Ten Key Questions Facing the Private Equity World David Rubenstein Co-founder & Managing Director February 27, 2008
Questions for Audience: <ul><li>1. How many of you are GP’s? </li></ul><ul><li>2. LP's? </li></ul><ul><li>3. Service providers? </li></ul><ul><li>4. Media? </li></ul><ul><li>5. Labor unions? </li></ul><ul><li>6. Think the golden age is over and that the best days of private equity are behind us? </li></ul><ul><li>7. Think the best days lie ahead? </li></ul><ul><li>8. Think there will be buyouts of 5 or 10 billion this year? </li></ul><ul><li>9. Next year? </li></ul><ul><li>10. Think there will be visible bankruptcies? </li></ul><ul><li>11. Think returns will be better from deals done now? worse? </li></ul><ul><li>12. Think taxes will go up? Stay the same? Go down? </li></ul><ul><li>13. Think private equity’s image will improve? Worsen? </li></ul><ul><li>14. How about the next president? Who thinks it will be Obama, Clinton, McCain, Huckabee? </li></ul>
1. Will Leverage for Buyouts Return in Time for PE Investors and Professionals to Stay with the Industry?
Leveraged Loan Volumes Will Recover <ul><li>US Leveraged Loan Volumes Bounced Back after the Downturn of 2000-2001 </li></ul>1996 1997 1998 1999 2000 2001 2004 2003 2005 2006 2002 2007 US Buyout Leveraged Loan Volume ($Bn) + 1,929% Source: S&P Leveraged Buyout Review
Leveraged Loan Volumes Will Recover <ul><li>While European Issuance has Grown Every Year Since 1999 </li></ul>European Buyout Leveraged Loan Volume ( € Bn) Source: S&P LCD 2005 2006 2001 2002 2007 2000 2003 1999 2004
But This Will Not Happen Overnight <ul><li>In the US, it took roughly three years for leveraged loan volumes to match their previous highs after 2000 </li></ul><ul><li>And those three years were challenging for private equity investors </li></ul><ul><ul><li>In 2001 and 2002, US leveraged loan issuance fell to approximately 1/3 of its 1998 total </li></ul></ul><ul><li>But when the recovery came, it exceeded all expectations </li></ul><ul><ul><li>Leveraged loan issuance more than doubled between 2002 and 2004 and again between 2004 and 2006 </li></ul></ul><ul><ul><li>Issuance jumped 20x between 2001 and 2007 </li></ul></ul>Source: S&P Leveraged Buyout Review
2. Are There Going to be Major Defaults from Buyouts Completed within the "Golden Age"?
Leverage Levels Are at Historical Highs 1997 1999 1998 2002 2001 2000 2007 2006 2005 2004 2003 Average Large LBO Leverage Multiples (Debt/EBITDA) Source: S&P Leveraged Buyout Review Note: Includes issuers with EBITDA of $50MM or more x
And Credit Ratios Are Depressed 2004 2005 2003 1997 2006 2007 1998 1999 2000 2001 2002 (EBITDA – Capex) / Cash Interest Source: S&P Leveraged Buyout Review x
Default Rates Have Remained Low Over the Past Three Years Percentage of Outstanding Leveraged Loans in Default or Bankruptcy Source: S&P LCD Avg. 3.80% %
And Remain Below Levels Seen During Past Market Downturns <ul><li>Leveraged Loan Default Rates During Recent Market Downturns: </li></ul>Source: Morgan Stanley
But the Trading Levels of Many LBO Debt Deals Suggest Defaults are Likely <ul><li>A Spread vs. Treasuries of Above 1,000 Indicates Significant Distress </li></ul>Source: Merrill Lynch High Yield Master II Index
3. What is Going to Happen to All of the Buyout Debt Still Held by the Major Syndicating Banks?
A Massive Backlog Remains <ul><li>Approximately $200 billion of leveraged loans are still sitting on banks’ balance sheets </li></ul><ul><ul><li>This represents a decrease of only $75 billion from last year’s peak </li></ul></ul><ul><li>Every bank is affected </li></ul>Sources: The Wall Street Journal, Morgan Stanley
