Our next step is to begin re-creating the income statement on the LBO tab. Why would we do this? Since we’re putting the entire LBO model on a single worksheet, we need to have an income statement on that worksheet. We cannot simply use the P&L from the analyst operating scenario because it is an input to one of our operating cases.
First, we need to make some assumptions regarding synergies. In an LBO, the post-transaction company is expected to be leaner than the pre-transaction company, meaning that operating costs are typically lower. In fact, operating enhancements are one of three possible ways that financial sponsors create value in an LBO. Revenue synergies, while potentially important in M&A deals between strategic acquirers and targets, have no place in LBOs. Therefore, we will consider COGS and SG&A synergies, specifically, and enter our assumptions regarding them under the Operating Performance Drivers section of our model.
In our scenario, we assume that no synergies will be realized until Year 2, given that the transaction is not expected to close until the second half of Year 1. Accordingly, note how COGS and SG&A as percentages of sales drop from Year 1 to Year 2. Now, inspect the underlying equations for these percentages in Years 1 and 2 to see how we are building synergies into the income statement. In Year 1, we simply pull the percentages of sales from our selected operating case. In Year 2 and beyond, we modify the equation to add synergies to these operating case assumptions. Once we have set up the synergies, we can easily calculate EBITDA.