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Seminaire Private Equity CERAM

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    Seminaire Private Equity CERAM Seminaire Private Equity CERAM Presentation Transcript

    • Seminar: introduction to private equity
    • Contact
      • Antoine Parmentier:
        • [email_address]
        • +44(0)7809.510.373
    • Final presentations
      • Corporate governance and public debate over private equity;
      • Private equity in emerging markets;
      • FIP, FCPI, defiscalisation;
      • Investments in infrastructure;
      • Private equity post credit crunch;
      • Private equity in retail and consumer goods.
    • Content
      • Introduction;
      • Why allocate assets to PE?;
      • LBO activity in Europe;
      • European fundraising activity;
      • The measure of perfromance;
      • FoF due diligence: selection of PE managers;
      • The world’s biggest private equity firms;
      • The mega-buyout era;
      • Value creation in private equity;
      • The structure of a leverage buyout deal;
      • The pros and cons of being private;
      • The credit crisis: impact and consequences on PE;
      • Case study: Baneasa
    • Introduction to Private Equity
    • Introduction
      • Asset class representing the companies not publicly traded (vs. public equity traded on stock exchange);
      • Medium to long term investment;
      • Venture capital, growth capital, buyout…
      • PE funds are raised from pension funds, insurance companies, large corporate, HNWI, etc…;
      • Investors in PE funds are called “Limited Partners”;
      • PE funds are managed by the “General Partners”
      • Structure of private equity participations
    • The fuel of private equity
      • The debt:
        • Acquisitions are made through leveraged buyout deals (LBOs);
      • The investors:
        • PE funds managers must be disciplined and patient;
      • The managers:
        • The success of an investment relies on the implementation of the business plan;
      • The macro environment:
        • Acquisition multiple arbitrage can be positive in period of growth;
    • A diversified asset class
      • Private equity includes a large number of strategies: venture, buyout, distressed, secondary…
      • Like-minded strategies: mezzanine, clean-tech/energy, infrastructure, real assets…
    • Venture capital (1/2)
      • Earlier stage: venture investors provide funds for start-up and early expansion;
      • Based on innovative business, development of a new product, new patent;
      • Two sectors: technology or life science;
      • Highly skilled professionals and scientists;
      • Scalable investments with a lot of failures and few great successes;
    • Venture capital (2/2)
      • Investment from up to €10m and often pre-revenues balance-sheet;
      • Financing in several rounds (round 1, round 2, round 3…) with typically clinical test results as threshold for next round;
      • Most of the exits are IPO (NASDAQ, Zurich…);
      • Examples: Skype, Google, Apple, Atari, Cisco, Yahoo, YouTube, LinkedIn, Paypal.
    • Buyout (1/3)
      • The most important strategy of PE;
      • Buyout comes after venture and growth capital;
      • Taking control of a company through leveraged buyout (LBO);
      • Management team of the company is investing alongside the PE fund (alignment of interest);
    • Buyout (2/3)
      • Development of a business plan over 4 to 6 years in order to add value;
      • Revenue growth + Margins improvement + deleveraging = added value;
      • Mature companies with leading market position, active management team, strong cash-flow;
      • PE funds provide capital for international expansion, corporate divestures, succession issues…
    • Buyout (3/3)
      • Buyout starts at €5 million enterprise value (EV);
      • At the bottom end: growth/expansion capital.
    • Distressed / Special situation (1/2)
      • Investment in debt-securities or equity of a company under financial stress;
      • Distressed companies are in default, under Chapter 11 (reorganization) or under Chapter 7 (liquidation=bankruptcy);
      • Loans are rated BB and below by S&P based on usual ratio (debt/EBITDA, EBITDA interest coverage, etc…);
    • Distressed / Special situation (2/2)
      • Distressed debt investors try first to influence the process;
      • Debt holders have access to confidential information;
      • Then, as debt holders, they can take the control of the company;
    • Secondary (1/2)
      • Purchase of existing (hence secondary) commitments in PE funds or portfolios of direct investments;
      • LP selling their portfolio = secondary deal;
      • Needs in depth valuation and bidding/auction process;
      • Specialized investors: Alpinvest, Coller Capital, Lexington Partners;
      • Booming specialization as most of institutional investors are seek cash.
