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Seminar: introduction to private equity


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Title: Seminar: introduction to private equity

Seminar introduction to private equity
  • Antoine Parmentier
  • 44(0)7809.510.373

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.

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

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

  • Structure of private equity participations

The fuel of private equity
  • The debt
  • Acquisitions are made through leveraged buyout
    deals (LBOs)
  • The investors
  • PE funds managers must be disciplined and
  • The managers
  • The success of an investment relies on the
    implementation of the business plan
  • The macro environment
  • Acquisition multiple arbitrage can be positive in
    period of growth

A diversified asset class
  • Private equity includes a large number of
    strategies venture, buyout, distressed,
  • Like-minded strategies mezzanine,
    clean-tech/energy, infrastructure, real assets

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

Venture capital (2/2)
  • Investment from up to 10m and often pre-revenues
  • Financing in several rounds (round 1, round 2,
    round 3) with typically clinical test results as
    threshold for next round
  • Most of the exits are IPO (NASDAQ, Zurich)
  • Examples Skype, Google, Apple, Atari, Cisco,
    Yahoo, YouTube, LinkedIn, Paypal.

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

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

Buyout (3/3)
  • Buyout starts at 5 million enterprise value
  • At the bottom end growth/expansion capital.

Distressed / Special situation (1/2)
  • Investment in debt-securities or equity of a
    company under financial stress
  • Distressed companies are in default, under
    Chapter 11 (reorganization) or under Chapter 7
  • Loans are rated BB and below by SP based on
    usual ratio (debt/EBITDA, EBITDA interest
    coverage, etc)

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

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

Secondary (2/2)
Mezzanine (1/3)
  • Debt instrument immediately subordinated to the
  • The most risky debt instrument highest yield
  • Returns generated by
  • cash interest payment fixed rate or fluctuate
    along an index (e.g. EURIBOR, LIBOR)
  • PIK interest payment is made by increasing the
    principal borrowed
  • Ownership mezzanine financing most of the time
    include equity ownership.

Mezzanine (2/3)
  • Mezzanine suffered before credit crunch as senior
    debt was easy to access
  • Since July 2007 and lack of funding, mezzanine is
  • As of 30 September 2008, 70 of PE deals used
    mezzanine vs. 48 in 2007
  • Q3 2008 average spread E1,042, versus E979 in
    Q2 2008

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

Infrastructure (2/2)
  • A multi trillion market opportunity
  • 1 trillion to 3 trillion annually through 2030
  • US power industry needs 1.5 trillion between
    2010 and 2030
  • Mexico a 5-year and 250 billion plan will be
    funded 50 by private capital
  • EU 164 billion to be invested in natural gas
    infrastructure by 2030 to facilitate import of
    gas to meet long-term shortfall
  • China close to 100 airports will be needed.

Source Global Infrastructure Demand through
2030, CG/LA Infrastructure, March 2008.
Infrastructure to 2030, volume 2, OECD
publication, 2007.
Real assets (1/2)
  • Cash-flow producing asset or pool of assets
    privately originated
  • Equipment leasing (shipping, aircraft) the
    asset is purchased and simultaneously leased back
    to the seller
  • Agricultural finance (forests, timber lands,
    etc) growing demand from the renewable energy
  • Mines, intellectual property rights, financial
    assets on the secondary market, etc
  • It is usually not asset-backed securities but a
    direct investment in the assets

Real assets (2/2)
  • Steady and regular cash flow 10-15 annual cash
  • Downside protection due to high recovery value of
    the assets loss of value of the asset is
  • Uncorrelated assets

Why allocate assets to PE ?
Portfolio management
  • Asset allocation is define by returns, risk
    (measured by standard deviations of returns) and
  • Diversification improve returns while reducing
  • Allocation is determined using public information
    of traditional asset classes (equity, bonds,
    REIT, etc...)

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
  • 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.

The issue with private equity
  • Illiquid investments
  • PE funds are closed-end funds (except secondary
  • Time line too long
  • PE funds has a 5-year investment period and a
    10-year life
  • Restricted information disclosure
  • Only LPs have access to the funds performance.

Private equity is an inefficient market
  • However, Allocation to PE increased significantly
    over the last years
  • Low correlation to pricing trends of traditional
  • Diversification thus risk reduction
  • Good returns over the years Average annual IRR
    1986-2005 is 18.3

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
  • Relatively good returns of PE over the last years.

