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Guide to LBO - How do PE firms operate

Updated: Dec 4, 2023

In today’s article we are going to simulate a Leveraged Buyout on Domino’s Pizza, a multinational pizza delivery corporation headquartered in Ann Arbor, Michigan, United States. Founded in 1960 as a two-store operation in Ypsilanti, Michigan, Domino's has since grown to be the largest pizza chain in the world, with over 17,000 stores in over 90 countries.

Domino's business model is primarily based on franchisee ownership, with over 98% of its stores owned and operated by franchisees. This allows Domino's to expand rapidly and reach new markets without the need for significant upfront capital investment. The company also generates revenue from royalties and fees paid by franchisees, as well as from sales of dough, toppings, and other products to franchisees.

Domino's is a well-established and respected company with a strong brand and a loyal customer base. The company is well-positioned for continued growth in the years to come, thanks to its strong business model, its commitment to innovation, and its focus on customer satisfaction.


We choose this company because it respects some crucial elements to consider while choosing a company for a Buyout:

  • A company in a mature industry, in order to pay the lowest price possible: the food sector in this case is already consolidated, with many large players that were founded over 10 years ago and a market share that is stable

  • A balance sheet with low amount of debt, because it will need to be refinanced: in this case there is quite a lot of debt, with a D/E ratio of around 30-35%

  • A strong management: Mr. Russell J. Weiner is the CEO of the company and has been part of the management since 2008, when he left Pepsi, the leadership team is quite experienced with over 2 years of average tenure while the board members have an average tenure of over 24 years.

  • A strong competitive advantage: The company is mainly a franchisor with 98% of its stores owned and operated by franchisees. However, despite being a largely franchise based model, it is not a complex business model. Domino’s Pizza has adopted a simple and straightforward business model. Its stores serve quality food at competitive prices. The company combines quality food and competitive prices with easy ordering access and efficient service. The company has enhanced its product offerings and customer experience through the use of technological innovations.

  • Steady cash flows: Its main source of revenues and earnings are the royalties and fees it charges from its franchisees. It also sells food equipment and supplies to its franchisees mainly in the US and Canada through its supply chain operations. The company is largely operated by franchisees but also owns a small number of restaurants whose revenues and earnings go to the company directly.The strength of Domino’s Business Model is that it generates significant returns for the franchisee and the franchisor both. Apart from that, low operating expenses have also helped the company generate significant profits. Domino’s generates most of its revenue from its US operations. International operations of the company account for a very small portion of the company’s net annual revenues.

  • Low future CapEx: due to the business model



1. Assumptions


The initial phase of our analysis involves establishing a set of assumptions for this company. With a LTM EBITDA of $913 million and a 21.3x EV/EBITDA multiple, we arrive at an enterprise value of approximately $19 billion. After subtracting $5 billion in debt, we are left with an equity value of $14 billion. The next step involves determining the debt financing structure. In this case, we opt for a 50/25 split between bank notes and subordinated debt, respectively. Bank notes will carry an anticipated cost of 6%, while subordinated debt will carry an expected cost of 12%. This debt financing strategy aligns with the typical LBO approach of borrowing funds to finance a significant portion of the transaction.


Moving forward, we assume a 10% growth rate for the next five years, consistent with consensus projections. Additionally, we anticipate a margin expansion of approximately 1% per year. These assumptions reflect the company's positive growth trajectory and its potential for continued margin improvement.

We believe that these assumptions are reasonable and well-supported by the company's historical performance and industry trends. They provide a solid foundation for our subsequent analysis and projections.





2. Sources and Uses


The second point in our LBO consists of calculating the sources and the uses. One step that is fundamental for this type of operation is repaying all the outstanding debt and the equity for the acquisition. These are the so called uses, while the sources must be equal to the uses and represent how we finance the operation, which are: bank debt, subordinated debt and sponsor equity, that is how much money does the PE firm deploys. This is what it will look like:



This shows how we are going to finance the deal. The deal will cost the PE sponsor around $5 billion in cash and the other $15 billion will be covered by debt emission.




3. Financials


Now we have to make some projections in order to estimate the FCF. We base on the previous assumption of 10% growth rate of revenue and 1% net margin increase, keeping D&A, CapEx and NWC at the same level in relation to the revenues.



What catches the attention is the low FCF in the first year and the high interest payments that results in an interest coverage ratio of around 1, which is not great.




4. Debt Schedule


Next we need to plan the debt schedule or debt waterfall, to see how much will be paid each year in interest. To see how much we are going to pay each year we are going to first compute the interests for both the bank debt and the senior tranche, then starting with the bank debt we see if the cash flow in each year is sufficient to repay all the interests or not. If it is sufficient we are also going to pay a part of the balance. We are not taking into account the interest payment because we have already put it in the levered FCF in the previous step. For the Senior notes we see that the repayment is always 0 because it is subordinated to the repayment of the first tranche which is the bank debt. In the last part we can see the total balance where we added the two tranches and we see that after 5 years we manage to reduce the balance by just $2 billion.




5. Return


The values shown in the image are indicative of a successful LBO exit. The EBITDA multiple of 18.0x is above average for LBOs, and the IRR of 32.4% is very strong. Usually PE firms take on projects which have an IRR over 20% and this seems a good opportunity. The MOIC of 4.1x indicates that the private equity sponsors more than quadrupled their investment.


One potential concern is the high level of net debt at exit (12.960). This means that the company is carrying a significant amount of debt, which could limit its flexibility in the future. However, the fact that the company was able to generate an EBITDA of 1.831 with this level of debt suggests that it is in a healthy financial position.

Overall, the values shown in the image are indicative of a successful LBO exit. The company was sold at a high valuation, and the private equity sponsors generated a strong return on their investment.






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