The Private Equity Play by Mike Lorelli (PDF)

The Private Equity Play

Mike Lorelli

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EBITDA

Earnings Before:• Interest• Taxes• Depreciation• Amortization

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Stages

Idea Up & Running Mature

VC PE

• Trailing EBITDA

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Agenda

History Returns Where is the money coming from? Terminology Where they are; where their companies are The p.e. model Some names p.e. compensation Results and Performance Measures “The Funnel” Management Compensation The Return Drivers The p.e.’s Plan In The News Importance of a good LinkedIn profile, and resume

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Worse than real estate brokers in Darien, CT

1977: Kohlberg, Kravis, and Roberts leave Bear Stearns, forming KKR

1978: 80 ‘Leveraged Buyout Groups’ in US 2012: Estimated 2,800 around the world

1,800 U.S.

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Value Creation

100% Value Creation90%

80%

70%

60%

50%

40%

30%

20%

10%

0%18%

31%

51%

22%

36%

46%

39%

32% 25%

Leverage era (1980s) Multiple Expansionera (1990s)

Earnings growthera (2000s)

Operational improvementera (2010s)

Operational improvement Multiple arbitrage Leverage

Valu

e C

reat

ion

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WSJ: “Buyouts Leave Simmons Little Rest”

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Terminology

The providers of capital: Limited Partners, or LP’s- who are they?

The fund manager: General Partner, or GP, or p.e.

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Returns Well Out‐Performed S&P

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Returns Comparisons

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Percentage of Capital by LP typeLBO Funds

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The “Vintage Year”

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‘Add‐On’s now fully half of Deals 

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LP’s pushing for Exits (i.e. distributions)

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1/4th of Exits are now to another p.e. firm

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GeographyPrivate Equity Firms  Portfolio Companies 

States % of total  States 

% of total 

1  New York  23.3% 1 California  18.8%2  California  15.1% 2 Texas  8.8%3  Illinois  9.4% 3 New York  6.6%4  Texas  7.4% 4 Massachusetts  5.9%5  Massachusetts  7.0% 5 Florida  4.5%6  Connecticut  6.5% 6 Pennsylvania  4.2%7  Pennsylvania  3.7% 7 Illinois  4.2%8  Virginia  2.4% 8 New Jersey  3.7%9  Florida  2.2% 9 Georgia  3.2%

10  Michigan  2.0% 10 Ohio  3.0%11  Ohio  2.0% 11 Colorado  2.7%12  Colorado  1.9% 12 North Carolina  2.5%13  North Carolina  1.9% 13 Virginia  2.4%14  New Jersey  1.8% 14 Minnesota  2.2%15  Georgia  1.7% 15 Michigan  2.0%16  Washington DC  1.6% 16 Washington  2.0%17  Minnesota  1.6% 17 Connecticut  1.9%18  Maryland  1.4% 18 Maryland  1.9%19  Indiana  0.8% 19 Wisconsin  1.8%20  Wisconsin  0.8% 20 Tennessee  1.8% Sample Size: 1,000+ private equity firms, 10,000+ portfolio companies

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Many ways to categorize the 1,800

By size• Large $1 billion+ revenues• Mid-market > $150 million • Small < $150 million

By sector specialty• Health care• Consumer• IT• Financial services• etc.

Net-net, sector first; and mid-market; not lower or upper

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Excellent

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Don’t unnecessarily limit where you can play

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Top Fund ManagersRank Firm City Capital ($Millions)

1 TPG Capital Fort Worth (Texas) $50,553

2 Goldman Sachs Principal Investment Area New York $47,224

3 The Carlyle Group Washington DC $40,540

4 Kohlberg Kravis Roberts & Co. New York $40,215

5 The Blackstone Group New York $33,418

6 Apollo Global Management New York $33,813

7 Bain Capital Boston $29,402

8 CVC Capital Partners London $25,068

9 Hellman & Friedman San Francisco $17,200

10 Apax Partners London $16,637

11 Warburg Pincus New York $15,000

12 Cerberus Capital Management New York $14,900

13 Advent International Boston $14,519

14 Permia London $13,572

15 Oaktree Capital Management Los Angeles $13,045

16 Tera Firma Capital Partners London $12,249

17 Providence Equity Partners Providence (RI) $12,100

18 Clayton Dubilier & Rice New York $11,404

19 Charterhouse Capital Partners London $11,268

20 Teacher’s Private Captial Toronto $10,758

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Top 12 p.e. Investors in 2012

