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Nicolaus Loos
Value Creation in Leveraged Buyouts
GABLER EDITION WISSENSCHAFT
Nicolaus Loos
Value Creation in Leveraged Buyouts
Analysis of Factors Driving Private Equity Investment Performance
With forewords by Prof. Dr. Martin Hilb/Prof. Dr. Beat Bernet and Prof. Oliver Gottschalg, PhD/Prof. Maurizio Zollo, PhD
Deutscher Universitats-Verlag
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Dissertation Universitat St. Gallon, 2005
I.Auflage August 2006
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ISBN-10 3-8350-0488-3 ISBN-13 978-3-8350-0488-7
To my Mother Beatrice -For her Love, unrelenting Dedication And Support towards my Education
Foreword I
The academic and public discussion about Private Equity and Buyout firms and their current acquisition frenzy has once again reached a climax in recent months. The reasons are twofold:
Firstly, the flexibility and sophistication of Private Equity investors, as well as the capital markets serving them, has increased dramatically over the recent years. The current availability of funds to be invested by Private Equity managers is enormous, estimated to be over $150 billion. Equity and debt is raised from institutional investors, pension funds and other asset managers who are keen to put their money to work in high-yielding investment areas and who continue to be highly receptive to Private Equity following a strong recent return track record of this asset class. Relatively cheap lending levels based on stable global economic outlook, as well as a much lower than historical level of default rates among buyouts has led banks to increase their risk appetite noticeably. Consequently, lending banks are offering significant additional financing sources to Private Equity investor clients. The year 2005 has been a record year in the industry in terms of overall deal volume including 845 leveraged buyout transactions totalling $198 billion in transaction value globally. This is in addition to a record $448 billion in leveraged loans being raised in the global capital markets. Buyout deal sizes have reached new heights with 45% of U.S. LBO transaction volume being $2 billion or greater and buyout sizes in 2005 quickly approaching new records, e.g. with the $15.0 billion buyout of Hertz and the $11.3 billion buyout of Sungard in the U.S., as well as the $15.3 billion buyout of Danish telecommunication company TDC - the second largest buyout ever - in Europe. The list of large and established listed companies that could hypothetically be targeted by Private Equity firms is constantly growing.
Secondly, based on the above mentioned trends. Private Equity has once again moved into the public debate arena. The influence and power that Private Equity firms have gained in today's capital markets has led some observers to be vocally concerned: Private Equity firms - and their like-minded, but often more short-term oriented colleagues in the Hedge Fund world - have gained a highly active role in exercising corporate governance change at listed corporations today. They have equally become heavily involved in turning around the fates of countless mis- or under-managed, sometimes already insolvent companies, thereby implicitly often becoming responsible for the destiny of thousands of employees and their families. Especially in Europe, and in particular in Germany, the recent buyout activity has prompted mostly socialist party leaders to condemn Private Equity as capitalistic "locusts", who simply buy out solid, healthy (German) companies, exploit them, and then move on to their next "prey". Notwith-
VIII Foreword I
standing the unqualified nature of such remarks, it should rather be highlighted at this stage that the phenomenon of such public outcry is nothing new. In fact, the current debate simply finds a "second spring" in Europe, while the original discussion had already started during the 1980s in the United States, where hostile takeover activity and leveraged buyouts were pretty much on the "everyday menu". Serious academic interest in the buyout phenomenon began during the second half of the 1980s, and several landmark studies and early work by Michael C. Jensen and Steven N. Kaplan, followed by others, soon proved that this new breed of "active investors" (Jensen) actually played a vital role in addressing management inefficiencies throughout Corporate America. Therefore, these investors should rather be seen as economically important and hence a "necessary evil". With these ideas in mind, how do we go about evaluating the apparently repeating history with respect to the current surge in Private Equity activity? What education and recommendations must we provide - not only to students, academics and practitioners - but also to the likes of populist politicians, stunned investors and concerned outside observers? How do we exercise proper judgement in order to protect all stakeholders' interest?
An attempt to answer these and other related questions is provided in this dissertation. The author has embarked on a "fact-finding mission", unfolding the complexity of the Private Equity asset class and in particular the leveraged buyout transaction to the reader. The aim of this study was first of all to alleviate some of the common beliefs about buyout investors, and secondly to substantiate that argumentation by making explicit where the sources of the evident value creation - which Private Equity firms seem to be pursuing so aggressively -come from. The author has singled out three key areas of value creation in concert with industry experts and has utilized quantitative research on an enviable dataset of buyout transactions to examine each respective area. The vast and intriguing results of this study not only offer novel insights into the Buyout phenomenon, but also contribute meaningfully to the above outlined academic and public discussion by providing an intellectual basis. The contribution of this work can therefore be seen as providing a crucial step forward in allowing us to make a more educated judgement (i) in the context of examining the extent of creation or destruction of value by Private Equity firms, as well as (ii) about which methodologies employed by these companies may be considered ethical or unethical. The author's work without doubt suggests that the economic justification for the existence of Private Equity firms is granted: for example, under these firms' ownership buyout target companies clearly outperformed their industry peers both operationally and financially. This leads to the generation of abnormal economic rents for shareholders on the one side, but at the same time also creates considerably more scope for future investment at the company, leading to new job creation, and hence contributes to overall higher economic welfare. The author makes several important contributions to theory by testing both
Foreword I IX
agency theoretical and strategic management theoretical constructs in the leveraged buyout context.
The presented dissertation can overall be seen as demonstrating a high degree of innovation and applied academic standards. In spite of its explorative character and holistic research approach, the work remains directly relevant to practitioners' education and application through formidable graphical and qualitative description of findings. The range of highly interesting questions and answers on all aspects of the value creation process in leveraged buyouts, often reinforced by strong levels of statistical significance, should be seen as a valuable contribution to the ongoing discussion and research in the field and could serve as basis for future studies.
University of St. Gallen, Switzerland:
Prof Martin Hilb Managing Partner, IFPM Center for Corporate Governance
Prof Beat Bemet Director, Swiss Institute for Banking and Finance
Foreword II
There are few areas in which the imbalance between the economic and social importance of a phenomenon on the one hand, and the available amount of rigorous and data-driven findings from academic research on this phenomenon on the other hand, is as striking as it in the Private Equity domain - in particular in the buyout area. Every year, buyouts affect hundreds of companies, tens of thousands of employees and other stakeholders, as well as a large group of investors. Successful buyouts contribute to the revitalization of mature and sometimes un-derperforming companies, to the enhanced competitiveness of entire industry sectors and to the wealth of countless of individual investors - which are not only high-net-worth limited partners, but also stakeholders in pension funds. Unsuccessful buyouts, on the contrary, lead to bankruptcies, layoffs and massive destruction of shareholder value. Understanding the value creation logic and strategic success factors of leveraged or management buyouts is therefore of crucial importance, and only rigorous and data-driven research can help illuminate the "buyout black-box". While few people would disagree with this assessment, progress in the area of buyout research has been slow compared to other areas of finance or strategic management. This is certainly not due to a lack of interest in the buyout phenomenon on behalf of the academic community, but a result of the proverbial secrecy of an industry that - not without reason - calls itSQlf private equity, and to which buyouts belong. For decades, reliable information about the characteristics and the performance of a large and unbiased worldwide sample of individual buyout transactions has been unavailable for academic research. Hence researchers have been highly limited in the degree to which they could address the fundamental buyout success factors in their work.