  • LBO activity in Europe

European buyout value
European buyout value 72 billion in Q1-Q3 2008
European buyout by region
PE as a percentage of GDP
  • Nordic countries have the most important PE
  • Benelux figures are impacted by few mega deals.

European fundraising activity
Funds on the market
Seeking capital is becoming difficult
  • Number of vehicles seeking capital keep on
  • But the number of final closing and the path
    investors deploy capital has slowed down
  • Investors (LPs) are hesitant and sometimes face
    liquidity issues

  • Distributions are expected to decrease as well
    this wont ease the fundraising processes
  • Average fundraising
  • 2008 14.2 months
  • 2007 12 months
  • 2006 11.1 months

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

Funds of the market
  • Permira 13.5 billion
  • CVC 13.7 billion
  • Apax Partners 11.4 billion
  • Cinven 8.2 billion
  • Charterhouse 7.4 billion
  • PAI Partners 5.5 billion.

  • PE is set to enter its most challenging time
  • Increasing pressure and difficulties for managers
    seeking capital
  • Fundraising take more time
  • Less deals are being signed so theres no rush to
  • Historical performances and focus strategies will
    become key factors in the future some GPs wont
  • Some LPs will need to free up some capital and
    clean up their portfolio increase in secondary

  • PE AUM has grown steadily since 1996
  • 60 of LPs are expected to increase their
    allocation to PE
  • Sovereign wealth funds are a huge source of
  • Represent today 3,000 of assets and are expected
    to reach 7,900 billion by 2011
  • Europe accounts for 19 (580 billion) of SW
    funds capital

Fundraising sources
LPs usually invest in home-based funds
  • Globally, US is the single largest investor
  • In Europe, UK is ahead of anybody

Profile of the LPs
The measure of performance
Track record
Measures of performance
  • Multiple of cost
  • Also called Total Value over Paid-In capital
  • (Cash distributions Unrealized value)/capital
  • Cash returned regardless of timing (total
  • Internal Rate of Return (IRR)
  • Discount rate that makes NPV of all cash flows
    equal zero
  • Linked to timing Quick flip high IRR.

The J-curve
  • In the early years, low or negative valuation due
  • Management fees drawn from committed capital
  • Initial investments to identify and improve

The J-curve
  • Fees are charged based on the funds entire
    committed capital
  • Example
  • Fund size 100 million
  • Management fee annual 2 committed capital
  • Organizational expenses 300,000
  • ? 2,300,000 expenses/fees called regardless of
    any investment made.

The J-curve
  • If 5 investments are made the first year for 3
    million each
  • 5 x 3 million 15 million
  • If 20 of committed capital is called the first
    year 20 million
  • Interim value is thus 17.7 million or 0.89x
    contributed capital

The J-curve
  • Underperforming investments tend to be written
    down more quickly than successful companies
  • Example 2nd year
  • Another 20 of committed capital 20 million
  • Five new deals at 3 million each 15 million
  • Two first-year investments are written down/off
  • Annual management fee 2 million.

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

Fund of Funds due diligence the selection of PE
Due diligence focus
  • Quantitative analysis
  • Past investments and track record
  • Leverage and debt
  • Sources of proceeds.
  • Qualitative analysis
  • Team
  • Strategy
  • Market opportunity

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

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

Track record
  • Entry and exit date
  • Realized and unrealized value (part sell off or
  • Multiples of cost and IRR.

Benchmark analysis
  • DPI Distributed Paid In gt Proceeds distributed,
    only realized deals
  • RVPI Residual Value Paid In gt Unrealized value
  • TVPI Total Value Paid In Realized and
    Unrealized value.

Vintage year performance
  • Private equity investors and their managers
    Vivre avec un fond dinvestissement, Les Echos,
    October 2006

The worlds biggest private equity firms
  • Founded in 1987 by David Rubenstein, Daniel
    DAniello and William Conway
  • Since inception, Carlyle has invested 49.4
    billion of equity in 836 deals for a total
    purchase price of 220 billion
  • Over 89 billion AUM throughout 64 funds in
    buyouts (69), growth capital (4), real estate
    (12) and leveraged finance (15)
  • Over 525 investment professionals operating in 21
  • Assets deployed in Americas (59), Europe (28)
    and Asia (13)
  • Currently 140 companies, 68 billion in revenues
    and 200,000 workers.

