Different priorities and demands: CEOs need to learn to cope with this very diverse range of investors;
In case of P2P, HF can block the privatization (95% threshold to delist): Alain Afflelou purchase by Bridgepoint.
Governance and risk management in public companies
Where public companies score the best: consequences of Sarbanes-Oxley legislation and Higgs Report;
Several subcommittees to scrutinize remuneration, audit, nomination, etc…
Overall Board supervise and can rely and decide on the sub-committees’ recommendations;
Important factor of investor confidence;
Downside: expensive, time-consuming, inefficient sometimes ( “The focus is on box-ticking and covering the right inputs, not delivering the right outputs”)
Governance and risk management in private companies
Lower level of governance than in public companies: only audit committees are needed in PE’s approach;
More focus on risk management than risk avoidance;
Not perceived as a pure operational factor.
Public companies Directors are more focus on risk avoidance than value creation:
They are not as well financially rewarded as PE Directors by a company’s success but they can still lose their hard-earned reputations if investors are disappointed.
Greater level of engagement by nonexecutive Directors at PE-backed companies:
In addition to formal meetings, PE nonexecutive Directors spend an additional 35 to 40 days a year to informal communication with the management.
Credit crisis: impact and consequences on private equity
Before July 2007 (1/3)
Growth of the institutional loan market, CDOs and second lien loans;
Intermediaries/brokers underwrote debt to sell to other investors for syndication fee: became less demanding in terms of potential risk/reward;
Multiplication of highly rated structured credit products (CDOs/CLOs) although their inherent value was increasingly complex to calculate;
Increasing interest from investors for LBO funds led to higher leverage;
New loans were issued as “covenant lite arrangements”: DONNER DES EXEMPLES DE COVENANT A RESPECTER DANS UN LOAN TYPE
Before July 2007 (2/3)
Increasing leverage loan activity but decline of credit quality of the new debt due to:
Rising ratio of debt to earnings for US and EU LBOs;
Mid and large LBO debt/EBITDA ratios were at all time high in 2007 (and were even higher for large than mid LBOs).
Before July 2007 (3/3)
Three indicators of a bubble:
Debt/EBITDA ratio at all time high in 2007: a decline of operating performance will expose the company to the risk of default;
Companies under LBOs have less liquidity to serve their debt;
Interest coverage ratio decreased since 2003 reaching a ten-year low of 1.7x in 2007.
More equity + more debt = bigger deals and bigger leverage;
After July 2007 (1/5)
Sudden increase in credit spreads makes the debt more expensive and more in line with the real risk held by the debt holder;
Banks and debt underwritters could not distribute their debt to other investors: had to keep it on their balance sheet while their value was declining;
A number of transactions collapsed and could not be closed;
Banks that did not distribute their debt had to report significant losses on their books.
After July 2007 (2/5)
Slowing buyout activity in US and Europe (almost no activity in 2008);
Debt was repriced and more difficult to access;
Default rate was historicaly low as of July 2007;
Meant to rise sharply since then, starting with construction, airline and retail industries as global recession is impacting our economy;
After July 2007 (3/5)
Increase in the issuance of junk bonds: in the past four years, almost half of the newly issued bonds have been rated as “junk” at their outset;
Default risk (according to Moodys and Edward Altman (NYU Salomon Center)):
CCC 4-year default risk: 53.6%;
CCC 10-year default risk: 91.4% in 10 years;
B default risk: 25.2% after four years.
In reality, the default rate over the last years is much lower that those predictions;
After July 2007 (4/5)
Reasons for the low deafult rate:
Given the lareg amount of liquidity, bonds that would have defaulted have been refinanced;
The rise of covenant lite means that any event short of a failure to pay interest would not result in a default;
Private equity deals should be seriously impacted very soon;
Deals signed in 2005, 2006 and H1 2007 are the most risky deals;
After July 2007 (5/5)
The crisis opens doors to new investment opportunities:
Distressed debt and special situation funds;
Need for leverage should benefit mezzanine funds;
Credit dislocation funds: purchase loans at a discount from lenders;
Small to mid-market buyout funds will benefit from desaffection for mega buyout firms;
Secondary funds: some large institutions need cash.
Consequences Recession Top of the cycle
Some interesting distressed situations (and even more to come)
No distressed opportunities
Buyer’s market but must proceed carefully and beware the falling knives
Lack of liquidity is driving behaviour
Liquidity is driving behaviour
The risk profile has changed fundamentally
Risk levels are extraordinary
Prices are falling. More to go
Prices are too high
June 2008 June 2007
Crisis = opportunities
Recession years have produced the best vintages for private equity;
Although some LPs are facing liquidity crisis, more money should be deployed now and in 2009 !
Recession years considered to be 1991 + 2 years and 2001 + 2 years.
Recession years are usually good vintage years
Recession vs Non-recession
Case study: Baneasa
Market leader in French retail (#1 in Footwear and #2 in clothing);
Experienced management team: Bogdan Novac has a long standing experience of the sector and the group;
Strong financial performance and strong growth in sales expected over the next 3 years;
Resilient business model: lower end of the market and diversified range of products;
Diversified offering: geography (city centre or out of town, France and overseas, apparel and footwear);
Potential growth prospect: organic growth (new stores openings) and consolidation (fragmented industry).
