When do you use an LBO Analysis as part of your valuation?
Answer
The typical answer is that you would use this whenever you’re looking at a Leveraged Buyout to establish how much a private equity firm could pay.
Anyways, you always want to do a test LBO; solved for with standard PE minimum returns so you can have a view on the absolute floor for an acquisition. The reason the minimum a PE can pay is a good valuation floor is because they do not have the ability to generate synergies in the way a strategic acquirer would.
If a PE firm were to acquire Coca Cola, they wouldn’t be able to underwrite to the increases in Revenue and decrease in Operating Expenses that Pepsi would be able to, and thus would likely bid lower.
Why this matters to bankers
LBOs are usually a floor for valuation for bankers. They’re used importantly as a sanity check for valuation as well. For example, your LBO shouldn’t be coming up higher than your Comparable Companies analysis or DCF. If it does, you need to investigate why.