Seminar: introduction to private equity

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Contact
‡ Antoine Parmentier:
± Antoine.parmentier@aig.com ± +44(0)7809.510.373

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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.
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The world¶s biggest private equity firms. Why allocate assets to PE?. Case study: Baneasa 4 . European fundraising activity. The credit crisis: impact and consequences on PE. The mega-buyout era. The pros and cons of being private. Value creation in private equity. The structure of a leverage buyout deal. FoF due diligence: selection of PE managers.Content ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ Introduction. LBO activity in Europe. The measure of perfromance.

Introduction to Private Equity 5 .

‡ Venture capital. large corporate. insurance companies. public equity traded on stock exchange). growth capital. ‡ Medium to long term investment. ‡ Investors in PE funds are called ³Limited Partners´. ‡ PE funds are managed by the ³General Partners´ 6 . HNWI. buyout« ‡ PE funds are raised from pension funds. etc«.Introduction ‡ Asset class representing the companies not publicly traded (vs.

‡ Structure of private equity participations LP nsurance co pany ension fun ar e corporate GP e fun ana er Portfolio Co pany Co pany Co pany C Co pany D Co pany Co pany D 7 .

‡ The macro environment: ± Acquisition multiple arbitrage can be positive in period of growth. ‡ The managers: ± The success of an investment relies on the implementation of the business plan.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. 8 .

distressed. real assets« 9 . infrastructure. secondary« ‡ Like-minded strategies: mezzanine.A diversified asset class ‡ Private equity includes a large number of strategies: venture. buyout. cleantech/energy.

‡ Two sectors: technology or life science. ‡ Scalable investments with a lot of failures and few great successes. development of a new product.Venture capital (1/2) ‡ Earlier stage: venture investors provide funds for start-up and early expansion. ‡ Based on innovative business. ‡ Highly skilled professionals and scientists. new patent. 10 .

LinkedIn. Yahoo. Apple. 11 . Zurich«). ‡ Financing in several rounds (round 1. ‡ Most of the exits are IPO (NAS AQ. Google. ‡ Examples: Skype. Paypal. round 2. YouTube.Venture capital (2/2) ‡ Investment from up to ¼10m and often prerevenues balance-sheet. Atari. round 3«) with typically clinical test results as threshold for next round. Cisco.

‡ Taking control of a company through leveraged buyout (LBO). ‡ Buyout comes after venture and growth capital. ‡ Management team of the company is investing alongside the PE fund (alignment of interest).Buyout (1/3) ‡ The most important strategy of PE. 12 .

Buyout (2/3) ‡ evelopment of a business plan over 4 to 6 years in order to add value. strong cash-flow. succession issues« 13 . ‡ PE funds provide capital for international expansion. ‡ Mature companies with leading market position. active management team. corporate divestures. ‡ Revenue growth + Margins improvement + deleveraging = added value.

Buyout (3/3) ‡ Buyout starts at ¼5 million enterprise value (EV). ‡ At the bottom end: growth/expansion capital. Large cap ¼800 million and above Mid market ¼100 million to ¼800 million Lower market ¼5 million to ¼100 million 14 .

etc«). EBIT A interest coverage. 15 . ‡ Loans are rated BB and below by S&P based on usual ratio (debt/EBIT A. under Chapter 11 (reorganization) or under Chapter 7 (liquidation=bankruptcy).istressed / Special situation (1/2) ‡ Investment in debt-securities or equity of a company under financial stress. ‡ istressed companies are in default.

Distressed / Special situation (2/2) ‡ Distressed debt investors try first to influence the process. ‡ Then. ‡ Debt holders have access to confidential information. 16 . as debt holders. they can take the control of the company.

‡ Specialized investors: Alpinvest. ‡ Needs in depth valuation and bidding/auction process. ‡ LP selling their portfolio = secondary deal. Coller Capital.Secondary (1/2) ‡ Purchase of existing (hence secondary) commitments in PE funds or portfolios of direct investments. Lexington Partners. ‡ Booming specialization as most of institutional investors are seek cash. 17 .

Secondary (2/2) LP Sec nda y buye n rance co any en on nd ar e cor ora e P e nd ana er P li o any o any o any o any o any o any 18 .

± PIK interest: payment is made by increasing the principal borrowed.g. ‡ Returns generated by: ± cash interest payment: fixed rate or fluctuate along an index (e. 19 . LIBOR). ± Ownership: mezzanine financing most of the time include equity ownership. ‡ The most risky debt instrument = highest yield.Mezzanine (1/3) ‡ Debt instrument immediately subordinated to the equity. EURIBOR.

70% of PE deals used mezzanine vs. 20 . ‡ Since July 2007 and lack of funding. versus E+979 in Q2 2008. ± Q3 2008 average spread: E+1. 48% in 2007.042.Mezzanine (2/3) ‡ Mezzanine suffered before credit crunch as senior debt was easy to access. mezzanine is back: ± As of 30 September 2008.

5 ps g 3-mo th v g sp Mezzanine (3/3) t s o m zz pt m 2008: E+1.042 ps 21 .051.E+ ps 1 1 11 6 Ma H gh st Ma 1 1 Ma 2 Jul-02 Nov-02 Ma -03 Jul-03 Nov-03 C Ma -04 Jul-04 Nov-04 Ma -05 Jul-05 Nov-05 Ma -06 Jul-06 Nov-06 Ma -07 Jul-07 Nov-07 Ma -08 Jul-08 h: E+780.5 ps 1 M 6 Ro 2003: E+1.

‡ Global needs for infrastructure assets ‡ Roads. airports. ‡ Longer term investment. steady cash-flow with regular yield. ports. 3i. ‡ French highways or Viaduc de Millau are contracted to Eiffage/Macquarie. CVC. hospitals.Infrastructure (1/2) ‡ Among the newest PE-like asset. etc« ‡ Mix of private investors and governments through PPP (Public-Private Partnerships). lower return. Macquarie. 22 . schools. ‡ Traditional PE funds raised infrastructure funds: KKR. energy plant. Prisons.

23 . CG/LA Infrastructure.Infrastructure (2/2) ‡ A multi trillion market opportunity: ± $1 trillion to $3 trillion annually through 2030. ± Mexico: a 5-year and $250 billion plan will be funded 50% by private capital. March 2008. ± US: power industry needs $1. ± China: close to 100 airports will be needed. volume 2.5 trillion between 2010 and 2030. ± EU: ¼164 billion to be invested in natural gas infrastructure by 2030 to facilitate import of gas to meet long-term shortfall. OECD publication. Infrastructure to 2030. 2007. Source: Global Infrastructure Demand through 2030.

etc«): growing demand from the renewable energy sector. etc« ‡ It is usually not asset-backed securities but a direct investment in the assets 24 . financial assets on the secondary market. aircraft«): the asset is purchased and simultaneously leased back to the seller. timber lands. intellectual property rights.Real assets (1/2) ‡ Cash-flow producing asset or pool of assets privately originated: ± Equipment leasing (shipping. ± Mines. ± Agricultural finance (forests.