This dissertation constitutes without a doubt a true pioneer's effort in terms of gathering and codifying of crucial (often qualitative) information on buyouts into a format suitable for statistical analyses. Through this effort the author composed a data source of unprecedented breadth and depth on thousands of buyouts worldwide, including many details about the acquirer and the portfolio company. The author leverages this data to look at an exceptionally broad range of questions related to buyout success factors that prior research was often unable to address in the same breadth and depth due to data limitations. This monumental effort led to a quantum leap in terms of research insights relative to the status quo ante. At the same time, one dissertation can also only be one - albeit huge and important - first step towards the goal of comprehensively understanding what determines buyout success or failure. Here lies an additional important contribution of this dissertation, as it serves as a powerful roadmap for future research. As others will follow into the author's footsteps and continue to improve
XII Foreword II
the breadth, depth and quality of the available data on buyout transactions, his work will be the basis for subsequent analyses that will be even stronger in terms of statistical power and hence in its ability to consider a broader range of variables simultaneously.
In summary, the presented study is what we consider to be a true landmark study in empirical buyout research. It shows what is possible to achieve through aspiration, inspiration and persistence even in an industry that is thorny territory for empirical research. At the same time, it points to a variety of fruitful avenues for future research in the buyout area that we would love to see explored in full depth by subsequent work. This will not only lead to additional insights of academic value, but also help the main actors in the buyout industry to manage buyouts even better than they currently do.
Paris/Fontainebleau, France:
Prof Oliver Gottschalg, PhD Coordinator of the INSEAD Buyout Research Project
Department of Strategy and Business Policy HEC School of Management, Paris
Prof Maurizio Zollo, PhD Supervisor of the INSEAD Buyout Research Project The Shell Fellow in Business and the Environment,
Associate Professor of Strategy INSEAD Fontainebleau
Acknowledgements
I would like to thank Professor Martin Hilb and Professor Beat Bemet for their patient supervision and their advice. Without their granted freedom and flexibility, encouragement, guidance, confidence and their academic example this thesis could not have been written. Professor Hilb has been very supportive throughout the development of my dissertation and gave me the necessary motivation and freedom to form my ideas. His patience with respect to my continued parallel professional obligations in London was gladly appreciated. Profound gratitude also goes to Professor Maurizio Zollo and Professor Oliver Gottschalg from the INSEAD Buyout Research Centre for inviting me as a visiting doctoral student and researcher to Fontainebleau. Their theoretical groundwork, introduction to the fundamentals of statistics during my studies and genuine insights into the development of this thesis has been invaluable. My appreciation especially goes to Prof. Gottschalg for our successfully developed research partnership around various LBO related research projects throughout my time in France, his availability for the countless brainstorming and "data crunching" sessions as well as for becoming a great friend (who also encouraged and pushed me through the New York Marathon in 2003). I am also much indebted to Prof Maurizio Zollo for giving me the opportunity of a stimulating and very hospitable stay at the Strategy department at INSEAD. It was an academic experience that will accompany me for the rest of my life.
Furthermore, great thanks must go to the armada of research assistants that supported my research efforts through wearisome ground research, data collection, database development and improvements: Ariadna Stefanescu, Pfumo Mu-bako, Gilad Pais, Sachar Rachim, Alfonso Olivares, Rabie Nadi, Qiang Guo, Li Rong, Kate Deurloo, Victor Alves, Arad Edrey, Shiri Katz, Anne-Laure Alviset and Sandrine Dupuis. Ariadna had become an invaluable buyout database "wizard" and through her ingenious computer scientific knowledge she could resolve any database related problems - sometimes even at "inhumane" hours of the day. Dr. Achim Berg's diligently collected and shared universal anthology of research material as well as his material theoretical groundwork has clearly benefited the literature review section of this study. Further thanks has to be extended to colleagues in the field of LBO research, including Christopher Boehringer, Dr. Ludovic Phalippou, Dr. Cristina Soppelsa, Dr. Daniel Zipser, as well as in other fields, including Dr. Michael Gibbert, Dr. Ralph Welpe and Dr. Stefanie Leenen for their help and advice.
I would like to thank Thomson Financial Venture Economics in New York, especially the head of the research department Mr. Jesse Reyes, for offering access to their vast databases on LBO deal and fund data via the INSEAD research
XIV Acknowledgements
collaboration. I am also grateful for the various fruitful early and continued discussions held with leading Private Equity fund of fund investors, including Al-lianz Capital Partners, Axa Private Equity, Credit Suisse First Boston Private Equity, Deutsche Bank Capital, Feri Investments, HarborVest Partners, Henderson Private Equity, Pantheon Ventures and The Partners Group regarding the determinants of buyout value creation, which contributed to this study's research model configuration. I am indebted to several Limited Partners, who through research collaborations have been able to grant access to the confidential LBO fund information that represents the main primary data source in this study. I would like to extend my special thanks to Mr. Norman Rafael and his colleagues in London and New York in on of these organizations - without their personal efforts this study would have not been made possible. All errors are mine alone.
Inexpressible is my gratitude for the help and support of my friends and family. My father's backing for the financing of my sabbatical year considerably helped me to exclusively focus on my research and to complete this study more swiftly. My mother's love and her hands-on encouragement have helped me not to lose track. She lifted my thoughts away and offered a vision of "a life after the dissertation" when it was most needed. As representatives for many supportive friends, I especially would like to thank Mrs. Juliane von Gehren and Mr. Florian Schick for being similarly strong "motivators" throughout some of my most isolated times, during which I completed this dissertation. Seiior Andres Rodenas de la Vega, Mr. Stefan Alceski-Pendoff and Mr. Florian Schick have become great friends and contributed a lot to make the year in France also a very social and enjoyable one. Last but not least I would like to thank the person that most closely followed the stepwise development of this thesis: Miss Sophie Werhahn-Mees has walked along with the ups and downs of its growth path, patient but always urging on, cheering on the way, listening to partly obscure thoughts and making the time working on it worth living.