    • Secondary (2/2)
    • Mezzanine (1/3)
      • Debt instrument immediately subordinated to the equity;
      • The most risky debt instrument = highest yield;
      • Returns generated by:
        • cash interest payment: fixed rate or fluctuate along an index (e.g. EURIBOR, LIBOR);
        • PIK interest: payment is made by increasing the principal borrowed;
        • Ownership: mezzanine financing most of the time include equity ownership.
    • Mezzanine (2/3)
      • Mezzanine suffered before credit crunch as senior debt was easy to access;
      • Since July 2007 and lack of funding, mezzanine is back:
        • As of 30 September 2008, 70% of PE deals used mezzanine vs. 48% in 2007;
        • Q3 2008 average spread: E+1,042, versus E+979 in Q2 2008;
    • Mezzanine (3/3)
    • Infrastructure (1/2)
      • Among the newest PE-like asset;
      • Global needs for infrastructure assets
      • Roads, ports, airports, energy plant, hospitals. Prisons, schools, etc…
      • Mix of private investors and governments through PPP (Public-Private Partnerships);
      • Traditional PE funds raised infrastructure funds: KKR, CVC, 3i, Macquarie;
      • Longer term investment, lower return, steady cash-flow with regular yield;
      • French highways or Viaduc de Millau are contracted to Eiffage/Macquarie;
    • Infrastructure (2/2)
      • A multi trillion market opportunity:
        • $1 trillion to $3 trillion annually through 2030;
        • US: power industry needs $1.5 trillion between 2010 and 2030;
        • Mexico: a 5-year and $250 billion plan will be funded 50% by private capital;
        • EU: €164 billion to be invested in natural gas infrastructure by 2030 to facilitate import of gas to meet long-term shortfall;
        • China: close to 100 airports will be needed.
      Source: Global Infrastructure Demand through 2030 , CG/LA Infrastructure, March 2008. Infrastructure to 2030 , volume 2, OECD publication, 2007.
    • Real assets (1/2)
      • Cash-flow producing asset or pool of assets privately originated:
        • Equipment leasing (shipping, aircraft…): the asset is purchased and simultaneously leased back to the seller;
        • Agricultural finance (forests, timber lands, etc…): growing demand from the renewable energy sector;
        • Mines, intellectual property rights, financial assets on the secondary market, etc…
      • It is usually not asset-backed securities but a direct investment in the assets
    • Real assets (2/2)
      • Steady and regular cash flow: 10%-15% annual cash return;
      • Downside protection due to high recovery value of the assets: loss of value of the asset is unlikely;
      • Uncorrelated assets;
    • Why allocate assets to PE ?
    • Portfolio management
      • Asset allocation is define by returns, risk (measured by standard deviations of returns) and correlations;
      • Diversification improve returns while reducing risk;
      • Allocation is determined using public information of traditional asset classes (equity, bonds, REIT, etc...)
    • The issue with private equity
      • Private market:
          • PE funds invest in private companies = no public market to help set the valuation;
          • PE funds are themselves private companies = no market to value them and no public disclosure required.
      • Quarterly valuation:
          • Risk of inconsistency: quarterly marked-to-market valuation = significant degree of subjectivity;
          • Risk of stale valuation: quarterly valuation can understate the standard deviation and correlation to other asset classes.
    • The issue with private equity
      • Illiquid investments:
          • PE funds are closed-end funds (except secondary market);
      • Time line too long:
          • PE funds has a 5-year investment period and a 10-year life;
      • Restricted information disclosure:
          • Only LPs have access to the fund’s performance.
      Private equity is an inefficient market
      • However, Allocation to PE increased significantly over the last years:
          • Low correlation to pricing trends of traditional assets;
          • Diversification thus risk reduction;
          • Good returns over the years: Average annual IRR 1986-2005 is 18.3%
    • Reason to invest in PE
      • Adding a risky asset with a low correlation of pricing trends compared to traditional asset classes can reduce the risk of an overall portfolio;
      • Relatively good returns of PE over the last years.
      • LBO activity in Europe
    • Geography
    • Sectors
    • European buyout value European buyout value: €72 billion in Q1-Q3 2008
    • European buyout by region
    • PE as a percentage of GDP
      • Nordic countries have the most important PE activity;
      • Benelux figures are impacted by few mega deals.
