Leveraged

Buyouts (LBOs)

Chapter 4 – Investment Banking by

Joshua Rosenbaum
 Learning Objectives – Leveraged Buyouts (LBOs)

1. Understand the key mechanics of a Leveraged Buyout (LBO)

1. Define LBO and explain its purpose
2. Identify value creation levers: deleveraging, operational improvement,
and multiple expansion
2. Recognize the key participants in an LBO transaction
1. Understand the roles of financial sponsors, lenders, investment banks,
and management
2. Explore real-world participants in Pakistan and the US
3. Evaluate the characteristics of an ideal LBO candidate
1. Analyze target company profiles that are cash-generative, asset-light,
and mature
2. Differentiate between growth-stage and mature business suitability
 Learning Objectives – Leveraged Buyouts (LBOs)

4. Analyze the capital structure and financing sources of LBOs

1. Explain the composition of debt and equity
2. Understand senior, mezzanine, and PIK instruments (payment in
kind)
5. Calculate LBO returns using financial metrics
3. Use Excel to model Free Cash Flow, IRR, and MOIC (Multiple on
Invested Capital
4. Understand the impact of leverage and tax shields on returns
6. Compare and contrast different exit strategies
5. Discuss IPOs, strategic sales, and secondary buyouts
6. Evaluate timing, liquidity, and valuation considerations
7. Apply LBO principles to real-world case studies
7. Analyze both a US and a Pakistan-based case (Dell, Engro Foods)
8. Discuss feasibility, challenges, and key learning outcomes
 💡 What Are PIK Instruments?
PIK = Payment-in-Kind
• A form of debt where interest is not paid in cash but instead accrues and is
paid in kind (i.e., added to principal or in additional securities).
• Used when the borrower wants to conserve cash in early years (common in
LBOs).
Example:
• A PKR 1 billion mezzanine loan at 12% PIK means no interest payments are
made in cash for 5 years.
• Instead, the principal increases by 12% each year.
• At maturity, borrower owes more than original principal — but gains time to
build cash flows.
Advantages:
• Cash flow relief in early years
• Flexible for companies with tight liquidity post-LBO
Risks:
• Increases leverage over time
• Higher cost to issuer due to compounding
What is MOIC? MOIC stands for Multiple on Invested Capital. It
measures how many times the investor has earned back their
original investment, without factoring in time.

Formula: MOIC = (Equity Value at Exit) / (Initial Equity Investment)

Example: If the initial equity investment was $270M and exit equity
value is $500M: MOIC = $500M / $270M = 1.85x
Note: While MOIC is a helpful benchmark for total returns, it should
be analyzed alongside IRR, which accounts for the time value of
money.

Metric Value
Entry EV $446M
Exit EV $500M
MOIC 1.85x
IRR ~11.1% over 7 years
 Agenda
• Key Participants
• Strong LBO Candidates
• Economics of LBOs
• Exit Strategies
• Financing Structure
• Case Examples (US & Pakistan)
• In-Class Activity
 Key Participants in an LBO
• Financial Sponsors
• Investment Banks
• Bank and Institutional Lenders
• Bond Investors
• Target Management
 Key Participants in an LBO
Financial Sponsors
• The term “financial sponsor”
refers to traditional private
equity (PE) firms, merchant
banking divisions of investment
banks, hedge funds, venture
capital funds, and special
purpose acquisition companies
(SPACs), among other
investment vehicles.
 🇵🇰 Private Equity Firms

Firm Name Focus Notable Activity

Previously invested in K-
Abraaj Group (defunct) Mid-to-large cap Electric, Karachi Electric
Supply Company
Acquired stakes in Sybrid
Lakson Investments Consumer, healthcare, (BPO), Aga Khan Health
Private Equity (LI PE) logistics Services
Backed rice exporters,
Indus Basin Holdings Agribusiness, logistics
agri-trade supply chains
Credit and equity
investments in high-
SME Financing, Energy,
Karandaaz Capital impact areas (supported
FinTech by DFID/Bill & Melinda
Gates)
Pakistan Catalyst Fund Invested in Airlift,
(Fatima Gobi Ventures) Seed-stage venture capital TelloTalk, Safepay
 🇵🇰 Private Equity Firms

