Monday, April 23, 2018 PRIVATE EQUITY 101: FROM VENTURE CAPITAL TO LBOs The Private Equity world
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1Monday, April 23, 2018
PRIVATE EQUITY 101: FROM VENTURE CAPITAL TO LBOs
The Private Equity world
2
Private Equity Overview
Global PE activity
Investment Mgmt & Divestitures
Cash cycle of a PE fund
Introduction Contractual Structures
▪ Private equity the investment in equity of unlisted firms
▪ 4 different types of investments
▪ LBOs: investment made using a large amount of debt
▪ Growth Capital: minority equity investments in mature
companies
▪ Mezzanine Capital: investment in subordinated debt or
preferred stocks, no voting control of the company
▪ Venture Capital: equity investments in young companies
3
Characteristics of PE Transactions
Ideal Targets
Participants Standard measure of profitability: IRR
▪ Robust and stable cash flows
▪ Leverageable Balance Sheet
▪ Low capital expenditures
▪ Quality & non-core assets
▪Co-invest with the private equity fund in the new equity of the acquired company
▪Manage the company on behalf of the PE fund
▪ Provide the committed capital
▪ Introduce potential acquisition targets
▪Help out in negotiating the price
▪Provide loans & underwrite high-yield bond offerings
▪Assist during the exit strategy
▪Select the LBO target
▪Negotiates the acquisition price
▪Oversees the activities of the acquired company
▪Decides when and how to sell
▪ Basic idea of a PE valuation: Given the estimated cash
flows, the amount of debt, and the estimated exit price,
the acquisition price to pay today is set to give the PE
investor a desired rate of return (IRR) – ca. 20-25%.
Lawyers Accountants Tax Experts Others …
▪ Room for cost cutting
▪ Good Management
▪ Mature market
▪ Strong market position
4
Value Creation
GrowthDeleverage Arbitrage
The Bet: at exit debt is completely
repaid, no growth and no new
investments
Example: entry in t0 EBITDA=100;
multiple 6x; outstanding Debt = 500;
Equity = 100
Result: exit in t5 EBITDA=100;
multiple 6x; outstanding debt = 0;
equity value = 600
The Bet: EV/EBITDA at exit is higher
than the initial value of the multiple
(debt can be refinanced)
Example: entry in t0 EBITDA=100;
multiple 6x; outstanding Debt = 500;
Equity = 100
Result: exit in t5 EBITDA=100;
multiple 8x; outstanding debt = 500;
equity value = 300
The Bet: EBITDA at exit is higher
than the initial value (debt can be
refinanced)
Example: entry in t0 EBITDA=100;
multiple 6x; outstanding Debt = 500;
Equity = 100
Result: exit in t5 EBITDA=133.3;
multiple 6x; outstanding debt = 500;
equity value = 300
Private equity acquisitions:
▪ Introduce uncertainty
▪ Temporary owners
▪ Bring in new capital
▪ Better knowledge of management practices
▪ Reduce agency problems
▪ Limit management discretion (high debt levels)
And stimulate:
▪ Higher productivity
▪ Innovation
▪ Organic growth
Improvements
5
The Fundraising Process
Marketing the Fund
• Appointment of the team
• Soliciting investors
• Formulation of the fundraising plan
• Initial terms discussion and PPM setup
Term Negotiation
• Negotiation with prospective investors
• Finalization of fund structure
• Preparation of documents (e.g. LPA) for the initial closing phase
Initial Closing
• Acceptance of initial investors’ commitments which become legally bound
• Launch date for the fund (operations are commenced)
• First calls are made
Subsequent Closings
• Additional closings on new commitments
• Subsequent closing period subject to any limitations in fund documents
• Fundraising period ends at final closing
6 to 12 months marketing
period
3 to 6 months negotiating
period
1 year or more subsequent
closings period
6
4 Major Trends in the 2017 Fundraising Scene (1/2)
1. COMMITMENTS AT POST-RECESSION HIGH 2. CAPITAL CONCENTRATION
During 2017, PE firms raised more capital than at any point in time
since 2007-2008. Almost $667bn were raised through the use of
1,091 funds.
If in 2006 1,576 funds raised capital for a total of $576bn, 10 years
later - in 2016 - 333 funds less were accounting for a $50bn more
of total capital raised - $626bn.