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The LBO model

Purchase• 7.0 X $9m = $63• Cash 27• Debt 36

Sale• 8.0 X $14.1m = $113

• Debt 32• Proceeds 81

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The LBO model

Purchase• 7.0 X $9m = $63• Cash 27• Debt 36

Sale• 8.0 X $14.1m = $113

• Debt 32• Proceeds 81

= 3.0 X cash-on-cash

The p.e. / L.P Model Pelosi 2008 Fund

2008 2009 2010 2011 2012 2013 2014 2015 2016

AB

C D

E

F

GH

IJ

F

E

DA

BC

Sale

Purchase

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The p.e. / L.P Model Pelosi 2008 Fund

2008 2009 2010 2011 2012 2013 2014 2015 2016 2017

AB

CD

E

FG H I

J

F

E

DA

BC

Sale

Purchase

Invest Harvest

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A lot of fish vs. Fortune 1,000 and Russell 2,000

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p.e. Compensation

2% of managed capital• pays salaries, rent, and nominal bonuses

20% carried interest from profits on distributions*

* pre-Obama

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Performance Measures

Good Great Awesome IRR 20% 28% 33+% Cash-on-cash return 2X 3X 5+X Hold period 8+ years 6 years 3- years

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Buyout Fund SamplePartnership/Year

CapitalCommitted (M)

CapitalCont. (M)

Dist. As of (M)

Net IRRAs of (%)

Oregon State Treasury 12/31/12 12/31/12

2000 Riverside Capital Appreciation Fund/2000 $50.0 $46.3 $73.1 22.1

2003 Riverside Capital Appreciation Fund/2003 $75.0 $77.4 $47.1 15.3

Apollo Investment Fund VI LP/2006 $200.0 $223.1 $57.5 3.1

Aurora Equity Partners III LP/2004 $50.0 $53.0 $20.8 17.7

BCI Growth V LP/1999 $75.0 $72.9 $27.2 -8.7

Castle Harlan Partners IV LP/2002 $100.0 $102.3 $109.8 17.3

CVC Capital Partners Asia Pacific II LP/2005 $100.0 $122.4 $38.3 -6.2

Diamond Castle Partners IV LP/2005 $100.0 $71.3 $16.1 -4.5

Endeavor Capital Fund III LP/2000 $25.0 $24.5 $43.7 28.9

Fenway Partners Capital Fund III LP/2006 $50.0 $53.9 $19.6 -4.9

Hicks Muse Tate & Furst Europe Fund LP/1999 $99.3 $116.8 $196.9 21.7

KKR European Fund LP/1999 $400.0 $532.3 $778.8 19.3

KKR Millennium Fund LP/2002 $1,000.0 $1,308.8 $1,064.2 17.9

Lion Capital Fund I LP/2004 $99.8 $108.8 $117.2 26.5

Oak Hill Capital Partners II LP/2004 $100.0 $105.8 $15.7 6.8

Parthenon Investors III LP/2005 $100.0 $67.8 $8.7 1.7

Rhone Partners III LP/2006 $100.0 $65.4 $11.5 5.8

TPG Partners III LP/2000 $300.0 $284.5 $571.9 24.5

HarbourVest Partners 2004 Direct Fund/2004 $75.0 $74.1 $21.1 11.1

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A typical 10 company fund result

2 out-of-the-park 1 triple 2 doubles 3 singles 2 the bank took the car keys

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Riverside Company

20% of the invested money will lost If less, we’re not taking enough risk Not sweat the duds, but rather the ones we missed

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The Funnel

300 teasers

100 books

7 LOI’s

2 due diligence

1 close

20 Meetings with Mgmt

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Options for Executives Working with Private Equity

Fund Commit-

ment

Advisorexpenses+upside

Deal Executive / Executive in Residenceretainer+upside

Portfolio Company Managementsalary+bonus+equity

Executive’s Income

Expert Network / Interim Executivehourly comp

Operating Partnersalary+bonus+carry

David Teten, www.Teten.com/executive

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Who the p.e. wants to meet

Job Seekers

Deal Resource

Thesis-DrivenDeal Exec

Target-Driven Deal

Exec

Source: Andy Thompson, Notch Partners

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Management Compensation

CEO $200K - $350K 50-75% 5.0% equity* CFO/COO 125K - $275K 40-50% 1.5% equity VP 125K- $225K 25-33% 1.0% equity