Nicolaus Loos
Brief Contents
1 Introduction 1
2 Literature Review 9
3 Methodology and Research Design 43
4 Empirical Part I - Market and Financial Value Drivers 89
5 Empirical Part II - The GP Firm and Manager Effect 251
6 Empirical Part III - Buyout Strategies 327
7 Summary and Conclusions 391
8 Appendices 421
9 Bibliography 439
Table of Contents
Foreword I VII Foreword II XI Acknowledgement XIII Brief Contents XV Table of Contents XVII List of Figures XXV List of Tables XXXIII List of Abbreviations XXXVII Abstract XLI
1 Introduction 1
1.1 Background of Research 1 1.2 Problem Statement 2 1.3 Need for Study 4 1.4 Purpose of Study 5 1.5 Scope and Limitations 6 1.6 Organization of Research 7
2 Literature Review 9
2.1 Definitions and the Buyout Process 9 2.1.1 The Private Equity Investment Asset Class 9
2.1.1.1 History of Private Equity 10 2.1.2 Buyout Classification, Organizational Form
and Corporate Governance 12 2.1.3 The Buyout Process 14
2.2 The Buyout Controversy - Alleviating Common Beliefs 17
2.3 Agency Theory of Leveraged Buyouts 19
2.4 Strategic Management View of Leveraged Buyouts 21
2.5 Value Creation in Leveraged Buyouts 23 2.5.1 Direct Drivers of Value Creation 24
2.5.1.1 Achieving Cost Reductions in Buyouts 24 2.5.1.2 Improving Asset Utilization in Buyouts 25 2.5.1.3 Generating Growth in Buyouts 26 2.5.1.4 Financial Engineering in Buyouts 28
2.5.2 Indirect Drivers of Value Creation 29
XVIII Table of Contents
2.5.2.1 Management and Employee Incentivation in Buyouts 30
2.5.2.2 Change in Corporate Governance in Buyouts 32 2.5.2.3 Leverage as Value Creator in Buyouts 32 2.5.2.4 Buyout Culture and Communication 34
2.5.3 Other Sources of Value Creation in Buyouts 35 2.5.3.1 Information Asymmetries and
Market Inefficiency around Buyouts 35 2.5.3.2 Acquisition and Negotiation Skills in Buyouts 36
2.6 Value Destruction in Acquisitions and Leveraged Buyouts 38
3 Methodology and Research Design 43
3.1 Research Goal of the Study 43 3.2 Research Object of the Study 45
3.2.1 Industry Perspective 45 3.2.1.1 Pressure for Disclosure in the Private Equity
Industry 45 3.2.1.2 Pressure for Performance in the Private Equity
Industry 46 3.2.1.3 Consolidation in the Private Equity Industry 47 3.2.1.4 Benchmarking Returns in the Private Equity
Industry 47 3.2.2 Transaction Perspective 48
3.3 Research Model 51 3.3.1 Development of the Research Model 51 3.3.2 The Research Model 52
3.4 General Hypotheses 57 3.5 Performance Evaluation 57
3.5.1 Overview of Performance Evaluation 57 3.5.2 Performance Evaluation in Leveraged Buyouts 58 3.5.3 The Internal Rate of Return Formula 59 3.5.4 Value Attribution in Buyouts - Deduction and Extension
of the IRR Formula through the Dupont Equation 60 3.5.5 Value Attribution Case Study -
The University of St. Gallen Catering Company 65 3.6 Empirical Approach 68
3.6.1 Private Equity Data Collection 68 3.6.2 The Thomson Venture Economics Database 70 3.6.3 The INSEAD LBO Research Database 73 3.6.4 Sample Comparison and Mean Comparison Test 75 3.6.5 Other Data Sources 80
Table of Contents XIX
3.7 Research Methodology and Data Analysis 83 3.7.1 Research Methodology Discussion 83 3.7.2 Approach to Data Analysis 86
4 Empirical Part I - Market and Financial Value Drivers 89
4.1 Introduction 89 4.2 Control Population Overview 90
4.2.1 Private Equity, Venture Capital and Buyout Market Historical Fundraising 90 4.2.1.1 Overview of Historical Private
Equity Fundraising 90 4.2.1.2 A Global View on Private Equity Fundraising 94 4.2.1.3 Private Equity Investment Allocation
by Industries 96 4.2.1.4 Summary of Findings 105
4.2.2 Private Equity, Venture Capital and Buyout Market Historical Fund Performance 105 4.2.2.1 Overall Private Equity Fund Performance 106 4.2.2.2 Buyout Fund Performance 108 4.2.2.3 Venture Capital Fund Performance 108 4.2.2.4 Weighted and Unweighted/i^ 109 4.2.2.5 Private Equity Risk and Return Development 111 4.2.2.6 Performance Trends by Industry Sector 113 4.2.2.7 Private Equity Returns across Countries 120 4.2.2.8 Private Equity Returns by Geography 121 4.2.2.9 Performance by Exit Mode of Private Equity
Investments 123 4.2.2.10 Performance by Investment Stage of
Private Equity Investments 125 4.2.2.11 Summary of Findings 126
4.3 Leveraged Buyout Deal Performance 127 4.3.1 Test Setting 128
4.3.1.1 Tested Variables and Hypotheses 129 4.3.1.2 Methodology and Data 133
4.3.2 Buyout Performance by Year 134 4.3.2.1 Overview of Buyout Performance by Year 134 4.3.2.2 Realized vs. Unrealized Buyout Performance
by Year 135 4.3.2.3 European vs. U.S. Buyout Performance
by Year 136 4.3.2.4 Regression Results 137
XX Table of Contents
4.3.2.5 Summary of Findings 140 4.3.3 Buyout Performance across Countries 141
4.3.3.1 Regression Results 142 4.3.3.2 Summary of Findings 144
4.3.4 Buyout Performance by Industry Sector 144 4.3.4.1 Level 3 Industry Classification 144 4.3.4.2 Level 4 Industry Classification 147 4.3.4.3 Regression Results 150 4.3.4.4 Summary of Findings 154
4.3.5 Ownership and Buyout Performance 154 4.3.5.1 Regression Model 158 4.3.5.2 Summary of Findings 158
4.3.6 Deal Size and Buyout Performance 159 4.3.6.1 Regression Results 160 4.3.6.2 Summary of Findings 163
4.3.7 Investment Holding Time and Buyout Performance 163 4.3.7.1 Regression Results 164 4.3.7.2 Summary of Findings 166
4.3.8 Leveraged Buyout Performance according to Entry and Exit Modes 167 4.3.8.1 Leveraged Buyout Performance according
to Entry Mode 167 4.3.8.2 Leveraged Buyout Performance according
to Exit Mode 172 4.3.8.3 Regression Results 177 4.3.8.4 Summary of Findings 180
4.3.9 Leveraged Buyout Performance according to Entry and Exit Types 180 4.3.9.1 Leveraged Buyout Performance according
to Entry Type 180 4.3.9.2 Leveraged Buyout Performance according
to Exit Type 186 4.3.9.3 Regression Results 189 4.3.9.4 Summary of Findings 192
4.3.10 Summary Tests 193 4.3.10.1 Test of Combined Entry and Exit Control
Variables 193 4.3.10.2 Test of Buyout Firm Variables 194 4.3.10.3 Test of Combined Entry, Exit and GP Firm
Variables 196 4.3.11 Summary of Test Results 197
Table of Contents XXI
4.4 Leveraged Buyout Deal vs. Public Market & Industry Financial Performance 199 4.4.1 Test Setting 199
4.4.1.1 Variables and Hypotheses 200 4.4.1.2 Methodology and Data 202
4.4.2 LBO Value Creation by Industry Sector 203 4.4.2.1 LBO Value Creation by Industry Sector
and Region 205 4.4.2.2 LBO vs. Equity Market Performance
(by Industry) 206 4.4.3 A Buyout Performance Index over Time 208
4.4.3.1 The Buyout Performance Entry Date Index 208 4.4.3.2 The Buyout Performance Exit Date Index 211
4.4.4 LBO Value Creation, Equity Market Return and Correlation 215 4.4.4.1 Regression Analysis 216 4.4.4.2 Additional Descriptive Findings 217
