The HEC - Dow Jones Private Equity Fitness Ranking 2010TM

Executive Summary

Frequently Asked Questions

What is new/interesting about the “HEC - Dow Jones Private Equity Fitness RankingsTM”?

The Private Equity (PE) industry is notoriously opaque and access to any data is chronically
difficult. In particular, little is known about the performance and competitive positioning of the
key PE firms. While rankings exists for many other areas (the best “business school”, the best
“place to work”, the best “stock market analyst” etc), nothing comparable existed in PE until very
recently. The only existing “rankings” were merely lists established by different trade journals
and based on some single measure of scale and thus had has relatively limited meaning.

In November 2009, HEC School of Management and DowJones published the first-ever Private
Equity Performance RankingTM of global PE firms in the Wall Street Journal, Financial News
and Private Equity News. The Private Equity Performance RankingTM uses an innovative
aggregated measure of past performance to identify and rank the top 10 GPs worldwide.

Now we are ready to present the second, complementary ranking that analyzes the world’s
leading PE firms in terms of their “competitive fitness”.

Simply speaking, what does “competitive fitness” mean?

The HEC - Dow Jones Private Equity Fitness Ranking answers the question: Which firms are
best positioned to generate strong long-term performance going forward? It evaluates each firm’s
competitive positioning based on 10 different empirically validated criteria and then derives an
overall future competitiveness score based on the historic link between firm performance and
each of these criteria. Collectively, these criteria capture some of the most relevant drivers of
value creation, including scale, quality of deal flow, ability to time debt and equity markets, and
strategic positioning.

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 Fitness
Score
(Standar
Rank Firm Name dized)
1 AXA Private Equity 3,10

2 CDC Entreprises Equity Capital (IXIS Equity Cap/Priv Equity) 3,07

3 Providence Equity Partners, Inc. (FKA: Providence Ventures) 2,68

4 Goldman, Sachs & Co. 2,46
5 TPG (FKA:Texas Pacific Group) 2,44

6 Oak Hill Capital Management, Inc. 2,40

7 Norwest Equity Partners 2,33
8 Madison Dearborn Partners LLC 2,14
9 Carlyle Group, The 2,11

10 Welsh, Carson, Anderson & Stowe 2,00

11 3i Group PLC 1,89
12 Warburg Pincus LLC 1,78
13 Apax Partners Worldwide 1,66

14 GMT Communications Partners, Ltd. 1,63

15 Parcom Capital (FKA: Parcom Ventures BV) 1,62

16 AIG Capital Partners 1,45
17 Barclays Private Equity, Ltd. 1,31
18 Kohlberg, Kravis, Roberts & Co. (AKA: KKR) 1,29
19 Charterhouse Capital Partners LLP 1,27
20 Hellman & Friedman 1,15
21 Bain Capital 1,09
22 American Capital, Ltd. (FKA: American Capital Strategies) 0,96
23 Odyssey Investment Partners, LLC 0,95
24 Thomas H. Lee Partners (AKA: TH Lee Partners) 0,75
25 TowerBrook Capital Partners L.P. (FKA: Soros Private Equity) 0,68

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GENERAL BACKGROUND

What are the data sources behind the rankings?

To obtain the most accurate picture of the universe of PE firms and their investments, we drew on
a variety of available databases and performed a number of cross-checks of the information used
in this study.

To calibrate our model based on the historic relationship firm performance and each of the fitness
criteria, we drew on a proprietary dataset with information on the activity and performance of PE
firms (the HEC Buyout Database). This dataset contains detailed information on the investment
characteristics and performance of thousands of PE transactions over the past 30 years.

To ensure consistency and comparability of the data, we used ThomsonReuter’s VentureXpert

database as the primary source for up-to-date investment activity. Both academics and
practitioners generally consider VentureXpert and as one of the most reliable sources of industry-
standard benchmark statistics.

To further enhance the quality of the underlying data, we surveyed 211 PE firms in February
2010. In this survey, we provided them with a list of investments made by their firm according to
VentureXpert and invited them to confirm, update or correct the information as needed.

