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Young Hedge Fund Manager Cracks The Private Equity Code


Parsad
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Thank you for sharing!

Do you know if the article means 7 times EV/EBITDA or P/EBITDA?

I think even in today's stock market it is not easy to find 7x EV/EBITDA stocks. P/EBITDA of 7 seems more likely. But then with debt, it could easily go to 14x EBITDA, a ridiculously high multiple.

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After a second read, I think the article is talking about EV/EBITDA less than 7, given the following language.

 

"Price matters because the typical PE firm puts 60% leverage on an acquisition. At a purchase price of five times cash flow, debt should equal about three times EBITDA"

 

 

I think it really depends on how capital intensive this business is.

Some business have 2% capex on revenue and some have 50%.

The 2% ones can have a much higher sustainable EV/EBITDA multiple.

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What he forgets to mention is that as a PE owner you are much more in control of what kind of debt (+ triggers, covenants) the company is taking on.. As a public equity holder, not so much..

 

Full link to the paper: http://poseidon01.ssrn.com/delivery.php?ID=607074089082020070021121093006078100019000031052064056118110008085029064069119123076045022127062105116060076102124005072081071105018000043039099126108110025118004123003044033106020076106020081028097020118098099123120014107004079091017003099074025096001&EXT=pdf

 

 

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When we've talked to PE they always discuss multiples related to us and others as a multiple of just EBITDA, 5-7x is what they seem to get. 10x is high for most mature industries from what I've been told.

 

I know they use multiples of other things as well, but usually they discuss multiples of just EBITDA when getting down to it.

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When we've talked to PE they always discuss multiples related to us and others as a multiple of just EBITDA, 5-7x is what they seem to get. 10x is high for most mature industries from what I've been told.

 

I know they use multiples of other things as well, but usually they discuss multiples of just EBITDA when getting down to it.

 

Is this EV/EBITDA or P/EBITDA?

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When we've talked to PE they always discuss multiples related to us and others as a multiple of just EBITDA, 5-7x is what they seem to get. 10x is high for most mature industries from what I've been told.

 

I know they use multiples of other things as well, but usually they discuss multiples of just EBITDA when getting down to it.

 

Is this EV/EBITDA or P/EBITDA?

 

P/EBITDA

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I don't think I would want to own equity in a bunch of small caps with tons of debt.

 

Jay Pritzker, Sam Zell, and I am sure others have done similar things by buying the debt of small to mid caps, especially in down trodden industries or ones needing consolidation.

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When we've talked to PE they always discuss multiples related to us and others as a multiple of just EBITDA, 5-7x is what they seem to get. 10x is high for most mature industries from what I've been told.

 

I know they use multiples of other things as well, but usually they discuss multiples of just EBITDA when getting down to it.

 

Is this EV/EBITDA or P/EBITDA?

 

P/EBITDA

 

It's EV/EBITDA.

 

Comparing price to EBITDA is like comparing apples to oranges.

 

He uses both FCF to equity and EV/EBITDA as metrics.  I've read his writeups on Sumzero. They're pretty good. Clear thinking.

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I don't think I would want to own equity in a bunch of small caps with tons of debt.

 

Jay Pritzker, Sam Zell, and I am sure others have done similar things by buying the debt of small to mid caps, especially in down trodden industries or ones needing consolidation.

 

I think the idea is to look for equities (leveraged, but paying  down debt with FCF), that have the same treats like the private equity deals that work out  from his set of data.

These would be:

1) small caps that are leveraged

2) Reasonably valued per EV/EBITDA

3) showed a pattern of paying down their debt from FCF

 

Not a bad idea. If there is a credit freeze, his fund will get absolutely destroyed, I think.

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I don't think I would want to own equity in a bunch of small caps with tons of debt.

 

Jay Pritzker, Sam Zell, and I am sure others have done similar things by buying the debt of small to mid caps, especially in down trodden industries or ones needing consolidation.

 

I think the idea is to look for equities (leveraged, but paying  down debt with FCF), that have the same treats like the private equity deals that work out  from his set of data.

These would be:

1) small caps that are leveraged

2) Reasonably valued per EV/EBITDA

3) showed a pattern of paying down their debt from FCF

 

Not a bad idea. If there is a credit freeze, his fund will get absolutely destroyed, I think.

 

I want to point out that small caps that are leveraged may also die.

Who knows if his data set contains the dead ones as well.

 

I think companies that have survived are much easier to be added to a research database than companies that failed. So the data set may contain a survivor bias.

 

Who still has the list of fortune 500 companies in 1945?  :)

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That's good. That's not what the PE who have discussed buying business or friends businesses used. When discussing an offer.

 

I understand the apples and oranges comparison and need for EV/EBITDA in that scenario, but when making an offer of $X to buy our company, they have used a multiple derived from P/EBITDA.

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Seemed like he may be caught a bit in the "just buy cheap" that myself and Buffett (not that we're otherwise at all similar) got caught in at first.

 

Yeah, is it just my reading comprehension or did you take away from the article that the strategy, in live performance, actually had "failed to crack the PE code" in almost complete contradiction to the title? 

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Buying levered microcaps ranks one rung above buying unlevered microcaps on leverage in my book.  Even if you survive, you'll probably wish you hadn't ;) You'll never feel diversified, and forget about publishing your Sharpe ratio.

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This whole levered strategy does not make sense to me. Does it not violate the first commandment of value investing? i.e., Margin of Safety?

 

Buffett never invested in levered small caps in his partnership days. All his small/micro cap investments had huge margin of safety, starting with a very solid balance sheet.

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  • 4 weeks later...

In order to account for missing price information, we used CRSP’s delisting dataset to recover

final prices for stocks that delisted from the data. In cases where price information was still

missing after reconciling against CRSP’s delisting dataset, we assumed a -100% return. This

assumption applied to less than 1% of the firms in our data.

 

 

OK. So at least he is taking the delisted and bankrupted companies into consideration, so the paper is kind of credible.  :)

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  • 2 weeks later...

When we've talked to PE they always discuss multiples related to us and others as a multiple of just EBITDA, 5-7x is what they seem to get. 10x is high for most mature industries from what I've been told.

 

I know they use multiples of other things as well, but usually they discuss multiples of just EBITDA when getting down to it.

 

Is this EV/EBITDA or P/EBITDA?

 

P/EBITDA

 

It's EV/EBITDA.

 

Comparing price to EBITDA is like comparing apples to oranges.

 

He uses both FCF to equity and EV/EBITDA as metrics.  I've read his writeups on Sumzero. They're pretty good. Clear thinking.

 

It is not even easy to find a lot of stocks trading at less than 7x EV/EBITDA these days. How are the PEs buying private companies at 7x EV/EBITDA or less? That seems very strange to me.

In addition, he did not factor in growth. I think that's one of the most important things in this evaluation. I am much more willing to pay 10x EV/EBITDA if EBITDA grows at 10% a year. I am not willing to pay 7x EV/EBITDA if there is no growth.

 

In addition, how about capital intensity? Some industries have real D&A and some industries have fake D&A. That makes a huge difference too. Especially the "A" element.

 

 

 

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