Carlyle deals
  • Hertz
  • Zodiac
  • Terreal
  • Le Figaro
  • VNU

  • Founded in 1985 by Steven Schwarzman and Peter
  • Global AUM 119.4 billion in private equity, real
    estate, Funds of Hedge Funds, CLOs, Mutual funds
  • 89 senior MDs and total staff of over 750
    investments and advisory professionals in US,
    Europe and Asia
  • 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, 85 billion in annual
    revenues and more than 350,000 employees.

Blackstone deals
  • The weather channel 3.6bn in September 2008
  • Hilton 26.9bn in October 2007
  • Center Parcs 2.1bn in May 2006
  • Deutsche Telekom 3.3bn in April 2006
  • Orangina 2.6bn in February 2006

  • Founded in 1976 by James Kohlberg, Henry Kravis
    and George Roberts
  • Total AUM 68.3bn from 25.4bn invested capital
  • Total of 165 deals since inception with an
    aggregate enterprise value of 420bn
  • KKR is currently from a one-trick pony to a
    multi asset manager with infrastructure and
    mezzanine funds being raised
  • The 31bn buyout of RJR Nabisco inspired the book
    Barbarians at the gate
  • Currently 35 companies, 95 billion in annual
    revenues and more than 500,000 employees.

KKR deals
  • Legrand
  • Pages Jaunes
  • Tarkett
  • Alliance Boots
  • ProSieben
  • TDC
  • Toys R Us.

PAI Partners
  • The biggest French PE firms formerly known as
    Paribas Affaires Industrielles
  • Since 1998, PAI invested 3.92bn in 36 deals
    across Europe
  • Last fund raised reach 5.2bn
  • Investments include Kaufman Broad, Vivarte,
    Neuf Cegetel, Panzani Lustucru, Atos Origin

Private equity deals
  • Private equity funds own companies of everyday
  • Pages jaunes
  • Comptoir des cotonniers
  • Pizza Pino
  • Picard
  • Alain Afflelou
  • Jimmy Choo
  • Odlo
  • Orangina

Impact of PE on French economy is overall positive
  • 2006-2007 employees growth rate
  • 2.1 (vs. 0.5 for CAC 40)
  • 2006-2007 sales growth
  • 5.3 (vs. 4.1 for CAC 40)

Source AFIC/ErnstYoung
  • As of 30 June 2006
  • 55 of PE-backed companies have less than 100
    empoyees and 83 have less than 500 employees
  • 79 have less than 50m revenues
  • 4852 PE-backed companies in France
  • Work force of 1.5 million people (9 of total
    private employees)
  • 199bn in revenues including 128bn generated

Source AFIC/ErnstYoung
  • KKR
  • Blackstone
  • Carlyle

The mega buyout era
Fund growth
  • PE AUM 1980-2006 24CAGR
  • 2003-2006 PE commitments increased 260
  • Cost of debt historically low
  • ? Global volume of LBOs increased to 700
    billion in 2006 (4x 2003 level)
  • ? Global volume of LBOs in H1 2007 reached
    560 billion (25 of global MA).

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

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

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

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

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

Rise of Club-deals
  • Club-deals are iconic of the concentration trends
    of private equity
  • 91 of US buyouts of over 5 billion were
  • ... 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.

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

Examples of mega club deals
  • Caveat Investor / the uneasy crown, The
    Economist, Feb 2007
  • Whos next, The Deal, July 2008

Value creation in private equity
Value creation drivers
  • EBITDA generation
  • Multiple expansion
  • Debt reduction

EBITDA generation
  • EBITDA is generated by
  • Sales expansion
  • Margin improvement
  • Add-on acquisitions
  • Organic growth (GDP growth)

Multiple expansion
  • Multiple EV/EBITDA
  • 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

Debt reduction
  • Entry net debt exit net debt

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

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

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

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

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

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

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

  • Foxtons The sale of the century, FT magazine,
    June 2008

Structure of a Leverage Buyout transaction
Structure of a leverage buyout
  • Deal structure
  • Equity
  • Debt
  • Debt is either
  • Unsecured
  • Secured

LBO structure
  • Common equity, preferred equity, shareholder
  • Equity is unsecured and the most risky and
    rewarding tranche
  • Equity is held by the shareholders private
    equity fund, management, various investors, often
    debt mezzanine providers, sometimes