25 . ‡ Downside protection due to high recovery value of the assets: loss of value of the asset is unlikely.Real assets (2/2) ‡ Steady and regular cash flow: 10%-15% annual cash return. ‡ Uncorrelated assets.

Why allocate assets to PE ?

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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...)
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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.
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The issue with private equity ‡ Illiquid investments: ‡ PE funds are closed-end funds (except secondary market). Private equity is an inefficient arket 29 . ‡ Time line too long: ‡ PE funds has a 5-year investment period and a 10year life. ‡ Restricted information disclosure: ‡ Only LPs have access to the fund¶s performance.

Allocation to PE increased significantly over the last years: ‡ Low correlation to pricing trends of traditional assets.‡ However.3% 30 . ‡ Good returns over the years: Average annual IRR 1986-2005 is 18. ‡ Diversification thus risk reduction.

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. 31 .

LBO activity in urope 32 .

Geography LBO activity in Eur 12% 2% 3% 3% 4% 5% 36% e per value (Q1-Q3 2008) LBO activity in Eur pe per v lu e (Q1-Q3 2008) 14% 24% 3% 3% 3% 3% 21% 4% ran e Ger any eden Ger any eden Ne her and Ne her and Nor ay egu pa n ay her Nor ay egu her 14% 21% % 1 % 33 ¥ ¦ ¥  ¨ ¤¦ © ©¨ § ¦ ¥ ¤ £ ¢ ¡  ran e   ¥ ¤¦ © ¨  ©¨ § ¦ ¥ ¤ £ ¢ ¡  .

Sectors LBO a ue in ur pe per ector (Q Q 3% ) LBO ume in ur pe per ector (Q Q 3% ) B M ter s He t c re Ret Foo & Dr ce c s 3% 3% % I s r e % % 8 % % 5 7 8 % 9   % O &G s % % % % Ot er 5 A Serv c es & e s 9 2 $ 0' 0$ ' 4 23 %$ & % (& 1 0'$ $ 2 0$ 0$' $ (%'10'& (%' $ ) ' (%' & $ &%$ 4% M f ct r % 2 ' 4 &D '% 0C &B 4 3 0$' $ (%'10'& 0$ ' 4 23 ($ 1 0'$ $ 2 0$ (%' & $ &%$ (%' $ ) ' M f ct r He t c re Ret Foo & Bever e c s B e M ter s o ters & to ot ve Ot er @  % 5 6   % Serv c es & e s ! #  " ectro c s 34 .

European buyout value European buyout value: ¼72 billion in Q1-Q3 2008 35 .

European buyout by region Europea LBO volume by regio (¼ billio ) 000 ¼ ¼ 0 0 2001 2002 2003 2004 2005 2006 2007 Jan Sep 08 ¼ 00 ¼ 0 60 UK rance er any taly or ic egion estern Europe 36 .

3. 3. ‡ Benelux figures are impacted by few mega deals. . . .PE as a percentage of GDP ‡ Nordic countries have the most important PE activity. . . 7 3 German spea ing countries rance Benelux U 37 . . . Nordic countries outhern Europe thers .

European fundraising activity 38 .

Funds on the market 39 .

‡ But the number of final closing and the path investors deploy capital has slowed down dramatically.Seeking capital is becoming difficult ‡ Number of vehicles seeking capital keep on increasing. 40 . ‡ 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: 14.1 months 41 .2 months. ± 2006: 11. ± 2007: 12 months.

Average fundraising 42 .

43 .000 billion (vs. FoF: 205 funds seeking $220 billion. $1.000 billion within 5 to 7 years).200 funds are currently seeking $713 billion including: ± ± ± ± Buyout: 290 funds seeking $320 billion.000 billion in 2003 and an expected $5. Venture: 470 funds seeking $85 billion. 1.State of the market ‡ Aggregate PE commitments globally are close to $2. Mezzanine: 25 funds seeking $10 billion. ‡ Globally: app.

5 billion.4 billion.4 billion.5 billion. 44 . ¼5.7 billion.2 billion.Funds of the market ‡ ‡ ‡ ‡ ‡ ‡ Permira: CVC: Apax Partners: Cinven: Charterhouse: PAI Partners: ¼13. ¼11. ¼8. ¼13. ¼7.

Outlook ‡ PE is set to enter its most challenging time. 45 . ‡ Increasing pressure and difficulties for managers seeking capital. ‡ Some LPs will need to free up some capital and clean up their portfolio: increase in secondary transactions. ‡ Less deals are being signed so there¶s no rush to raise. ‡ Fundraising take more time. ‡ Historical performances and focus strategies will become key factors in the future: some GPs won¶t survive.

‡ Europe accounts for 19% ($580 billion) of SW funds capital.000 of assets and are expected to reach $7. ‡ Sovereign wealth funds are a huge source of capital: ‡ Represent today $3.900 billion by 2011.Outlook ‡ PE AUM has grown steadily since 1996: ‡ 60% of LPs are expected to increase their allocation to PE. 46 .

Fundraising sources 47 .

48 .‡ LPs usually invest in home-based funds.

‡ Globally. 49 . US is the single largest investor. ‡ In Europe. UK is ahead of anybody.

Profile of the LPs 50 .

The measure of performance 51 .