How have the evaluated PE firms been selected?

We initially gathered data from VentureXpert all investments made by buyout-type or

generalists-type PE funds involving portfolio companies located in "Americas" or "Europe". We
further considered only the following investor types:

Fund Type
SBIC Affiliated with Commercial Bank
SBIC Affiliated with Investment/Merchant Bank
Independent Private Partnership
Venture/PE Subsidiary of Other Fin. Institution
Evergreen Funds
SBIC Private Partnership
Direct Investor-Investment/Merchant Bank
Commercial Bank Affil. or Subsidiary Partnership
Venture/PE Subsidiary of Investment/Merchant Bank
Venture/PE Subsidiary of Commercial Bank
Investment Bank Affil. or Subsidiary Partnership
Other Fin. Institution Affil or Subsid. Partnership
Venture/PE Subsidiary of Insurance Company

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This data (a total of 35,372 investments1 of US$ 672B in equity by 2,904 funds and 1,403 PE
firms into 18,005 distinct portfolio companies) captures the “universe” of PE investing.

From this universe, we then selected all those PE firms that met, as of 1/8/2009, the following
objective criteria:
! More than 20 transactions completed
! More than $100M in equity invested
! Over 5 years of PE investment activity

How large and representative is your sample of PE firms?

The filters we applied led to a sample of 276 PE firms and over 1,200 funds which made over
23,000 investments2 totaling over US$ 500B in equity into over 11,000 portfolio companies. This
corresponds to about 2/3 of all PE activity covered in VentureXpert in terms of the volume of
equity investment.

For some of these PE firms, insufficient data was available for some of the analyses and
consequently they had to be excluded from the rankings.

METHODOLOGY

According to which criteria is the competitive fitness of the PE firms assessed?

We indentified and empirically validated 10 criteria3 that capture various aspect of a firm’s
competitive fitness, i.e. ability to generate high future returns. Generally, the components of a
firm’s competitive fitness cannot be measured directly. To make an objective and data-driven
assessment possible, we followed a well-established statistical approach and identified suitable
and measurable proxies for the underlying skills and abilities of PE firms. To the extent that these
proxies are strongly correlated with the actual underlying skills and abilities, they can used to
assess a firm’s future ability to generate high returns.

# Criterion What it captures How it is calculated

1 Active Portfolio Scale of Current Joint size of all companies in the current portfolio,
Size (Volume) Activities measured in terms of the total equity invested
2 Avg BAA Yield Ability to take Average 1-year yield on BAA corporate bonds over
advantage of all investments of a firm, measured at the time a
cheap debt given investment is made.
financing

1
This number includes double-counts for each participant of a club-deal or multiple investments by the same PE
firm in the same portfolio company.
2
This number includes double-counts for each participant of a club-deal or multiple investments by the same PE
firm in the same portfolio company.
3
Initially, we calculated over 30 criteria, but the model calibration (see below) pointed to 10 empirically valid
criteria, so we excluded the others from the analysis.

