Jarrod Barraza, CFA, ASA, ABV, CVA’s Post

Jarrod Barraza, CFA, ASA, ABV, CVA

Healthcare M&A Advisory | Healthcare Valuation

5mo

Here is a VERY simple version of some "buyer math" illustrating one of the reasons I think there is a holdup for those healthcare portfolio companies long into their hold periods. Clearly, entry and exit values are having the biggest impact on IRR, and I suspect those investments made out of 2016-2020 vintage funds have a greater degree of compression on multiples just based on where the market was in 2021. #healthcare #mergersandacquisitions #manda #healthcaremanda

Transcript

OK, so here's a little bit of math quick illustration furthering the conversation on why I why I think we haven't seen very many at all platform transactions in the last six months, 6 plus months with with just a ton of simplifying assumptions. So to do that I've cooked up what is probably the simplest LBO model known to mankind and it's. Frighteningly simple because I made it and I have to understand it. So I've got just a number of simplifying assumptions. I'll walk through those right now. So I guess I've got $100 million of EBITDA. That would be nice, right? 5% annual growth rate in the EBITDA, see some depreciation taxes, so on and so forth. You can see here so this. Entry multiple Here is what I'm solving for in order to achieve a 20% internal rate of return. So that's kind of where we're going to end U in in the video and what I've done on the leverage side. Is assumed 40% of the transaction would be borrowed and what I've assumed on the exit multiple side is only a one time expansion. Of the EBITDA. Multiple upon the exit. So this is me trying to factor in the environment we find ourselves in where I, I don't see multiples just ever increasing in and expanding. So this is just an ever so slight increase in that multiple is kind of what I've baked into the the model. So just going through kind of what an again, this is a frighteningly simplified income statement might look like what I've done is converted. To free cash flow, you can see all my assumptions is that everything is easy and simple. If only it were that easy. Now on the debt service side, what I've assumed is any cash flow that's positive would be used to pay down that debt. You know, just in absence of a better assumption to make. Another interesting thing to point out is I've assumed an 8% interest rate on the whole model right now and so at an 8% interest rate with this borrowing. Amount, you can see how the interest expense itself on very, very simplified terms is almost half of the discretionary cash flow in that first year. It gets better after, but that is an interesting point to make. Now again, here's where we end up. So with all of these assumptions, we are at a 20% internal rate of return. And so if I bring this home to the first page again, you can see that. The entry multiple has to be 7 1/2 times with all of these other assumptions and simplifications in order to achieve a 20% internal rate of return, which is a respectable internal rate of return, right? But a 7 1/2 times entry multiple is what is needed to achieve that. And so and by the way, I ran the same model at a 10% interest rate and the entry multiple goes down another half turn. So we can see how any other assumptions more aggressive on the valuation side it it just doesn't even pencil to a 20% IRR in terms of deal math. And so I think this is a lot of these assumptions while not realistic in the slightest are, are still illustrative in terms of the direction that a lot of buyers find themselves in, in terms of not being able to justify much higher. Evaluations or any higher valuations than what is probably considered modest in relative terms in order to achieve those internal rates of return. So again, I think this is just a little bit of a simplified, a little bit more quantitative numbers to illustrate the phenomenon that we see at the upper echelons of the middle market in those larger buyout styles and why there's such a logjam right now waiting to transact.

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