4.4.5 Statistical Tests 218 4.4.5.1 Financial Industry Conditions at Deal Entry 218 4.4.5.2 Financial Industry Conditions at Deal Exit 222 4.4.5.3 Modeling Buyout Performance vs. Benchmark
Industry and Equity Market Performance 227 4.4.6 Summary of Test Results 233
4.5 Leveraged Buyout Value Attribution Analysis 235 4.5.1 Test Setting 235
4.5.1.1 Tested Variables and Hypotheses 235 4.5.1.2 Methodology and Data 237
4.5.2 Test Results 238 4.5.2.1 Descriptive Results 238 4.5.2.2 Regression Test 244 4.5.2.3 Summary of Test Results 245
4.6 Conclusions 245
5 Empirical Part II - The GP Firm and Manager Effect 251
5.1 Introduction 251
5.2 Investment Manager and General Partner Firm Characteristics 252 5.2.1 Test Setting 252
5.2.1.1 Tested Variables and Hypotheses 252 5.2.1.2 Methodology and Data 257
5.2.2 Investment Manager Characteristics 260
XXII Table of Contents
5.2.2.1 Age, Tenure with the Firm and Private Equity Experience 260
5.2.2.2 Education of Buyout Fund Investment Professionals 262
5.2.2.3 Professional Experience and Network of Buyout Investment Managers 271
5.2.3 General Partner Firm Characteristics 275 5.2.3.1 Average Buyout Firm Team Size and Hierarchy..275
5.2.4 Performance of Buyout Firms 279 5.2.4.1 Buyout Firm Returns 279 5.2.4.2 Realized vs. Unrealized Buyout Fund Returns 281 5.2.4.3 General Partner Team Size and Performance 283
5.2.5 Performance of Investment Managers 285 5.2.5.1 Buyout Performance by Education 286 5.2.5.2 Professional Experience, Network and
Buyout Performance 291 5.2.5.3 Experience and Buyout Performance 292
5.2.6 Modeling the Buyout Firm and Team Manager Effect 298 5.2.6.1 Descriptive Statistics 298 5.2.6.2 Coefficient Statistics Analysis 305 5.2.6.3 Linear Regression Models Analysis 308
5.2.7 Summary of Findings 310 5.3 Modeling the Buyout Firm Experience Effect 313
5.3.1 Test Setting 313 5.3.1.1 Tested Variables and Hypotheses 314 5.3.1.2 Methodology and Data 316
5.3.2 Test Results 318 5.3.2.1 Descriptive Statistics 318 5.3.2.2 Coefficient Statistics 319 5.3.2.3 Linear Regression Models Analysis 322
5.3.3 Summary of Findings 323
5.4 Conclusions 324
6 Empirical Part III - Buyout Strategies 327
6.1 Introduction 327 6.1.1 Test Setting 328
6.1.1.1 Tested Variables and Hypotheses 328 6.1.1.2 Methodology and Data 343
6.2 Target Company Characteristics 344 6.2.1 Test results 344
6.2.1.1 Geographic Scope and Buyouts Performance 344
Table of Contents XXIII
6.2.1.2 Type of Goods and Buyouts Performance 345 6.2.1.3 Industry Cyclicality and Buyouts Performance ....346 6.2.1.4 Market Share and Buyouts Performance 347 6.2.1.5 Generic Business Strategy and Buyouts
Performance 348 6.2.1.6 Market Structure and Buyouts Performance 350 6.2.1.7 Product Diversification and Buyouts
Performance 351 6.2.1.8 Customer Base and Buyout Performance 352 6.2.1.9 Distribution Channels and Buyout Performance ..353 6.2.1.10 Prior Organizational Structure and Buyout
Performance 354 6.2.1.11 Prior Corporate Governance Structure and
Buyout Performance 355 6.2.1.12 Prior Ownership Structure and Buyout
Performance 356 6.3 Deal Decisions and Characteristics 357
6.3.1 Test results 357 6.3.1.1 Management Incentives through Equity
Participation and Buyout Performance 358 6.3.1.2 MBO vs. MBI and Buyout Performance 360 6.3.1.3 Deal Source and Buyout Performance 362 6.3.1.4 Seller Type and Buyout Performance 363 6.3.1.5 Co-Investors and Buyout Performance 364 6.3.1.6 Further Involvement of Previous Owner
and Buyout Performance 366 6.3.1.7 Seller's Motivation and Buyout Performance 367 6.3.1.8 Buyer's Motivation and Buyout Performance 369
6.4 Acquisition Process and Strategic Events 371 6.4.1 Test results 371
6.4.1.1 Key Strategic Reorientation/Organizational Events and Buyout Performance 371
6.4.1.2 New Sub-Strategy Implementation Events 372 6.4.1.3 Capacity, Resource Planning and (Dis)Investment
Activities 374
6.5 Modelling Buyout Characteristics, Decisions and Strategic Events ..380 6.5.1 Test results 380
6.5.1.1 Descriptive Statistics 380 6.5.1.2 Coefficient Statistics 383 6.5.1.3 Linear Regression Models Analysis 385
6.5.2 Summary of Findings 386 6.6 Conclusions 388
XXIV Table of Contents
7 Summary and Conclusions 391
7.1 Summary of Study's Key Findings 391 7.1.1 Summary Findings on Market & Financial Related
Value Creation Drivers 391 7.1.2 Summary Findings on Buyout Firm and Investment
Manager Related Value Creation Drivers 399 7.1.3 Summary Findings on Buyout Strategy Related Value
Creation Drivers 404 7.1.4 Interpretation of Results with Research Hypotheses 411
7.2 Contributions to Research and Applications to Practice 412 7.2.1 Contributions to Agency Theoretical and Finance
Research 412 7.2.2 Contributions to Strategic Management Research 415 7.2.3 Applications of Findings to Private Equity Practitioners 416
7.3 Limitations of Study and Areas of Future Research 418
8 Appendices 421
9 Bibliography 439
List of Figures
Figure 1: Purpose of Study - Suggested Approach to Reading according to Audience 6
Figure 2: Areas of Private Equity Investment 9 Figure 3: Overview of the Buyout Process 16 Figure 4: Key Areas and Criteria for LBO Fund Due Diligence 46 Figure 5: General Acquisition Process 52 Figure 6: Acquisition Process - adapted to Leveraged Buyouts 53 Figure 7: LBO Value Creation Model 53 Figure 8: Research Model 55 Figure 9: Summary of Value Attribution in Buyout of the
St. Gallen University Catering Company, Inc 68 Figure 10: Flow of Private Equity Financial Reporting Information 69 Figure 11: Study's Thomas Venture Economics Sample Overview
(January 1980 - June 2003) 72 Figure 12: Conceptual Approach to Data Analysis in the Study 87 Figure 13: Total Global Venture Capital, LBO and
Private Equity Funds Raised (US$ mm) by Year 91 Figure 14: Total Global Venture Capital, LBO and
Private Equity Funds Raised (No. of Funds) by Year 92 Figure 15: Average Fund Size of Total Global Venture Capital, LBO
and all Private Equity Funds Raised (US$ mm) by Year 93 Figure 16: Total Global Venture Capital, LBO and all
Private Equity Funds Raised (US$ mm) by Country 94 Figure 17: Total Global Venture Capital, LBO and all
Private Equity Funds Raised (No. of Funds Raised) by Country 95 Figure 18: Total Amount of Deal Investments (1980-2002)
by Industry Sector (Level 3) 97 Figure 19: Total Number of Deals (1980-2002) by
Industry Sector (Level 3) 98 Figure 20: Average Deal Size (1980-2002) by Industry Sector (Level 3) 99 Figure 21: Average Private Equity Deal Sizes (1980-2002) by Year 100 Figure 22: Total Amount of Deal Investments (1980-2002) by
Industry Sector (Level 4) 101 Figure 23: Total Number of Deals (1980-2002) by