Track record
Napoca Fund II
As of 30 December 2007 - $ million

Country

Initial investment date Feb-04 Feb-05 Jun-06 Jul-05

Exit

Cost

Realized value 49.6 151.0 164.2 12.1 376.9 376.9

Unrealized value 0.0 0.0 0.0 0.0 0.0 131.7 55.6 52.8 55.8 46.2 72.2 150.0 564.3 564.3

Total value

Multiple of cost 2.1x 2.3x 4.0x 0.8x 1.9x 1.0x 1.2x 1.4x 1.1x 1.0x 1.0x 1.0x 1.1x 1.3x

Gross IRR

Realized investments Beverage Plus Holdings, LLC Dear Lagoon Sport Management Arizona Napoca Distressed Credit To tal re alize d in v e s tm e n ts Unrealized investments Fenchurch Street Insurance Alketechnic OutSpace Clothing Avi Construction Hospital Management Holdings Pack4Life Foxtruck Finance To tal u n re alize d in v e s tm e n ts

US UK US Other

Mar-07 Jul-06 Apr-08 Jan-08

23.3 65.6 97.7 14.6 201.2 130.0 48.2 38.0 49.7 46.2 72.2 150.0 534.3 735.5

49.6 151.0 387.7 12.1 376.9 131.7 55.6 52.8 55.8 46.2 72.2 150.0 564.3 941.2

38.0% 43.0% 96.0% -

Bermuda Germany Switzerland France US Belgium US

Dec-06 Jun-06 Apr-06 Apr-06 Feb-06 Mar-08 Mar-08

-

Total Napoca Fund II

5.3% 26.1% 5.1% 5.3%

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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.
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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;
Th J-cur ff ct
ctual returns 5 Investments valued elow its cost: - Management fees; - Initial investments V lue

5

-5 Y r

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000 expenses/fees called regardless of any investment made.300.The J-curve ‡ Fees are charged based on the fund¶s entire committed capital. ‡ Example: ‡ Fund size: ¼100 million. ‡ Organizational expenses: ¼300. ‡ Management fee: annual 2% committed capital. 55 .000 ¼2.

89x contributed capital.The J-curve ‡ If 5 investments are made the first year for ¼3 million each: ‡ 5 x ¼3 million = ¼15 million. Capital contributed Ass ts Investments emainin cash Total assets ¼20 million 20% of committed capital ¼15 million 5 investments at ¼3 million each held at cost ¼2.3 = ¼2.7 million = 0. 56 .7 million ¼17.7 million 20-15-2.89x the 20 million contributed by s ‡ Interim value is thus: ¼17. ‡ If 20% of committed capital is called the first year: ¼20 million.7 million or 0.

Five new deals at ¼3 million each: ¼15 million.7 cash after ¼ .The J-curve ‡ Underperforming investments tend to be written down more quickly than successful companies develop. Two first-year investments are written down/off.3 and ¼30 million of investments ¼31. ¼ 0 million 0% of committed capital apital contributed Assets: First-year investments 2nd-year investments ash on hand Total assets ¼10.5 million original 5 investments one written off one written down to half its value ¼15 million another five investments at ¼3 million each held at cost ¼5.7 x the ¼ 0 million 57 .3 million of expenses 2+2+0. ‡ Example 2nd year: ‡ ‡ ‡ ‡ Another 20% of committed capital : ¼20 million.2 million 0. Annual management fee: ¼2 million.

‡ Interim is thus often misleading. ‡ NAV + cumulative distributions track over time relative to contributed capital: 58 . understate the value of the portfolio. held at cost or conservative valuation.The J-curve ‡ Companies performing well.

Fund of Funds due diligence: the selection of PE managers 59 .

± Strategy.Due diligence focus ‡ Quantitative analysis: ± Past investments and track record. ± Leverage and debt. ‡ Qualitative analysis: ± Team. ± Sources of proceeds. ± Market opportunity 60 .

risk of spin-off. ‡ Unrealized portfolio: lack of recent track record and ability of current team ± look at current valuation carefully. ‡ Team: number of Partners. ‡ Organization: fund size. Principles and Associates. domestic or transatlantic. 61 . key man clause. motivation in case of large distribution under previous funds. succession issues. autocratic management. multi or single office. Pan-European.Critical items of due diligence ‡ Track record: what¶s behind a bad investment?. carry split. staff retention and turnover. etc.

62 . Proprietary deal flow. ‡ Must be combined with FoF portfolio management and exposure > seek diversification. Experienced investment team. Differentiated investment strategy. Sector/geographic focus.Reasons to invest ‡ ‡ ‡ ‡ ‡ Attractive track record.

. . ear ag rt Ma age e t ri a a ca istresse re it T o tal p artially re alize d i v e s t e t s Unreali ed invest ents Fe c rc treet I s ra ce l etec ic t ace l t i g i str cti s ital Ma age e t l i gs ac ife Foxtr c Fi a ce T o tal r e alize d i v e s t e t s t er . . . 5. . . . ‡ Multiples of cost and IRR. . . . . . . . . . . .$ illio Countr Exit Cost ` ` Y X V ” • rq ‡q rq    Ž ll zn |z Œ  l q „‰ l p l ‚ „‰ l„ n l„ ƒ ‡ y l „ ƒ ‚o n m l z l nl o mn l y mj m k – — – g pg f † ‰“ hf ’ h  h f ‰r ‘ hff h g fe d c i b † W ` Y U R T PPS R Q PI p ii H G FE Napoca II Initial invest ent ate eali ed value Unreali ed value Total value Multiple of cost ross I . 1. . . . . % YY . Belgi 63 ™ œ ›˜™ Total Napoca und II . . . . . . . . . - . x . . . . . . . . . ‡ Realized and unrealized value (part sell off or recapitalization). . . . . . . . a ih d ƒ„ u ƒu v ƒy x ƒ‚ x W As of ece ber . . . 1. . . . . €u  €u t~ €v  ž œ ’ “” ‘ s su ~ ~w ~ t| }  } ~ t  w uvu ™ ›š ’ “” ‘ s su ~ ~w ~ t| }  } ~ t  w uvu š š™˜ ’ “’ ‘ s su ~ ~w ~ t| w ˆ| s }v ~ }| s svu — oŠ pn oŠ l ql † …o lp { qnp Ber a er a y it erla Fra ce ecJ rrFe MarMar- - .Track record ‡ Entry and exit date. . x …u € …u yv …u „y ™ –• • su xs u xs u xu u x| u x~ u xs u h gfe ‚ x‚ w w„y u ‚ˆ‚  €v ™™ uu uu uu uu h gfe ‚ x‚ x v‚ u ‚ˆ‚  €v ˜ d ™˜  v‚ w w€  ˆ y yx „u h „u ‰ u d ‘ wu }s }s ts ‹ ts ‚ ts ‚y y ts ln ts r ˆu d u hd ˆu t s vu t s e e J J l- MarJ lrJa - . . . . . . eali ed invest ents Be erage l s l i gs. . .