4. What Areas Will PE Firms Pursue to Achieve the Types of Returns Sought by Their Investors?
PE Firms Will Invest More in Emerging Markets <ul><li>Emerging Market Fundraising Has Grown Exponentially </li></ul>2007 2006 2004 2003 2005 Emerging Asia ($Bn) 2005 2004 2003 2006 2007 CEE/Russia ($Bn) 2006 2003 2004 2005 2007 Latin America ($Bn) 2003 2004 2005 2006 2007 Middle East & Africa ($Bn) 11.4 Source: EMPEA
PE Firms Will Invest More in Emerging Markets <ul><li>As Has Deal Volume </li></ul>Emerging Asia ($Bn) CEE/Russia ($Bn) Latin America ($Bn) Middle East & Africa ($Bn) Source: Morgan Stanley, Thomson 2003 2004 2005 2006 54.5 1H 2007 10.5 1H 2007 2003 2004 2005 2006 2003 2004 2005 2007 5.9 2006 2003 32.2 2005 2006 2007 2004 24.9
PE Firms Will Invest More in Emerging Markets <ul><li>A growing percentage of global private equity activity is dedicated to Emerging Markets </li></ul><ul><li>In 2001, they accounted for 4.5% of private equity fundraising and 3.3% of deal volume </li></ul><ul><ul><li>In 2007, they accounted for 15.9% of fundraising </li></ul></ul><ul><ul><li>In the first half of 2007, they accounted for 7.0% of global LBO deal volume </li></ul></ul>Source: Morgan Stanley, Thomson
Private Equity Firms Will Make More Minority Investments <ul><li>Private equity firms have increased their commitments to non-control investments: </li></ul>Source: Dealogic <ul><li>In the past six months, private equity firms have made large minority investments in companies including </li></ul><ul><ul><li>Sprint Nextel, NC Numericable, MBIA, Global Hyatt, Antero Resources, Galaxy Entertainments, MoneyGram International, Legacy Hospital Partners, and Bharti Infratel </li></ul></ul>
And They Will Commit More Capital to Distressed Investments <ul><li>Distressed Debt Fundraising Anticipating Debt Maturity Schedule: </li></ul>Source: Private Equity Analyst, data as of 6/30/07; Fitch Ratings, data as of July 2007
5. Should Investors in PE Expect Higher or Lower Rates of Return?
Top Quartile PE Returns Are Unrivalled Source: Thomson Venture Economics Note: PE data as of 30 June 2007; Bloomberg, market data as of 30 June 2007 Top Quartile US Buyout Returns IRR % 6.1% 5.7% 5.4% 18.2% 21.8% 12.2% 7.7% 8.7% 22.1% 20.4% 19.9% 20.3% 18.4% 28.5% 32.1% 0% 10% 20% 30% 40% NASDAQ DJIA S&P 500 Top Quartile >$2Bn Top Quartile U.S. Buyout 10-year 5-year 1-year
Top Quartile PE Returns Are Unrivalled Source: Thomson Venture Economics Note: PE data as of 30 June 2007; Bloomberg, market data as of 30 June 2007 Top Quartile European Buyout Returns 7.6% Top Quartile Eu. Buyout FTSE 100 CAC-40 1-year 10-year 5-year
6. Is Now the Right Time for Investors to Pursue Private Equity Investments?
PE Funds Raised During Times of Market Distress Generally Perform Well <ul><li>Private equity investments have produced healthy returns during each of the three most recent global economic slowdowns </li></ul>Top Quartile Private Equity IRRs by Vintage Source: Thomson Venture Expert Note: IRRs are cumulative and are calculated from inception to 9/30/07
7. Will Regulators and Legislators Continue to Seek Changes in PE Regulation, Oversight and Taxation?
The PE Industry Faces Various Legislative and Regulatory Proposals <ul><li>Several countries are considering or have introduced changes to the way that private equity returns are taxed </li></ul><ul><li>The industry is under pressure to increase disclosure and transparency </li></ul><ul><li>In some markets, foreign private equity firms are subject to limitations on their investment activity </li></ul>
8. Will Sovereign Wealth Funds Replace PE Firms as Principal Sources of Capital for Corporations/Sellers Seeking New Capital?