Firm Name Focus Notable Activity

Invested in TelloTalk, Dot
i2i Ventures Early-stage startups (VC) and Line, CreditBook
Invests in logistics,
Treet Corp. Ventures Corporate VC diagnostics, and medtech
startups
Acquired minority stakes
Millat Global Holdings Family office/private in logistics and retail
equity
ventures
Tech incubator and
VentureDive Ventures Tech-focused sponsor of multiple seed-
to-growth stage firms
 Key Participants in an LBO
Investment Banks
• Provider of financing and as a
strategic M&A advisor. Sponsors rely
heavily on investment banks to help
develop and market an optimal
financing structure.
• They may also engage investment
banks as buy-side M&A advisors in
return for sourcing deals and/or for
their expertise, relationships, and in-
house resources.
• On the sell-side, sponsors typically
engage bankers as M&A advisors to
market their portfolio companies to
prospective buyers through an
organized sale process.
 🏦 1. Full-Service Investment Banks / Financial
Groups
Firm Name Services Offered Notable Deals/Activity

Equity/debt underwriting, Bookrunner for multiple PSX

Arif Habib Limited
M&A, IPOs, advisory IPOs (e.g., Interloop)

Brokerage, research, Involved in IPOs and equity

AKD Securities Ltd.
advisory, capital markets placements

Equity underwriting, M&A, Part of JS Group, advised on

JS Global Capital
financial advisory multiple divestitures

Investment research, IPO Co-managed IPOs and PSX

Topline Securities
advisory, ECM listings

Capital raising, underwriting, ECM and DCM support to IGI

IGI Securities
mutual funds Holdings
 💼 2. Banks with Investment Banking Divisions

Bank Name Investment Banking Role Notes

Structured finance, debt
Habib Bank Limited syndication, project Lead arranger for
(HBL) finance infrastructure deals

United Bank Limited Corporate advisory, Debt arranger and IPO

(UBL) Islamic instruments sponsor

Capital market advisory, Active in Islamic capital

Faysal Bank Sukuk structuring markets

Bank Alfalah Corporate advisory, Works with SMEs and

private placements corporates

Meezan Bank Islamic finance Shariah-compliant

structuring and advisory transaction advisor
 📈 3. Boutique Investment Banks / Specialized Advisors

Firm Name Focus Area Notable Deals

Mid-market investment
Pak Oman Investment
banking and debt M&A, leasing, and DCM
Company
structuring

Debt structuring, Sukuk

Pak Brunei Investment SME sector, real estate
advisory, development
Company financing
finance

Credit enhancement for PPP and infrastructure-

InfraZamin Pakistan infra/private sector bonds focused

NIB Bank (pre-merged Former M&A and project Historical M&A advisory
with MCB) finance advisor role
 Key Participants in an LBO
Bank and Institutional Lenders
• Bank and institutional lenders are the capital
providers for the bank debt in an LBO financing
structure.
• lenders perform due diligence and undergo an
internal credit process before participating in an
LBO financing.
• Look to mitigate downside risk by requiring
covenants and collateral coverage.
• Prior experience with a given credit, sector, or
particular sponsor is also factored into the decision
to participate.
 Key Participants in an LBO

Bond Investors
• Bond investors are the purchasers of the
high yield bonds issued as part of the LBO
financing structure.
• Bond investors receive a preliminary offering
memorandum (OM), which is a legal
document containing much of the target’s
business, industry, and financial information
found in the bank book.
 📊 Key Bond Investors in Pakistan
🏦 1. Pension and Provident Funds

Name Type Notes

EOBI (Employees’ Old-Age Government-run pension Invests in PIBs, mutual funds,

Benefits Institution) fund and selected TFCs

Corporate Provident & Conservative investors in

Private employer-managed
Gratuity Funds investment-grade bonds

Private Pension Funds Managed by AMCs like Al Allocate a portion to debt

(under VPS rules) Meezan, UBL Funds, etc. (government + corporate)
 📊 Key Bond Investors in Pakistan

🏦 2. Insurance Companies

Name Type Notes

State Life Insurance Government-owned Largest institutional fixed-

Corporation income investor

Conservative but active in

EFU Life / Jubilee Life Private sukuk and bond
subscriptions

Invests in rated private

Adamjee Insurance Hybrid investor
placements and Sukuk
 📊 Key Bond Investors in Pakistan
💰 3. Mutual Funds (Fixed Income Funds)