Banesa is #1 footwear retailer with 14.4% of the French market and #2 clothing retailer in France with only 3.7% of the French apparel market
Fragmented industry, gives M&A opportunity/growth by acquisition
45% of OOT footwear market and 24% of OOT clothing market
Indication about competition: Zara, H&M, Mango, etc… are city centres = Baneasa has a dominant position where those competitors are not present. Zara, H&M, Mango, etc… are thus the main city centre competitors;
Historically, Baneasa has always been active in OOT: created suburban discount shoe stores in 1981 with Osier Chaussures; and in 1984 with Osier Vetements
First mover advantage
Clothing business: 44% sales and 43% of EBITDA and
Footwear business: 56% sales and 57% EBITDA
Well balanced, similar EBITDA margins in both segments
France: 93% sales and 95% EBITDA;
Out Of Town: 68% sales and 72% EBITDA
Baneasa is diversified (but maybe not as much as the investor thinks);
Sales and EBITDA indicates that city centres and overseas stores are more expensive (lower margins, Baneasa has lower performances abroad and in city centres where is the tough competition)
Bogdan Novac was CEO of Baneasa from 2000 to 2003 and 2004 to today.
EBITDA has grown from €231m to €365m (a CAGR of 16.4%)
Good management team // experienced CEO
Strong performance over the last years (since 2003)
Nataf estimates sales and EBITDA in the financial year to 28 February 2007 of €237 million and €23 million respectively (9.7% margin).
Berrilio had sales in the 12 months to 30 September 2006 of €64.5 million and EBITDA of €4.6 million (7.3% margin).
Nataf and Berrilio offer potential margin improvements as the margin is 9.7% and 7.3% respectively versus 16.1% margin for Baneasa.
French clothing market has been stable since 2000 with 0.2% CAGR
The actors must gain market share to grow: no organic growth resulting from industry growth
Average prices have decreased by 1.5% CAGR. Price-volume elasticity is high with declines in average prices driven by the pass-through of purchasing gains from lower-cost sourcing (Asia) to end-customers and from the increasing development of value retail.
Pressure on cost, margins are difficult to increase and can only be increased through cost reduction (rather than price increase): price pressure on Baneasa + tough competition + need to keep production cost low (cost cutting and tough negotiation with suppliers)
Womenswear represents the majority of the French market with 51% of sales. It was the strongest growing segment as well as the most competitive and innovative until 2002.
Womenswear is the core business
Menswear has experienced fast growth rates in recent years due to the introduction of semi-annual collections and has increased its share of the total French clothing market (from 31% in 2002 up to 35% in 2004).
Menswear is a new business with high growth so absolute need to be active
Baby and childrenswear are expected to remain broadly stable, with upside coming from increased spend per child and the emerging trend of higher-priced designer baby and childrenswear.
Children wear is a good market with higher consumer spending
Between 2001 and 2003, out-of-town banners saw their market share decline from 11.9% in 2000 to 10.9% in 2003. This reflected the impact of hard discount retailing and the growth of city-centre banners. Since 2003, however, OOT specialised chains have regained share and have returned to 11.7% market share, growing by 3.9% in 2004 and 4.7% in 2005, to €3.1 billion. This dynamism has been driven by new store openings and volume increases supported by increased price-competitiveness.
Potential decline of OOT/inconsistent growth rate: risk.
Specialist out-of-town (OOT) distribution has seen the strongest growth in share (2.3% growth per annum over 2003-05 and 3.2% over 1998-2003) and continues to gain market share on the food retailers and the lower-end city-centre players due to a broad product range and low prices.
Footwear: OOT has a strong growth in share; OOT is where Baneasa is the best with 45% market share (with Osier Chaussures, Velo and Blue Shoes) while the closest competitor has only 10%.
The Spanish footwear market is more dynamic than the French one (3.9% p.a growth since 2000) but experiences the same volume and price trends with volumes up 6.5% p.a while prices decreased by 2.6% p.a largely driven by growing Asian imports. The market is still dominated by independent city centre stores (40% market share vs 15% in France) and OOT footwear is gaining share (8.4% p.a between 1998 and 2003).
Spanish market: active market at the time of the investment (quid now?) but city centres have more market shares than OOT (risk: Baneasa is better in OOT).
Suburban stores are typically large format value stores and account for the great majority of sales and profits, whilst city centre stores are more fashionable premium stores.
OOT stores need high volume sales to be profitable // city centres are more fashionable products so potentially higher margins although probably higher costs (including marketing costs)
Over 2003-06, gross margin has grown at a 9.5% CAGR and EBITDA at 16.4% CAGR while sales CAGR was 5.8%, of which like-for-like sales growth of 3.7%.
Indicates that Baneasa has grown organically and by acquisitions but acquisitions are the main growth factor.