FINA 652 Private Equity

Class I Introduction to the Private Equity industry

Todays class
What is an LBO? Introduction
Some LBO mega-deals Recent evolution

Terminology: Venture Capital versus Private Equity How big is Private Equity?
Who are the main Private Equity firms?

Impact of Private Equity on financial markets

Some well-known LBOs

Large LBOs

Large LBOs
Announced Final price

February 2007 January 2007 June 2006 November 1988 December 2006 December 2005 November 2005 June 2006 May 2006 March 2005
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$43.8 b $39 b $33 b $25 b $16 b $15 b $ 14.5 b $13.7 $12.7 b $11.4 b

What about Europe?

Biggest deal in 2007
Alliance boots 17.8 Billion euros In comparison in 2008 Angel trains for 4.5 Billion euros

In 2011 biggest European deal

Securitas Direct for 2.4 Billion Euros

2006-2007 The heyday of the buyout business

Multibillion-dollar deals were announced almost every week: of the 10 largest buyouts in history, 9 have been completed in this period The leveraged buyout model has evolved into a powerful mechanism for corporate transformation. For investors, private equity often constitutes an interesting alternative asset class. Buyouts are not, however, without critics and do feel the pain of the financial7crisis

European PE & the financial crisis

According to the august 2010 review by Bowne :
value H1 2008 saw a total of e56.5bn from 559 deals, Down 57% on H1 2007 in value terms down 20% on H1 2007 in volume terms

2009 continued this down trend with a rebound post summer 2009

European PE & the post financial crisis

2010 turned positive with mid market transactions (H1) and large buyouts picking up in H2. Total 2010: 76.29bn

According to the unquote Private Equity Barometer in 2011, deal activity was down 11.5% at 1059 (1196) and deal values were down 4.7% at 72.66bn

Largest Private Equity Deals for 2012

1. $7.2 Billion - EP ENERGY CORP (Headquarters: Houston, TX) Acquired By P.E. Buyers: Apollo, Riverstone, Access Industries, Korea National Oil Corporation 2. $6.6 Billion - CEQUEL COMMUNICATIONS (St. Louis, MO) Acquired By BC Partners, Canada Pension Plan Investment Board 3. $4.9 Billion - DUPONT PERFORMANCE COATINGS (Wilmington, DE) Acquired By Carlyle 4. $3.7 Billion - FOCUS MEDIA (Shanghai, China) Acquired By Carlyle, Fountainvest, China Everbright, CITIC Capital, Jason Nanchun Jiang 5. $3.5 Billion - HAMILTON SUNDSTRAND INDUSTRIAL (Windsor Locks, CT) Acquired By Carlyle, BC Partners 6. $3.3 Billion - GETTY IMAGES (Seattle, WA) Acquired By Carlyle, Getty Images management, the Getty Family 7. $3.2 Billion - TRANSUNION (Chicago, IL) Acquired By Goldman Sachs Capital Partners, Advent International 8. $2.7 Billion - PARTY CITY (Elmsford, NY) Acquired By Thomas H. Lee Partners 9. $2.5 Billion - MCGRAW-HILL EDUCATION (New York, NY) Acquired By Apollo 10. $2.3 Billion - USI INSURANCE (Briarcliff Manor, NY) Acquired By Onex Corporation
SOURCE: PrivCo Media LLC

Private Equity reputation: Barbarians at the gate?

Private equity

Barbarians in the dock

Mar 1st 2007. From The Economist print edition

The 1980s are back. Once again, omnipotent and fabulously rich

financiers are storming huge public companies. And once again, they are being denounced as asset strippers prepared to wreck companies and lives in their desire for personal gain. http://www.economist.com/node/8776229?story_id=E1_RSSGNNJ

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Private Equity firms as locusts

Franz Mntefering, then head of the SPD, Germanys Social Democratic party, attacked the behaviour of certain financial firms whose profit-maximising strategies were a long-term threat to our democracy. He described them as swarms of locusts that fall on companies, stripping them bare before moving on.

Criticism of Private Equity

Criticism of the Private Equity industry centers on three charges: 1. Private Equity destroys jobs and runs businesses in bare-bones frugality, neglecting investment and growth opportunities 2. Private Equity unfairly benefits from tax breaks on interest payments 3. Private Equity is non-transparent and secretive, partly because it wants to conceal the exorbitant amount of money it makes

What is Private Equity?