Asset Manager Fund Types Notes

Shariah-compliant Participated in many

Al Meezan Investment
income/sukuk funds private Sukuk deals

Income + Aggressive Participated in bank and

UBL Fund Managers Income Funds corporate debt

Fixed income + hybrid Invests in high-quality

HBL Asset Management
allocation funds TFCs and GOP Ijara

One of the largest by Mix of conventional and

MCB-Arif Habib Funds AUM Islamic debt allocations
 📊 Key Bond Investors in Pakistan
🏦 4. DFIs / Strategic Debt Investors

Investor Role in LBOs

Provides long-term debt for acquisition

Pak Brunei Investment Company
financing and structured bonds

Offers credit enhancement (guarantees) to

InfraZamin Pakistan
crowd in debt investors

Pakistan Kuwait Investment Co. / Pak Libya

Support structured private placements
Holding
 🔄 How Do These Institutions Participate in LBO-Style
Transactions?

1. Private Placements of Debt Instruments:

1. Sponsors issue Sukuk or TFCs to raise long-term debt.
2. Institutional investors subscribe to these fixed-income instruments.
3. Example: Meezan Bank issuing Sukuk for corporate acquisition deals.
2. Participation in Structured Syndications:
1. In rare large LBO-like cases, banks arrange syndicated loans.
2. Institutions like State Life or Al Meezan may co-invest as long-term
lenders.
3. Credit-Enhanced Instruments (via InfraZamin):
1. Investors more likely to participate when risk is shared or enhanced.
2. Guarantees improve pricing and investor appetite for acquisition-
related bonds.
 🧠 Limitations Compared to Developed LBO Markets:

US/Developed
Factor Pakistan Markets

Bond Liquidity Low (OTC) High (listed)

High-Yield Market Largely absent Thriving

Investor Risk Appetite Conservative Broad spectrum

Regulatory Support Developing Mature frameworks

 Key Participants in an LBO

Target Management
• Management plays a crucial role in the
marketing of the target to potential buyers
and lenders alike, working closely with the
bankers on the preparation of marketing
materials and financial information.
• Management also serves as the primary face
of the company and must articulate the
investment merits of the transaction to these
constituents.
 Key Participants in an LBO
Management Buyout
• An LBO originated and led by a target’s existing
management team is referred to as a
management buyout (MBO). Often, an MBO is
effected with the help of an equity partner, such
as a financial sponsor, who provides capital
support and access to debt financing through
established investment banking relationships.
• The basic premise behind an MBO is that the
management team believes it can create more
value running the company on its own than under
current ownership.
• The MBO structure also serves to eliminate the
conflict between management and the board of
 📘 Examples of MBOs in Pakistan

1. Inbox Business Technologies

Details Description
Type MBO (with private capital)
Year ~2013
The management team led a buyout
Description of majority ownership from The
Dawood Group. Later institutional
investors also participated.
Gained operational control and
Outcome expanded into defense, IT, and public
sector digital solutions.

LBO Link Elements of LBO with structured

debt and private equity participation.
 📘 Examples of MBOs in Pakistan

2. TRG Pakistan – Portfolio Company Divestitures

Details Description
Series of MBOs within TRG’s global
Type
outsourcing portfolio

MBOs or partial buyouts occurred in

entities like IBEX Global (when it
Companies demerged), and Afiniti’s internal equity
rounds

Management acquired or expanded

Outcome ownership stakes in these firms as TRG
exited or reduced control.

LBO Link Debt-light, but structurally similar to

sponsor-backed MBOs globally.
 🧠 Challenges for MBOs in Pakistan

Challenge Explanation

Debt markets for acquisition finance

Limited access to buyout financing are underdeveloped.

Cultural resistance to management- Family businesses may prefer

led control intergenerational succession.

SECP oversight, minority rights, and

Regulatory constraints delisting rules complicate private
MBOs.