    • European fundraising activity
    • Funds on the market
    • Seeking capital is becoming difficult
      • Number of vehicles seeking capital keep on increasing;
      • But the number of final closing and the path investors deploy capital has slowed down dramatically;
      • Investors (LPs) are hesitant and sometimes face liquidity issues;
      • Distributions are expected to decrease as well: this won’t ease the fundraising processes;
      • Average fundraising:
        • 2008: 14.2 months;
        • 2007: 12 months;
        • 2006: 11.1 months
    • Average fundraising
    • State of the market
      • Aggregate PE commitments globally are close to $2,000 billion (vs. $1,000 billion in 2003 and an expected $5,000 billion within 5 to 7 years);
      • Globally: app. 1,200 funds are currently seeking $713 billion including:
        • Buyout: 290 funds seeking $320 billion;
        • Venture: 470 funds seeking $85 billion;
        • Mezzanine: 25 funds seeking $10 billion;
        • FoF: 205 funds seeking $220 billion.
    • Funds of the market
      • Permira: €13.5 billion;
      • CVC: €13.7 billion;
      • Apax Partners: €11.4 billion;
      • Cinven: €8.2 billion;
      • Charterhouse: €7.4 billion;
      • PAI Partners: €5.5 billion.
    • Outlook
      • PE is set to enter its most challenging time;
      • Increasing pressure and difficulties for managers seeking capital;
      • Fundraising take more time;
      • Less deals are being signed so there’s no rush to raise;
      • Historical performances and focus strategies will become key factors in the future: some GPs won’t survive;
      • Some LPs will need to free up some capital and clean up their portfolio: increase in secondary transactions.
    • Outlook
      • PE AUM has grown steadily since 1996:
          • 60% of LPs are expected to increase their allocation to PE;
      • Sovereign wealth funds are a huge source of capital:
          • Represent today $3,000 of assets and are expected to reach $7,900 billion by 2011;
      • Europe accounts for 19% ($580 billion) of SW funds capital;
    • Fundraising sources
      • LPs usually invest in home-based funds;
      • Globally, US is the single largest investor;
      • In Europe, UK is ahead of anybody;
    • Profile of the LPs
    • The measure of performance
    • Track record
    • Measures of performance
      • Multiple of cost:
          • Also called Total Value over Paid-In capital (TVPI);
          • (Cash distributions + Unrealized value)/capital invested;
          • Cash returned regardless of timing (total return).
      • Internal Rate of Return (IRR):
          • Discount rate that makes NPV of all cash flows equal zero;
          • Linked to timing: Quick flip = high IRR.
    • The J-curve
      • In the early years, low or negative valuation due to:
          • Management fees drawn from committed capital;
          • Initial investments to identify and improve inefficiencies;
    • The J-curve
      • Fees are charged based on the fund’s entire committed capital;
      • Example:
          • Fund size: €100 million;
          • Management fee: annual 2% committed capital;
          • Organizational expenses: €300,000
          • -> € 2,300,000 expenses/fees called regardless of any investment made.
    • The J-curve
      • If 5 investments are made the first year for €3 million each:
          • 5 x €3 million = €15 million;
      • If 20% of committed capital is called the first year: €20 million;
      • Interim value is thus: €17.7 million or 0.89x contributed capital;
    • The J-curve
      • Underperforming investments tend to be written down more quickly than successful companies develop;
      • Example 2 nd year:
          • Another 20% of committed capital : €20 million;
          • Five new deals at €3 million each: €15 million;
          • Two first-year investments are written down/off;
          • Annual management fee: €2 million.
    • The J-curve
      • Companies performing well, held at cost or conservative valuation, understate the value of the portfolio;
      • Interim is thus often misleading;
      • NAV + cumulative distributions track over time relative to contributed capital:
    • Fund of Funds due diligence: the selection of PE managers
    • Due diligence focus
      • Quantitative analysis:
        • Past investments and track record;
        • Leverage and debt;
        • Sources of proceeds.
      • Qualitative analysis:
        • Team;
        • Strategy;
        • Market opportunity
    • Critical items of due diligence
      • Track record : what’s behind a bad investment?;
      • Unrealized portfolio: lack of recent track record and ability of current team – look at current valuation carefully.
      • Organization: fund size, multi or single office, Pan-European, domestic or transatlantic, risk of spin-off, autocratic management, etc;
      • Team: number of Partners, Principles and Associates, carry split, staff retention and turnover, motivation in case of large distribution under previous funds, key man clause, succession issues.