* and opportunity to co-invest

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The Three Primary Return Drivers

Leverage Value Improvement: EBITDA Growth Exit Multiple Expansion

Courtesy: Wind Point Partners

The Deal

Project NTL Sept 1st, 2007

Offer: $55 million for 75% of the company + $34 million debt, implies $107 millionBank Adj. +$4.0 excesses 2006 EBITDA

2007 Adjusted EBITDA 12,744 16,744 Sources Debt Multiple

EBITDA Multiple 8.4x 6.41x Debt Financing 58,000 3.46xOffer Price 107,333 107,333 new p.e. Equity 35,000 2007 2008 2009 2010Company Debt 34,000 34,000 Total Sources: 93,000 EBITDA 12,744 17,840 23,700 29,300Current Equity 73,333 73,333 Interest @ 12% (6,553) (5,645) (4,450)

Uses Taxes % 40% (4,515) (7,222) (9,940)Payment to 5 owners 55,000 Capex (2,500) (2,500) (2,500)

Current Owner Proceeds 55,000 Refinancing of Debt 34,000 Debt Pay (6,788) (8,333) (11,591)Estimated Fees and Expenses 4,000 Cash Flow 0.0 0.0 0.0

new p.e. $ 35,000 75% Total Uses: 93,000Equity Rollover 11,667 25% Cash 0 0.0 0.0 0.0Total Post-Deal Equity 46,667 100.0% ? equity Debt 58,000 51,212 42,877 31,286

196,039 Year 3 Ownership Net Debt 58,000 51,212 42,877 31,286

Management: of 15.0 pts 2.5%now 2011 new p.e. 63.8%Mike Lorelli 0.0550 672 10,782 Current Owners 21.3% Exit EV 142,720 189,600 234,400CFO 0.0300 367 5,881 Immediate skin in game 2.5% Exit Equity 91,508 146,723 203,114EVP 0.0200 244 3,921 3 year option program 12.5% Equity to p.e. 58,336 93,536 129,485

V.P. and GC 0.0220 269 4,313 100.0% Equity to 5 owners 19,445 31,179 50,920R&D 0.0060 73 1,176 Total cash to 5 owners 74,445 86,179 105,920Sub. GM 0.0060 73 1,176 p.e. cash

CMO (new hire) 0.0060 73 1,176 IRR (5 years)VP Supply Chain (new hire) 0.0050 61 980 Exit multiple 8Total Management 0.1500 1,833 29,406

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The Plan

Fleshed out approach for how value will be created• Strategic and operational blueprint

Rapid change principles• 80/100 rule: an 80% solution that’s ready to go now,

beats a 100% effective, theoretical solution, ready to go in 4 months

Make capital work hard• Re-deploy underperforming assets

Project NTL 100 Day Plan1. Full Court Press on Basic Revenue Projects

a GROWING THE BASE BUSINESS- will be relatively easy for an organization in this space that focuses, prioritizes and executes. The ISI partners have for the last two years been focused and spending the majority of ISI's time and resources on acquisitions, strategic alliances, new ventures, etc and have not focused on ISI core brands and business. To date none of these ventures have been successful but have utilized significant management time and expense. A sharp focus on the core business / brands with the some advertising/ promotion and introduction of new products in these brands will result in strong growth. In addition, providing more products and new and improved products to existing customers and improving current service levels and fill rates to existing customers will definitely provide positive growth. New domestic customer opportunities will also be a focal point.

b INTERNATIONAL-there is still currently a strong demand for ISI products, especially Twin Lab in the International arena. Again, during the last two years because of the intended Pharmaton acquisition, ISI basically ignored existing International distributors, never hired a new head of International sales and never entertained new distributors that contacted us for our product. ISI is now beginning to refocus on that area with a European head of Intl sales. More resources and specific plan for Int'l growth on a number of fronts could result in strong and quick Int'l growth.

c HERBS AND TEAS- these brands have essentially been allowed to run themselves for the last three years. Despite that they have only declined slightly in revenues. Lack of focus and strategy are the primary reasons for these declines. Reversing these revenue declines and growing these brands, which are both in comparatively active and hot growth areas, is not that difficult. We need to hire a brand manager to work with our customers and suppliers to revitalize and contemporize these lines. Both Alvita and Nature's Herbs are well recognized and trusted brands that still have a loyal following. We need to add some new more popular flavors which customers have been asking for and update our packaging. We can also easily look to expand the channels of distribution for these brands.

