPO), Trade Sale or Strategic Sale, Secondary Buyout (SBO), Recapitalization, Management Buyout (MBO), Special Purpose Acquisition Company (SPAC), etc. Here we’ll briefly consider only the first two.
IPO
When considering an exit through an IPO, timing the market becomes the most critical factor. Additionally, PE firms carefully evaluate aspects such as the listing location, cornerstone investors, and potential discounts offered to public investors. Despite entailing higher transaction costs compared to an outright sale, IPOs are often favored for their potential to generate significant value in thriving markets. Given Fenix's equity value, a listing on the Swedish Large Cap Market (OMX) could be pursued with the assistance of an investment bank active in the Nordic countries, such as the Nordic Investment Bank or Morgan Stanley.
Strategic Sale
In contrast to an exit through an IPO, a strategic sale typically involves a complete exit, where 100% of Fenix would be sold. Furthermore, a strategic sale offers a quicker exit route, eliminating the market exposure faced by PE firms when selling remaining blocks of shares post-IPO. The strategic sale is also less sensitive to the overall economic climate than an IPO, as the selling price depends more on the synergies the specific buyer would gain from combining activities. In this scenario, the PE firm would enlist the support of an investment bank to conduct research and facilitate a deal with a potential buyer interested in acquiring the target or its components.
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