0
500
1000
1500
2000
$0M
$100B
$200B
$300B
$400B
$500B
$600B
$700B
$800B
$900B
2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018YTD
Source: PitchBook Data, Inc.Total Capital Raised Fund Count
7
4 Major Trends in the 2017 Fundraising Scene (2/2)
3. PREVALENCE OF BUYOUT MEGA-FUNDS 4. SHRINKING IN FUNDS’ CLOSING TIME
15% 14%
25% 26% 25% 29%
19%14%
19% 15% 21%23%
21%
17%
14% 16%15%
15%
19%
26%
20% 18% 15%
17%
25% 29%22% 24% 25%
16%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2012 2013 2014 2015 2016 2017 YTDSource: Preqin Data
More than 24Months
19-24Months
13-18Months
7-12 Months
Less than 6Months
Buyout54%
Venture Capital13%
Fund of Funds10%
Growth/Expansion6%
Infrastructure6%
Secondaries5%
Mezzanine5%
Real Estate1%
Source: PitchBook Data, Inc.
In 2017 funds took on average 13.2 months to be
closed, almost 17% less than the 16.8 months in 2016.
During 2017, 54% of the total committed capital was
raised by buyout funds.
8
Venture
Capital
Growth
EquityBuyout Distressed
Sa
les
Time
Investing Over Company’s Life Cycle
Extremely
specialised
investors, deep
technical
expertise
requiredIt usually
exploits
complex legal
procedures to
obtain returns
9
How the Buy-Out Works
ASSETS
DEBT
EQUITY CASHDEBT
EQUITY
ASSETS
DEBT
DEBT
EQUITY
OpCo
SPV
SPV
ASSETSDEBT
EQUITY
NewCo
ASSETS EQUITY
NewCo
1 2
3 4
New Debt
Pre-Existing
Debt
Debt has been
completely
refinanced
Debt has been
paid out fully
10
Case Study: KKR Purchase of Safeway Stores
Target: Safeway Stores Inc.
Buyer: Kohlberg, Kravis, Roberts & Company
Year: 1986
Sector: Supermarket Chain
Country: USA
Rationale: Unprofitable supermarket chain stores, with too
much leverage, lots of money-losing stores and frequent union problems
Strategy: Sell off unprofitable stores to repay debt quickly,restructure the company’s business model and re-sell it
DEAL HIGHLIGHTS
• Target company was already very
much in debt at the time of the
acquisition
• The US supermarket store
business is extremely crowded
and competitive
• KKR paid $6bn in cash and
securities
• Stores were closed, employees
laid off and unions’ issues settled
• KKR turned around the
company, making it profitable
again after years of losses
11
Case Study: Blackstone Purchase of Celanese
Target: Celanese AG
Buyer: The Blackstone Group
Year: 2003
Sector: Chemical
Country: Germany
Rationale: Extremely cyclical business, company relatively
undervalued on the German Stock Exchange (the same kindof companies trade at 1x multiple more in the US)
Strategy: Take the company private, move it to the US, trim out unnecessary operations, list it on NYSE
DEAL HIGHLIGHTS
• German takeover laws are very
restrictive, giving much power to
employees’ representatives
• The purchase of shares had to
reach at least 95% to be able to
relocate it in the US (key)
• Blackstone paid €3.1bn and also
assumed around €1.5bn of debt
• Relocation, sale of non-core
assets and relisting in US took
place in less than 18 months
• Eventually, Blackstone realised
5 times the cash invested in
under 2 years → stellar IRR
12
Exit Strategies
SALE OF BUSINESS
IPO
M&ASECONDARY
BUYOUT
DIVIDEND RECAPITALIZATIONBELOW-PAR DEBT
REPURCHASE
13
Exit Trends
14
Case Study: JLL Partners LLC sells Patheon NV to Thermo Fisher Scientific
2007
$150 MILLION RESTUCTURING INVESTMENT
2014 2017
$462 MILLION ADDITIONAL INVESTMENT
PHARMACEUTICAL DIVISION
‘S
+
51% STAKE
49% STAKE
PHARMACEUTICAL DIVISION
‘S
$7.2 BILLION(including $2.2 billion of debt)
100% STAKE
BOTTOM LINE: JJL Partners earns $2.2 billion out of its $462 million investment, implying a 4.8x multiple in three years
15Monday, April 23, 2018
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