3 $303.03x t º ºº º ¾º er Quartile º ¼½ Eu ro p e .4 $2.3% Too i Eu ro p e .305. x st US 0.04x 1st ÌÍ ÊÊÉ È Ç ‡ TVPI: Total Value Paid In: Realized and Unrealized value.53x 0.Benchmark analysis und by fund basis Napoca und I 2001 $714.09x er Quartile 0. Vi tage Year Fund i e ontri uted ca ital istri utions Residual alue Total Value Lower oundary of Quartile DPI Na oca Lower oundary of Quartile RVPI Na oca Lower oundary of Quartile TVPI Na oca Lower oundary of Quartile er Quartile 3. x st US 0.1 5. x st Eu ro p e NA US 1. . x er Quartile ÌË Eu ro p e 1. st ÎÎ «« Net I a oca «« Gross I 55. 1.8 $2. only realized deals. x st ³µ µ ³± µ ° ³± ´° ° ³² ±° º ¼» º ¯¯® ¹¹¸ ÂÂÁ ­ · À ¶ ‡ RVPI: Residual Value Paid In > Unrealized value.5 $67.04x US 1. 42.15x 3rd 64 ÆÅ Å Äà Eu ro p e NA US 0.585.18x 1st US 1.0 $713.55x 3. x 1st Eu ro p e 0.7 $637. st US .50x 0.3% Eu ro p e .6% Ï Ï ¨ ¢ ª § © § ¦ ¥¤ £ ¨¬ ¿ ‡ DPI: Distributed Paid In > Proceeds distributed.4 $333. Venture Economics Benchmark Comparison (as of 0 September 00 ) ¡   Ÿ ature US .0 $611.518. x st Eu ro p e 0.9 Napoca und II 2005 $1.

60 26.70 16.40 -17.90 6.80 28.30 23.80 1.10 42.40 32.40 -9.97 -4.00 11.60 -5.10 73.20 -0.70 40.50 Lower Lower Lower boundary of boundary of boundary of 1st Quartile 2nd Quartile 3rd Quartile 14.10 -8.90 13.50 32.30 268.80 107.40 -1.20 9.50 1.80 Minimum -24.30 9.30 26.60 9.80 Maximum 23.00 6.9 1.30 35.70 -9.60 19.10 8.70 27.10 21.30 -5.80 8.20 27.80 27.10 15.90 -1.80 -16.30 436.30 6.10 13.90 11.90 12.90 -1.80 35.30 8.0 -50.90 17.40 91.20 -3.70 17.90 1.40 -11.30 Average 5.2 -15.60 -0.90 7.40 0.30 19.00 2007 Average Minimum Maximum Median 85.50 11.20 17.75 1.4 14.60 8.60 12.10 132.00 64.00 -12.70 5.10 -14.Vintage year performance Cumulative Vintage Year Performance (Thomson Venture Xpert .10 -0.40 -0.10 10.50 13.70 8.60 -0.80 49.20 10.00 14.70 22.as of 30 June 2008) Vintage Year 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Number of funds included 12 17 15 8 12 14 14 20 32 34 31 32 21 27 17 15 33 19 11 Capital Weighted Average 10.60 60.80 11.80 27.20 42.60 32.30 18.40 16.60 1.20 16.30 -7.00 23.40 -17.10 21.00 6.50 234.10 82.60 -50.50 -19.70 -4.42 5.10 -7.50 5.80 6.80 12.70 12.20 22.00 15.60 43.90 27.80 110.40 14.70 -11.30 9.20 40.50 21.90 14.50 36.20 60.30 -12.10 3.10 45.50 14.50 10.10 21.30 268.80 87.3 -14.60 26.10 21.10 62.30 Pooled Average 9.50 22.90 -13.70 28.00 21.30 6.10 15.70 5.8 65 .50 23.30 26.90 -40.20 11.15 8.20 2.90 -0.20 27.90 59.12 23.80 30.90 -0.30 14.30 42.70 4.30 20.00 8.10 -16.40 20.4 22.00 8.00 14.

October 2006 66 .Presentation ‡ Private equity investors and their managers: Vivre avec un fond d¶investissement. Les Echos.

The world¶s biggest private equity firms 67 .

000 workers. Europe (28%) and Asia (13%).com .carlyle. ‡ Over $89 billion AUM throughout 64 funds in buyouts (69%). 68 Source: www.4 billion of equity in 836 deals for a total purchase price of $220 billion. $68 billion in revenues and 200. ‡ Over 525 investment professionals operating in 21 countries. Carlyle has invested $49. Daniel D¶Aniello and William Conway. ‡ Assets deployed in Americas (59%).Carlyle ‡ Founded in 1987 by David Rubenstein. ‡ Currently: 140 companies. growth capital (4%). real estate (12%) and leveraged finance (15%). ‡ Since inception.

Carlyle deals ‡ ‡ ‡ ‡ ‡ Hertz Zodiac Terreal Le Figaro VNU 69 .

Blackstone ‡ Founded in 1985 by Steven Schwarzman and Peter Peterson. real estate.000 employees. ‡ 89 senior MDs and total staff of over 750 investments and advisory professionals in US. ‡ Global AUM $119. Funds of Hedge Funds. 70 . CLOs. $85 billion in annual revenues and more than 350.4 billion in private equity. ‡ 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. Europe and Asia. Mutual funds.

3bn in April 2006 (minority). ‡ Hilton: $26. 71 .9bn in October 2007. ‡ Center Parcs: $2. ‡ Deutsche Telekom: £3.1bn in May 2006. ‡ Orangina: $2.Blackstone deals ‡ The weather channel: $3.6bn in February 2006.6bn in September 2008.

‡ Total AUM $68.3bn from $25. ‡ Currently: 35 companies. 72 . $95 billion in annual revenues and more than 500.KKR ‡ Founded in 1976 by James Kohlberg. ‡ Total of 165 deals since inception with an aggregate enterprise value of $420bn. Henry Kravis and George Roberts.000 employees. ‡ The $31bn buyout of RJR Nabisco inspired the book ³Barbarians at the gate´. ‡ KKR is currently from a ³one-trick pony´ to a multi asset manager with infrastructure and mezzanine funds being raised.4bn invested capital.

KKR deals ‡ ‡ ‡ ‡ ‡ ‡ ‡ Legrand. Pages Jaunes. TDC. Alliance Boots. Tarkett. Toys R¶ Us. ProSieben. 73 .

Panzani Lustucru. Vivarte. PAI invested ¼3.2bn ‡ Investments include: Kaufman & Broad.92bn in 36 deals across Europe.PAI Partners ‡ The biggest French PE firms formerly known as Paribas Affaires Industrielles. ‡ Last fund raised reach ¼5. Atos Origin 74 . Neuf Cegetel. ‡ Since 1998.

Private equity deals ‡ Private equity funds own companies of ³everyday life´« ± ± ± ± ± ± ± ± Pages jaunes. Orangina« 75 . Comptoir des cotonniers. Odlo. Picard. Jimmy Choo. Alain Afflelou. Pizza Pino.

3% (vs. ‡ 2006-2007 sales growth: ± +5. 76 Source: AFIC/Ernst&Young . 4.1% (vs.1% for CAC 40).5% for CAC 40).Impact of PE on French economy is overall positive ‡ 2006-2007 employees growth rate: ± +2. 0.