Fewer financial sponsors actively

Lack of sponsor support pursuing MBO opportunities.
 Ideal LBO Candidates

• Strong Cash Flow Generation

• Leading and Defensible Market Positions
• Growth Opportunities
• Efficiency Enhancement Opportunities
• Low Capex Requirements
• Strong Asset Base
• Proven Management Team
 Ideal LBO Candidates

Strong Cash Flow Generation

• The ability to generate strong, predictable cash flow is
critical for LBO candidates given the highly leveraged
capital structure.
• Strong LBO candidates operate in a mature or niche
business with stable customer demand and end
markets.
• They often feature a strong brand name, established
customer base, and/or long-term sales contracts, all of
which serve to increase the predictability of cash flow.
 Ideal LBO Candidates

Leading and Defensible Market Positions

• Generally, reflect entrenched customer
relationships, brand name recognition,
superior products and services, a favorable
cost structure, and scale advantages, among
other attributes.
• These qualities create barriers to entry and
increase the stability and predictability of a
company’s cash flow.
 Ideal LBO Candidates

Growth Opportunities
• Sponsors seek companies with growth potential,
both organically and through potential future bolt-
on acquisitions.
• Growth also enhances the speed and optionality for
exit opportunities. For example, a strong growth
profile is particularly important if the target is
designated for an eventual IPO exit.
• Companies with robust growth profiles have a
greater likelihood of driving EBITDA “multiple
expansion”
 Ideal LBO Candidates

Efficiency Enhancement Opportunities

• Sponsors seek opportunities to improve
operational efficiencies and generate cost savings.
• Traditional cost saving measures include lowering
corporate overhead, streamlining operations,
reducing headcount, rationalizing the supply chain,
and implementing new management information
systems.
 Ideal LBO Candidates

Low Capex Requirements

• Low capex requirements enhance a company’s
cash flow generation capabilities.
• A company with substantial capex requirements
may still represent an attractive investment
opportunity if it has a strong growth profile, high
profit margins, and the business strategy is
validated during due diligence.
 Ideal LBO Candidates

Strong Asset Base

A strong asset base pledged as collateral against a
loan benefits lenders by increasing the likelihood of
principal recovery in the event of bankruptcy (and
liquidation).
 Ideal LBO Candidates
Proven Management Team
• Talented management is critical
in an LBO scenario given the
need to operate under a highly
leveraged capital structure with
ambitious performance targets.
✅ Ideal LBO Candidate – United States: Dell Inc. (2013
LBO)

🏢 Company Overview
• Name: Dell Inc.
• Industry: Computer Hardware / IT Services
• Deal: $24.9 billion LBO by Michael Dell & Silver Lake (2013)
 ✅ Ideal LBO Candidate – United States: Dell Inc. (2013
LBO)
📊 Why It Was Ideal for an LBO:

Attribute Details
Dell had strong, recurring enterprise
Predictable Cash Flows
hardware and service revenues.
Compared to peers, Dell required
Low CapEx modest CapEx, making cash flow
available for debt service.

Strong Asset Base Dell owned significant IP, receivables,

and inventory that could be leveraged.
It operated in a mature, low-growth
Mature Business
industry, which made it stable.
Michael Dell stayed on as CEO and co-
Capable Management
invested, ensuring alignment.

Buyback Potential Dell was undervalued in public markets;

sponsors expected multiple expansion.
 📈 Outcome:

• Debt was repaid over time.

• Company was successfully restructured.
• Re-listed in 2018 with significantly higher valuation.
• Sponsors earned a 22–24% IRR and ~2.5–3x MOIC.
 ✅ Ideal LBO Candidate – Pakistan: Packages Ltd.
(Hypothetical)

No full-scale LBO has been officially reported in Pakistan,

but Packages Limited represents a near-perfect candidate
based on its fundamentals.
🏢 Company Overview
• Name: Packages Ltd.
• Industry: Packaging, paperboard, consumer products
• Listed: Pakistan Stock Exchange (PSX)
 📊 Why It’s an Ideal Candidate for LBO

:
Attribute Details

Strong Cash Flow Generation Stable B2B packaging contracts and

recurring consumer products revenue.

Asset Backing Owns real estate (Packages Mall),

industrial plants, and subsidiaries.

Low Working Capital Volatility B2B supply model reduces receivable

risks.

Proven management team and strong

Operational Efficiency
governance.

