Let’s continue our conversation (from the last post) about the private equity LBO modeling test. The LBO modeling test is used by many, perhaps most, PE firms both large and small as part of the interview process to test 3 things:
- Finance knowledge
- Excel modeling skills
- Executive presentation / communication skills
This is a short series that covers the “who” and “what” of the LBO modeling test, the specific components of the LBO modeling slide presentation, delivering the oral presentation to your interview committee, how to practice for the LBO modeling test, and how the modeling test is evaluated in the context of other recruiting considerations.
This post is about the key components of the LBO modeling test presentation. You can see other posts in this series here:
- Who gets the private equity LBO modeling test and what is it?
- The LBO modeling test oral interview presentation, how to practice for the LBO modeling test, and how the test is evaluated
In the last post, I covered what you are expected to show when you present your findings to the interview committee. But what should you cover in each of the specific components of the LBO modeling slide presentation?
Executive summary slide
Your goal here is to summarize 3 things clearly.
- Whether the firm should invest: You need to give a clear recommendation one way or the other — without equivocating, hedging, or conditioning your response on additional “TBD” factors. You would be surprised how many candidates fail to do this basic task, which may translate into an automatic rejection.
- Key Merits: You need to highlight the most important merits supporting your investment recommendation (try to limit yourself to no more than 3-4, otherwise it suggests lack of editorial judgment on your part)
- Key Risks: Similarly, you need to touch on the biggest concerns and risk factors (again, limiting yourself to no more than 3-4)
Just to illustrate, here are some sample bullets you might write for an executive summary:
+ The deal team recommends that we proceed with a bid to invest in TargetCo at a 6.5x EBITDA multiple ($850M purchase price)
- TargetCo presents a strong investment opportunity that could provide a 2.8x MoM over a 5-year holding period (~24% IRR) given base case assumptions (revenue growth in line with historical trend line, 2% EBITDA margin expansion through cost improvements by year 3)
+ Key Merits
- Strong company fundamentals, robust cash flow
- Comparables trade at 15% higher multiples on average, making TargetCo especially price-attractive
- Untapped international expansion presents key growth opportunity (not factored into base case)
- Distinctive senior management team
+ Key Risks
- Continuing sluggish economic recovery continues to make consumer spending rebound very uncertain (“new normal”)
- New technology emerging could threaten defensibility of one of TargetCo’s major product lines
- Regulatory issues that could impede international expansion
Market, industry, and operations slides
With the market and industry slides, you goal is to cover the most interesting, relevant, and insightful macro analyses possible given the information provided to you.
For example, you might show data or charts about the market as a whole, including how fast it is growing, what consensus out-year forecasts are, and what various trends are in terms of innovation, regulation, etc.
You might also show the industry’s or company’s historical growth, key near-term expansion opportunities the company could pursue, and any forecast expectations for whether the company is expected to grow faster or slower than the market as a whole (and why).
You could also show a competitive analysis — primary competitors, key advantages / weaknesses of the company and its peers, and strategies the company might consider including how the landscape might shake out over the next few years.
Focus on the core economic forces and market drivers that most greatly impact your investment decision, and let that guide the analyses you show in this section.
LBO model slides
This cluster of slides is meant to show valuation and expected returns, along with key assumptions and drivers that lead to your conclusions.
You can get yourself into trouble (and increase the risk of mistakes) by making your model too detailed and ambitious with 10 different operating cases, a slew of EBITDA add-backs, multiple debt tranches, PIK vs. cash interest scenarios, and book vs. cash tax reconciliations.
Fight the urge to impress the firm by going into unnecessary detail and instead focus only on the key assumptions and drivers. Your interviewers will not nit-pick over your assumptions and projections as long as they are reasonable and thoughtful; they will not say “how come you didn’t think about using mezz debt?” or “why didn’t you consider the difference between book vs. cash taxes?”
Keep it simple and clear.
The core things you need to show in your model are:
- Sources and uses showing how much debt vs. equity you are financing the transaction with, how much is being used to re-finance existing debt, pay fees, etc
- Entry / exit multiples and leverage ratios
- Income statement / EBITDA projections
- Free cash flow projections
- Working capital projections (balance sheet not necessary, unless they specifically ask for it or you are facing an unusual acquisition scenario)
- Returns scenarios and sensitivities at various multiples / prices, EBITDA projections, and leverage ratios
So you might structure your 3 slides as follows:
- Sources and uses, entry / exit multiples, and leverage ratios
- Income statement / EBITDA projections, Free cash flow projections, and working capital schedule (if needed)
- Returns scenarios and sensitivity tables at various multiples / prices, EBITDA projections, and leverage ratios
The conclusion slide is essentially a rehash of your executive summary slide (i.e., slide 1). Here you are simply summarizing your conclusions, perhaps with specific key points from your market and model slides, along with re-stating your go / no-go recommendation on whether to invest and how the PE firm should mitigate risk factors you identified in the presentation.
If your recommendation is NOT to invest, then you could perhaps mention under what terms the deal would be attractive — e.g., how much would the price have to decline or what would have to change about the company’s prospects in order for your recommendation to change?
The go / no-go recommendation is seldom clear-cut, and there can quite possibly be good arguments on both sides. Your job is to provide a well-reasoned argument for your particular recommendation, and your actual answer doesn’t matter so much as how you support your reasoning and defend your recommendation.
To make a go / no-go recommendation, keep in mind that the numbers in your model do matter, but they are best used to test key assumptions for whether the deal would work. If your model shows the IRR below 15% over a 5-year hold even under very aggressive assumptioms, for example, the deal isn’t going to work. By contrast, if it shows the IRR over 25% under even the most conservative assumptions, then the deal is likely quite attractive.
With your model as a sanity check against your biggest assumptions, your ultimate decision should likely rest on more macro factors about where the market is going, the growth prospects of the industry, and the company’s outlook given its strengths and weaknesses, etc. Use your LBO analyses (valuation, returns scenarios) to support your arguments around these macro factors, not to drive your entire investment decision.
Ideally, you want to say to your interview committee: “I recommend we invest in TargetCo because consumer spending in this sector is recovering quickly, and the industry as a whole has experienced double-digit tailwinds over the past 2 years, with no signs of slowing down. Moreover, TargetCo is already the leader in its category with 4 additional new products in the pipeline that will likely reinforce its market leadership over the next 18-24 months. Given base case assumptions, TargetCo can easily produce a 22% IRR if it simply maintains trend line growth, without even factoring in extra share capture expected to accrue from the release of these 4 new products.”
In the next post of this series, we’ll cover how to deliver the oral presentation of your investment thesis to the interview committee, how to practice for the LBO modeling test, and how the modeling test is evaluated in the context of other recruiting considerations.
Found this series useful?
Check out our step-by-step PE modeling training videos for walk-through tutorials on how to build an LBO model, navigate Excel with ruthless efficiency, and rapidly create an LBO PowerPoint deck to present to your PE interviewers.
Also check out our PDF guide “How to Nail Your Private Equity Interview (whether you have finance training or not)” for much more in-depth tips and strategies on how to successfully interview for top private equity jobs!