‡ As of 30 June 2006: ± 55% of PE-backed companies have less than 100 empoyees and 83% have less than 500 employees.5 million people (9% of total private employees). ± Work force of 1. ± 4852 PE-backed companies in France. ± 79% have less than ¼50m revenues. 77 Source: AFIC/Ernst&Young . ± ¼199bn in revenues including ¼128bn generated abroad.

Presentations ‡ KKR ‡ Blackstone ‡ Carlyle 78 .

The mega buyout era 79 .

‡ 2003-2006: PE commitments increased 260%.Fund growth ‡ PE AUM 1980-2006: 24%CAGR. 80 . Global volume of LBOs in H1 2007 reached $560 billion (25% of global M&A). ‡ Cost of debt historically low Global volume of LBOs increased to $700 billion in 2006 (4x 2003 level).

81 .‡ Bigger are the funds. ‡ Fund size and deal size are correlated. bigger are the target companies. ‡ ³Club-deals´ were required to complete the biggest acquisitions. LPs or shareholders of target companies were sought after.more cash you need: ‡ Co-investors such as other funds. ‡ More cash you have. ‡ Some funds created quoted vehicles to access permanent capital or listed the management companies on the public market.

82 . GPs were starting to raise at shorter intervals. the fund-to-fund increase of the 12 largest funds was only 75%. ‡ In addition.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.

‡ Expanded buyout opportunities at the larger end of the market: ‡ Higher quality assets. ‡ Higher management fee enable to build top investment teams. ‡ Huge potential returns. ‡ Less competition at the upper-end of the market.Rational for larger pools of capital ‡ Economies of scale in the management of the fund. 83 .

‡ Flexible (covenant-lite) and low-cost financing. ‡ Various exit options (IPO. ‡ Implement a levered capital structure... Corporate transaction.Rational for larger pools of capital ‡ Ability to pursue a pro-active acquisition strategy.) 84 . secondary buyouts.

85 . ‡ Usually less competition among the buyers. ‡ The value-addition is thus often obvious an obvious path. ‡ Public market offer a lot of opportunities: ‡ PE investors add value to the company they invest in as opposed to passive public shareholders.Target companies ‡ Very large companies are attractive targets: ‡ Mature companies need restructuring effort to get rid of the ³fat´.

.. ‡ . 86 . 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..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..

87 . ‡ Ego-issues.Disappearance of club-deals ‡ Collusion charges. ‡ Difficulties to share informations. ‡ Tendency to monopolize the control the control.

Riverstone. Blackstone. KKR. Merrill Lynch Apax.6 billion $15. TPG Bain. Carlyle.6 billion $17.9 billion Buyers Bain Capital.7 billion $21. of America Harrah¶s Entertainment Clear Channel Kinder Morgan Freescale Semiconductor Hertz TDC a ue $32.Examples of mega club deals Target Hospital Corp.0 billion $13.7 billion $27. Permira. Goldman Sachs Blackstone. Providence 88 . Thomas H Lee Carlyle. Permira . TPG Carlyle. CD&R.4 billion $25. KKR. Merrill Lynch Apollo.

The Economist. The Deal. July 2008 89 . ‡ Who¶s next. Feb 2007.Presentations ‡ Caveat Investor / the uneasy crown.

Value creation in private equity 90 .

Value creation drivers ‡ EBITDA generation ‡ Multiple expansion ‡ Debt reduction 91 .

EBITDA generation ‡ EBITDA is generated by: ± Sales expansion. ± Margin improvement. ± Organic growth (=GDP growth) 92 . ± Add-on acquisitions.

‡ 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 93 .Multiple expansion ‡ Multiple: EV/EBITDA.

Debt reduction ‡ = Entry net debt ± exit net debt 94 .

0 En y E E gene a ion Mul iple expansion ele e aging Exi E Ó Ñ Ð ¼ 61.0 ¼ 1 493.6 ¼ 345.1 ¼ 764.7 ÒÙ × Ñ ÑÒ ×Õ Ø ÖÔ Ó ÒÑ 95 .Example EV creati ¼ 323.

etc« ± Deleveraging: usually the last factor to be implemented. disposed of non core assets. the investors rationalized and optimized the production. 96 . possibly in a young market or efforts mainly on sales force. cut costs. Debt reduced by cash not reinvested. arbitrage strategy.What to understand from EV creation ‡ If most of the value comes from: ± EBITDA increase: growing industry and/or company. ± Multiple expansion: margin increased over the holding period.

0 = Entry EV + Total value creation Multiple expan i n Debt reducti n Total value creation Exit EV: 97 . = (5) .97 . EBITDA generati n 1.0 = Entry net debt (5) 5.785.C mpany A EV 1.0 Exit EBITDA Net debt 210.275.0 5. 1.0 = Exit EBIT A (4) = ( ) x (4) 45.0 Multiple 8.(6) 697.0 = Exit EBIT A x Entry multiple (2) =( )-( ) 0.5 EV 1.0 45.0 = Enty EBIT A x Entry multiple (1) 1.0 Multiple 9.7 = Multiple uplift (exit EV/EBIT A .0 = Exit net debt ( ) 4 .0 Entry EBITDA Net debt 150.275.97 .entry EV/EBIT A) (3) 210.

: r i : . si : D r . r . i : i 9 : r D g r i M li l si D r i i 98 .V lue creat o chart M li l D g .

Factors of value creation ‡ Changing business and driving growth: ‡ Taking advantage of market cycles (buying cheap. ‡ Objectives must be well defined. 99 . ‡ Must create value for the next acquirer: PE is not necessarily short term focused. selling at better price) and financial engineering are no longer enough. ‡ Management is incentivized: alignment of interest between Board members and shareholders.

‡ Strong operating cash-flows: ‡ PE businesses are cash-flow driven rather than earning driven: need to pay down the debt ‡ Industry-wide revenue growth.Other factor: Industry characteristics ‡ Stability. 100 . ‡ High margins (or potential for improvement). low cyclicality. ‡ Potential for overall efficiency improvements.

‡ Example of bad deal in the wrong industry: Foxton deal ³The deal of the century´. FT 101 . ‡ 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.Other factor: The GP makes the difference ‡ Managers contribute to value creation: ‡ Select the right target companies. ‡ Focus strategy exposes to industry cycles but good industry expertise. ‡ Undertake appropriate changes.

‡ Buy-and-build.‡ Recruitment/management. ‡ Optimization/cost cutting. ‡ Divesture of non core business(es) 102 . ‡ New investments to develop to new markets.