Can be monetized (e.g., real estate),

Non-Core Assets
allowing deleveraging.
Exposure to both industrial and retail
Diversification consumer goods (Tetra Pak, FMCG
units).
 🧮 Hypothetical LBO Deal Structure:

• EV: PKR 100 billion

• Debt: 60% = PKR 60B (via local banks/Sukuk)
• Equity: 40% = PKR 40B (from sponsor)
• IRR Projection: ~20–25% (based on EBITDA growth, asset
sales, tax shield)
 🔍 Key Takeaways

Criteria Dell (US) Packages Ltd. (Pakistan)

Conservative,
Market Deep, mature, leveraged
underdeveloped

High – leveraged loan & Limited – requires

Financing Access HY bond markets bank/Sukuk financing

IPO or secondary sale on

Exit Options IPO, strategic sale
PSX

Sponsor Appetite Broad and deep Emerging but cautious

 Economics of an LBO
• Returns Analysis – Internal Rate of Return
• It is defined as the discount rate that must be
applied to the sponsor’s cash outflows and
inflows during the investment horizon in order
to produce a net present value (NPV) of zero.
 Economics of an LBO
• Returns Analysis – Internal Rate of Return

• We assume that a sponsor contributes $250 million of

equity (cash outflow) at the end of Year 0 as part of the
LBO financing structure and receives equity proceeds
upon sale of $750 million (cash inflow) at the end of
Year 5. This scenario produces an IRR of 24.6%, as
demonstrated by the NPV of zero.
 Economics of an LBO

Returns Analysis – Cash Return

• In addition to IRR, sponsors also examine returns
on the basis of a multiple of their cash
investment (“cash return”)
 Economics of an LBO
How LBOs Generate Returns
• LBOs generate returns through a combination of debt
repayment and growth in enterprise value.
 Economics of an LBO
How LBOs Generate Returns
 Economics of an LBO
How Leverage is Used to Enhance Returns
• The concept of using leverage to enhance returns is fundamental to
understanding LBOs.
 Economics of an LBO
How Leverage is Used to Enhance Returns
• The concept of using leverage to enhance returns is fundamental to
understanding LBOs.
 Economics of an LBO
How Leverage is Used to Enhance Returns
• The concept of using leverage to enhance returns is fundamental to
understanding LBOs.
 Exit Strategies

• Most sponsors aim to exit or monetize their

investments within a five-year holding period in
order to provide timely returns to their LPs.
• These returns are typically realized via a sale to
another company (commonly referred to as a
“strategic sale”), a sale to another sponsor, or an
IPO. Sponsors may also extract a return prior to
exit through a dividend recapitalization.
 Exit Strategies

• Sale of Business
• Sponsors have sought to sell portfolio
companies to strategic buyers, who typically
represent the strongest potential bidder due
to their ability to realize synergies from the
target and, therefore, pay a higher price.
• Strategic buyers may also benefit from a lower
cost of capital and a lower return threshold.
 Exit Strategies

Initial Public Offering

• In an IPO exit, the sponsor sells a portion of its

shares in the target to the public.
• Post-IPO, the sponsor typically retains the largest
single equity stake in the target with the
understanding that a full exit will come through
future follow-on equity offerings or an eventual
sale of the company.
 Exit Strategies

Dividend Recapitalization
• While not a true “exit strategy,” a dividend
recapitalization (“dividend recap”) provides the
sponsor with a viable option for monetizing a
sizeable portion of its investment prior to exit.
• In a dividend recap, the target raises proceeds
through the issuance of additional debt to pay
shareholders a dividend.
 LBO FINANCING: STRUCTURE

In a traditional LBO, debt has typically comprised 60%

to 70% of the financing structure, with the remainder
of the purchase price funded by an equity
contribution from a sponsor (or group of sponsors)
and rolled/contributed equity from management.
Given the inherently high leverage associated with
an LBO, the various debt components of the capital
structure are usually deemed non-investment grade
LBO FINANCING: STRUCTURE
 LBO FINANCING: PRIMARY SOURCES

• Bank Debt
 LBO FINANCING: PRIMARY
SOURCES
• Revolving Credit Facility A traditional cash flow
revolving credit facility (“revolver”) is a line of credit
extended by a bank or group of banks that permits
the borrower to draw varying amounts up to a
specified aggregate limit for a specified period of
time.
• It is unique in that amounts borrowed can be freely
repaid and reborrowed during the term of the
facility, subject to agreed-upon conditions set forth
in a credit agreement
 LBO FINANCING: PRIMARY SOURCES