Industry Sector (Level 4) 103 Figure 24: Average Deal Size (1980-2002) by Industry Sector (Level 4) 104 Figure 25: Non-weighted Average Net Fund Returns by Year and
by Fund Type (1983-2002) 106
XXVI List of Figures
Figure 26: Weighted Average Net Fund Returns by Year and by Fund Type (1980-2003) 107
Figure 27: Weighted and Unweighted Net Venture Capital Fund Returns by Year (1980-2003) 109
Figure 28: Weighted and Unweighted Net Buyout Fund Returns by Year (1980-2003) 110
Figure 29: Weighted Net Buyout Fund Returns and Volatility by Year (1980-2003) I l l
Figure 30: Weighted Net Venture Capital Fund Returns and VolatiHty by Year (1980-2003) 112
Figure 31: Average Net Fund Return of Investments made (1983-2003) by Level 3 Industry Sector (Proxy Trend) 114
Figure 32: Average Net Buyout Fund Return of Investments made (1983-2003) by Industry Sector (Proxy Trend) vs. Total Amount of Deal Investments (1980-2002) by Industry Sector (Level 3) 115
Figure 33: Average Net Venture Capital Fund Return of Investments made (1983-2003) by Industry Sector (Proxy Trend) vs. Total Amount of Deal Investments (1980-2002) by Industry Sector (Level 3) 116
Figure 34: Average Net Fund Return of Investments made (1983-2003) by Level 4 Industry Sector (Proxy Trend) 117
Figure 35: Average Net Buyout Fund Return of Investments made (1983-2003) by Industry Sector (Proxy Trend) vs. Total Amount of Deal Investments (1980-2002) by Industry Sector (Level 4) 118
Figure 36: Average Net Venture Capital Fund Return of Investments made (1983-2002) by Industry Sector (Proxy Trend) vs. Total Amount of Deal Investments (1980-2002) by Industry Sector (Level 4) 119
Figure 37: Average Net Fund Returns (1983-2002) by Country 120 Figure 38: Average Net Private Equity Fund Returns (1980-2002) of
Investments made by Year and by Region (Fund's jurisdiction)...121 Figure 39: Average Net Venture Capital Fund Returns (1980-2002) of
Investments made by Year and by Region (Fund's jurisdiction)...122 Figure 40: Average Net Buyout Fund Returns (1980-2002) of Investments
made by Year and by Region (Fund's jurisdiction) 123 Figure 41: Weighted Average Net Fund Returns of Funds based
on Investment Status 124 Figure 42: Weighted Average Net Fund Returns of Funds based
on Investment Stage 126 Figure 43: Average Gross Returns of Buyout Deals by
Investment Status and by Year (1981-2002) 134
List of Figures XXVII
Figure 44: Average Gross Returns of Realized Buyout Deals by Region and by Year (1981-2002) 137
Figure 45: Average Gross Returns of Realized Buyout Deals by Country 141 Figure 46: Average Gross Returns of Buyout Deals by Industry Sector
and Investment Status (1980-2002) 145 Figure 47: Average Gross Returns of Buyout Deals by Industry Sector
and by Region (1980-2002) 146 Figure 48: Average Gross Returns of Buyout Deals by Industry Sector
(Level 4) and Investment Status (1980-2002) 148 Figure 49: Average Gross Returns of Buyout Deals by Industry Sector
(Level 4) and Region (1980-2002) 149 Figure 50: Average Gross Returns of Realized Buyout Deals by
Ownership Percentage Quartile 155 Figure 51: Average Gross Returns of Realized U.S. Buyout Deals
by Ownership Percentage Quartile 157 Figure 52: Weighted Average Gross Returns of Realized European
Buyout Deals by Ownership Percentage Quartile 158 Figure 53: Weighted Average Gross Returns of Realized Buyout Deals
by Average Investment Size Categories 159 Figure 54: Average Gross Returns of Realized Buyout Deals
by Holding Period 164 Figure 55: Weighted Average Gross Returns of Buyout Deals by Entry
Mode, Average Invested Capital and Investment Status 168 Figure 56: Weighted Average Gross Returns of Buyout Deals by Entry
Mode, Holding Period and Region 170 Figure 57: Weighted Average Gross Returns of Buyout Deals by Entry
Mode, Holding Period and Investment Status 171 Figure 58: Weighted Average Gross Returns of Buyout Deals by Entry
Mode, Average Invested Capital and Region 172 Figure 59: Weighted Average Gross Returns of Buyout Deals by Exit
Mode and Invested Capital 173 Figure 60: Weighted Average Gross Returns of Buyout Deals by Exit
Mode, Holding Period and Region 175 Figure 61: Weighted Average Gross Returns of Buyout Deals by Exit
Mode and Holding Period 176 Figure 62: Weighted Average Gross Returns of Buyout Deals by Exit
Mode, Holding Period and Region 177 Figure 63: Weighted Average Gross Returns of Buyout Deals by
Entry Type, Holding Period and Investment Status 182 Figure 64: Weighted Average Gross Returns of Buyout Deals by
Entry Type, Average Invested Capital and Investment Status 183 Figure 65: Weighted Average Gross Returns of Buyout Deals by
Entry Type, Holding Period and Region 184
XXVIII List of Figures
Figure 66: Weighted Average Gross Returns of Buyout Deals by Entry Type, Average Invested Capital and Region 185
Figure 67: Development of Weighted Average Gross Returns, Average Invested Capital and Average Holding Period of Buyout Deals acquired via Auction 186
Figure 68: Weighted Average Gross Returns of Buyout Deals by Exit Type, Average Invested Capital and Average Holding Period 187
Figure 69: Weighted Average Gross Returns of Buyout Deals by Exit Type, Average Invested Capital, Average Holding Period and Region... 188
Figure 70: Realized LBO Deals' Value Creation vs. Industry Indices (Level 3) 204
Figure 71: Realized LBO Deals' Value Creation vs. Industry Indices (Level 4) 205
Figure 72: Realized LBO Deals' Value Creation vs. Industry Indices (Level 3) for selected Industries by Region 206
Figure 73: Realized LBO Deals' Value Creation Index vs. Equity Market Performance (S&P 500, MSCI EuropeAVorld) grouped by Deal's Industry Classification 207
Figure 74: Realized LBO Deals' Value Creation Index vs. Industry Indices Performance (Level 6) by Buyout Acquisition Year 209
Figure 75: Realized LBO Deals' Value Creation Index vs. Average Holding Period of Deals by Buyout Acquisition Year 210
Figure 76: Realized LBO Deals' Value Creation Index vs. Average Industry Performance Driver CAGRs by Acquisition Year 211
Figure 77: Realized LBO Deals' Value Creation Index vs. Industry Indices Performance (Level 6) by Buyout Exit Year 212
Figure 78: Realized LBO Deals' Value Creation Index vs. Average Industry Performance Driver CAGRs by Buyout Exit Year 213
Figure 79: Realized LBO Deals' Value Creation Index vs. Average Holding Period of Deals by Buyout Exit Year 214
Figure 80: Realized LBO Deals' Value Creation Index vs. Average Industry Indices Performance (Level 6) and S&P 500 Composite Price Index by Buyout Acquisition Year 217
Figure 81: Revenue, Cash Flow and Profitability Development for Buyout Deals vs. Industry Comparables 239