PE Firms Pale in Comparison to the Largest Sovereign Wealth Funds Top Sovereign Wealth Funds Source: Citigroup
Sovereign Wealth Fund Investment Activity Has Increased Dramatically Value of Deals 2007 Number of Deals 2006 Deal Volume ($Bn) # of Deals 1997 1998 1999 2000 2001 2002 2004 2003 2005 + 1,151% Sovereign Wealth Fund Deal Volume Sources: World Economic Forum, Thomson Financial
But These Investments Still Represent A Tiny Proportion of Total M&A Activity 2002 2001 2000 1999 1998 2007 2006 2005 2004 2003 1997 Breakdown of Global M&A Activity ($Bn) Sources: World Economic Forum, Thomson Financial Sovereign Wealth Funds Strategic Private Equity
Sovereign Wealth Funds and PE Firms Are Forming a Productive Partnership <ul><li>Sovereign wealth funds have purchased substantial equity stakes in several alternative asset managers </li></ul><ul><ul><li>China Investment Corp. invested $3 billion in Blackstone </li></ul></ul><ul><ul><li>Abu Dhabi’s Mubadala invested $1.4 billion in Carlyle </li></ul></ul><ul><ul><li>Dubai International Capital invested 1.3 billion in Och-Ziff </li></ul></ul><ul><li>They are among the private equity industry’s largest individual investors </li></ul><ul><li>In the future, sovereign wealth funds and private equity firms are likely to pursue large investment opportunities through joint ventures </li></ul><ul><ul><li>Sovereign wealth funds will benefit from PE firms’ deep pools of investment talent and deal expertise </li></ul></ul>
9. Can the PE Industry Improve its Image with the Public, Media, Governments, Unions, Environmental and Consumer Groups?
Private Equity’s Image Could be Better Gluttons at the Gate Private equity are using slick new tricks to gorge on corporate assets. A story of excess – Business Week A Backlash Against Private Equity Grumbling by unions over post-deal job cuts has escalated into a public outcry – Business Week
10. Is PE's Future Going to Be Better, Bigger, and Stronger than Before, Or Have We Already Seen the High-water Mark?
It’s Always Darkest Just Before Dawn <ul><li>As before, deal volume will rebound and yesterday’s records will be left far behind </li></ul>2007 2006 2005 2004 2003 2002 2001 2000 1999 1998 # of Deals Deal Volume ($Bn) 1997 Deal Volume # of Deals 1996 1995 Global LBO Activity Source: Dealogic CAGR: 31%
What I Was Supposed to Talk About: “Giving Private Equity a Positive Image: Why is there such Disparity Between the Public’s Perception of the Industry and the Industry’s Perception of Itself, and What can be done to bring these Views into Alignment”
The Current Situation Perception of the Industry outside the Industry Destroyed Jobs Relocated Facilities Overseas Focused Only on Short-Term Profits Left Companies in Worse Shape Made Too Much Money for PE Professionals Insufficient Level of Taxes Paid Perception of the Industry within the Industry Improved operation of companies Prevented job losses; created jobs Improved Economies Created High Returns for Investors/Pension Funds Paid Large Amount of Taxes Created an Industry
Why the Disparity in Perceptions? <ul><li>Industry Focused for Long Time Principally on Returns </li></ul><ul><li>Industry Spent Little Time Explaining its Actions to those Outside of Investor Base </li></ul><ul><li>Industry Lacked Data to Support its Views </li></ul><ul><li>No Industry Vehicle for Long Time </li></ul><ul><li>Other Problems of Industry Critics/Convenient and Attractive Target </li></ul>
What Can the Industry Do to Improve Its Image? <ul><li>Continue to Produce Hard Data </li></ul><ul><li>Engage Industry Critics in Debate/Discussion </li></ul><ul><li>Consider Factors Other than Just Returns When Assessing/Overseeing Investments </li></ul><ul><li>Involve Portfolio Companies Directly in the Effort </li></ul><ul><li>Enhance Transparency/Public Focus </li></ul><ul><li>Recognize that Some Changes Can and Should Occur </li></ul>
Ten Leading Questions Facing the Private Equity World David Rubenstein Co-founder & Managing Director February 27, 2008
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