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 Ar itrage % Market/sector appreciation plus financial leverage 32% Company outperformance 3% So r e: M Kinse & Compan 103 Ü Ü Û ÛÚ .

trusted external source. detail responsibilities and challenge the management. ‡ Focused 100-day plan: deal partners must devote most of their time to a new deals to build relationship. ‡ Substantial and focused performance incentives: top management usually owns 15-20% of the equity.‡ Five features of a leading-edge practice: ‡ Expertise and knowledge: insights from the management. ‡ Management should be changed sooner rather than later 104 . ‡ Performance management process: initial business plans are subject to continual review and revision.

FT magazine. June 2008 105 .Presentation ‡ Foxtons: The sale of the century.

Structure of a Leverage Buyout transaction 106 .

Structure of a leverage buyout ‡ Deal structure: ± Equity ± Debt ‡ Debt is either: ± Unsecured ± Secured 107 .

maximum: E+287. Me anine Me anine benefits from the credit crunch. median: E+287. they ere seen as cheap me anine. Secured 2nd lien 2nd lien have disappeared ith the credit crunch. 1 2008 cash spread: E+414.5 in une 2008*.6% in 1997. minimum: E+249. 10-years median: 35. 10-year average: 36.5.LBO structure Senior debt Nine-year Nine-year Nine-year Nine-year average: E+284. Me anine reimbursement has cash and PIK components.3 nsecured debt nsecured debt usually bonds nsecured Equity contribution 10-year minimum: 29.7 1 2008 PIK spread: E+535.0% Equity 108 .5 in une 2007.5.9%.9% in 1 2008. 10-year maximum: 42.

shareholder loan. various investors.Equity ‡ Common equity. management. ‡ Equity is unsecured and the most risky and rewarding tranche. sometimes intermediaries. often debt mezzanine providers. ‡ Equity is held by the shareholders: private equity fund. 109 . preferred equity.

Mezzanine is usually reimbursed at exit if not refinanced before. H1 2008 cash spread: E+414.7bps H1 2008 PIK spread: E+535.3bps 110 . PIK note: payment made in additional bonds or preferred stocks which increase the performance of the investment. 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.Mezzanine debt ‡ ‡ ‡ ‡ ‡ ‡ ‡ ‡ Secured debt but subordinated to senior debt.

12% of LBOs used 2nd lien versus 52% in 2007. priority level between senior debt and mezzanine.Second lien ‡ Developed pre-July 2007 and does not really exist anymore: as of Q3 2008. ‡ Second lien was seen as a cheap mezzanine. ‡ Reimbursement in cash. 111 .

‡ Tranche D is a revolving credit to refinance previous debt of the target company.48bps 112 . ‡ H1 2008 spread: E+337. Other tranches (B and C) are usually reimbursed in fine.Senior debt ‡ Negotiated for a period of time between 7 and 9 years usually based on expected cash flow. ‡ Tranche A is first reimbursed.

3 Unsecured debt Unsecured debt usually bonds Unsecured Equity contribution 10-year minimum 29.Capital structure enior debt Nine-year Nine-year Nine-year Nine-year average E+284.5 minimum E+249.5 in une 2008 .7 H1 2008 IK spread E+535.9% 10-year average 36.5 median E+287.6% in 1997 10-year maximum 42.9% in H1 2008 10-years median 35. Secured 2nd lien 2nd lien have disappeared with the credit crunch they were seen as cheap me anine.5 in une 2007 maximum E+287.0% Equity 113 . Me anine Me anine benefits from the credit crunch Me anine reimbursement has cash and IK components H1 2008 cash spread E+414.

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);
114

Average LBO equity contribution
Less debt available = ore equit required to close a deal

Average LBO equit co tributio
5 5
. . . 5.9 . . . . .9 .

5 5 15 1 5 1

5

1

115

Loan volume dropped significantly
Banks¶ lending capacities are dry ! 1-Q3 2008 loan volume: ¼46.6 billion Q1 2007 loan volume: ¼45.75 billion
Annua senior loan volume (in ¼ bn)
¼ 150 ¼ 130 ¼ 110 ¼ 90 4 ¼ 70 ¼ 50 ¼ 30 ¼ 10 - 10 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 3 2 1

116

Evolution of capital structure Back t th classic structur : S nior D t + M zzanine Ev lution f 1 1 it l structur v ry rs à ß áä r r r r n Mezz n nly ien ien Mezz 1 1 1 1 7 1H à ß âÞ 7 7 à ß à ß ä ã à ß â ã à ß â á à ß 7 7 á à ß 1 7 à ß ä áã å à ß 11 7 à ß â Þæ à ß Ý åã à ß ã áá à ß ä Ýá 7 à ß 7 à ß ä ã 7 Þã à ß äâ à ß å åâ à ß æ à ß ÞÝ áÝ à ß Ý ÞÝ à ß æ â 7 117 .

Se ior debt Se ior debt Me i e -Se 8 9. . . .9 ing in b s 118 . . 1 1 . . . . .Cost of debt C st f ebt increase significantly in 2008 LBO c st f f . .

78 in Sept. 8 in June 2007 ç è 119 .39 in Au ust 2001 E+301. 2000 ç E+298. 6 in January 2004 E+249.LBO spread Avera e rea f r initial and ec ndary uyout E+344. 8 in June 2008 340 320 300 280 2 0 240 220 200 n00 ay -0 0 ep -0 Ja 0 n0 M 1 ay S e 01 p0 Ja 1 n0 M 2 ay -0 2 ep -0 Ja 2 n0 M 3 ay -0 3 ep -0 Ja 3 n0 M 4 ay -0 4 ep -0 Ja 4 n0 M 5 ay -0 5 ep -0 Ja 5 n0 M ay -0 ep -0 Ja n0 M 7 ay -0 7 ep -0 Ja 7 n0 M 8 ay -0 8 M Ja ç E+253.

etc) but presents some good buying opportunities. ‡ A lot of new investors (incl. traditional PE funds) entered the loan market in H1 2008 with levered vehicles. decline in value. ‡ Default rate at its lowest level although was expected to increase in 2008.The loan market ‡ Loans started to fall below ³par value´ (100) in June 2007. ‡ Secondary market became depressed (less liquidity. ‡ 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 120 .

‡ Deals are negotiated at cheaper: ± EBITDA multiples are lower ± More equity and less debt = more conservative structure 121 . ‡ Buyers don¶t want/cannot pay high price.Consequences ‡ The market is stuck: ‡ sellers have not yet adjusted their price.

x . x . x . x . x . x . x . x . x .EBITDA multiples Average LBO 12.2x 9. x . x .1x .9x 1 . x rc ase rice (EB TDA ltiple) 1 . x . x . x 1 . x 2. 99 9 9 3 1 2 2Q 3Q 19 19 19 2 2 2 2 2 2 2 2 1 122 . x .

