Download - Exploring Private Equity
Exploring Private Equity
October 29, 2013
1
Introduction
Justin Shuman
– Education:
Drexel University (B.S., Business Administration)
Cornell University (M.B.A., Concentration in Investment Banking)
– Professional Experience:
Woodlawn Partners – Senior Associate (Current)
Harris Williams & Co. – Associate (2011 – 2013)
DuPont Capital Management – Analyst (2007 – 2009)
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Contact Information
E-mail: [email protected]
Private equity definition and overview of the industry
ecosystem including funds, investors, and portfolio
companies
Step-by-step walk through a hypothetical private equity
transaction including sourcing, valuation, and
confirmatory diligence topics
Recommended reference materials for learning more
about valuation, investment banking, and private equity
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PE Market Overview PE Transaction Recommended Reading
Private Equity Value Chain
Value Chain
Investors commit capital to funds, fund-of-funds, or directly invest in
assets
Funds deploy capital into assets on behalf of their investors (LPs or
Fund-of-Funds)
Investments receive capital from LPs, Funds, and Fund-of-Funds
Pension Funds
Endowments
Foundations
Bank Holding Companies
High-Net-Worth Individuals
Insurance Companies
Investment Banks
Corporations
Other…
INVESTORS (“LPs”) FUNDS
PE Fund
PE Fund
PE Fund
Fund of Funds
INVESTMENTS
Venture
Growth Equity
Buyouts
Mezzanine
Special Situations
Real Assets Direct Investments
Invests in PE Funds
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PE Market Overview PE Transaction Recommended Reading
A Short Vocabulary Lesson…
Limited Partnership Agreement (“LPA”): the agreement that binds LPs to GPs and defines investment
strategy as well as all other rules for fund governance
Commitment: LP investment in a private equity fund
Capital Call: issued by the GP before the closing of a transaction. A capital call requests capital from LPs to
fund investment
Investment Period: normally 5 years from the fund being “turned on” (i.e. fees commencing and the first
capital call). After 5 years the GP may not draw down capital for new investments (“use it or lose it”)
Fund Life: usually 10 years
Fund Extension: highly negotiated but often 2 year increments to provide more time for the GP to manage
and exit existing investments in the fund.
Deal-by-Deal: economic calculation that determines carried interest on a deal-by-deal basis (easier to get to
the carry early)
Back-Ended: economic calculation that determines carried interest on a total fund basis (more difficult to get
to the carry early)
Hurdle Rate: the IRR hurdle which a GP must earn for LPs before it can begin to take 20% of the profits
IRR: internal rate of return is the discount rate that will bring a series of cash flows to an NPV of 0
Return on Invested Capital (“ROIC”): realized capital / invested capital
EBITDA Multiple: purchase price / EBITDA
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PE Market Overview PE Transaction Recommended Reading
Fundraising Climate
Significant amounts of private equity raised before the downturn created buying power
– Moving further into an investment period heightens pressure to invest
– Assuming a five-year investment horizon, $141 billion of private equity’s $348 billion of dry powder will need to
be invested over the next two to three years
Given the capital overhang, fundraising has proven challenging since 2008
– With 805 funds currently in the market, time from initiation to final close is proving longer than 2005 – 2008.
– Fundraising in 2012 fell to the lowest level seen in more than a decade, but the amount of capital raised increased 13%
from 2011 as larger funds found the most success
$428
$501 $481
$433
$373
$348
$0
$100
$200
$300
$400
$500
$600
$0
$20
$40
$60
$80
$100
$120
$140
$160
$180
2007 2008 2009 2010 2011 2012
Cu
mu
lativ
e O
verh
an
gOv
erh
an
g b
y Y
ea
r
Cumulative Overhang Under $100M $100M - $250M $250M - $500M
$500M - $1B $1B - $5B $5B +
For the Years Ended December 31, 2007 – 2012
($ in billions)
Capital Overhang of U.S. PE Investors by Vintage Year
Source: Pitchbook.
229 228
275
221
118 113 128
110
0
50
100
150
200
250
300
2005 2006 2007 2008 2009 2010 2011 2012
No
. o
f F
un
ds
Ra
ised
U.S. Private Equity Fundraising
Source: Pitchbook.
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PE Market Overview PE Transaction Recommended Reading
33%
21% 13%
12%
9%
8% 4% 34%
20%
13%
14%
6%
7%
5%
Business Products & Services Consumer Products & Services
Healthcare Information Technology
Financial Services Energy
Materials and Resources
0
100
200
300
400
500
600
700
800
900
$0
$50
$100
$150
$200
$250
$300
1Q
07
2Q
07
3Q
07
4Q
07
1Q
08
2Q
08
3Q
08
4Q
08
1Q
09
2Q
09
3Q
09
4Q
09
1Q
10
2Q
10
3Q
10
4Q
10
1Q
11
2Q
11
3Q
11
4Q
11
1Q
12
2Q
12
3Q
12
4Q
12
Total Capital Invested Deal Count
Private Equity Deal Activity
172 exits took place in 4Q 2012, and the record 6,538 portfolio companies still held will drive
future activity
Private equity deal flow has been partially supplemented by the record $64.1 billion in dividend
recapitalizations in 2012, 58% higher than the previous record of $40.5 billion for the full year
2010
Total Private Equity Deal Flow PE Deals by Industry
For the Years Ended December 31, 2011 – 2012
Source: Pitchbook.