• Asset Based Lending Facility; An ABL facility is a type

of revolving credit facility that is available to
asset intensive companies.
• ABL facilities are secured by a first priority lien on
all current assets (typically accounts receivable
and inventory) of the borrower and may include a
second priority lien on all other assets (typically
PP&E).
 LBO FINANCING: PRIMARY SOURCES
Term Loan Facilities
• A term loan (“leveraged loan,” when non-
investment grade) is a loan with a specified
maturity that requires principal repayment
(“amortization”) according to a defined schedule,
typically on a quarterly basis.
• Unlike a revolver, however, a term loan is fully
funded on the date of closing and once principal
is repaid, it cannot be reborrowed.
• Amortizing Term Loans
• Typically require substantial principal repayment
throughout the life of the loan. Term loans with
significant, annual required amortization are
perceived by lenders as less risky
 LBO FINANCING: PRIMARY SOURCES
• High Yield Bonds
• High yield bonds are non-investment grade debt securities
that obligate the issuer to make interest payments to
bondholders at regularly defined intervals
• Bridge Loans A bridge loan facility (“bridge”) is interim,
committed financing provided to the borrower to “bridge”
to the issuance of permanent capital, most often high yield
bonds
• Mezzanine Debt
mezzanine debt refers to a layer of capital that lies
between traditional debt and equity.
• For sponsors, mezzanine debt provides incremental capital
at a cost below that of equity, which enables them to
stretch leverage levels and purchase price when
alternative capital sources are inaccessible.
• For the investor, mezzanine debt offers a higher rate of
return than traditional high yield bonds and can be
 🧾 Mezzanine Debt in Pakistan – Overview and
Examples

What is Mezzanine Debt?

• Hybrid financing instrument combining features of debt and
equity
• Subordinated to senior debt but ranks above equity
• Often includes warrants or convertible features
• Typically used to fill the capital gap in LBOs
 🧾 Mezzanine Debt in Pakistan – Overview and
Examples

Characteristics:
• Higher interest rates than senior debt
• Often includes Payment-in-Kind (PIK) interest
• Flexible repayment and covenant-light structure
• Use in Pakistan: While the mezzanine market is nascent in
Pakistan, some structures mirror mezzanine characteristics
through private placements or convertible Islamic
instruments.
 🧾 Mezzanine Debt in Pakistan – Overview and
Examples

1. Pak Brunei Investment Company

1. Provides subordinated debt and long-term structured
instruments
2. Supported infrastructure and SME expansions that
resemble mezzanine in structure
2. Karandaaz Capital
1. Blended finance structure including equity-like debt in
growth-stage firms
2. Supports capital-light MBO or recapitalizations in
education and healthcare
 🧾 Mezzanine Debt in Pakistan – Overview and
Examples

Challenges:
• Lack of standardized mezzanine structures
• Limited investor appetite due to risk profile
• Underdeveloped high-yield or private debt market
Opportunities for LBOs:
• Sponsors could use convertible Islamic instruments or private
term finance certificates (TFCs) structured with subordinated
clauses
• Partnerships with DFIs and credit-enhancers can make
mezzanine viable for MBOs or mid-market buyouts
 LBO FINANCING: PRIMARY SOURCES

• Equity Contribution
• The equity contribution provides a cushion for lenders
and bondholders in the event that the company’s
enterprise value deteriorates as equity value is
eliminated before debt holders lose recovery value.
• Security
• Security refers to the pledge of, or lien on, collateral
that is granted by the borrower to the holders of a
given debt instrument. Collateral represents assets,
property, and/or securities pledged by a borrower to
secure a loan or other debt obligation, which is
subject to seizure and/or liquidation in the event of a
default.
Seniority
• Seniority refers to the priority status of a creditor’s
 LBO FINANCING: PRIMARY SOURCES
• The maturity (“tenor” or “term”) of a debt obligation refers
to the length of time the instrument remains outstanding
until the full principal amount must be repaid.
• In an LBO, various debt instruments with different maturities
are issued to finance the debt portion of the transaction.
Coupon
• Coupon refers to the annual interest rate (“pricing”) paid on
a debt obligation’s principal amount outstanding
Call Protection
• Call protection refers to certain restrictions on voluntary
prepayments (of bank debt) or redemptions (of bonds)
during a defined time period within a given debt
instrument’s term. These restrictions may prohibit voluntary
prepayments or redemptions outright or require payment of
a substantial fee
Covenants
• Covenants are provisions in credit agreements and
 LBO FINANCING: PRIMARY SOURCES

