Presentation on Private Equity

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Presentation on Private Equity LBO Modelling

• May 11, 2008

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(No Transcript)
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What is private equity? Why care about it?
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Its quickly risen to become a huge and
critically important industry
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that is controlled by a few very powerful men
Steve Schwarzman The Blackstone Group
Henry Kravis KKR
David Rubenstein The Carlyle Group
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and has been the subject of much debate and
criticism
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So what exactly do private equity firms do?
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They buy companiesand then sell them (hopefully)
at a profit in a few years
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• Quick primer on industry jargon
• Private equity firm financial sponsor (e.g.
  The Blackstone Group)
• Strategic investor corporation (e.g. Walmart)
• LBO leveraged buyout

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The private equity process

• Private equity firms raise funds e.g. ABC
  Fund I, ABC Fund II
• Within each fund, the private equity firm is a
  General Partner (GP). GP directly invests 1 of
  the fund
• All other investors are Limited Partners (LP)
  and they invest 99 of the fund
• GP LP is an important distinction both for
  legal purposes and also for understanding how PE
  process works
• The fund itself is structured as a limited
  partnership
• Funds invest in multiple companies, acquire a
  controlling stake (usually 100 of equity)
• IRR threshold is 20-25 depending on size of
  the fund
• Lifetime of fund is 5-10 years, this means
  that all companies in the fund must be sold
  within this period

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PE hiring

• Private Equity firms usually setup groups
  based on Industry and/or Geography
• Many of the big firms are global
• Most firms are small with 50-100 investment
  professionals
• Some firms separate investment team from
  portfolio management team
• At entry level, most PE firms hire investment
  banking analysts with 2 years of experience
• Hard to break into industry, best way to do so
  is through contacts
• Lucrative and better hours than banking
• Culture tends to vary by firm most PE guys
  are ex-bankers so some similarities in culture

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PE exits

• Exits can be of the following types
• IPO
• Sale to another PE firm
• Sale to a strategic investor
• Any fool can buy a company. You should be
  congratulated when you sell.
• -- Henry Kravis, founding partner of KKR

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How do private equity firms make money?

• How do Limited Partners make money
• Periodic return on capital (e.g. dividends),
  80 of profits
• Profit on exit, proportionate to investment
• How do General Partners make money
• Management fee of 2 per annum on raised fund
• Carry or Carried Interest, usually 20 of
  profits
• Profit on exit, proportionate to investment

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What company makes a good target for a buyout?

• Mature Industry
• Mature Company
• Strong Management Team
• Low Leverage
• Low CapEx Requirements
• Strong Cashflows
• Good Exit Options

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3-step IRR calculation for PE deals

• Step 1
• Determine purchase price
• Determine how much will be paid for using debt
  vs. equity
• What is the entry multiple (i.e. EV/EBITDA of x)
• Step 2
• Project companys cash flows over investment
  horizon (e.g. over 5 years)
• Use any excess cash (after operating expenses and
  interest has been paid) to pay down debt
• Equity holders receive no cash during these years

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3-step IRR calculation for PE deals

• Step 3
• Assume an exit multiple (i.e. EV/EBITDA of x)
• Multiply this with EBITDA in exit year (e.g. in
  year 5)
• You now have EV. EV outstanding debt Value
  of Equity at Exit
• Using Equity put in from Step 1 and Equity at
  exit from Step 3, you can calculate IRR of equity
  investment

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Case Study Barneys Deal
Barneys New York, a high-end fashion retailer was
recently bought out by Istithmar World Capital (a
7 billion Dubai-based PE firm)
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Barneys Case Study

• Deal size 950 million
• Financed by 30 equity, 70 debt
• GPs invest 1 of the equity, LPs invest 99
• Assume 5 year investment horizon
• 2 management fees per annum
• Profit sharing among GPs LPs is 20 and 80
  respectively
• Assume 120mm debt paid down each year no cash
  distribution to equity holders during years 1-5
• Assume entry multiple (EV/EBITDA) of 8.0x and
  exit multiple (EV/EBITDA) of 8.5x
• How much money did the General Partners invest
  initially?
• How much money will the General Partners make in
  management fees on this deal?
• What is the IRR earned by GPs?

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Barneys IRR (for LPs)
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Barneys IRR (for GPs)
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Questions?
fkhalid2008_at_kellogg.northwestern.edu