    • Reasons to invest
      • Attractive track record;
      • Experienced investment team;
      • Differentiated investment strategy;
      • Proprietary deal flow;
      • Sector/geographic focus.
      • Must be combined with FoF portfolio management and exposure > seek diversification.
    • Track record
      • Entry and exit date;
      • Realized and unrealized value (part sell off or recapitalization);
      • Multiples of cost and IRR.
    • Benchmark analysis
      • DPI: Distributed Paid In > Proceeds distributed, only realized deals;
      • RVPI: Residual Value Paid In > Unrealized value;
      • TVPI: Total Value Paid In: Realized and Unrealized value.
    • Vintage year performance
    • Presentation
      • Private equity investors and their managers: Vivre avec un fond d’investissement, Les Echos, October 2006
    • The world’s biggest private equity firms
    • Carlyle
      • Founded in 1987 by David Rubenstein, Daniel D’Aniello and William Conway;
      • Since inception, Carlyle has invested $49.4 billion of equity in 836 deals for a total purchase price of $220 billion;
      • Over $89 billion AUM throughout 64 funds in buyouts (69%), growth capital (4%), real estate (12%) and leveraged finance (15%);
      • Over 525 investment professionals operating in 21 countries;
      • Assets deployed in Americas (59%), Europe (28%) and Asia (13%);
      • Currently: 140 companies, $68 billion in revenues and 200,000 workers.
      Source: www.carlyle.com
    • Carlyle deals
      • Hertz
      • Zodiac
      • Terreal
      • Le Figaro
      • VNU
    • Blackstone
      • Founded in 1985 by Steven Schwarzman and Peter Peterson;
      • Global AUM $119.4 billion in private equity, real estate, Funds of Hedge Funds, CLOs, Mutual funds;
      • 89 senior MDs and total staff of over 750 investments and advisory professionals in US, Europe and Asia;
      • Blackstone is the first major PE firm to become public: IPO was in June 2007 at $36 – under water since first day !
      • Currently: 47 companies, $85 billion in annual revenues and more than 350,000 employees.
    • Blackstone deals
      • The weather channel: $3.6bn in September 2008;
      • Hilton: $26.9bn in October 2007;
      • Center Parcs: $2.1bn in May 2006;
      • Deutsche Telekom: £3.3bn in April 2006 (minority);
      • Orangina: $2.6bn in February 2006;
    • KKR
      • Founded in 1976 by James Kohlberg, Henry Kravis and George Roberts;
      • Total AUM $68.3bn from $25.4bn invested capital;
      • Total of 165 deals since inception with an aggregate enterprise value of $420bn;
      • KKR is currently from a “one-trick pony” to a multi asset manager with infrastructure and mezzanine funds being raised;
      • The $31bn buyout of RJR Nabisco inspired the book “ Barbarians at the gate ”;
      • Currently: 35 companies, $95 billion in annual revenues and more than 500,000 employees.
    • KKR deals
      • Legrand;
      • Pages Jaunes;
      • Tarkett;
      • Alliance Boots;
      • ProSieben;
      • TDC;
      • Toys R’ Us.
    • PAI Partners
      • The biggest French PE firms formerly known as Paribas Affaires Industrielles;
      • Since 1998, PAI invested €3.92bn in 36 deals across Europe;
      • Last fund raised reach €5.2bn
      • Investments include: Kaufman & Broad, Vivarte, Neuf Cegetel, Panzani Lustucru, Atos Origin
    • Private equity deals
      • Private equity funds own companies of “everyday life”…
        • Pages jaunes;
        • Comptoir des cotonniers;
        • Pizza Pino;
        • Picard;
        • Alain Afflelou;
        • Jimmy Choo;
        • Odlo;
        • Orangina…
    • Impact of PE on French economy is overall positive
      • 2006-2007 employees growth rate:
        • +2.1% (vs. 0.5% for CAC 40);
      • 2006-2007 sales growth:
        • +5.3% (vs. 4.1% for CAC 40);
      Source: AFIC/Ernst&Young
      • As of 30 June 2006:
        • 55% of PE-backed companies have less than 100 empoyees and 83% have less than 500 employees;
        • 79% have less than €50m revenues;
        • 4852 PE-backed companies in France;
        • Work force of 1.5 million people (9% of total private employees);
        • € 199bn in revenues including €128bn generated abroad.