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3 Market Timing Ability to time Average percentage difference between the level of
the stock market the S&P 500 index at the date of the entry and level
to benefit from of the S&P 500 index at the date of the exit, over all
market trends investments made by a firm.
over the holding
period
4 Exit Timing Ability to time Average percentage difference between the level of
the stock market the S&P 500 index at the date of the exit and the
to exit at high exit average level of the S&P 500 index over the period
valuations 182 days prior to and 182 days after the exit, over all
investments made by a firm.
5 Industry Focus Level of industry Level of industry concentration (measured as a
focus Herfindahl-type measure of industry concentration)
for all investments made by a firm
6 5-yrs-chg-in- Change in level Difference between the levels of industry
Herfindahl of industry focus concentration (measured as a Herfindahl-type
measure of industry concentration based on the
amount of equity invested) for investments made 6-
11 years ago and the same measure for investments
made in the past 5 years.
7 Procyclicality Quality of deal Correlation coefficient in amount invested per month
flow, i.e. ability between focal firm and all PE firms
to continue to
invest during
periods when all
other PE firms are
decreasing their
investing pace.
8 Recent Flexibility to take Coefficient of variance in the amount of equity
Variance in advantage of invested over the investments made by a firm in the
Deal Size investment past 5 years.
opportunities of
different sizes.
9 Strategic Level of strategic Percentage of activity in each “strategic cell” for (a)
Overlap uniqueness/ the focal firm and (b) all PE firms. A strategic cell is
differentiation the combination of a given industry sector and a
given size category. It then calculates the “strategic
overlap” as the sum of joint activity (minimum of the
percentage invested of the firm and the percentage
invested by all firms in a given cell) over all cells. A
strategic overlap of 1 means that a firm invests
exactly like the average firm – a score of 0 indicates
that no other firm makes similar investments.
10 Increase in Recent Change in Difference between the Scale of Activity (measure as
Scale Scale of Activity the number of active investments in the portfolio) (a)
today and (b) 5 years ago.

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How are missing values or outliers treated?

Inevitably, we have to deal with missing values and outliers for some firms. We chose a
conservative approach and only considered data points where full information is available. This
means that, for example, when the exact exit date on an investment in now known, we ignore this
investment for the calculation of the “Exit Timing” value. If for one of the firms we do not have a
sufficient number of data points to calculate a given value, e.g. at least six investments with valid
exit date information to calculate the “Exit Timing” value, and then we exclude this firm from the
ranking. We also had to deal with extreme values, for example, a firm may have grown “four
standard deviations” faster than the average. Such cases would distort the ranking, so that we
followed a standard practice in statistics and capped outliers at a value of two standard “two
standard deviations” above/below the average.

How are the individual values in the 10 criteria combined to obtain the overall ranking of
competitive fitness?

To avoid any subjectivity in our ranking, we have used empirically derived weightings of the 10
individual criteria, based on the historic relationship between the score in each criterion and
subsequent performance.

The weights have been calculated based on the following “back testing” analysis: For the years
1996 to 2003, we calculated historic scores for all 10 criteria for 217 anonymous firms in the
HEC Buyout Database in all criteria, i.e. considering their investment activity only until that
point in time. We then measured the aggregate performance of each firm for a five-year window
starting on 1/1/1996, 1/1/1997 … to 1/1/2003 based on the performance information available in
this database. Then we constructed a panel dataset by linking for each firm and each point in time
the values for the 10 criteria to the 5-year subsequent performance to calibrate a complex
multivariate statistical model4.

A more simplistic, but conceptually similar approach would be to look at the correlation between
each criterion and subsequent performance to see which criterion would have been historically
(i.e. in “96, “97 … “03) a good predictor of subsequent performance and use the correlations as
weights to combine the criteria: a criterion that strongly predicts performance has a higher weight
than another.

Based on this model, we were able to quantify to what extent a given criterion (measured in the
past) would have predicted subsequent performance. Using the results from this “back testing”
analysis, we were able to calibrate a reliable statistical model5 of the performance impact of
different aspects of competitive fitness for PE firms that enables us to identify and rank the most
competitive PE firms worldwide.

4
US Patent Pending
5
F-test significant at p<0.0001, R-square of 13.9%

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How reliable is the statistical model behind the aggregate ranking?

The results indicate a strong model fit with the data (F-test significant at p<0.0001), and a high
explanatory power of our criteria: They explain about 14% of the variation in performance across
the 217 anonymous PE firms over the 1996-2003 period (R-square of 13.9%). The “explanatory
power” of our model is thus of the same area of magnitude as the historic explanatory power of
the widely used Capital Asset Pricing Model (CAPM) or the Fama-French-3-Factor-Model6.

What is the economic impact of the fitness score?