Purchase prices econdary buyou s are he mos impac ed as: ‡ hey were radi ionally he mos e pensi e ransac ions = price adjus men . ‡ ellers are ery likely forced o sell so accep l wer prices Purchase rice er deal t 11 0 10 5 10 0 95 90 ll 85 80 75 70 65 60 2002 2003 2004 2005 2006 2007 2008 uyou s ponsor o ponsor orpora e Public o Pri a e e 123 .

The pros and cons of being private 124 .

125 . ‡ More extensive and transparent approach to governance and more explicit balancing of stakeholder interests.Results of a 2008 McKinsey survey: ‡ Private equity Boards are overall more efficient than public equity Boards: ‡ Better financial engineering. ‡ Pros and cons of public equity Boards offer some: ‡ Superior access to capital and liquidity. ‡ Stronger operatonal performance.

compliance. ‡ Management development across the board. risk). ‡ Private equity companies have more efficient processes: ‡ Stronger strategic leadership.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. ‡ Manage only key stakeholders¶ interests. 126 . ‡ More effective performance oversight.

3 4. The V c e f Ex er ence P c vs. 4.3 3.6 ðò õð ð ô óò ï ðï Source: cKinsey uarterly.1 3.1 3.3 3.Rating of public and private Boards of Directors Private e uity Boards Public co panies Boards 4.8 3.8 3.2 4.8 4. Pr v te Eq ty ê ë ê é ê ê ê ê ê ê Strategic leaders ip Perfor ance anage ent Develop ent/succession anage ent Stake older anage ent overnance (audit. co pliance and risk) ì verall effectiveness ð ñ ê é 127 î í .8 4.

‡ Executive management reports on the progress of the latest strategic decision implemented. 128 . ‡ PE funds stimulate management¶s ambition and creativity. defined and shaped dring the due diligence (prior acquisition). ‡ Boards approve management strategic decision (in M&A for example).Strategic leadership in PE companies ‡ Joined efforts of all Directors. ‡ Usually.

challenge and shape the strategic plans.Strategic leadership in public companies ‡ Boards only oversee. ‡ The executive management takes the lead in proposing and developing it. it is mainly a formal reporting. accompanying the management in the implementation. 129 .

‡ Consequently. PE Boards have a relentless focus on value creation drivers ».Performance management in private equity companies ‡ Private equity have one focus: realisation of their investment. ‡ Performance indicators are clearly defined and focus on cash metrics and speed of delivery. 130 .

no real detailed analysis. ‡ Need to communicate an accurate picture of short-term performance.Performance management in public companies ‡ High level performance managment. ‡ Focus on quarterly profit targets and market expectations. ‡ Budgetary control. short-term accounting profits. 131 . ‡ Public companies Boards focus on information that will impact the share price.

CFO) and replace underperformers very quickly. etc 132 .Management development and succession in private companies ‡ PE companies mainly focus on top management (CEO. succession. ‡ Very little efforts deployed on long-term challenges such as development of management.

‡ Focus on challenges and key capabilities for long-term success: management development and remuneration policies. ‡ However. ‡ Remuneration decisions sometimes more driven by public/stakeholders expected reaction than performance 133 .Management development and succession in public companies ‡ Efficient thorough management-review: top management and their successors. public Boards have weaknesses: ‡ Slow to react and their voice is more (perceived as) advisory than directive.

‡ PE fund represent a single block and are much more involved and informed than public shareholders.Stakeholder management in private companies ‡ Executive management can clearly identify a majority shareholder. ‡ No or little experience dealing with media and unions (see Walker report and debate over PE in 2007) 134 . ‡ Less onerous and constructive dialogue. ‡ PE funds are locked-in for the duration of the fund.

long-term strategic. HF can block the privatization (95% threshold to delist): Alain Afflelou purchase by Bridgepoint. short-term hedge funds. ‡ In case of P2P. minority individuals.Stakeholder management in public companies ‡ Shareholding struture is more complex and diversified than private companies: ‡ Institutionals. growth investors. ‡ Different priorities and demands: CEOs need to learn to cope with this very diverse range of investors. 135 .

not delivering the right outputs´) 136 . time-consuming. inefficient sometimes (³The focus is on box-ticking and covering the right inputs.Governance and risk management in public companies ‡ Where public companies score the best: consequences of Sarbanes-Oxley legislation and Higgs Report. nomination. ‡ Downside: expensive. audit. etc« ‡ Overall Board supervise and can rely and decide on the subcommittees¶ recommendations. ‡ Several subcommittees to scrutinize remuneration. ‡ Important factor of investor confidence.

‡ Not perceived as a pure operational factor.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. 137 .

o pli n e nd ris r ni tion desi n nd su ession 138 our e inse Quarterl . most it an of million. 11 7 4 0 alue re tion it str te tr te i initi tives in lu. The Voice of Experience Public vs. Private Equity ø û ÷÷ ø¨ øû § ¦ ø ÷ø ¥ ÷ ÷ ü ¤££ úù ¢ ÿ ÷ þ ¡  ø ÷û ø ý üû ø úù  ø ÷      © ö . ternal relations 1 da plan Governan e.Top priorities Private e uit 18 oards Publi o panies oards ample of 20 based dire tors o ave served on t e boards of bot private and publi ompanies.

‡ 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. 139 .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.

Credit crisis: impact and consequences on private equity 140 .

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. ‡ Increasing interest from investors for LBO funds led to higher leverage.Before July 2007 (1/3) ‡ Growth of the institutional loan market. ‡ Multiplication of highly rated structured credit products (CDOs/CLOs) although their inherent value was increasingly complex to calculate. ‡ New loans were issued as ³covenant lite arrangements´: DONNER DES EXEMPLES DE COVENANT A RESPECTER DANS UN LOAN TYPE 141 .

±Rising ratio of debt to earnings for US and EU LBOs.Before July 2007 (2/3) ‡ Increasing leverage loan activity but decline of credit quality of the new debt due to: ±Covenant lite. 142 . ±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. 143 .7x in 2007. ± Companies under LBOs have less liquidity to serve their debt. ‡ More equity + more debt = bigger deals and bigger leverage. ± Interest coverage ratio decreased since 2003 reaching a ten-year low of 1.

± Banks that did not distribute their debt had to report significant losses on their books. 144 .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.