For the Quarters 1Q07– 4Q12
Source: Pitchbook.
Tra
nsa
ction
Volu
me
Valu
e of
Dea
ls
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PE Market Overview PE Transaction Recommended Reading
Middle market M&A transactions (<$500MM) accounted for 91% of private equity deal volume in
2012 as investors exhibited a preference toward smaller deals
49% of private equity capital was allocated to deals below $500 million in 2012, the second
highest total since 2005
Since credit market conditions are positive, the proportion of large deals should grow in 2013
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2005 2006 2007 2008 2009 2010 2011 2012
0-24M 25M-99M 100M-499M 500M-999M 1B-2.5B 2.5B+
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
2005 2006 2007 2008 2009 2010 2011 2012
0-24M 25M-99M 100M-499M 500M-999M 1B-2.5B 2.5B+
Private Equity Deal Size
For Years Ended Dec. 31, 2005 – 2012 For Years Ended Dec. 31, 2005 – 2012
Percentage of PE Transactions (Count) by Size Percentage of PE Investment by Deal Size
Source: Pitchbook. Source: Pitchbook.
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PE Market Overview PE Transaction Recommended Reading
1 – 2 Weeks
Conduct
Due
Diligence
/ Arrange
Financing
Negotiate
Purchase
Agreement
Deal Time-Line
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PE Market Overview PE Transaction Recommended Reading
Source Lead
Speak
with
Owner
Indication
of Interest
(“IOI”)
Negotiate
Letter of Intent
(“LOI”)
Close
Transaction
Create
Valuation &
Returns
Model
1 – 2 Weeks 1 Week 1 Week 2 - 4 Weeks 12 – 16 Weeks
1 2 4
TRANSACTIONS TAKE ANYWHERE FROM 5 MONTHS TO 6 MONTHS OR MORE TO CLOSE
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Sourcing
Traditional Intermediaries
– Investment Banks
– Business Brokers
Proprietary Sources
– Accountants
– Lawyers
– Business Owners
– Trade Associations
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PE Market Overview PE Transaction Recommended Reading
1
PROPRIETARY DEAL FLOW NORMALLY EQUALS BETTER/CHEAPER PURCHASE PRICES
Valuation & Return Analysis
DCF
– Use management’s assumptions (revenue growth, profit margins, etc.) to back
into what equity value is worth
LBO
– Similar to a DCF analysis, but a LBO shows an investor how much it can pay in
order to achieve its target equity return
– Can simulate return scenarios under various capital structures
Public Comparables
– Evaluate what EBITDA multiples similar businesses trade at in today’s market
Precedent Transactions
– Review what similar private businesses were acquired for within the last 12-24
months
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PE Market Overview PE Transaction Recommended Reading
2
TRIANGULATE IN ON FAIR PRICE THAT MEETS UNDERWRITING RETURN TARGETS
Due Diligence
Accounting
– Vet accounting practices and controls
– “Quality of earnings” report normally done to validate that
operating results are conservative
Business
– Evaluate product/service offering to validate financial model
– Analyze competitive landscape
– Review key employees
Environmental / Legal
– Scrutinize potential environmental and legal liabilities that could
impact a transaction
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PE Market Overview PE Transaction Recommended Reading
3
FIND AND UNDERSTAND EVERY RISK ASSOCIATED WITH THE ACQUISITION
Transaction Financing
Equity
– Fund: capital call draws down equity from LPs in pro-rata fashion at close
– Management: existing management usually “rolls” equity
– Co-investors: LPs that directly invest in the equity outside of the fund
Debt
– Senior Debt: secured by assets
– Subordinated Debt: unsecured, second lien on assets
– Mezzanine Debt: fills the gap between equity and debt
14%-16%, PIK, warrants, no amortization (principal payments) until maturity
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CAPITAL STRUCTURES & FINANCING FLEX DURING DILIGENCE AS RISK IS UNDERSTOOD
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Books “Applied Mergers & Acquisitions” – Robert F. Bruner
“Investment Banking: Valuation, Leverage Buyouts, and Mergers & Acquisitions” – Joshua Rosenbaum and Joshua Pearl
“Competition Demystified” – Bruce C. Greenwald & Judd Kahn
“Understanding Michael Porter” – Joan Magretta
Websites www.prequin.com
www.pehub.com
www.pitchbook.com
www.thedeal.com
www.dealbook.com
www.altassets.com
www.bloggingbuyouts.com
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PE Market Overview PE Transaction Recommended Reading