Seminar: introduction to private equity

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Seminar introduction to private equity
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Contact

• Antoine Parmentier
• Antoine.parmentier_at_aig.com
• 44(0)7809.510.373

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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.

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Content

• 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

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Introduction to Private Equity
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Introduction

• 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
  Partners
• PE funds are managed by the General Partners

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• Structure of private equity participations

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The fuel of private equity

• The debt
• Acquisitions are made through leveraged buyout
  deals (LBOs)
• The investors
• PE funds managers must be disciplined and
  patient
• 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

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A diversified asset class

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

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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

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Venture capital (2/2)

• Investment from up to 10m and often pre-revenues
  balance-sheet
• 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.

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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)

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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
  issues

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Buyout (3/3)

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

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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
  (liquidationbankruptcy)
• Loans are rated BB and below by SP based on
  usual ratio (debt/EBITDA, EBITDA interest
  coverage, etc)

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Distressed / Special situation (2/2)

• Distressed debt investors try first to influence
  the process
• Debt holders have access to confidential
  information
• Then, as debt holders, they can take the control
  of the company

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Secondary (1/2)

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

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Secondary (2/2)
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Mezzanine (1/3)

• Debt instrument immediately subordinated to the
  equity
• 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.

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Mezzanine (2/3)

• Mezzanine suffered before credit crunch as senior
  debt was easy to access
• Since July 2007 and lack of funding, mezzanine is
  back
• 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

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Mezzanine (3/3)
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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

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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.
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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
  sector
• 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

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Real assets (2/2)

• Steady and regular cash flow 10-15 annual cash
  return
• Downside protection due to high recovery value of
  the assets loss of value of the asset is
  unlikely
• Uncorrelated assets

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Why allocate assets to PE ?
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Portfolio management

• Asset allocation is define by returns, risk
  (measured by standard deviations of returns) and
  correlations
• Diversification improve returns while reducing
  risk
• Allocation is determined using public information
  of traditional asset classes (equity, bonds,
  REIT, etc...)

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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
  required.
• 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.

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The issue with private equity

• Illiquid investments
• PE funds are closed-end funds (except secondary
  market)
• 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
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• However, Allocation to PE increased significantly
  over the last years
• Low correlation to pricing trends of traditional
  assets
• Diversification thus risk reduction
• Good returns over the years Average annual IRR
  1986-2005 is 18.3

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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
  portfolio
• Relatively good returns of PE over the last years.

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• LBO activity in Europe

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Geography
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Sectors
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European buyout value
European buyout value 72 billion in Q1-Q3 2008
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European buyout by region
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PE as a percentage of GDP

• Nordic countries have the most important PE
  activity
• Benelux figures are impacted by few mega deals.

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European fundraising activity
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Funds on the market
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Seeking capital is becoming difficult

• Number of vehicles seeking capital keep on
  increasing
• But the number of final closing and the path
  investors deploy capital has slowed down
  dramatically
• Investors (LPs) are hesitant and sometimes face
  liquidity issues

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• 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

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Average fundraising
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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.

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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.

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Outlook

• 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
  raise
• Historical performances and focus strategies will
  become key factors in the future some GPs wont
  survive
• Some LPs will need to free up some capital and
  clean up their portfolio increase in secondary
  transactions.

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Outlook

• 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
  capital
• 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

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

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Profile of the LPs
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The measure of performance
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Track record
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Measures of performance

• Multiple of cost
• Also called Total Value over Paid-In capital
  (TVPI)
• (Cash distributions Unrealized value)/capital
  invested
• Cash returned regardless of timing (total
  return).
• Internal Rate of Return (IRR)
• Discount rate that makes NPV of all cash flows
  equal zero
• Linked to timing Quick flip high IRR.

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The J-curve

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

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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.

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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

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The J-curve

• Underperforming investments tend to be written
  down more quickly than successful companies
  develop
• 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.

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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

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Fund of Funds due diligence the selection of PE
managers
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Due diligence focus

• Quantitative analysis
• Past investments and track record
• Leverage and debt
• Sources of proceeds.
• Qualitative analysis
• Team
• Strategy
• Market opportunity

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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.

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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.

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Track record

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

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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.

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Vintage year performance
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Presentation

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

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The worlds biggest private equity firms
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Carlyle

• 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
  countries
• Assets deployed in Americas (59), Europe (28)
  and Asia (13)
• Currently 140 companies, 68 billion in revenues
  and 200,000 workers.

Source www.carlyle.com
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Carlyle deals

• Hertz
• Zodiac
• Terreal
• Le Figaro
• VNU

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Blackstone

• Founded in 1985 by Steven Schwarzman and Peter
  Peterson
• 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.

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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
  (minority)
• Orangina 2.6bn in February 2006

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KKR

• 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.

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KKR deals

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

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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

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Private equity deals

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

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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
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• 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
  abroad.

Source AFIC/ErnstYoung
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Presentations

• KKR
• Blackstone
• Carlyle

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The mega buyout era
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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).

