Introduction to Private

Equity
September 2009

Slides 1 6 inserted by Professor Blemaster

Private Equity

Generic LBO Candidates

Private Equity

Generic LBO Capital Structure

Private Equity

What Does PE Offer?

For investors, superior returns, at least for the top quartile players
The diversification of another asset class

A better governance model

Stable shareholder
Direct involvement with the business via the board and control of CEO
selection
Proactive intervention frequent i.e. replacing the CEO

A longer time frame not quarters but not forever

Buy, improve, sell

Superior compensation more and better designed

Better alignment
Attract the best talent

More efficient capital structures i.e. more debt

Debts helps returns and acts as a governance item

Higher expectations, a sense of urgency

3

Private Equity

Big Time PE Firm Advantages

Competitive Advantages of a Leading Buyout Firm

Ability to support global infrastructure

Requires over $20bn under management

Allows firm to move with opportunities over time

Ability to organize around sector groups

Requires substantial size to support 10-15 sector groups

Allows firm to follow sector cycles

Portfolio power

Creates investment insight (easier to understand a retailer if you

already own 5 of them)

Economic cycles, both positive and negative, can be identified

from portfolio data

Large base to encourage investment banking-created

opportunities

Ability to attract senior advisors to sit on significant boards

Ability to support a functional operating group

Requires 30-40 portfolio companies

Must be large enough to offer Ops team a career path

Strategic relationships with major capital partners

4

Private Equity
Remember

Structural Issues
whose money it is!

The

risks are largely limited to the special purpose borrowing

entity

The

PE firm and its partners are not primarily the ones at risk

The

limited partners investors i.e. the institutional investors

and the lenders have 95% of the risk more or less

For

example, Blackstone is not liable for the debt of any

specific buyout deal

The

risks to the PE firm are more reputational and related to

their ability to raise future funds
5

Private Equity

Disclaimer

This presentation is provided for informational purposes and reference only. The contents hereof should not be
construed as investment, legal, tax or other advice. This presentation may not be used or relied upon in evaluating
the merits of any investment. No representation or warranty, express or implied, is made as to the accuracy or
completeness of the information contained herein.
By acceptance hereof, you agree that you will keep confidential all information contained in this presentation and
will only use it for informational purposes.

Agenda

Private Equity

I.

Nuts and Bolts of Private Equity

II.

Overview of TPG

III. Case Studies

IV. Discussion

What Do Private Equity Investors Do?

Private Equity

Pension funds

Life insurance companies

Financial institutions

High net worth individuals/families

PE Cycle
Raise Money
Buy
Transform
Sell

1. Raise Capital

Buy operating businesses

Usually obtain control or

significant influence

2. Invest
Capital

Private Equity
Investors

4. Sell
Investments

Hold period typically

3-7 years

Capital markets

Strategic sales

3. Manage
Investments

Active members of board of directors

Help in development of strategy

Provide direct assistance in certain areas (M&A; corporate finance)

Private Equity

Deal Flow and Fundraising

GLOBAL PE VOLUME

BUYOUT FUNDRAISING

($ Billions)

($ Billions)

$292

$238
$205

$159

$760

$818

$336
$23

$32

$230
$109 $100 $81 $106 $132
$52 $64

$240 $66
$33

1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 1H09

Source: Morgan Stanley, SDC, Thompson

$23

$44

$67

$88
$44

$53

$43

$64
$28

$36

1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 1H09
Source: Buyouts.

Recent deal flow and fundraising environment for buyouts near

trough levels
9

Private Equity

Why the Explosion and Decline in Private Equity?

10

Growth of Private Equity

Private Equity

More

Big Deals

Strategic
Big

Acquirer Behavior

Companies were Cheaper

More

Public to Privates

Lower
Entry

Cost of Debt Capital

into New Geographies

11

Private Equity

Largest LBOs of All Time

TOP 10 GLOBAL LBOS OF ALL TIME

($ Billions)

$43.8
$38.9
$32.7

$31.1

$27.4

$25.7
$21.6
$17.6

TXU

Equity
Office

HCA

RJR
Nabisco

Harrah's

Clear

Kinder

Channel

Morgan

$17.4

$15.0

Freescale Albertson's Hertz

Source: Mergermarket and SDC

9 of the 10 largest LBOs of all time have occurred since 2005

12

Private Equity

Strategic Competition

PRIVATE EQUITY MARKET SHARE OF M&A

(% Market Share)

22.7%

19.0%

13.5%

10.1%

13.0%

10.7%
8.9%

YTD 2009

2008

2007

2006

2005

2004

2003

2002

2.9%

2001

3.6% 3.2%

2000

2.8%

1999

1997

3.4% 3.6%

1996

1995

2.9%

1998

5.3%

Source: Morgan Stanley

Strategic competition increasing

13

Private Equity Market Overview

Private Equity

Large Cap Valuations

March 2000
Forward PE of the 50 Largest (Market Cap)
175x

150x

P/E Multiple

125x

z
z

100x

z
z

z
z

75x
50x
25x

z zz
z
z

z
z z
z
z

z
z

zz

z
z

z z
zz

z
z
z z z
z
z
zz
z

z
z
z z

0x
Source: ISI Group

Large cap stocks earned premium valuations in 2000

14

Private Equity

Private Equity Market Overview

Large Cap Valuations
September 2006
Forward PE of the 50 Largest (Market Cap)