Project NTL August 9th, 20072004 % 2005 % 2006 % 2007 est % 2008 % 2009 % 2010 %

P&LNet Sales 108,874 100.0% 118,293 100.0% 113,168 100.0% 115,579 100.0% 136,000 100.0% 150,000 100.0% 175,000 100.0%

Base business 98,193 97,768 100,579 109,000 115,000 125,000Int'l 10,800 8,000 7,000 12,000 15,000 21,000

Water 0 0 1,000 5,000 7,000 12,000Teas & Herbs 9,300 7,400 7,000 10,000 13,000 17,000

Gross Profit 45,436 38.4% 48,829 43.1% 53,124 46.0% 65,280 48.0% 73,500 49.0% 87,500 50.00%R&D 2,192 1.9% 1,923 1.7% 1,919 1.7%

Selling 16,624 14.1% 13,783 12.2% 13,298 11.5%Shipping & dist. 5,022 4.2% 4,411 3.9% 4,411 3.8%

Mktg G&A 1,607 1.4% 147 0.1% 2,700 2.3%Adv. & Promo. 5,445 4.6% 2,438 2.2% 4,600 4.0%Bus. Planning 493 0.4% 0 0.0% 0 0.0%Consumer Aff. 132 0.1% 140 0.1% 125 0.1%

Executive 9,172 7.8% 6,596 5.8% 6,307 5.5%Finance 2,010 1.7% 2,633 2.3% 2,529 2.2%

General Office 1,543 1.3% 1,809 1.6% 2,071 1.8%HR 709 0.6% 818 0.7% 830 0.7%

IT 3,058 2.6% 2,921 2.6% 2,291 2.0%ISI/N2U 282 0.2% 549 0.5% 547 0.5%

Legal 1,494 1.3% 1,949 1.7% 1,783 1.5%Order Entry 284 0.2% 255 0.2% 249 0.2%

Other expense 1,458 1.2% 2,509 2.2% 7,819 6.8%Production 365 0.3% 534 0.5% 313 0.3%Purchasing 1,092 0.9% 860 0.8% 761 0.7%

Rebus 2,259 1.9% 807 0.7% 459 0.4%Regulatory 0 0.0% 158 0.1% 180 0.2%

Corporate M&A 0 0.0% 308 0.3% 215 0.2%nt'l sales expansion 0 0.0% 0 0.0% 536 0.5%

G&Aalloc toCOG (3,145) -2.7% (3,407) -3.0% (3,472) -3.0%Total Op. exp. 52,147 44.1% 42,952 38.0% 51,920 44.9% 54,400 40.0% 58,000 38.7% 64,000 36.60%

∆ GrossMargin-OpExp +9,046 +13,666 +21,666

Int. income 58 0.0% 18 0.0% 0 0.0%Interest exp. 10,101 8.5% 12,594 11.1% 11,825 10.2%

Other Exp (Inc.) 167 0.1% (330) -0.3% 350 0.3%Net Income (16,921) -14.3% (6,535) -5.8% (10,970) -9.5%

Dep. & Amort. 2,897 2.4% 3,457 3.1% 3,721 3.2%EBITDA (3,814) -3.2% 9,334 8.2% 4,925 4.3%

adjustments 4,505 3.8% 3,729 3.3% 7,819 6.8%BankAdj.EBITDA 690 0.6% 13,065 11.5% 12,744 11.0% 21,000 25,000 33,000-excessive Mgt. 0.0% 4,000 3.5% 4,000 3.5%ProFormaEBITDA 17,065 15.1% 16,744 14.5% 25,000 18.4% 29,000 19.3% 37,000 21.1%

Buyout Example Economics

WPP/Co-Investors Results • 30% IRR• 3.7x cash-on-cash return

CEO • Assuming

CEO co-invest of $750k CEO gets 7.5% of common

• CEO receives over $10 million

Investment (Example)• Acquire a business for 5.5x EBITDA• Over 5 year horizon

Sales grow at 7% annually Margins improve from 14% to 15.5%

• Sell business in year 5 for 5.5x EBITDA

Courtesy: Wind Point Partners

Components of Equity Value Creation

As EBITDA grows, the value of the enterprise increases.At the same time, free cash flow reduces debt.

