An introduction to Private Equity, the private equity investment model, private equity strategy, private equity structure, private equity performance and how it is achieved
1. Introduction
to
Private Equity
Errol Danziger
Danziger Capital Partners LLP
October 2011
1
2. This Presentation
covers
Three Topics…
• What is private equity?
• How does private equity differ from other
investment models?
• How does private equity boost corporate
performance and enhance investor
returns?
2
3. Wealth Creation through
Private Equity
• Wealth creation through the private equity
investment model can be impressive, and
sometimes even spectacular
• Although average private equity returns
have been shown to track but not exceed
the S&P 500, some private equity
investments have greatly outperformed
other types of investment
3
4. KKR’s Acquisition of Duracell
8 7.8
7
6 Acquisition
5 price
$ billions 4 Bank deposit
3 2.4 at 5%
2 1.8
Selling price
1
0
Investor value
Source: McKinsey
4
5. Desai Capital’s Acquisition of
Sunglass Hut
100%
90%
80% Operating
improvements
70%
Leverage
60%
50% Industry gain
40%
Market gain
30%
20% Cost
10%
0%
Source: McKinsey
Value
5
7. Scale of Private Equity Investment
in the United Kingdom
Source: TheCityJK
7
8. Features of Private Equity
• Target companies are taken private
• Acquisitions are financed with debt capital
• Investors are entrepreneurs, private equity
specialists, high-net worth individuals, and
institutions
• Agents are appointed to manage target
companies
• Private equity is a form of financial
innovation
8
9. Objectives of
Private Equity Investment
• Improvements in operating
efficiency
• Increases in manufacturing
and service productivity
• Increases in shareholder value
9
10. The Private Equity
Investment Model
• Resolves public company conflicts of interest
• Helps overcome the failure of public company
controls
• Conflicts of interest in the public company have not
been controlled by –
1. Internal controls, including boards of
directors
2. Product markets
• but have been controlled to some extent by capital
markets
• Activist investors have intervened and the result
has been the development of private equity
10
11. The Strategy of Private Equity
Fund founded by specialist
investors
Raises debt and
equity capital
Buys out listed
and unlisted Takes the listed
targets targets private
Restructures
the targets
Exits through sale or IPO
11
12. The Structure of Private Equity
The legal and economic structure is made up of
these factors and elements
1. Funds 6. Management
2. Debt incentives
7. Decentralisation
3. Partnership
8. No cross-
4. Manager-held equity subsidisation
5. Institutional 9. Limited lifespan
investors 10. Targets taken
private
12
13. Public Company
Structure Diagram
Director pay:
performance
sensitivity is small Board of Directors
CEO
pay:performance CEO
sensitivity is small
Corporate Headquarters
Headquarters staff
in the 1,000s
Division Division Division Division
1 2 3 4
Divisional head
pay:performance
sensitivity is tiny
13
14. Private Equity
Structure Diagram
CEO
pay:performance Partnership Limited
sensitivity is big Headquarters Partnership
Buyout Fund
Headquarters staff
in the 10s
LBO target LBO target LBO target LBO target
1 2 3 4
LBO target CEO
pay:performance
sensitivity is big
14
15. Private Equity Investment Targets
Private Equity pursues corporate targets that
are underperforming or are undervalued, and
that have these features:
1. Poor management
2. Under-investment
3. Over-investment
4. Strategic neglect
5. Inadequate debt financing
6. Excessive debt financing
7. Incorrect financing mix
8. Excessive cash holdings
9. Excessive conglomeration
15
16. How Private Equity Boosts
Corporate Performance
By focusing on the following factors -
1. Assets in place 9. Period of high growth
2. Redeployment 10. Cost of financing
3. Operating efficiency 11. Less discretionary
4. Tax burden 12. Operating leverage
13. Financing mix
5. Capital maintenance,
working capital 14. Matching
15. Non-operating assets
6. Expected growth
16. Acquisitions
7. New investments
8. Existing assets
16
17. Features of
Private Equity Target Performance
1. Target shareholders gain from leveraged
buyouts of target companies
2. Private equity gains are not at made at the
expense of other constituencies
3. Leveraged buyouts boost target operating
efficiency
4. Private Equity gains are not subsidised by
tax system through interest deductibility
5. Private Equity targets taken private are
seldom taken public again
17
18. How Private Equity Achieves
Outperformance
1. Cash retention is minimised and excess
cash is distributed promptly to investors
2. Capital structure is optimised to
minimise cost of capital
3. An operating plan is developed and
followed rigorously
4. Target company management is heavily
incentivised to perform
5. Target company directors play an active
and ongoing role in operational
management
18