Drawing on the data on 217 anonymous PE firms in the HEC Buyout Database, we can assess the
economic relevance of the fitness score. To this end, we identified for the period from 1996 to
2003 those data points with the highest Competitive Fitness Score. When we compare the
average performance of the 10% with the highest Competitive Fitness Score to the sample
average, we can see that the performance (expressed as the % of annual value creation relative to
the amount of capital invested at a given point of time) of the Top 10% sample is higher than the
average performance by a factor of 1.7x.

It is striking that according to this back-testing analysis, the fitness score has been a much more
accurate indicator of subsequent performance than prior performance itself. We replicate the
above described exercise by identifying those PE firms who created the most value during the 5
years following 1998 and then looked at their performance during the next cycle (2003-2008).
The performance of the 10% with the highest performance from 1998 to 2003 performed better
than the average PE firm from 2003-2008, but only higher by a factor of 1.15x. This supports the
view that fundamental indicators of competitiveness fitness are much better predictors of
subsequent performance than prior performance itself.

How subjective is the choice of criteria and their weighting for the overall competitiveness
ranking?

The great advantage of the methodology we applied is its high objectivity. We started out with a
total of over 30 possible criteria for competitiveness fitness that were measurable and that could
be potentially related to future performance. We calculated the score for each firm and each
criterion based over time based on hard facts in the databases we used. We then applied an
objective statistical method (see above) to derive the weighting of each criterion for the overall
fitness ranking. This method assesses (based on the historic relationship between the score in
each criterion and subsequent performance) whether a given criterion should have a strong
(positive or negative) influence on the overall ranking. Accordingly, 10 empirically valid criteria
have been identified and the other 20 were discarded. The final ranking is thus entirely data-
driven and has been created without any influence by judgment calls, assumptions or opinions of
the researchers involved.

6
See, for example Suh, Daniel, The Correlations and Volatilities of Stock Returns: The CAPM Beta and the Fama-
French Factors (March 18, 2009). Available at SSRN: http://ssrn.com/abstract=1364567

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What are the most relevant drives of competitiveness according to this analysis?
Order of Direction of
Importance Performance
Impact
1 Positive
2 Negative
3 Positive
4 Positive
5 Positive
6 Positive
7 Negative
8 Negative
9 Negative
10 Positive
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Factor Intuitive Interpretation
Recent Variance in Deal Size Ability to take advantage of
investment opportunities
across large range of deal-
sizes helps performance
Avg BAA Yield Ability to take advantage of
cheap debt financing helps
performance
Industry Focus Specialization on a select
few industry sectors
facilitates value creation
Market Timing Ability to time the stock
market to benefit from
market trends over the
holding period helps
performance
Exit Timing Ability to time the stock
market to exit at high exit
valuations helps
performance
5-yrs-chg-in-Herfindahl “Strategy Drift” due to
diversification into a larger
set of industries hurts
performance
Active Portfolio Size A smaller portfolio under
management at a given point
in time facilitates value
creation to each of the
portfolio companies
Procyclicality A low level of procyclicality,
indicating a high quality deal
flow that allows PE firms to
invest even in “slow” PE
markets helps performance
Strategic Overlap A low level of Strategic
Overlap, indicating a high
level of strategic
differentiation allows PE
firms to avoid the “money
chasing deals” phenomenon
and helps performance
Increase in Scale As our multivariate analysis
already considers the
negative effect of a large
portfolio size, an increase in
firm scale is an indication of
strong deal flow and goes
with higher performance.
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Note that in the multivariate analysis we perform, each factor is considered in terms of its
marginal influence on performance, i.e. the influence beyond all other factors. Some of the 10
criteria have a relatively small impact on our aggregate fitness ranking in a multivariate analysis.
This does not mean that they have no impact on performance, but rather that their consideration
does not add anything to those factors already included in the model.

Further note that the results of this analysis capture (by design) only the average performance
impact of a given factor for the typical PE firms. Clearly there are many investors who generate
(and will continue to generate) strong returns based on very different, and maybe even opposite,
approaches. Considering the broader PE universe we analyzed, however, these will be the
proverbial exceptions to the statistical “rules” identified in our analysis.