Figure 82: Entry and Exit Conditions for Buyout Deals vs. Industry Comparables 239
Figure 83: Value Attribution of All Buyout Deals vs. Industry Comparables 242
Figure 84: Value Attribution of Buyout Deals vs. Industry Comparables - Consumer Goods Sector 242
Figure 85: Value Attribution of Buyout Deals vs. Industry Comparables - Basic Industries and General Industrials 243
List of Figures XXIX
Figure 86: Value Attribution of Buyout Deals vs. Industry Comparables - Information Technology Sector 244
Figure 87: Investment Manager and General Partner Firm Drivers of Value Creation 253
Figure 88: Distribution of Age of Buyout Fund Investment Professionals 260 Figure 89: Distribution of Tenure of Buyout Fund Investment
Professionals 261 Figure 90: Distribution of Private Equity Experience of Buyout
Fund Investment Professionals 262 Figure 91: Distribution of all Degrees Earned by Buyout Fund
Investment Professionals 263 Figure 92: Distribution of First Degree Earned by Buyout Fund
Investment Professionals 264 Figure 93: Distribution of Second Degree Earned by Buyout Fund
Investment Professionals 264 Figure 94: Distribution of Third Degree Earned by Buyout Fund
Investment Professionals 265 Figure 95: Additional Professional Qualifications Earned by
Buyout Fund Investment Professionals 265 Figure 96: Field of all Degrees Earned by Buyout Fund
Investment Professionals 266 Figure 97: Field of first Degree Earned by Buyout Fund
Investment Professionals 266 Figure 98: Field of second Degree Earned by Buyout Fund
Investment Professionals 267 Figure 99: Field of third Degree Earned by Buyout Fund
Investment Professionals 267 Figure 100: Top 31 Universities - All Degrees Earned by
Buyout Fund Investment Professionals 268 Figure 101: Top 12 Universities - MBA Degrees Earned by
Buyout Fund Investment Professionals 270 Figure 102: Network, Professional Experience and Current Positions
of Buyout Fund Investment Professionals by Sector 271 Figure 103: Typical Buyout Fund Hierarchy and Functions with
Average Number of Investment Professionals per Level 276 Figure 104: Average GP Team Size and Size Category Frequency vs.
Average Deal Size of Buyout Funds 278 Figure 105: Weighted Average Gross IRR based on all underlying
Transactions by General Partner 280 Figure 106: Realized vs. Unrealized deal-based Weighted Average
Gross IRR by General Partner 282 Figure 107: Weighted Average Gross IRR on Realized Deals by
Buyout Firm Team Size 283
XXX List of Figures
Figure 108: Weighted Average Gross IRR on Deals by Individual Buyout Investment Professionals by Degree Level 287
Figure 109: Weighted Average Gross IRR on Deals by Individual Buyout Investment Professionals by Degree Type 288
Figure 110: Weighted Average Gross IRR on Deals by Individual Buyout Investment Professionals by attended University 289
Figure 111: Weighted Average Gross IRR on Deals by Individual Buyout Investment Professionals by attended Business School ....290
Figure 112: Weighted Average Gross IRR on Deals by Individual Buyout Investment Professionals by Position 292
Figure 113: Weighted Average Gross IRR on Deals by Individual Buyout Investment Professionals by Years of Private Equity Experience .293
Figure 114: Weighted Average Gross IRR on Deals by Individual Buyout Investment Professionals by Years of Tenure 295
Figure 115: Weighted Average Gross IRR on Deals by Individual Buyout Investment Professionals by Hierarchy 296
Figure 116: Weighted Average Gross IRR on Deals by Individual Buyout Investment Professionals by Age 297
Figure 117: Strategic Drivers of Value Creation 329 Figure 118: Buyout Deal Performance by Level of Geographic
Scope of Operations 345 Figure 119: Buyout Deal Performance by Type of Goods 346 Figure 120: Buyout Deal Performance by Cyclicality of Industry 347 Figure 121: Buyout Deal Performance by Market Share Position 348 Figure 122: Buyout Deal Performance by Generic Business Strategy 349 Figure 123: Buyout Deal Performance by Market Structure Position 350 Figure 124: Buyout Deal Performance by Product Diversification of
Buyout Target 351 Figure 125: Buyout Deal Performance by Size of Customer Base of
Buyout Target 352 Figure 126: Buyout Deal Performance by Distribution Channel of
Buyout Target 353 Figure 127: Buyout Deal Performance by Organizational Structure of
Buyout Target 354 Figure 128: Buyout Deal Performance by Corporate Governance
Structure of Buyout Target 355 Figure 129: Buyout Deal Performance by Corporate Governance
Structure of Buyout Target 357 Figure 130: Buyout Deal Performance by GP's Management
Incentive Strategy of Buyout Target 358 Figure 131: Buyout Deal Performance by Percentage of
Target Management Equity Participation 360
List of Figures XXXI
Figure 132: Buyout Deal Performance by Role of Management in Deal Origination 361
Figure 133: Buyout Deal Performance by Deal Source 362 Figure 134: Buyout Deal Performance by Seller Type 364 Figure 135: Buyout Deal Performance by Type of Co-Investor 365 Figure 136: Buyout Deal Performance by Number of Co-Investors 366 Figure 137: Buyout Deal Performance by Involvement of Previous Owner 367 Figure 138: Buyout Deal Performance by Seller Motivation 368 Figure 139: Buyout Deal Performance by Buyer Motivation 369 Figure 140: Buyout Deal Performance by Key Strategic
Reorientation/Organizational Event 372 Figure 141: Buyout Deal Performance by
New Sub-Strategy Implementation Events 373 Figure 142: Buyout Deal Performance by Capacity,
Resource Planning and (Dis)Investment Activities 375 Figure 143: Buyout Deal Performance by Acquisition
and Divestiture Activity 376 Figure 144: Buyout Deal Performance by Type of Add-on Acquisition 378 Figure 145: Buyout Deal Performance by Number of Add-on Acquisitions ....379
List of Tables
Table 1: Characteristics of the Ideal LBO Candidate 13 Table 2: Types of Corporate Restructuring 49 Table 3: Forms of Leveraged Buyout Transactions Classification 50 Table 4: Private Equity Funds and Buyout Funds -
Total Population Overview 71 Table 5: Buyout Funds' underlying Deals - Total Population Overview 72 Table 6: Limited Partners' Primary Dataset Overview 76 Table 7: Mean Comparison Test - Group Statistics Summary 79 Table 8: Mean Comparison Test - Independent Samples Test Results 80 Table 9: Datastream Industry Classifications (Level 3, Level 4) 81 Table 10: Datastream Industry Classifications (Level 6) 82 Table 11: Descriptive and Correlation Statistics on Entry and Exit Years 138 Table 12: Coefficients and Collinearity Statistics on Entry and Exit Years 139 Table 13: Linear Regression Model on Entry and
