Playing the Perpetuity Game
The name of the perpetuity game is to build as large and passive a benefit stream as possible. There are three sides that one can engage in in order to do so as mentioned in the last chapter; the build side, sell side and buy side.
Though there are different sides to the perpetuity, the perpetuity scientist should understand the entire process of playing the perpetuity game including mastering the capabilities and knowledge necessary to play the game.
Process of Playing the Perpetuity Game
The perpetuity scientist uses the valuation methodologies to determine a valuation range for a target perpetuity that is less than its DCF value (positive NPV project) via using the two valuation methodologies of:
- Comp companies
- Comp transactions
The perpetuity scientist then uses an LBO or merger structure for the purchase (syndication on build side) of the perpetuity utilizing a deal structure (cash, stock, cash & stock) and goes through the syndication or M&A process to build or buy the perpetuity.
The perpetuity scientist then operates the company, focusing on debt paydown if there is any and then in five to seven years exits the perpetuity receiving a 25%+ return on capital invested.
The perpetuity scientist understand the buy side perspective to every deal, the perpetuity marketplace (multiples), the process and thus he knows the perpetuity game.
The perpetuity scientist knows how to pull comps from a coverage database such as Mergr (www.mergr.com) as well as comp transactions to get an understanding of the multiples in a sector and then sub-sector. He then knows how to spread these comps into his valuation model to obtain a mean and median multiple for the sector and sub-sector to value his own target.
The perpetuity scientist then knows how to collect financials and calculate adjusted EBITDA (proxy for cash flow) including addbacks (also called Total Owners Benefit in the lower middle market).
The perpetuity scientist then knowns how to perform a DCF valuation in excel based upon the adjusted EBITDA and compare the NPV valuation to the multiples of comp companies and comp transactions. This gives an understanding if an investment actually exists (if DCF value > comp multiples).
The perpetuity scientist then knows how to procure financing of various sorts to fund the transaction including various types of equity, debt or hybrid from their different sources (can be found in Mergr). He builds a financial model that incorporates these sources of capital along with the corresponding uses of capital in the perpetuity itself and runs an analysis according to what type of buyer he is (strategic with a merger model or financial with an LBO model) in excel to understand the returns from an IRR perspective.
The perpetuity scientist then knows how to originate the M&A opportunity in terms of approaching the target and issuing an IOI in order to do a deeper dive with management and how to have a buyer/seller meeting.
The perpetuity scientist then knows how to obtain longer period and more detailed financials of 3 to 5 years and confirms the analysis from before to see if still meeting the hurdle rate and performs various sensitivity analysis.
The perpetuity scientist then knows how to issue an LOI then purchase agreement to begin due diligence and then ultimately takes ownership of the perpetuity.