Venture Capital versus Buyout

What some people say about private equity

is all about IPO you mean venture capital has low correlations

is just bad equity

is completely illiquid
means high risks

Private equity

means high retuns

Source: Capital Dynamics

What is Private Equity?

It used to be quite easy to define what was and was not a private equity investment: any equity investment in a company which is not quoted on a stock exchange. Private Equity investments build value in private that is, not publicly traded companies.
Venture capital investments are made in young, start-up companies. Buyout investments are made in (usually) mature, public companies, that are acquired and taken private, restructured and then sold.

Private Equity versus Venture Capital

In Europe, the asset class as a whole is called Private Equity, and it is broadly subdivided into buyout and venture capital (or just venture).

In the US the asset class as a whole is usually called venture capital and buyouts (particularly large ones) are often referred to as private equity.

Defining Private Equity

The National Venture Capital Association: www.nvca.org The Venture Capital IndustryAn Overview
Venture capital investing has grown from a small investment pool in the 1960s and early 1970s to a mainstream asset class that is a viable and significant part of the institutional and corporate investment portfolio. Recently, some investors have been referring to venture investing and buyout investing as "private equity investing." This term can be confusing because some in the investment industry use the term "private equity" to refer only to buyout fund investing.

Terminology in US vs. Europe

Europe U.S.A.

buyout

Private Equity
venture capital

Private equity (= buyout)

Venture Capital

venture capital

IUM courses

Private equity (buyout + spec situations)

FINA 652: this course

venture capital

FINA 651 Venture Capital & Entrepreneurial Finance

Buyout as Private Equity

Buyout investments are made in (usually) mature, public companies, that are acquired and taken private, restructured and then sold.

From Brealey-Myers, page 905: Leveraged buyouts (LBOs) differ from ordinary acquisitions in two immediately obvious ways. First, a large fraction of the purchase price is financed by debt... Second, the company goes private and its shares no longer trade on the open market. The LBOs stock is held by a partnership of (usually institutional) investors and is often referred to as private equity.
When the buyout group is led by the companys management, the transaction is called a management buyout (MBO).

Private equity itself is a diversified asset class

Investments with high value creation potential
Growth expansion Secondary Special situations Distressed

Investments into closely held non quoted companies

Private equity universe Controlling influence and proactive ownership

Mezzanine debt Venture capital Buyout MBO/MBI

Turn-around capital

Investments with a typical horizon of 3 to 7 years

Source: Capital Dynamics

PE as a diversified asset class 1

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PE as a diversified asset class 2

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LBO versus VC: fundraising

Private Equity returns

* But see later our discussion of Private Equity returns

LBO returns
According to the data collected by Thomson Financial and the National Venture Capital Association, for the period 1985-2005 the average net annual return for the buyout industry was 13.3%, while the S&P 500 returned 12.1% a year, on average. However, the top quartile buyout funds have generated net annual returns in excess of 40% during the 20-year period.

LBO return characteristics

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What is an LBO?

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What is an LBO?
The typical view since the 1980s was:
Acquiring companies showing underperformance Aligning Management interests with potentially large incentives Cutting all unnecessary costs, revisiting Adding substantial amount of debt (as much as can be supported by the business) Waiting 5 years and sell!

What is an LBO?
What is an LBO? How does it work? Lets ask one of the best experts.

Henry Kravis (KKR)

1969 Started in Bear Stearns in the corporate finance department. Under Jerome Kohlberg he learned "bootstrap" acquisition. 1976 Founded KKR with Kohlberg and George Roberts Participated in first Public to private deals 1988 won bid for Nabisco, largest LBO in history (until 2006) 2007 Largest LBO (again) TXU for deal estimated at $43.8 B

Barbarians at the Gate

The battle for the control of RJR Nabisco between CEO Ross Johnson and Kohlberg, Kravis & Roberts (KKR) in October-November 1988. The battle ended with the LBO of RJR Nabisco by KKR, valued at $25 billion, the largest in history until July 2006 (HCA was valued at $33 billion).