Mezzanine debt
  • Secured debt but subordinated to senior debt
  • 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
  • PIK note payment made in additional bonds or
    preferred stocks which increase the performance
    of the investment
  • Mezzanine is usually reimbursed at exit if not
    refinanced before.
  • H1 2008 cash spread E414.7bps
  • H1 2008 PIK spread E535.3bps

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

Senior debt
  • Negotiated for a period of time between 7 and 9
    years usually based on expected cash flow
  • Tranche A is first reimbursed. Other tranches (B
    and C) are usually reimbursed in fine
  • Tranche D is a revolving credit to refinance
    previous debt of the target company
  • H1 2008 spread E337.48bps

Capital structure
The loan marketin 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)

Average LBO equity contribution
Less debt available more equity required to
close a deal
Loan volume dropped significantly
Banks lending capacities are dry ! Q1-Q3 2008
loan volume 46.6 billion Q1 2007 loan volume
45.75 billion
Evolution of capital structure
Back to the classic structure Senior Debt
Cost of debt
Cost of debt increased significantly in 2008
LBO spread
The loan market
  • Loans started to fall below par value (100) in
    June 2007
  • Secondary market became depressed (less
    liquidity, decline in value, etc) but presents
    some good buying opportunities
  • Default rate at its lowest level although was
    expected to increase in 2008
  • A lot of new investors (incl. traditional PE
    funds) entered the loan market in H1 2008 with
    levered vehicles
  • 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 companys performance

  • The market is stuck
  • sellers have not yet adjusted their price
  • Buyers dont want/cannot pay high price.
  • Deals are negotiated at cheaper
  • EBITDA multiples are lower
  • More equity and less debt more conservative

EBITDA multiples
Purchase prices
  • Secondary buyouts are the most impacted as
  • They were traditionally the most expensive
    transactions price adjustment
  • Sellers are very likely forced to sell so accept
    lower prices.

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

Public versus Private differences in ownership
structures and governance
  • Public companies have arms length shareholders
  • Need for accurate and equal information among
    shareholders and capital market (audit,
    remuneration, compliance, risk)
  • Management development across the board.
  • Private equity companies have more efficient
  • Stronger strategic leadership
  • More effective performance oversight
  • Manage only key stakeholders interests.

Rating of public and private Boards of Directors
Strategic leadership in PE companies
  • Joined efforts of all Directors
  • Usually, defined and shaped dring the due
    diligence (prior acquisition)
  • Boards approve management strategic decision (in
    MA for example)
  • PE funds stimulate managements ambition and
  • Executive management reports on the progress of
    the latest strategic decision implemented.

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

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

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

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

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

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

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

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

Governance and risk management in private
  • Lower level of governance than in public
    companies only audit committees are needed in
    PEs approach
  • More focus on risk management than risk
  • Not perceived as a pure operational factor.

Top priorities
Surveys 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 companys success but they can
    still lose their hard-earned reputations if
    investors are disappointed.
  • 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

Credit crisis impact and consequences on private
Before July 2007 (1/3)
  • Growth of the institutional loan market, 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
  • Multiplication of highly rated structured credit
    products (CDOs/CLOs) although their inherent
    value was increasingly complex to calculate
  • Increasing interest from investors for LBO funds
    led to higher leverage
  • New loans were issued as covenant lite

Before July 2007 (2/3)
  • Increasing leverage loan activity but decline of
    credit quality of the new debt due to
  • Covenant lite
  • Rising ratio of debt to earnings for US and EU
  • 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
  • Companies under LBOs have less liquidity to serve
    their debt
  • Interest coverage ratio decreased since 2003
    reaching a ten-year low of 1.7x in 2007.
  • More equity more debt bigger deals and bigger

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
  • A number of transactions collapsed and could not
    be closed
  • Banks that did not distribute their debt had to
    report significant losses on their books.

