Congoleum Case
Question 1: Is Congoleum a good LBO candidate? In other words, does this company have a lot of debt capacity?
To judge if a company is a good LBO candidate the following are very important factors: low levels of debt in the target, stable cash flows, excess cash on-hand, assets that can be used as collateral to raise debt and no major capital requirements to keep the business running on an on-going basis. Congoleum is an ideal LBO candidate because:
1. Low level of debt – estimated long term debt is around 15.6 million
2. High asset base with assets worth 323 million
3. Stable cash flows with estimated total revenues increasing from 559.9 million in 1978 to 937.8 million in 1984 (Note also its strong intellectual property as shown by its numerous patents and ability to defend its patents against infringement supporting the stable cash flow projections)
4. Excess cash of 95.1 million that can be used as a source of funds
5. Tax rate of 48% and net interest expenses are inflows instead of outflows without the LBO – implying value can be created by levering up and utilizing the interest expenses through the associated income tax shield
6. Potential reduced taxable income due to increased deductions for amortization, depreciation and cost of goods sold as a result of the write-up of inventories
The exhibits below demonstrate how the leveraged buyout will be able to meet the debt obligations under the proposed interest and principal repayment schedule.
Step 1: Calculating FCF from Exhibit 13 before LBO
(FCF = NOPLAT + Depreciation - Change in Working Capital - Capex on new investments + Investment Tax Credit)
YEAR 1979 1980 1981 1982 1983 1984
EBIT 89.80 71.69 90.84 115.73 113.15 137.27
Tax rate 0.48 0.48 0.48 0.48 0.48 0.48
Tax expense 46.32 35.74 44.86 56.79 55.50 67.47
NOPLAT 50.18 38.72 48.59 61.52 60.12 73.09
Add back depreciation and amortization 35.51 36.26 37.07 37.95 21.23
Less change in Working Capital -2.00 -14.00 -23.30 -11.20 -12.80
To judge if a company is a good LBO candidate the following are very important factors: low levels of debt in the target, stable cash flows, excess cash on-hand, assets that can be used as collateral to raise debt and no major capital requirements to keep the business running on an on-going basis. Congoleum is an ideal LBO candidate because:
1. Low level of debt – estimated long term debt is around 15.6 million
2. High asset base with assets worth 323 million
3. Stable cash flows with estimated total revenues increasing from 559.9 million in 1978 to 937.8 million in 1984 (Note also its strong intellectual property as shown by its numerous patents and ability to defend its patents against infringement supporting the stable cash flow projections)
4. Excess cash of 95.1 million that can be used as a source of funds
5. Tax rate of 48% and net interest expenses are inflows instead of outflows without the LBO – implying value can be created by levering up and utilizing the interest expenses through the associated income tax shield
6. Potential reduced taxable income due to increased deductions for amortization, depreciation and cost of goods sold as a result of the write-up of inventories
The exhibits below demonstrate how the leveraged buyout will be able to meet the debt obligations under the proposed interest and principal repayment schedule.
Step 1: Calculating FCF from Exhibit 13 before LBO
(FCF = NOPLAT + Depreciation - Change in Working Capital - Capex on new investments + Investment Tax Credit)
YEAR 1979 1980 1981 1982 1983 1984
EBIT 89.80 71.69 90.84 115.73 113.15 137.27
Tax rate 0.48 0.48 0.48 0.48 0.48 0.48
Tax expense 46.32 35.74 44.86 56.79 55.50 67.47
NOPLAT 50.18 38.72 48.59 61.52 60.12 73.09
Add back depreciation and amortization 35.51 36.26 37.07 37.95 21.23
Less change in Working Capital -2.00 -14.00 -23.30 -11.20 -12.80