Barbarians at the Gate

Main characters:
Ross F. Johnson, President and CEO, RJR Nabisco Charlie Hugel, Chairman of the Board, RJR Nabisco John Greeniaus, President and CEO of Nabisco

Henry Kravis, Senior Partner, Kohlberg Kravis Roberts & Co. George R. Roberts, Senior Partner, Kohlberg Kravis Roberts & Co. Peter Cohen, President Shearson Lehman Hutton Jim Robinson, Chairman of the Board American Express

What is an LBO? Debt

From Barbarians at the Gate: Henry Kravis: Everyone benefits when management takes over. Some of the money we borrow. Some we raise from the public sale of securities. We pay off the debt incurred in buying the company with cash from its ongoing operations. And by selling off pieces of the business. Debt can be an asset. Debt tightens a company.

What is an LBO? The valuation

From Barbarians at the Gate:
Henry Kravis: Why dont I have some of my people take a look at your numbers. To get an idea of the value of the company. Something to base a bid on.

What is an LBO? The role of management

From Barbarians at the Gate: Ross Johnson: Tell me one thing. If we did do this deal together, who would be in charge? Who would run the business? How does it work? Henry Kravis: Ask Don. Don: I run my company. Henry and his cousin George are the majority owners, but they maintain a total hands-off policy. Ross Johnson: Whats the catch? Henry Kravis: The catch is: we like people who know what theyre doing, doing it for us. We think youre one of those people, Ross.

What is an LBO? After the buyout

From Barbarians at the Gate:
By the end of the 1980s, American businesses piled up nearly one trillion dollars in debt. John Greeniaus improved Nabiscos earnings by 40% in the first six months of the takeover. RJR Reynolds abandoned Premier cigarettes. Almost half a billion dollars going up in smokeless smoke. For his settlement with RJR Nabisco, Ross Johnson received $53 million (but that was only $23 million after taxes).

Do LBOs destroy jobs?

From Barbarians at the Gate: Henry Kravis: Everyone benefits when management takes over. We pay off the debt incurred in buying the company with cash from its ongoing operations. And by selling off pieces of the business. Ross Johnson: Thats French for firing people, isnt it? Henry Kravis: As few as possible, of course. Ross Johnson: A few dozens? Ten thousand? Henry Kravis: As I said, as few as possible.

The main players and deals

Largest Private Equity firms Largest buyout deals

Henry Kravis, of KKR

Private equity

A barbarian no more
Mar 30th 2006 From The Economist print edition

After 30 years in private equity, Henry Kravis has become the acceptable face of capitalism

Steve Schwarzman, of Blackstone

The new king of Wall Street
February 21 2007
From Fortune magazine

With a history-making deal and a headline-making birthday party, Steve Schwarzman has become the symbol of a new era in finance. And that's always a risky proposition. By Nelson D. Schwartz, Fortune senior writer
http://money.cnn.com/magazines/fortune/fortune_archive/2007/03/05/8401261/

Large Private Equity funds

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Other metrics for recent activity

2011 ranking based on the amount of private equity direct-investment capital raised over a five-year window
http://www.privateequityinternational.com/pei300 See doc Private Equity firms rankings by money raised over 5 years

 The Blackstone Group

www.blackstone.com

A leading global Investments and Advisory firm

Private Equity Group:
Blackstone has been a leader in the field of private equity investing since 1987, managing $28 billion through its Blackstone Capital Partners I, II, III, IV, and V and Blackstone Communications Partners funds.

Portfolio:
http://www.blackstone.com/private_equity/portfolio.asp?Orde r=ByTransactionSize

News: 2/1/2007 Equity Office Reaffirms Support for Blackstone Transaction

 Kohlberg, Kravis, Roberts & Co.

www.kkr.com

Experience. Global Reach. Value Creation KKR:

KKR, one of the worlds largest and most successful private equity firms, has completed buyout transactions that are among the most complex in history. The firms investment approach, however, is fundamentally simple: KKR acquires industry-leading companies and works with management to grow and improve them and thereby create shareholder value.