Exit Year Dummy Variables 140 Table 14: Descriptive and Correlation Statistics on Country Variables 143 Table 15: Coefficients and Collinearity Statistics on Country Variables 143 Table 16: Linear Regression Model on Country Variables - Model 1 144 Table 17: Descriptive and Correlation Statistics on (significant) Industries 151 Table 18: Coefficients and Collinearity Statistics on Combined Entry
and Exit Dummy Variables - Model 1 152 Table 19: Linear Regression Model on Industries Level 3, 4 and 6 153 Table 20: Descriptive and Correlation Statistics on Deal Size Variables 161 Table 21: Coefficients and Collinearity Statistics on Deal Size Variables -
Model 1 162 Table 22: Linear Regression Model on Deal Size Variables - Model 1 162 Table 23: Descriptive and Correlation Statistics on
Holding Period Variables 165 Table 24: Coefficients and Collinearity Statistics on
Holding Period Variables - Model 1 166 Table 25: Linear Regression Model on Holding Period Variables -
Model 1 166 Table 26: Descriptive and Correlation Statistics on Entry and Exit Modes 178 Table 27: Coefficients and Collinearity Statistics on Entry and Exit Modes..., 179 Table 28: Linear Regression Model on Entry and
Exit Mode Dummy Variables 180 Table 29: Descriptive and Correlation Statistics on Entry and Exit Types 190 Table 30: Coefficients and Collinearity Statistics on Entry and Exit Modes.... 191
XXXIV List of Tables
Table 31: Linear Regression Model on Entry and Exit Type Dummy Variables 192
Table 32: Linear Regression Model on all combined Entry and Exit Dummy Variables - Model 1 193
Table 33: Descriptive and Correlation Statistics on General Partners 194 Table 34: Coefficients and Collinearity Statistics on General Partners -
Model 1 195 Table 35: Linear Regression Model on General Partners - Model 1 196 Table 36: Linear Regression Model on Deal Size Variables 197 Table 37: Overview of Correlation Tests between Private Equity
and Market Returns 215 Table 38: Correlation Table on Buyout Correlation with
Industry Performance 216 Table 39: Linear Regression Model on Buyout Correlation with
Industry Performance - Model 1 217 Table 40: Descriptive Statistics on Industry Financial Entry Conditions 220 Table 41: Coefficients and Collinearity Statistics on
Entry Condition Variables 221 Table 42: Linear Regression Model on Entry Condition Variables 222 Table 43: Descriptive Statistics on Industry Financial Exit Conditions 224 Table 44: Coefficients and Collinearity Statistics on
Exit Condition Variables 225 Table 45: Linear Regression Model on Exit Condition Variables 226 Table 46: Nested Linear Regression Models on
Industry Financial Performance Drivers (Level 3/4/6) 230 Table 47: Operationalization of Buyout Team Characteristics
Explanatory Variables 259 Table 48: Examples of Positions and Institutions of
Buyout Fund Investment Managers by Profession 272 Table 49: Examples of Positions and Institutions of
Buyout Fund Investment Managers by Profession or Affiliation 274 Table 50: Descriptive and Correlation Statistics on
Buyout Firm Deal Experience Variables 301 Table 51: Descriptive and Correlation Statistics on
Buyout Firm Deal Experience Variables (Unis) 304 Table 52: Coefficients and Collinearity Statistics on
Buyout Firm Team Experience Variables - Model 7 307 Table 53: Linear Regression Model on
Buyout Firm Deal Experience Variables 309 Table 54: Operationalization of Explanatory Variables 317 Table 55: Descriptive and Correlation Statistics on
Buyout Firm Deal Experience Variables 318
List of Tables XXXV
Table 56: Coefficients and Collinearity Statistics on Buyout Firm Deal Experience Variables 320
Table 57: Linear Regression Model on Buyout Firm Deal Experience Variables 323
Table 58: Descriptive and Correlation Statistics on Buyout Firm Strategy Variables 382
Table 59: Coefficients and Collinearity Statistics on Buyout Strategy Variables - Model 4 384
Table 60: Linear Regression Model on Buyout Firm Strategy Variables 386 Table 61: Summary Findings - Buyout Deal Performance and
Entry and Exit (Control) Variables 392 Table 62: Summary Findings - Buyout Performance vs.
Industry Performance and Financials 396 Table 63: Summary Findings - Buyout vs. Industry Financial Performance ...398 Table 64: Summary Findings - Investment Manager and
GP Firm Characteristics 400 Table 65: Summary Findings - GP Firm Buyout Experience Profile 404 Table 66: Summary Findings - Buyout Target Strategic Characteristics 406 Table 67: Summary Findings - Buyout Strategic Deal Decisions
and Characteristics 408 Table 68: Summary Findings - Buyout Acquisition Process and
Strategic Events 410 Table 69: Coefficients and Collinearity Statistics on Combined Entry
and Exit Dummy Variables 422 Table 70: Descriptive and Correlation Statistics on
Industry Financial Performance Driver (Level 3/4/6) 424 Table 71: Coefficients and Collinearity Statistics on
Industry Financial Performance Driver (Level 3) 426 Table 72: Coefficients and Collinearity Statistics on
Industry Financial Performance Driver (Level 4) 427 Table 73: Coefficients and Collinearity Statistics on
Industry Financial Performance Driver (Level 6) 429 Table 74: Correlation Statistics on Deal Entry Condition Variables 430 Table 75: Correlation Statistics on Deal Exit Condition Variables 431
List of Abbreviations
A Assets
Acq. Acquisition
AIM Alternative Investment Management
ARD American Research and Development Corporation
Avg Average
BO Buyout
bn Billion
CAGR Compounded Annual Growth Rate
CalPERS The California Public Employees' Retirement System
CAPM Capital Asset Pricing Model
CD&R Clayton, Dubilier & Rice, Inc.
CEO Chief Executive Officer
CFA Certified Financial Analyst
CFO Chief Financial Officer
CH Switzerland
CPA Certified Public Accountant
DB Deutsche Bank
Df (Statistical) Degree of Freedom
E Equity
EBITDA Earnings before Interest, Depreciation, Amortization and Taxes
Ec. Economics
e.g. Exempli gratia (Latin), for example
EM Equity Multiplier
ESOP Employee Stock Ownership Plan
et al. Et alii, et aliae, et alia (Latin), and others
etc. Et cetera (Latin), and other things, and so forth
EU European Union, Europe
EV Enterprise Value
EVCA European Private Equity and Venture Capital Association
Exp. Experience
XXXVIII
FV
GDP
GH
GP
H
HBS
HEC
Herf. D.
Hold Per
i.e.
Ind.
Inv Cap
IPO
IRR
IT
JD
KKR
LBO
In
LP
M&A
M.B.A.
Mgmt
mm
MBI
MBO
MIT
MSCI
MSDW
N/A
NAV
N,n
ND
List of Abbreviations
Future Value
Gross Domestic Product
General Hypothesis
General Partner
Hypothesis
Harvard Business School
Haute Etudes Commerciales School of Management
Herfmdahl Degree (Index)
Holding Period (of Investment)
Id est (Latin), that is
Industry
Invested Capital
Initial Public Offering
Internal Rate of Return
Information Technology
Juris Doctor, Doctor of Law
Kohlberg Kravis Roberts & Co.