± Debt was repriced and more difficult to access. ± Meant to rise sharply since then. starting with construction. airline and retail industries as global recession is impacting our economy. ± Default rate was historicaly low as of July 2007. 145 .After July 2007 (2/5) ± Slowing buyout activity in US and Europe (almost no activity in 2008).

± B default risk: 25.6%. the default rate over the last years is much lower that those predictions. almost half of the newly issued bonds have been rated as ³junk´ at their outset. ± In reality.After July 2007 (3/5) ± Increase in the issuance of junk bonds: in the past four years. ± Default risk (according to Moodys and Edward Altman (NYU Salomon Center)): ± CCC 4-year default risk: 53. ± CCC 10-year default risk: 91.2% after four years. 146 .4% in 10 years.

After July 2007 (4/5) ± Reasons for the low deafult rate: ± Given the lareg amount of liquidity. ± Deals signed in 2005. ± Private equity deals should be seriously impacted very soon. 147 . ± The rise of covenant lite means that any event short of a failure to pay interest would not result in a default. bonds that would have defaulted have been refinanced. 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. 148 . ± Need for leverage should benefit mezzanine funds. ± Small to mid-market buyout funds will benefit from desaffection for mega buyout firms. ± Secondary funds: some large institutions need cash. ± Credit dislocation funds: purchase loans at a discount from lenders.

Consequences June 2007 Top of the cycle June 2008 Recession ‡ Prices are too high ‡ Risk levels are extraordinary ‡ Liquidity is driving behaviour ‡ Seller¶s market ‡ No distressed opportunities ‡ Prices are falling. More to go ‡ The risk profile has changed fundamentally ‡ Lack of liquidity is driving behaviour ‡ Buyer¶s market but must proceed carefully and beware the falling knives ‡ Some interesting distressed situations (and even more to come) 149 .

150 . ‡ 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.Crisis = opportunities ‡ Recession years have produced the best vintages for private equity.

Recession years are usually good vintage years 151 .

Recession vs Non-recession 152 .

Case study: Baneasa 153 .

154 .Investment rationale ‡ Market leader in French retail (#1 in Footwear and #2 in clothing). ‡ Strong financial performance and strong growth in sales expected over the next 3 years. ‡ Experienced management team: Bogdan Novac has a long standing experience of the sector and the group. France and overseas. ‡ Resilient business model: lower end of the market and diversified range of products. apparel and footwear). ‡ Diversified offering: geography (city centre or out of town. ‡ Potential growth prospect: organic growth (new stores openings) and consolidation (fragmented industry).

4% of the French opportunity/growth by market and #2 acquisition clothing retailer in France with only 3.7% of the French apparel market 155 .‡ Banesa is #1 ‡ Fragmented industry. footwear retailer with gives M&A 14.

etc« are thus the main city centre competitors. etc« are city centres = Baneasa has a dominant position where those competitors are not present. Mango. Zara. H&M.‡ 45% of OOT footwear market and 24% of OOT clothing market ‡ Indication about competition: Zara. 156 . H&M. Mango.

Baneasa has always been active in OOT: created suburban discount shoe stores in 1981 with Osier Chaussures.‡ Historically. and in 1984 with Osier Vetements ‡ First mover advantage 157 .

‡ Clothing business: 44% sales and 43% of EBITDA and ‡ Footwear business: 56% sales and 57% EBITDA ‡ Well balanced. similar EBITDA margins in both segments 158 .

‡ France: 93% sales and 95% EBITDA. ‡ 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) 159 . ‡ Out Of Town: 68% sales and 72% EBITDA ‡ Baneasa is diversified (but maybe not as much as the investor thinks).

4%) ‡ Good management team // experienced CEO ‡ Strong performance over the last years (since 2003) 160 . ‡ EBITDA has grown from ¼231m to ¼365m (a CAGR of 16.‡ Bogdan Novac was CEO of Baneasa from 2000 to 2003 and 2004 to today.

‡ Nataf estimates sales and EBITDA in the financial year to 28 February 2007 of ¼237 million and ¼23 million respectively (9.7% margin). ‡ Berrilio had sales in the 12 months to 30 September 2006 of ¼64.5 million and EBITDA of ¼4.6 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.

161

‡ The actors must gain ‡ French clothing market share to grow: market has been no organic growth stable since 2000 with 0.2% CAGR resulting from industry growth

162

‡ Average prices have decreased by 1.5% CAGR. Price-volume elasticity is high with declines in average prices driven by the passthrough of purchasing gains from lower-cost sourcing (Asia) to endcustomers 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)
163

‡ Womenswear represents the majority of the French market with 51% of sales. ‡ Womenswear is the core business 164 . It was the strongest growing segment as well as the most competitive and innovative until 2002.

‡ Menswear is a new business with high growth so absolute need to be active 165 .‡ 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).

‡ Children wear is a good market with higher consumer spending 166 . with upside coming from increased spend per child and the emerging trend of higher-priced designer baby and childrenswear.‡ Baby and childrenswear are expected to remain broadly stable.

Since 2003.9% in 2000 to 10. This dynamism has been driven by new store openings and volume increases supported by increased price-competitiveness. growing by 3. OOT specialised chains have regained share and have returned to 11.9% in 2004 and 4.1 billion.9% in 2003. however. This reflected the impact of hard discount retailing and the growth of citycentre banners. ‡ Potential decline of OOT/inconsistent growth rate: risk. to ¼3.‡ Between 2001 and 2003.7% market share. out-oftown banners saw their market share decline from 11. 167 .7% in 2005.

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%.2% over 1998-2003) and continues to gain market share on the food retailers and the lowerend city-centre players due to a broad product range and low prices. ‡ Footwear: OOT has a strong growth in share.‡ Specialist out-of-town (OOT) distribution has seen the strongest growth in share (2.3% growth per annum over 2003-05 and 3. 168 .

‡ 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).a largely driven by growing Asian imports.a between 1998 and 2003).‡ The Spanish footwear market is more dynamic than the French one (3.4% p.a while prices decreased by 2.5% p.a growth since 2000) but experiences the same volume and price trends with volumes up 6.9% p. 169 .6% p. The market is still dominated by independent city centre stores (40% market share vs 15% in France) and OOT footwear is gaining share (8.

‡ 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) 170 . whilst city centre stores are more fashionable premium stores.‡ Suburban stores are typically large format value stores and account for the great majority of sales and profits.

7%. ‡ Indicates that Baneasa has grown organically and by acquisitions but acquisitions are the main growth factor.8%.‡ Over 2003-06.5% CAGR and EBITDA at 16. of which like-for-like sales growth of 3.4% CAGR while sales CAGR was 5. 171 . gross margin has grown at a 9.

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