      Source: AFIC/Ernst&Young
    • Presentations
      • KKR
      • Blackstone
      • Carlyle
    • The mega buyout era
    • Fund growth
      • PE AUM 1980-2006: 24%CAGR;
      • 2003-2006: PE commitments increased 260%;
      • Cost of debt historically low
      • -> Global volume of LBOs increased to $700 billion in 2006 (4x 2003 level);
      • -> Global volume of LBOs in H1 2007 reached $560 billion (25% of global M&A).
      • Bigger are the funds, bigger are the target companies;
          • Fund size and deal size are correlated;
          • “ Club-deals” were required to complete the biggest acquisitions;
      • More cash you have,more cash you need:
          • Co-investors such as other funds, LPs or shareholders of target companies were sought after;
          • Some funds created quoted vehicles to access permanent capital or listed the management companies on the public market;
    • Large funds are getting (much) larger
      • US 12 largest funds raised in the US as of June 2007 totaled close to $155 billion:
          • This represents a 142% increase compared with their predecessor funds;
          • In Europe, the fund-to-fund increase of the 12 largest funds was only 75%;
      • In addition, GPs were starting to raise at shorter intervals.
    • Rational for larger pools of capital
      • Economies of scale in the management of the fund;
      • Higher management fee enable to build top investment teams;
      • Expanded buyout opportunities at the larger end of the market:
          • Higher quality assets;
          • Less competition at the upper-end of the market;
          • Huge potential returns.
    • Rational for larger pools of capital
      • Ability to pursue a pro-active acquisition strategy;
      • Implement a levered capital structure;
      • Flexible (covenant-lite) and low-cost financing;
      • Various exit options (IPO, Corporate transaction, secondary buyouts...)
    • Target companies
      • Very large companies are attractive targets:
          • Mature companies need restructuring effort to get rid of the “fat”;
          • The value-addition is thus often obvious an obvious path;
          • Usually less competition among the buyers.
      • Public market offer a lot of opportunities:
          • PE investors add value to the company they invest in as opposed to passive public shareholders.
    • Rise of Club-deals
      • Club-deals are iconic of the concentration trends of private equity;
      • 91% of US buyouts of over $5 billion were club-deals...
      • ... but also 38% of P-to-P valued between $250 million and $1 billion were club deals:
          • Many firms shared the risks and pooled resources.
    • Disappearance of club-deals
      • Collusion charges;
      • Difficulties to share informations;
      • Tendency to monopolize the control the control;
      • Ego-issues.
    • Examples of mega club deals Apax, Blackstone, KKR, Permira, Providence $13.9 billion TDC Carlyle, CD&R, Merrill Lynch $15.0 billion Hertz Blackstone, Carlyle, Permira , TPG $17.6 billion Freescale Semiconductor Carlyle, Riverstone, Goldman Sachs $21.6 billion Kinder Morgan Bain, Thomas H Lee $25.7 billion Clear Channel Apollo, TPG $27.4 billion Harrah’s Entertainment Bain Capital, KKR, Merrill Lynch $32.7 billion Hospital Corp, of America Buyers Value Target
    • Presentations
      • Caveat Investor / the uneasy crown, The Economist, Feb 2007;
      • Who’s next, The Deal, July 2008
    • Value creation in private equity
    • Value creation drivers
      • EBITDA generation
      • Multiple expansion
      • Debt reduction
    • EBITDA generation
      • EBITDA is generated by:
        • Sales expansion;
        • Margin improvement;
        • Add-on acquisitions;
        • Organic growth (=GDP growth)
    • Multiple expansion
      • Multiple: EV/EBITDA;
      • Based on comparable transactions;
      • Multiple expansion: Difference between entry and exit multiple;
      • =Multiple uplift x Exit EBITDA
      • Multiple uplift:
      • =Exit EV/EBITDA – entry EV/EBITDA
    • Debt reduction
      • = Entry net debt – exit net debt
    • Example
    • What to understand from EV creation
      • If most of the value comes from:
        • EBITDA increase: growing industry and/or company, possibly in a young market or efforts mainly on sales force;
        • Multiple expansion: margin increased over the holding period; the investors rationalized and optimized the production, cut costs, disposed of non core assets, arbitrage strategy, etc…
        • Deleveraging: usually the last factor to be implemented; Debt reduced by cash not reinvested.