How robust is the ranking to alternative model specifications or to measurement error?

The confidential nature of the PE industry makes it impossible to be 100% certain of the accuracy
of the data we use, even if the same data sources are typically used for leading academic research
and to compose industry-standard statistics of PE activity. We further conducted a number of
robustness checks to verify to what extent the membership of a PE firm in the group of the fittest
PE firms changes (a) if we exclude one of the 10 criteria from our model or (b) if we consider a
25% measurement error for one of the 10 criteria for a given firm or (c) if we consider a 10%
measurement error for all 10 criteria for a given firm. The results from these robustness checks
confirmed the overall reliability of the method.

What is the economic impact of the fitness score?

Drawing on the data on 217 anonymous PE firms in the HEC Buyout Database, we can assess the
economic relevance of the fitness score. To this end, we identified for the period from 1996 to
2003 those data points with the highest Competitive Fitness Score. When we compare the
average performance of the 10% with the highest Competitive Fitness Score to the sample
average, we can see that the performance (expressed as the % of annual value creation relative to
the NAVs at a given point of time) of the Top 10% sample is higher than the average
performance by a factor of 1.7.

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LIMITATIONS

Limitations of the data

The confidential nature of the PE industry makes it impossible to compose a 100% accurate
database on private equity and we cannot exclude the possibility of biases in our results due to
missing or inaccurate information. However, we rely on the same data sources typically used to
compose industry-standard statistics of PE activity and we consider our data by far the “best
available” for this kind of analysis. We have taken great care to exclude PE firms from the
rankings for which no sufficient data was available to derive an accurate fitness score.

Limitations of the method

Our methodology has two inevitable limitations:

First, the ranking of competitive fitness is based on the historic relationship between a given
criterion and subsequent performance. To the extent that the success factors in PE change
drastically over time, the accuracy of the predications from our model decreases. However, the
long time-period (28 years) over which the model has been derived and the fact that the
relationships captured in our model generally make intuitive sense (“face-validity”) suggest that
the predications from the model are generally valid.

Second, our analysis is limited to aspects of PE firms that are related to hard data on investment
activity we can observe. Hence our model does not capture unobserved factors, such as the
departure of key personnel, future changes in strategy that are not yet reflected in recent
investment decisions etc. that may also influence the future performance or a firm. Overall, it is
important to keep in mind that such an analysis can never be expected to lead to a perfect
prediction of future performance. However, it can be a useful indicator that captures a substantial
part of a firm’s competitiveness. This is illustrated by the fact that an application of our model in
the past (1996-2003) would have captured performance over the 1996-2008 period with an
accuracy of 13.9% (R-square of the statistical model).

CONCLUSIONS

In summary, the HEC - Dow Jones Private Equity Fitness RankingTM constitutes a landmark
project that increases the understanding of the strategic logic and the performance drivers of PE.
It uses a data-driven methodology to provide investors with reliable and objective insights into
the strategic positioning and competitive fitness of the world’s leading PE firms and gives an
indication of which firms are best positioned to generate strong long-term performance going
forward.

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IMPORTANT DISCLAIMER

This material has been prepared on the basis of publicly available information, internally
developed data and other third party sources believed to be reliable, however, HEC Paris and
Peracs, LLC have not sought to independently verify information obtained from these sources
and makes no representations or warranties as to accuracy, completeness or reliability of such
information. This material is for information and illustrative purposes only, is not investment
advice and is no assurance of actual future performance or results of any private equity segment
or fund. HEC and Peracs do not represent, warrant or guarantee that this information is suitable
for any investment purpose and it should not be used as a basis for investment decisions. Nothing
herein should be construed as any past, current or future recommendation to buy or sell any
security or an offer to sell, or a solicitation of an offer to buy any security. This material does not
purport to contain all of the information that a prospective investor may wish to consider and is
not to be relied upon as such or used in substitution for the exercise of independent judgment.

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