175x
150x

P/E Multiple

125x
100x
75x
50x
25x
0x
Source: FactSet

... but looked relatively cheap in 2006

15

Private Equity

Public-to-Privates

US PUBLICTOPRIVATE TRANSACTIONS
Volume ($ Billions)

$304.8
$278.7

$55.7
$33.6
$3.7

$0.6

$0.5

$6.4

$4.2

$4.9

$9.4

$6.8

$14.8 $13.2

$3.8

$5.2

$3.4

$10.4

$0.2

1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 YTD
2009
Source: SDC, Morgan Stanley, S&P

Dramatic decline in public-to private volume over the last year

16

Private Equity

Private Equity Market Overview

High Yield Pricing

Era #4
the 11% Era
Era?
21%

Era #2
the 12% Era

HY Index

18%

15%

Era #1
the 10% Era

12%

Era #3
the 8% Era

9%

6%

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

Source: JPMorgan

The market has experienced a dramatic recovery since early 2009

17

Private Equity

Private Equity Market Overview

Increase in PE Cost of Capital

Representative Cost of Capital for a Large Transaction(1)

Total Debt

25%

25%
Hurdle

35%

Equity

25%
Hurdle

40%

25%
Hurdle

High Yield
High Yield
Average
Cost of
Debt =
8.7%

Bank Debt

Average
Cost of
Debt =
7.3%

Bank Debt

Bank Debt

2005

2009

2002

WACC =12.4%

High Yield

WACC = 9.8%

Average
Cost of
Debt =
7.8%

WACC = 14.7%

(1) Large transactions typically reflect below-market average equity contribution

Source: TPG Estimates

Significant increase in WACC

18

Private Equity

Private Equity Market Overview

Increase in PE Cost of Capital

Lower Multiples Enable Lower Price for Same Returns(1)

17% premium
23% discount
$995

$850
$770

Illustrative Deal at
2002 WACC (12.4%)

Illustrative Deal at
2005 WACC (9.8%)

Illustrative Deal at
2009 WACC (14.7%)

(1) Illustrative case assumes 15% EBITDA CAGR, and capital structure per previous slide
Source: TPG Estimates

but lower valuation multiples may allow Private Equity buyers to pay
a lower purchase price and earn the same returns
19

Shift of Cost of Capital

Private Equity

WACCS FOR NON-FINANCIAL S&P 500 COMPANIES 2007

Number of Companies

72

PE WACC: 8.3%

17

5%

6%

7%

86

95
63
34

8%

9%

10%

11%

12%

13%

14%

14%+

74%
WACC
Eligible

Public After Tax WACC

WACCS FOR NON-FINANCIAL S&P 500 COMPANIES 2008

Number of Companies

60
13
<=5%

21

6%

7%

8%

76

76

Normalized PE WACC: ~14%

63
43

9%

10%

11%

12%

16
13%

14%

14%+

<3%
WACC
Eligible

Public After Tax WACC

Source: Bloomberg, McKinsey analysis

The buyout opportunity set has markedly declined,

but historic M&A cycle suggests it will return
20

Private Equity

Asian PE Market is Coming of Age

SPONSOR-LED M&A VOLUME

PRIVATE EQUITY DEAL VALUE AS % OF GDP

($ Billions)

(2008)
$39

0.4%

$40

$25

2x

$18

$9
$4

2001

0.2%

$11

$3

2002

North America

2003

2004

2005

2006

2007

2008

Source: Dealogic

Accelerating growth through

2007

GDP:
PE Deal Value:

U.S. $17 Trillion

U.S. $70 Billion

Asia
U.S. $13 Trillion
U.S. $25 Billion

Source: Dealogic

but still in early stages

of development
21

Growth of Private Equity

Private Equity

Currently
Big

Deals

Strategic
Big

Activity

Companies PE Multiples

Public

to Privates

Cost

of Debt Capital

New

Geographies

22

What Explains Rise and Fall of Deal Volumes?

Private Equity

Its All About Expectations

150%

Increasing

100

50

PE Deal
Volume
Growth
Decreasing

Correlation:
0.82
Deals
Q2 2005 Get Done

0
(60%)

(40%)

(20%)

Deals
Dont Happen

(0%)

20%

40%

60%

(50)

Q4 2008

(100)

Actual Earnings Growth

Lower than Expectations

Earnings

Actual Earnings Growth

Higher than Expectations

Inside diligence by PE firms drives deal volume growth when

work reveals potential performance ahead of expectations
23

Supply Shadow Participants Exit

Private Equity

BREAKDOWN OF EQUITY SYNDICATION

SELLDOWN IN LARGE 05 07 TRANSACTIONS

Strategic / Other
Other PE

Lead Sponsors

4%

7%

Banks

9%
48%

10%

22%

Hedge
Funds

LPs

Total = $44 Billion

Note: Selected companies as of May 2007

Non-traditional participants, who contributed ~50% of the equity

during peak PE deal flow, have already largely exited
24

The Next Opportunities

Private Equity
Baby with the Bath Water
I.
II.