    •  
    •  
    • Factors of value creation
      • Changing business and driving growth:
          • Taking advantage of market cycles (buying cheap, selling at better price) and financial engineering are no longer enough;
      • Objectives must be well defined;
      • Management is incentivized: alignment of interest between Board members and shareholders;
      • Must create value for the next acquirer: PE is not necessarily short term focused.
    • Other factor: Industry characteristics
      • Stability, low cyclicality;
      • High margins (or potential for improvement);
      • Strong operating cash-flows:
          • PE businesses are cash-flow driven rather than earning driven: need to pay down the debt
      • Industry-wide revenue growth;
      • Potential for overall efficiency improvements.
    • Other factor: The GP makes the difference
      • Managers contribute to value creation:
          • Select the right target companies;
          • Undertake appropriate changes;
          • Experience of the GPs/prior buyout experience
      • Focus on few sectors generates better returns:
          • Industry-focus strategy generate better returns…;
          • … but moderately diversified approach generates better returns;
          • Focus strategy exposes to industry cycles but good industry expertise;
      • Example of bad deal in the wrong industry: Foxton deal “ The deal of the century ”, FT
      • Recruitment/management;
      • Buy-and-build;
      • New investments to develop to new markets;
      • Optimization/cost cutting;
      • Divesture of non core business(es)
    • Primary source of value creation (%)
      • Almost 2/3 of the value generated comes from company outperformance: Companies’ fundamentals are key drivers of growth.
      • Sample: 60 deals from 11 leading PE firms
      • Five features of a leading-edge practice:
          • Expertise and knowledge: insights from the management, trusted external source;
          • Substantial and focused performance incentives: top management usually owns 15-20% of the equity;
          • Performance management process: initial business plans are subject to continual review and revision;
          • Focused 100-day plan: deal partners must devote most of their time to a new deals to build relationship, detail responsibilities and challenge the management;
          • Management should be changed sooner rather than later
    • Presentation
      • Foxtons: The sale of the century, FT magazine, June 2008
    • Structure of a Leverage Buyout transaction
    • Structure of a leverage buyout
      • Deal structure:
        • Equity
        • Debt
      • Debt is either:
        • Unsecured
        • Secured
    • LBO structure
    • Equity
      • Common equity, preferred equity, shareholder loan;
      • Equity is unsecured and the most risky and rewarding tranche;
      • Equity is held by the shareholders: private equity fund, management, various investors, often debt mezzanine providers, sometimes intermediaries.
    • Mezzanine debt
      • Secured debt but subordinated to senior debt;
      • Mezzanine is provided by mezzanine funds and sometimes hedge funds;
      • Reimbursement after the senior debt but has priority over the equity holders
      • Reimbursement is cash or PIK;
      • PIK note: payment made in additional bonds or preferred stocks which increase the performance of the investment;
      • Mezzanine is usually reimbursed at exit if not refinanced before.
      • H1 2008 cash spread: E+414.7bps
      • H1 2008 PIK spread: E+535.3bps
    • Second lien
      • Developed pre-July 2007 and does not really exist anymore: as of Q3 2008, 12% of LBOs used 2 nd lien versus 52% in 2007;
      • Reimbursement in cash, priority level between senior debt and mezzanine;
      • Second lien was seen as a cheap mezzanine.
    • Senior debt
      • Negotiated for a period of time between 7 and 9 years usually based on expected cash flow;
      • Tranche A is first reimbursed. Other tranches (B and C) are usually reimbursed in fine;
      • Tranche D is a revolving credit to refinance previous debt of the target company;
      • H1 2008 spread: E+337.48bps
    • Capital structure
    • The loan market: in 2008
      • Average leverage of European LBOs: 4.5x in Q3 2008 vs. 7.0x in Q3 2007;
      • Average equity contributions: 43% in Q3 2008 vs. 34% in Q3 2007
      • European Senior loan in Q3 2008: 450-550bps (compared to 225bps-275bps in early 2007) – partly offset by lower base rates;
      • Mezzanine margins have increased to 1100 –1300bps plus warrants or equity co-invest (compared to 750-900bps with little call protection and no equity participation in 2007);
    • Average LBO equity contribution
          • Less debt available = more equity required to close a deal
    • Loan volume dropped significantly Banks’ lending capacities are dry ! Q1-Q3 2008 loan volume: €46.6 billion Q1 2007 loan volume: €45.75 billion
    • Evolution of capital structure
          • Back to the classic structure: Senior Debt + Mezzanine
    • Cost of debt
          • Cost of debt increased significantly in 2008
    • LBO spread
    • The loan market
      • Loans started to fall below “par value” (100) in June 2007;
      • Secondary market became depressed (less liquidity, decline in value, etc) but presents some good buying opportunities;
      • Default rate at its lowest level although was expected to increase in 2008;
      • A lot of new investors (incl. traditional PE funds) entered the loan market in H1 2008 with levered vehicles;
      • They did not anticipate that the loan market will decline even more sharply in 2008 = BAD
      • Sponsor-backed credit is usually poorly valued regardless of the company’s performance
    • Consequences
      • The market is stuck:
          • sellers have not yet adjusted their price;
          • Buyers don’t want/cannot pay high price.
