Modeling Week!

Thursday marked the conclusion of “Modeling Week” here at Ellery Partners – a four session introduction to DCF and LBO modeling. It is something that I know most all of the interns were interested in learning more about, and we were lucky enough to be taught by two individuals whose combined experience includes investment banking, private equity, and consulting (shoutout Beth and Orlando). Being an older intern (I graduated from Notre Dame this past Spring), I have a little more experience and have been exposed to these topics in school. Nevertheless, I learned quite a bit this week. Beth and Orlando took time to explain the intuition behind each area which brought my understanding of each topic to a new level.

Beth taught days 1-3, the DCF portion. Here we discussed comps and what kind of characteristics make a comp viable. Some important things to think about here include size, stage, geography, revenue, capital structure, and, of course, what the business actually does. We looked at public car manufacturers. I chose to analyze Fiat Chrysler with the competitors being GM, Ford, Toyota, and Honda. After choosing comps we went through making projections. In this stage you need to make decisions on future revenue, costs, and operating expenses for your firm. We thought about two ways of doing this: (1) using growth stage and macro trends or (2) projecting actual unit sales for the company. These assumptions get you to EBIT. We next made assumptions regarding D&A, Capex, and NWC to get to our FCF. While you can spend a lot of time making these assumptions, we were more focused on the process of getting to FCF. Finally, making an assumption about capital structure allowed us to get to our WACC (discount rate) and find the NPV of our company. While this is a very high level look at what we did, the most important take away I had can be summed up by a phrase Beth shared with us: “put garage in, get garbage out.” As you may have noticed, I used the word “assumption” quite often in describing what we did. In order to make a practical model, you really need to spend time to make realistic assumptions regarding various aspects of your company and have tangible reasons as to why you made those decisions.

Session 4 was led by Orlando and gave us a shortened (yet still very complex, in my opinion) LBO model. It starts out similarly with the DCF in making assumptions and getting to your EBIT, but really takes off from there. In an LBO, you utilize debt to make the purchase and then pay down this debt throughout the period that you own the firm. So, you have to incorporate the debt you will take on and how will pay this down, and how this ultimately affects the value of your firm. While it may sound simple, it is extremely complex. Yet, Orlando laid it out in a very detailed step by step process to the point where we are currently building our own (based on his model).

I think I speak for all the interns in saying that we learned a lot this week due to the way Beth and Orlando taught us these complex subjects. Taking the time to learn the intuition behind each aspect and how it fits into the whole was very beneficial in truly understanding DCF and LBO models.