Leveraged Buy-Out
Natural Logarithm
Limited Partner
Mergers & Acquisitions
Master of Business Administration
Management
Million
Management Buy-In
Management Buy-Out
Massachusetts Institute of Technology
Morgan Stanley Capital International, Inc. (Capital Market Indices Provider)
Morgan Stanley Dean Witter
Not announced, not applicable
Net Asset Value
Statistical Frequency, Case Number
Net Debt
List of Abbreviations
NI
NVCA
NYU
P PC
PE
PEIGG
PhD
PPM
P-to-P
R&D
Rev
ROE
S&P
SBA
SBIC
SFA
Sig.
StDev
TMT
UCLA
U.K.
Uni
U.S.
USA
us$ USD
VC
VE
VIF
WACC
yrs
Net Income
American National Venture Capital Association
New York University
(Statistical) Probability Value
Portfolio Company
Private Equity
Private Equity Industry Guidelines Group
Philosophi Doctor (Latin), Doctor of Philosophy
Private Purchase Memorandum
Public to Private
Research and Development
Revenues
Return on Equity
Standard and Poors
Small Business Administration
Small Business Investment Companies
Securities and Futures Authority
Significance
Standard Deviation
Technology, Media and Telecom; Top Management Team
University of California Los Angeles
United Kingdom
University
United States of America
United States of America
U.S. Dollar
U.S. Dollar
Venture Capital
(Thomson Financial) Venture Economics
Variance Inflation Factor
Weighted Average Cost of Capital
Years
XXXIX
Abstract
This study addresses sources of value creation in leveraged buyouts. Prior studies in the field of Private Equity - and especially buyout - research broadly suffered from a lack of accessibility to the highly confidential buyout deal and fiind performance data of Private Equity firms. Following the establishment of a few selective, successfiil research collaborations with leading Private Equity Fund investors (Limited Partners) and subsequent access to their vast archives of collected information, including obtained performance data, this study sheds light on the performance dynamics of a sample of more than 3,000 realized and unrealized leveraged buyout transactions, undertaken by 84 of the major buyout-focused U.S. and European Private Equity firms, drawn from 252 of these firms' funds between 1973 and 2003, with the majority of recorded transactions taking place during the 1990s. The study addresses value creation drivers according to three dimensions: (i) exogenous, i.e. capital market-, industry-, financial- and acquisition-related value drivers, (ii) endogenous, i.e. buyout investment manager and buyout firm profile as well as experience related drivers, and (iii) buyout acquisition strategy related value drivers.
The theoretical part reviews two competing explanations for the phenomenon of apparently significantly higher value generation and return out-performance of leveraged buyouts undertaken by financial buyers, when weighed against comparable companies on the one side, as well as compared to common merger and acquisition activity of strategic buyers on the other side. The agency theoretical explanation is established around the far-reaching changes in corporate governance regimes at buyout targets post acquisition: the frequent use of managerial incentives act as stimuli for closer management supervision and control on the one side, and as a mean to initiate more radical strategic change on the other side. By contrast, the strategic management view is centred around the fact that in the event of a complete absence of synergies that would drive acquisition rationales of strategic buyers, the interaction and knowledge transfer between the LBO firm and its portfolio companies as well as the development of an acquisition competence on part of the LBO organization must be seen as most important available source for the observed degree of value generation. Subsequently, the theoretical part continues by providing an in-depth overview of possible direct and indirect drivers of value creation or value destruction in leveraged buyouts, based on the universe of available buyout literature. The theoretical section also offers a framework to analyse leveraged buyout transactions and introduces the "leveraged buyout value attribution formula", a deduction from the Dupont formula that makes explicit the relative sources of value generation in a particular buyout.
XLII Abstract
The empirical part is structured into three main chapters alongside the above identified three dimensions of potential sources of value creation. The first empirical chapter starts with an overview of the universe of leveraged buyout transactions, assembled by Private Equity information provider Thomson Financial Venture Economics, with respect to Private Equity fundraising and fund performance history. Subsequently, based on the primary transaction dataset collected from Limited Partners, the study finds evidence that several of the herein examined exogenous factors such as entry and exit years, entry and exit types and modes, industry, country/origin, amount of invested capital, percentage of ownership, holding period, acquiring GP firm, industry and equity market performance, as well as industry financial development, have demonstrated to be (statistically) significant value/performance drivers in the leveraged buyout value creation process, as measured by the dependent variable gross deal performance's internal rate of return (IRR).
The second empirical chapter introduces endogenous factors of value creation, focusing on the LBO organization and its members. The Private Equity firms examined in this study were screened with a view on their investment managers' level and type of education, professional experience as well as the buyout firm's hierarchical homogeneity/diversity and organizational deal-making experience profile. The study finds evidence that the professional experience, and to a lesser degree the investment managers' education, has a significant impact on expected returns. In addition, the LBO firm's organizational structure, team composition and diversity vs. homogeneity configuration are found to play an important role from a return perspective. Detailed, previously unpublished descriptive results with respect to profiling characteristics of investment manager backgrounds and LBO firm organizations are presented. Moreover, in contrast to earlier findings from the M&A literature field, this study uncovers evidence for the existence of a learning effect in executing buyout transactions. While a long transaction experience track record (often associated with more established funds) and geographic investment focus proves to be positively correlated to performance, a focus limited to one or few industries does not. These findings collectively underline the existence of a "GP effecf in leveraged buyouts.
The third and final chapter of the empirical part presents descriptive and statistical results published for the first time in this form of an analysis of leveraged buyouts' strategic value drivers, i.e. what observable strategies do buyout firms follow and which buyout target characteristics and strategic deal decisions may lead to higher value creation. Despite being partially restricted by lower sub-sample sizes for a few of the analyzed independent variables (and hence accompanied by lower statistical significance levels), the exploratory micro-level analysis in this study offers several surprising results regarding buyout target characteristics, affirming both prior agency theoretical and to a lesser extent strategic management theory oriented M&A literature. The analysis of strategic measures in the critical post-acquisition management phase demonstrates that an exchange
Abstract XLIII
of top management teams as well as growth oriented (also through add-on acquisitions) rather than cost cutting strategies will benefit buyout transaction returns. Overall, the agency theoretical explanation of superior returns in leveraged buyout fmds stronger evidence.
In summary, the presented study's research approach has been of exploratory nature and its main contributions to theory and practice can be seen in the developed three-pillared conceptual framework, an unparalleled sample size compared to any study in Private Equity research (as known by the author at this time) as well as the magnitude of previously unpublished descriptive and statistical findings regarding performance of leveraged buyout transactions. The consistently high levels of statistical significance further support the chosen research design. Each of the three chapters of the empirical results part is thereby seen as major ground to further deepen the understanding of academia and practitioners in the future. Moreover, this study has also intentionally omitted one area of potential future research: the acquisition-related dynamics and interactions initialized through the buyout firm on the portfolio company management level.
"Once you buy a company, you are married. You are married to that company.
It's a lot harder to sell a company than it is to buy a company. People always call and congratulate us when we buy a company.
I say, 'Look, don't congratulate us when we buy a company, congratulate us when we sell it.
Because any fool can overpay and buy a company, as long as money will last to buy it.'
Our Job really begins the day we buy the company, and we start working with the management,
we start working with where this company is headed. "
Henry R. Kravis Financier and Investor