Private Equity interview preparation

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1. 027How would you underwrite a carve-out from a large corporate?Investment judgementHardsuperdayPlatinum EquityPrivate Equity · Los Angeles · 2014

   Say this

   The core problem is that the carve-out financials are not the real financials. You have to build a standalone cost base, including everything the parent was providing for free, and then underwrite the separation itself.

   Then walk it

   1. Start with the standalone cost base. The division has been receiving IT, HR, finance, legal, procurement and possibly premises from the parent. Allocated corporate costs in the carve-out accounts are almost never what standalone will actually cost.
   2. Usually standalone costs more, because you lose the parent's scale in procurement and have to build functions from nothing. Sometimes it costs less, because the allocation was punitive. You have to build it bottom-up either way.
   3. Then the transitional services agreement: what the parent will provide, for how long and at what price. The TSA is the bridge, and running out of TSA before you have built the replacement capability is the classic carve-out failure.
   4. Separation costs are real cash: systems migration, rebranding, new contracts, recruitment. These are often 5 to 10 percent of enterprise value and must be funded on day one.
   5. Commercial questions: which contracts transfer and which need customer consent, whether the division sells to the parent, and whether that relationship continues on the same terms.
   6. The upside case is what makes carve-outs attractive: these businesses are typically under-managed and under-invested because they were non-core. Freed of the parent's bureaucracy and given a dedicated management team, margin improvement is often substantial. That is the thesis, and the separation risk is the price of admission.

   Where candidates lose it

   Modelling the division's reported EBITDA as if it were standalone. Stranded costs and the TSA are the whole substance of a carve-out, and separation costs are real cash that must appear in sources and uses.

   Expect next

   • What is a TSA and what happens when it expires?
   • How do you size stranded costs?
   • Why are carve-outs attractive to sponsors?

   Reported by candidates at Platinum Equity (Private Equity, Los Angeles, 2014). Source: Wall Street Oasis.

Firm tags come from public, anonymous candidate reports on Wall Street Oasis: strong signal, not sworn testimony. Firms are named as the places a question was reported, not as partners of Fin Maverick. Answers are written for this page to show how to think out loud; they are not scripts to recite.