Valuation: LBO math

What it is

You model the target as if a private equity buyer were acquiring it, applying typical PE leverage levels, holding period, and target IRR. The output: the maximum price a PE buyer could rationally pay — which becomes the implied take-out floor for your thesis.

The framework most useful for establishing a take-out price floor or arguing for capital return (the company can clearly support more leverage than it carries).

When to use

✅ Sale-of-company theses where PE is a credible buyer
✅ Capital-return theses (proves the leverage capacity)
✅ Cash-generative businesses with limited capex (PE love these)
✅ Sectors with active PE buyout history (consumer, healthcare services, software)
❌ High-growth, high-capex businesses that PE wouldn't touch
❌ Highly cyclical (PE leverage requires stable FCF)
❌ Regulated industries with capital constraints (banks, utilities)

Methodology

Establish baseline financials — current EBITDA, FCF, capex
Choose entry multiple — typically 1–2× above current trading multiple (PE pays a premium)
Set capital structure:
- Total debt: 5.5–7.5× EBITDA at entry (varies by sector)
- Equity: 30–40% of purchase price
Project 5-year operating performance:
- Modest revenue growth (3–5%)
- Margin expansion via cost-out (200–400bps)
- Working capital optimisation
Project debt paydown from FCF
Set exit multiple — usually equal to or slightly below entry (don't assume multiple expansion)
Compute exit equity value = exit EV - exit debt
Solve for entry equity that delivers PE target IRR (typically 20–25% over 5 years = 2.5–3.0× MOIC)
Add target's net debt at entry → maximum take-out EV
Divide by share count → maximum per-share take-out price

The "PE could pay $X" framing

The killer line in any LBO-backed thesis:

"At a 6.0× leverage multiple, 4-year hold, and 22% IRR, a PE buyer could rationally pay $[X] per share — [Y]% above current — without assuming any operational improvement beyond peer median."

This frames the activist's standalone value case as the conservative case (no buyer needed; just close the gap independently).

Sensitivity

Entry multiple    Hold period    Target IRR    Implied $/share
9.5×              4 years        20%           $58
9.5×              5 years        20%           $62
10.5×             4 years        22%           $66
10.5×             5 years        22%           $71

Common defences against rebuttals

Rebuttal	Pre-empt with
"PE wouldn't pay that much"	Cite recent sector deals at the entry multiple
"Leverage levels are too high"	Reference current high-yield market terms; model interest coverage
"Margin expansion assumes too much"	Show the operational levers (this is where companion thesis types matter)
"Exit multiple compression risk"	Hold exit = entry; show downside case

Exemplars

Elliott · Juniper Networks (Jan 2014) — explicit LBO math underpinning the take-out thesis
Pershing Square · McDonald's (Nov 2005) — quasi-LBO math via the leveraged-recap structure ($14.7bn CMBS + $40 buyback)
Pershing Square · Lowe's (Nov 2011) — leveraged-recap proposal with PE-style math
Engaged Capital · Outerwall (Feb 2016) — LBO math as floor in sale process
Engine Capital · various — periodic LBO framings as part of campaign material

Full list: examples/by_valuation.json → lbo_math

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