Chapter 3 of 5 · 10 min

Cost-out programs

Pay once to save every year. The run-rate saving, the cost to achieve, the phasing, and why the exit multiple makes it worth it.

By the end of this chapter you can

Calculate the run-rate saving, cost to achieve and year-one cash
Work out the cash payback allowing for phasing
Value the program at exit and net of its cost
Find the run-rate saving a value target needs

The intuition

Insulating your house costs $15,000 once and saves $10,000 a year on heating, but the work takes months, so you save only part of it in the first year. The cash takes about two years to come back. And if you sell the house, a buyer will pay more for one with low heating bills.

A cost-out program works the same way: severance, consultants or closing a site cost money once, and save money every year after. At exit, a buyer values the higher EBITDA at the exit multiple.

The key idea

Cost to achieve = cost multiple × run-rate saving. Year one saves a share of the run-rate; every later year the full amount. Net value = run-rate × exit multiple + savings banked − cost.

Why it works

The conventions here: a run-rate saving (the full yearly saving once complete), a one-off cost to achieve quoted as a multiple of it, a share of the saving in year one and all of it from year two. At exit the saving is valued at the exit multiple. No discounting.
Year one usually looks worse than doing nothing. The whole cost is paid while only part of the saving arrives.
Payback = 1 year + (cost − year-one saving) ÷ run-rate, when year one does not cover the cost. It depends on the cost multiple and the phasing, not the size of the program.
The exit multiple is the prize. A dollar of run-rate saving is worth the multiple at exit, against a cost to achieve of one or two dollars.
Do it early. Savings that sit in two full years of audited accounts are simply EBITDA to a buyer; savings completed just before a sale are an 'adjustment' the buyer will argue down.
Run-rate EBITDA adds back the annual effect of actions already taken. Buyers check each one and haircut anything not yet visible in the numbers.

EBITDA $100M; a 10% saving ($10M run-rate); cost to achieve 1.5x; 40% in year one; exit in 4 years at 9x

Cost to achieve: 1.5 × 10	15
Year one: 40% × 10 − 15	−11 net cash
Payback: 1 + (15 − 4) ÷ 10	2.1 years
Savings banked before exit: 4 + 3 × 10	34
Value at exit: 10 × 9	90
Net: 90 + 34 − 15	109; on banked cash alone, 19

For $135M of exit value from cost at 9x: 135 ÷ 9 = $15M run-rate, 15% of EBITDA.

The formulas

Cost to achieve = cost multiple × run-rate saving

Paid once, up front.

Year-one saving = phasing × run-rate; later years = run-rate

The saving builds.

Payback = 1 + (cost − year-one saving) ÷ run-rate

When year one does not cover the cost.

Value at exit = run-rate × exit multiple

The buyer pays for the higher EBITDA.

Net value = value at exit + savings banked − cost to achieve

Everything together.

Run-rate for a value target = target ÷ exit multiple

Run it backwards.

Worked example

Run-rate first, then the one-off cost, then year one: part of the saving in, the whole cost out.

Drawing the numbers…

See it move

Same company. Change the size of the saving, what it costs, how fast it arrives, the exit multiple and the years to exit.

Drawing the numbers…

Try this

Raise the exit multiple. Net value rises; the no-credit line does not move.
Raise the cost to achieve. Year-one cash and net value fall, and payback lengthens.
Raise the share saved in year one. Year-one cash improves, more is banked before exit, and payback shortens.
Raise the size of the saving. Every dollar grows, but payback does not move: it depends on the cost multiple and the phasing.

Run it backwards

Same company, reversed: the plan counts on a set amount of exit value from cost reduction. What run-rate saving does that need?

Drawing the numbers…

At exit the saving is worth run-rate × multiple, so divide the value target by the multiple. As a share of EBITDA it tells you how ambitious the plan is.

Mid-single-digit uplifts from procurement and overhead are routine; much more than 15% from cost alone usually means cutting into things the business needs.

Traps

Counting the full saving in year one.

Programs phase in. Year one gets a share; the cost is paid in full.

Leaving out the cost to achieve.

It is real cash, often one to two times the run-rate saving.

Valuing only the cash saved before exit.

Most of the value is the higher EBITDA at the exit multiple.

Assuming the buyer will pay the multiple on every saving.

Only on savings visible in the accounts, and only if revenue did not go with the cost.

Accepting run-rate EBITDA at face value.

Check each action has happened, and haircut anything that has not shown up in results.

Say it in the interview

The interviewer asks

“How would you evaluate a cost-reduction plan in a portfolio company?”

Say yours out loud first, then compare.

Check yourself

4 fresh questions, with new numbers. Answer each one correctly to finish the chapter. Get one wrong and you will see the full working, then you can try it again with new numbers.

Answers within 1% are marked right. Type the number; $, %, x and M are fine. First tries count toward Learned: the topic is Learned once every chapter is done and 75% of first tries were right.

0 of 4

Drawing your questions…

Remember

Cost to achieve = multiple × run-rate; year one saves only a share.
Payback = 1 + (cost − year-one saving) ÷ run-rate.
Net value = run-rate × exit multiple + banked − cost.
Do it early, so the buyer pays for it.