Courtesy: Wind Point Partners

At Close Y1 Y2 Y3 Y4 Y5

EBITDA 25.2 27.5 30.1 32.9 35.9 39.1Exit Value (5.5x EBITDA) 138.6 151.5 165.5 180.7 197.2 215.2

Cash Available for Debt Pay down 7.9 9.6 11.5 13.6 15.8Net Debt 100.8 92.9 83.2 71.7 58.1 42.4

$ millions

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A word on covenants

Max Capital expenditure $1.5 million Min LTM EBITDA 11.0 million Fixed Charge Coverage 1.00x Total Deb Leverage 3.75x Maximum Senior Leverage 4.50x

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WSJ

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Private Equity Analyst- November 2012

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Private Equity Analyst- November 2012

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The Trades

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The Importance of a Killer LinkedIn Profile

50% of candidates are found via LinkedIn

Or they will at least check you out

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below average

slightly above average

Above average

Very Good

Excellent

OutstandingKiller*

You and 6,999

You and 3,999

You and 1,999

You and 999

You and 499

You and 99

140 million LinkedIn members

14,000 serious C‐Level Candidates = .0001

You and 199

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Keywords

EBITDA growth Revenue Acceleration Margin Enhancement Multiple Expansion Visioning/Strategic Planning Topgrading New Channels/Markets International Expansion CEO CXO Lean Manufacturing Turnarounds Exit Strategies

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LinkedIn Profile

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Visit www.linkedin.com/in/mikelorelli

Mike Lorelli(203) 655-2444

[email protected]

Q  & A

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Michael K. Lorelli15 Norman Lane

Darien, CT 06820

Office: 203 655-2444

FAX: 203 655-6916

Email: [email protected]

Website: www.Lorelli.net

www.LinkedIn.com/in/MikeLorelli

http://www.gplus.to/MikeLorelli

Michael K. Lorelli

Mike Lorelli’s 30-year career spans a wide range of consumer products and services, and B2Bcategories, with responsibilities for both domestic and international units. His years as a line-operating manager have largely been with Fortune 100 companies: PepsiCo and Bristol MyersSquibb. For the last decade, as CEO, he has led revitalizations and turnarounds for private equityfirms. For example, Dr. John Rutledge, Chairman of Rutledge Capital, will say: “I would invade Chinawith Mike alone in a rubber boat.” Most recently, he was CEO of Carlstadt, NJ based WaterJelTechnologies, the leader in burn care products. Today he is Executive Chairman of the Board ofRita’s Italian Ices, which was acquired by Falconhead Capital.

Mike has also led CEO engagements for Riverside Company, Rutledge Capital, and Pouschine CookCapital.

Mike’s assignments at PepsiCo included Executive Vice President – Marketing, Sales and R&D forPepsi-Cola North America, President of Pepsi-Cola East, a $1.5 Billion operating company, andPresident for Pizza Hut’s International division where he led a “global or bust” charge, resulting inexpanding the Company’s presence from 68 to 92 countries, surpassing McDonalds in country count.During his PepsiCo tenure, he is given credit for authoring the soft drink company’s “Big EventMarketing” strategy, which coupled the product with leading- edge events in entertainment, sports,consumer electronics, movies and home video.

Mike holds a Bachelor of Engineering degree from New York University, and an MBA in Marketingfrom NYU’s Stern Graduate School of Business. He has traveled to 58 countries, is an avid runner,claims to excel at no sport, is an active private pilot, member The CEO Trust, former member of YPO,and author of the childrens’ best-seller “Traveling Again, Dad?” with profits donated to childrens’charities. Mike is a Director of CP Kelco, and iControl. He holds a Professional Director Certificationfrom The American College of Corporate Directors, and is also an NACD 2011 Governance Fellow.Mike is also a registered speaker with Vistage International.

Leading The World In Burn Care