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

After July 2007 (3/5)
  • Increase in the issuance of junk bonds in the
    past four years, almost half of the newly issued
    bonds have been rated as junk at their outset
  • Default risk (according to Moodys and Edward
    Altman (NYU Salomon Center))
  • CCC 4-year default risk 53.6
  • CCC 10-year default risk 91.4 in 10 years
  • B default risk 25.2 after four years.
  • In reality, the default rate over the last years
    is much lower that those predictions

After July 2007 (4/5)
  • Reasons for the low deafult rate
  • Given the lareg amount of liquidity, bonds that
    would have defaulted have been refinanced
  • The rise of covenant lite means that any event
    short of a failure to pay interest would not
    result in a default
  • Private equity deals should be seriously impacted
    very soon
  • Deals signed in 2005, 2006 and H1 2007 are the
    most risky deals

After July 2007 (5/5)
  • The crisis opens doors to new investment
  • Distressed debt and special situation funds
  • Need for leverage should benefit mezzanine funds
  • Credit dislocation funds purchase loans at a
    discount from lenders
  • Small to mid-market buyout funds will benefit
    from desaffection for mega buyout firms
  • Secondary funds some large institutions need

Crisis opportunities
  • Recession years have produced the best vintages
    for private equity
  • 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.

Recession years are usually good vintage years
Recession vs Non-recession
Case study Baneasa
Investment rationale
  • Market leader in French retail (1 in Footwear
    and 2 in clothing)
  • Experienced management team Bogdan Novac has a
    long standing experience of the sector and the
  • Strong financial performance and strong growth in
    sales expected over the next 3 years
  • Resilient business model lower end of the market
    and diversified range of products
  • Diversified offering geography (city centre or
    out of town, France and overseas, apparel and
  • Potential growth prospect organic growth (new
    stores openings) and consolidation (fragmented

  • Banesa is 1 footwear retailer with 14.4 of the
    French market and 2 clothing retailer in France
    with only 3.7 of the French apparel market
  • Fragmented industry, gives MA opportunity/growth
    by acquisition

  • 45 of OOT footwear market and 24 of OOT
    clothing market
  • Indication about competition Zara, HM, Mango,
    etc are city centres Baneasa has a dominant
    position where those competitors are not present.
    Zara, HM, Mango, etc are thus the main city
    centre competitors

  • Historically, Baneasa has always been active in
    OOT created suburban discount shoe stores in
    1981 with Osier Chaussures and in 1984 with
    Osier Vetements
  • First mover advantage

  • Clothing business 44 sales and 43 of EBITDA
  • Footwear business 56 sales and 57 EBITDA
  • Well balanced, similar EBITDA margins in both

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

  • Bogdan Novac was CEO of Baneasa from 2000 to 2003
    and 2004 to today.
  • EBITDA has grown from 231m to 365m (a CAGR of
  • Good management team // experienced CEO
  • Strong performance over the last years (since

  • Nataf estimates sales and EBITDA in the financial
    year to 28 February 2007 of 237 million and 23
    million respectively (9.7 margin).
  • Berrilio had sales in the 12 months to 30
    September 2006 of 64.5 million and EBITDA of
    4.6 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.

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

  • Average prices have decreased by 1.5 CAGR.
    Price-volume elasticity is high with declines in
    average prices driven by the pass-through of
    purchasing gains from lower-cost sourcing (Asia)
    to end-customers 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)

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

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

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

  • Between 2001 and 2003, out-of-town banners saw
    their market share decline from 11.9 in 2000 to
    10.9 in 2003. This reflected the impact of hard
    discount retailing and the growth of city-centre
    banners. Since 2003, however, OOT specialised
    chains have regained share and have returned to
    11.7 market share, growing by 3.9 in 2004 and
    4.7 in 2005, to 3.1 billion. This dynamism has
    been driven by new store openings and volume
    increases supported by increased
  • Potential decline of OOT/inconsistent growth
    rate risk.

  • Specialist out-of-town (OOT) distribution has
    seen the strongest growth in share (2.3 growth
    per annum over 2003-05 and 3.2 over 1998-2003)
    and continues to gain market share on the food
    retailers and the lower-end city-centre players
    due to a broad product range and low prices.
  • Footwear OOT has a strong growth in share 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.

  • The Spanish footwear market is more dynamic than
    the French one (3.9 p.a growth since 2000) but
    experiences the same volume and price trends with
    volumes up 6.5 p.a while prices decreased by
    2.6 p.a largely driven by growing Asian imports.
    The market is still dominated by independent city
    centre stores (40 market share vs 15 in France)
    and OOT footwear is gaining share (8.4 p.a
    between 1998 and 2003).
  • 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).

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

  • Over 2003-06, gross margin has grown at a 9.5
    CAGR and EBITDA at 16.4 CAGR while sales CAGR
    was 5.8, of which like-for-like sales growth of
  • Indicates that Baneasa has grown organically and
    by acquisitions but acquisitions are the main
    growth factor.