      • Deals are negotiated at cheaper:
        • EBITDA multiples are lower
        • More equity and less debt = more conservative structure
    • EBITDA multiples
    • Purchase prices
      • Secondary buyouts are the most impacted as:
        • They were traditionally the most expensive transactions = price adjustment;
        • Sellers are very likely forced to sell so accept lower prices.
    • The pros and cons of being private
    • Results of a 2008 McKinsey survey:
      • Private equity Boards are overall more efficient than public equity Boards:
          • Better financial engineering;
          • Stronger operatonal performance.
      • Pros and cons of public equity Boards offer some:
          • Superior access to capital and liquidity;
      • More extensive and transparent approach to governance and more explicit balancing of stakeholder interests.
    • Public versus Private: differences in ownership structures and governance
      • Public companies have arm’s length shareholders :
          • Need for accurate and equal information among shareholders and capital market (audit, remuneration, compliance, risk);
          • Management development across the board .
      • Private equity companies have more efficient processes :
          • Stronger strategic leadership;
          • More effective performance oversight ;
      • Manage only key stakeholders’ interests .
    • Rating of public and private Boards of Directors
    • Strategic leadership in PE companies
      • Joined efforts of all Directors;
      • Usually, defined and shaped dring the due diligence (prior acquisition);
      • Boards approve management strategic decision (in M&A for example);
      • PE funds stimulate management’s ambition and creativity;
      • Executive management reports on the progress of the latest strategic decision implemented.
    • Strategic leadership in public companies
      • Boards only oversee, challenge and shape the strategic plans, accompanying the management in the implementation;
      • The executive management takes the lead in proposing and developing it; it is mainly a formal reporting.
    • Performance management in private equity companies
      • Private equity have one focus: realisation of their investment;
      • Consequently, PE Boards have a « relentless focus on value creation drivers »;
      • Performance indicators are clearly defined and focus on cash metrics and speed of delivery.
    • Performance management in public companies
      • High level performance managment, no real detailed analysis;
      • Focus on quarterly profit targets and market expectations;
      • Need to communicate an accurate picture of short-term performance;
      • Budgetary control, short-term accounting profits;
      • Public companies Boards focus on information that will impact the share price.
    • Management development and succession in private companies
      • PE companies mainly focus on top management (CEO, CFO) and replace underperformers very quickly;
      • Very little efforts deployed on long-term challenges such as development of management, succession, etc
    • Management development and succession in public companies
      • Efficient thorough management-review: top management and their successors;
      • Focus on challenges and key capabilities for long-term success: management development and remuneration policies;
      • However, public Boards have weaknesses:
          • Slow to react and their voice is more (perceived as) advisory than directive;
          • Remuneration decisions sometimes more driven by public/stakeholders expected reaction than performance
    • Stakeholder management in private companies
      • Executive management can clearly identify a majority shareholder;
      • PE funds are locked-in for the duration of the fund;
      • PE fund represent a single block and are much more involved and informed than public shareholders;
      • Less onerous and constructive dialogue;
      • No or little experience dealing with media and unions (see Walker report and debate over PE in 2007)
    • Stakeholder management in public companies
      • Shareholding struture is more complex and diversified than private companies:
          • Institutionals, minority individuals, growth investors, long-term strategic, short-term hedge funds.
      • 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.
    • Top priorities
    • Survey’s conclusion
      • 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:
            • Covenant lite;
            • 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
      • Seller’s market
      • 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
    • Investment rationale
      • 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.