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• Bigger are the funds, bigger are the target
  companies
• 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
  after
• Some funds created quoted vehicles to access
  permanent capital or listed the management
  companies on the public market

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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.

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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.

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Rational for larger pools of capital

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

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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.

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Rise of Club-deals

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

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Disappearance of club-deals

• Collusion charges
• Difficulties to share informations
• Tendency to monopolize the control the control
• Ego-issues.

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Examples of mega club deals
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Presentations

• Caveat Investor / the uneasy crown, The
  Economist, Feb 2007
• Whos next, The Deal, July 2008

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Value creation in private equity
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Value creation drivers

• EBITDA generation
• Multiple expansion
• Debt reduction

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EBITDA generation

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

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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

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Debt reduction

• Entry net debt exit net debt

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Example
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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.

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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.

101
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

102

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

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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

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• 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
  revision
• 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
  later

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Presentation

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

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Structure of a Leverage Buyout transaction
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Structure of a leverage buyout

• Deal structure
• Equity
• Debt
• Debt is either
• Unsecured
• Secured

108
LBO structure
109
Equity

• Common equity, preferred equity, shareholder
  loan
• 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
  intermediaries.

110
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

111
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.

112
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

113
Capital structure
114
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)

115
Average LBO equity contribution
Less debt available more equity required to
close a deal
116
Loan volume dropped significantly
Banks lending capacities are dry ! Q1-Q3 2008
loan volume 46.6 billion Q1 2007 loan volume
45.75 billion
117
Evolution of capital structure
Back to the classic structure Senior Debt
Mezzanine
118
Cost of debt
Cost of debt increased significantly in 2008
119
LBO spread
120
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

121
Consequences

• 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
  structure

122
EBITDA multiples
123
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.

124
The pros and cons of being private
125
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
  some
• Superior access to capital and liquidity
• More extensive and transparent approach to
  governance and more explicit balancing of
  stakeholder interests.

126
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
  processes
• Stronger strategic leadership
• More effective performance oversight
• Manage only key stakeholders interests.

127
Rating of public and private Boards of Directors
128
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
  creativity
• Executive management reports on the progress of
  the latest strategic decision implemented.

129
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.

130
Performance management in private equity
companies

• 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.

131
Performance management in public companies

• High level performance managment, no real
  detailed analysis
• Focus on quarterly profit targets and market
  expectations
• 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.

132
Management development and succession in private
companies

• 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

133
Management development and succession in public
companies

• 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
  performance

134
Stakeholder management in private companies

• Executive management can clearly identify a
  majority shareholder
• PE funds are locked-in for the duration of the
  fund
• PE fund represent a single block and are much
  more involved and informed than public
  shareholders
• Less onerous and constructive dialogue
• No or little experience dealing with media and
  unions (see Walker report and debate over PE in
  2007)

135
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
  funds.
• Different priorities and demands CEOs need to
  learn to cope with this very diverse range of
  investors
• In case of P2P, HF can block the privatization
  (95 threshold to delist) Alain Afflelou
  purchase by Bridgepoint.

136
Governance and risk management in public
companies

• 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)

137
Governance and risk management in private
companies

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

138
Top priorities
139
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
  management.

140
Credit crisis impact and consequences on private
equity
141
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
  arrangements DONNER DES EXEMPLES DE COVENANT A
  RESPECTER DANS UN LOAN TYPE

142
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
  LBOs
• Mid and large LBO debt/EBITDA ratios were at all
  time high in 2007 (and were even higher for large
  than mid LBOs).

143
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
  leverage

144
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
  declining
• 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.

145
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

146
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

147
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

148
After July 2007 (5/5)

• The crisis opens doors to new investment
  opportunities
• 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
  cash.

149
Consequences
150
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.

151
Recession years are usually good vintage years
152
Recession vs Non-recession
153
Case study Baneasa
154
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
  group
• 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
  footwear)
• Potential growth prospect organic growth (new
  stores openings) and consolidation (fragmented
  industry).

155

• 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

156

• 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

157

• 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

158

• Clothing business 44 sales and 43 of EBITDA
  and
• Footwear business 56 sales and 57 EBITDA

• Well balanced, similar EBITDA margins in both
  segments

159

• 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
  competition)

160

• Bogdan Novac was CEO of Baneasa from 2000 to 2003
  and 2004 to today.
• EBITDA has grown from 231m to 365m (a CAGR of
  16.4)

• Good management team // experienced CEO
• Strong performance over the last years (since
  2003)

161

• 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.

162

• 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

163

• 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)

164

• 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

165

• 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

166

• 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

167

• 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
  price-competitiveness.

• Potential decline of OOT/inconsistent growth
  rate risk.

168

• 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.

169

• 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).

170

• 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)

171

• 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
  3.7.

• Indicates that Baneasa has grown organically and
  by acquisitions but acquisitions are the main
  growth factor.