Healthcare
Software

Restructuring
III.

Chapter 11 is our friend

Profit-Cycle Opportunities
IV.
V.
VI.
VII.

Retail
Inventory destocking
Sweat the assets
Capitalizing on latent demand

Macro Trends
VIII.
IX.
X.

China Stimulus
U.S. Stimulus
Inflation
25

Firm

Private Equity

Private Equity Firm Building

Art of the Deal

Return

Three bankers
and a Rolodex

1985
Core
Competencies:

Wave 1
Ability to do
the deal

Sector Expertise

Investment
Judgment

1995

Wave 2
Ability to find and spot
the value

Active Transformation
of Companies

Operating
Value Add

2005

Replicable,
Sustainable Model

Firm
Building

2007

Wave 3

Wave 4

Ability to improve
the value

Ability to build and

sustain a firm

26

Private Equity

Private Equity Overview

Relative Tool Kits: Public vs. Private Investors

Public Market

Buy decision

Sell decision

27

Private Equity Overview

Private Equity

Relative Tool Kits: Public vs. Private Investors

Public Market

Buy decision

Private Equity

Buy decision

The Deal

Sell decision

Purchase negotiations

Structure

Financial leverage

New debt

Restructuring

Management control

Incentives

New Management

Cost cutting

Strategic direction

Business model changes

Growth

Sell decision

Public or private
28

Private Equity Overview

Private Equity

Private Equity Required Skill Set

Investment
Judgment

Portfolio
Management

Deal Skills

Industry knowledge

Financing

Value-added

Themes

Negotiation

Strategic direction

Top-down/bottom-up

Turnarounds

Build all skill sets to optimize performance

29

Private Equity Overview

Private Equity

Private Equity Return Drivers

Earnings/EBITDA Growth

Revenue growth
Margin improvement

or
Multiple Arbitrage

Buy cheap
Improve strategic positioning

or
Debt Paydown

Leverage important, but risky

Requires focus on cash generation
capability (working capital, capex, etc.)

One is probably okay, two is

great, three is a home run

30

Private Equity Overview

Private Equity

Private Equity Return Drivers

Change During
5 Year Hold Period

At Exit

$1,000

10% CAGR

$1,611

EBITDA

200

10% CAGR

322

margin

20%

At Investment
Sales

20%
No Expansion

5.0x

TEV Multiple

5.0x

Leverage Multiple

3.0x

1.9x

$1,000

$1,611

Total Enterprise Value

less: Net Debt
Equity Value

No Debt Paydown

600

600
$1,011

$400

IRR =

20%

31

Private Equity Overview

Private Equity

Private Equity Return Drivers - Multiple Arbitrage

At Investment

Change During
5 Year Hold Period

At Exit

$1,000

No Growth

$1,000

EBITDA

200

No Growth

200

margin

20%

Sales

20%

5.0x

Leverage Multiple

3.0x

3.0x

$1,000

$1,600

Total Enterprise Value

less: Net Debt
Equity Value

3.0x Multiple Expansion

8.0x

TEV Multiple

No Debt Paydown

600

600
$1,000

$400

IRR =

20%

32

Private Equity Overview

Private Equity

Private Equity Return Drivers - Debt Paydown

At Investment
Sales

Change During
5 Year Hold Period

At Exit

$1,000

No Growth

$1,000

EBITDA

200

No Growth

200

margin

20%

20%

TEV Multiple

5.0x

Leverage Multiple

3.0x

0.2x

$1,000

$1,000

Total Enterprise Value

less: Net Debt
Equity Value

No Expansion

600

Debt Paydown from

Cash Flow

$400

IRR =

5.0x

41
$959

19%

33

Private Equity Overview

Private Equity

Private Equity Return Drivers - the Trifecta

At Investment
Sales
EBITDA
margin

Change During
5 Year Hold Period

At Exit

$1,000

10% CAGR

$1,611

200

10% CAGR

322

20%

20%

TEV Multiple

5.0x

Leverage Multiple

3.0x

nm

$1,000

$2,577

Total Enterprise Value

less: Net Debt
Equity Value

3.0x Multiple Expansion

600

Debt Paydown from

Cash Flow

$400

IRR =

8.0x

(206)
$2,783

47%

34

General Partners Compensation

Private Equity

Management Fees
1-2% per year of committed capital
Ratchets down after investment period

Transaction Fees
Ability to charge varies with deal
GP usually allowed to keep 20-50% with balance going to
LPs

Carried Interest
15-30% of profit subject to 8-20% LP hurdle rate
Based on total fund performance
Funds typically target 20-30% IRRs

35