Bank Debt Covenants

Affirmative Covenants
Require the borrower and its subsidiaries to perform
certain actions. Examples of standard affirmative
covenants include:
• maintaining corporate existence and books and
records
• regular financial reporting (e.g., supplying
financial statements on a quarterly basis)
• maintaining assets, collateral, or other security
• maintaining insurance
• complying with laws
• paying taxes
• continuing in the same line of business
 Pakistan Deal Structuring;
Engro Foods Buyout by FrieslandCampina
In 2016, FrieslandCampina acquired 51% of Engro Foods for ~$446
million. While not a traditional LBO, it showcases LBO-like value
creation.
Key Assumptions (Hypothetical LBO):
• Entry EV: $446M
• Debt: $180M (40%)
• Equity: $270M (60%)
• EBITDA at entry: $35M
• Exit Year 7: EBITDA = $50M
• Exit Multiple: 10x
• Exit EV: $500M
• MOIC: 1.85x
• IRR: ~11.1%
 Pakistan Deal Structuring;
Engro Foods Buyout by FrieslandCampina
Value Creation:
• Operational improvements and quality control post-
acquisition
• Stronger governance, export potential, product branding
Challenges:
• FX volatility (PKR depreciation)
• Dairy input price variability
• Regulatory shifts
• Competitive pricing pressures
 LBO Risks
• High leverage, rate hikes, FX volatility,
regulations
• Mitigation: Hedging, covenants.
🧪 Class Exercise – Estimate IRR and MOIC
Objective: Understand LBO return metrics without Excel modeling
Problem Statement for Students:
• You acquire a company for PKR 50 billion
• You finance it with 60% debt (PKR 30B) and 40% equity (PKR 20B)
• Initial EBITDA = PKR 5 billion
• EBITDA grows at 5% annually for 5 years
• Interest rate on debt is 10%
• Annual CapEx = PKR 1 billion, Change in WC = PKR 0.5 billion
• Assume debt is repaid equally over 5 years (PKR 6B/year)
• Exit at 7x EBITDA in Year 5
Tasks for Students:
1. Calculate EBITDA in Year 5
2. Compute Exit Enterprise Value (EV)
3. Estimate cash flow to equity for each year
4. Approximate IRR and MOIC using logical reasoning
 Solution

Step 1: EBITDA Projection Year 1 EBITDA = 5.00 × 1.05 = 5.25B

Year 2 = 5.51B
Year 3 = 5.79B
Year 4 = 6.08B
Year 5 = 6.38B
Step 2: Exit EV Exit EV = 7 × 6.38 = PKR 44.66B Assume full debt repayment → Exit
Equity = PKR 44.66B
Step 3: Free Cash Flow to Equity) Formula:
Debt: PKR 6B repaid annually (total PKR 30B over 5 years)
Interest: 10% on opening debt each year
• Year 1: Debt = 30B → Interest = 3.0B
• Year 2: Debt = 24B → Interest = 2.4B
• Year 3: Debt = 18B → Interest = 1.8B
• Year 4: Debt = 12B → Interest = 1.2B
• Year 5: Debt = 6B → Interest = 0.6B
 Solution
FCF Calculations (in billions):
• Year 1: 5.25 – 3 – 1 – 0.5 – 6 = –5.25
• Year 2: 5.51 – 2.4 – 1 – 0.5 – 6 = –4.39
• Year 3: 5.79 – 1.8 – 1 – 0.5 – 6 = –3.51
• Year 4: 6.08 – 1.2 – 1 – 0.5 – 6 = –2.62
• Year 5: 6.38 – 0.6 – 1 – 0.5 – 6 = –1.72 + Exit Equity = 44.66 – 1.72 = 42.94
Cash Flows to Equity (Rounded):
• Year 0: –20 (equity investment)
• Year 1: –5.25
• Year 2: –4.39
• Year 3: –3.51
• Year 4: –2.62
• Year 5: +42.94
Step 4: MOIC and IRR
MOIC = Total return / Equity = (–5.25 –4.39 –3.51 –2.62 + 42.94) / 20 = 27.17 / 20 = 1.36x
IRR Calculation: IRR of cash flows:
Trial-and-error using a financial calculator or Excel: → IRR ≈ 7.6%
• Conclusion: Including loan repayments gives a much lower IRR (~7.6%) and MOIC (1.36x),
demonstrating the importance of correctly modeling cash flows to equity.