Portfolio:
http://www.kkr.com/investments/index.html

 The Carlyle Group

www.thecarlylegroup.com Buyout Real Estate Leveraged Finance Venture & Growth Capital

Company Profile:
The Carlyle Group is one of the worlds largest private equity firms, with more than $54.5 billion under management. With 48 funds across four investment disciplines (buyouts, venture & growth capital, real estate and leveraged finance), Carlyle combines global vision with local insight, relying on a top-flight team of more than 400 investment professionals operating out of offices in 16 countries to uncover superior opportunities in North America, Europe, Asia and Australia.

Portfolio:
http://www.thecarlylegroup.com/eng/portfolio/index.ht ml

 Leveraged Finance U.S. mezzanine

Investment Approach
The Carlyle Mezzanine Partners (CMP) team invests in debt and equity securities of leveraged buyouts, recapitalizations and growth financings. CMP pursues a generalist industry approach and leverages The Carlyle Group's extensive expertise in industries such as automotive and transportation, aerospace and defense, media and telecommunications, healthcare, consumer and basic industrial manufacturing. CMP primarily invests in senior subordinated notes with warrants, preferred stock, and minority common equity securities. Investing in debt securities allows CMP to provide current income on a quarterly basis.
http://www.thecarlylegroup.com/eng/fund/investment2276.html

Large Private Equity deals: HCA

Private equity

A record-breaking buy-out
Jul 25th 2006 From The Economist Global Agenda

The $33 billion private-equity deal to buy HCA, an American hospitals group, is the worlds biggest-ever buy-out The attraction of HCA is reasonably clear. The company owns and operates 182 hospitals and 94 surgery centres in America, Britain and Switzerland. Analysts suggest the firm's share price has languished as bad debts from uninsured patients have mounted and competition has grown. Though profits are waning, a healthy cash-flow should help to service new debts. In the longer term, ageing populations will provide ready-made customers.

Large Private Equity deals

American property

Quite a performance
Feb 8th 2007 From The Economist print edition

Blackstone wins the battle for EOP, but the clear victor is the seller Equity Office Properties (EOP), America's largest commercial landlord. cash offer from The Blackstone Group, a private-equity giant that valued the company at nearly $39 billion (including debt), There was an alternative bid (slightly higher) but a riskier mix of cash and shares, from a group led by Vornado Realty Trust, another listed property company Check VNO price evolution over the past two years

Large Private Equity deals

Private equity

A private power play

Feb 26th 2007 From Economist.com

A record takeover of a big energy firm. Expect grumbles In the bear pit of capitalism a little name-calling is an inseparable part of the show. Private equity has attracted a fair amount of abuse down the years. As Kohlberg Kravis Roberts and Texas Pacific Group tie up the worlds largest ever private-equity deal with a $45 billion (including debt) takeover of TXU, a Texas energy firm, expect a little more. KKRs acquisition of RJR Nabisco in 1988, for a long time the worlds biggest and bestknown private-equity deal, earned it the title barbarian. Last year a leading German politician labelled the entire industry locusts. More recently a British union leader chipped in with immoral asset strippers and casino capitalists. But vitriol aimed at the booming business is largely undeserved.

KKR and TPG buy

February 26, 2007. TXU, one of Americas largest utilities, on Monday agreed a $45bn (33.8bn, 22.7bn) takeover by a group led by Kohlberg Kravis Roberts (KKR) and Texas Pacific Group (TPG), the largest private equity deal on record.
The two private equity buyers are paying about $32bn in cash, or $69.25 a share, for TXU, which the utility said represented a 25% premium to the average closing share price over the 20 days ending February 22. KKR and TPG will also agree to take on a $12bn chunk of TXUs outstanding debt. GS capital partners, Lehman Brothers, Citigroup and Morgan Stanley intend to be equity investors at closing, TXU said in a statement

http://www.ft.com/cms/s/568f1b4c-c38f-11db-9047-000b5df10621.html
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Major Private Equity deals

KKR deals
TXU -$43.8 (2007) RJR Nabisco $30bn (1989) HCA $33bn (2006) VNU $11.6bn (2006) TDC 13bn (2006) NXP (Philips) Semiconductors $11bn (2006)

TPG deals
Harrahs $17.1bn (2006) Freescale Semiconductor $17.6bn (2006) Univision $12.3bn (2006) Qantas A$11.1bn (2006)