The grease in the machinery

1
The grease in the machinery An introduction to
the buy-out industry and EQT A presentation at
the University of Gothenburg, School of Economics
and Commercial Law Håkan Johansson, Partner
October 2004
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Who can argue with a new model of enterprise
that aligns the interest of owners and managers,
improves efficiency and productivity, and unlocks
hundreds of billions of dollars of shareholder
value. Michael Jensen, Harvard Business School
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Introduction to private equity
There are a number of incorrect misconceptions
about private equity (organized investments in
non-listed equity)

• Due to the limited information and transparency
  in the private equity world, there are a number
  of incorrect misconceptions and rumours about the
  industry
• It is all about buying at low multiples and
  selling at high multiples
• Value creation comes from aggressive
  over-leveraging
• In private equity-owned companies, RD costs are
  slashed and people loose their jobs
• The only winners from the private equity
  industry are the greedy private equity managers -
  all other stake-holders are losers

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Introduction to private equity
On the contrary, there are number of evidences
that all these misconceptions are incorrect
In fact, private equity is today an important and
valuable part of the global economy, benefiting
industries in development/transition, owners of
businesses, employees, investors and the economy
as a whole. Private equity investors are
prepared to take risks where there exists a
potential to create value! Hence, private
equity is today an important grease in the
global economy providing liquidity and ensures
accelerated industrial development and change.
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Introduction to private equity
There are two principal parts of private equity
venture capital (unproven start-ups) and
buy-outs (mature/proven businesses)
Focus of presentation

• Buy-outs
• Mature companies and industries (proven)
• Proven technology and industries
• Low or declining margins, scope for increased
  efficiency
• Outdated/ill-suited ownership structure
• Need for industrial change and consolidation
• Experienced management
• Tax shields from interest costs and leverage on
  equity invested by using debt
• Low operational risk, low/moderate growth,
  positive cash flows

Cash flows

• Venture Capital
• New companies and industries (unproven)
• Technology/industry bets
• New business models with potentially high margins
• High operational risk, high growth, negative cash
  flows

Cash flows -
Organic growth rate -
Time/Maturity -
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The history of buy-out funds
Serving a fundamental need and niche, buy-out
players are an institutionalized evolvement with
several predecessors

• Value ensurers Ensuring no-value arbitrage
  opportunities in the public and private equity
  markets.
• Cleaners/fixers Fixing up underperforming
  companies.
• Preparers Preparing companies for being
  listed on a stock exchange or other types of
  institutional ownership.
• Developers and risk takers Actively driving
  undeveloped potential without the short-sighted
  mind-set of the stock market (quarterly
  capitalism).
• Liquidity enhancers Ensuring liquidity in
  times of poor liquidity and in succession
  situations, and other complicated ownership
  structures etc.

There is a fundamental need for a type of owner
that is always flexible, liquid, and hands-on
1900
1850
1950
2000
Wealthy families
Merchant banks
Investment companies/conglomerates
Buy-out companies
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The history of buy-out funds
Why have the buy-out players been so successful
as a concept?
Why have the buy-out players been successful?
Where did the predecessors fall short?

• Funded by a number institutions/ investors for
  10-year periods the buy-out players are always
  liquid and not affected by individual economic
  circumstances
• Buy-out players are temporary owners focused
  solely on their strategy of implementing their
  value-enhancing strategies there are no side
  agendas
• Buy-out players have explicit competences in
  their focus areas of change management, sector
  expertise, financial engineering etc
• Buy-out players are professionally structured to
  act as a temporary owner
• 10 year funds
• Clear governance models GP/LP
• Clear split of value creation

• Liquidity affected by individual/ corporate/stock
  market cycles and fortunes
• Temporary holdings are non-core.
• No clear exit strategies can lead to a very large
  portfolio and lack of focus
• Usually, their competences are centred around
  other issues than being a professional temporary
  owner
• No uniform structures exists

Capital base
Approach
Expertise
Set-up and structure
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The history of buy-out funds
Conclusions on the background of the buy-out funds

• Act as a professional temporary owner take a
  business from one level to the next
• Develop businesses
• Create value and make money for the investors
• There is a need for flexibility and liquidity in
  the market place for corporate ownership
• A company can always be taken to the next level!
• Institutional investors do not have the
  organisations, know-how or experience to make
  these investments themselves there is hence a
  need for buy-out management companies like EQT
• Being private is advantageous in many ways no
  politics, no distractions, no short-sightedness,
  only focus on long-term value creation
• Broad ownership and buy-in of strategies
  motivated staff and management
• Aggressive, continuous focus on all value
  creation strategies
• Strategic re-positioning
• New growth venues markets, products
• Sustainable improvements to costs and margins
• Low hanging fruits on costs
• Efficiency improvements
• Leverage - tax efficient, leverage on equity
  invested
• Flexibility on exit

Role and purpose
Why needed?
Why does it work so well?
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Development of the buy-out business models
What is corporate value and value creation?
Enterprise value
Net debt
Equity value

• Perceived value of all cash flows from the
  Company to debt and equity holders.
• Hence, deducting the future value of all
  operational costs and tax.

• Net present value of net debt undertakings
  (interest bearing debt-cash).
• Usually book value of debt.

• All remaining value after deducting net debt.

Description
DCF value, or
Factors affecting valuation of the equity
Company and industry
Top-line growth
Release of cash flows
Margins EBITDA, EBIT, etc
profile
Without a doubt, top-line growth and margin
improvements are the most important value drivers
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Development of the buy-out business models
The buy-out business model has evolved
significantly the last three decades
1960s and 1970s
1970s and 1980s
1990s and 2000
Phase I Value Arbitrage
Phase II Financial Engineering
Phase III Industrial/Accelerating Development

• Market Conditions
• Inefficient market place
• Few buyers several
• companies for sale
• Limited availability of loan
• capital

• Market Conditions
• Semi-efficient market place
• Several MBO firms competing
• Abundance of capital both
• equity and debt

• Market Conditions
• Efficient market place
• Many MBO firms competing
• Plenty of financing and
• financial engineering available

• Focus of transactions
• Break-up of conglomerates
• Asset disposals
• Value arbitrage

• Focus of transactions
• Old economy industries
• Cost-cutting strategies
• Financial engineering

• Focus of transactions
• Companies with development potential
• Create value by building businesses

• Competitive advantage
• MA transaction competence needed
• Ability to maximize leverage

• Competitive advantage
• Restructure balance sheet
• Manage cash flows

• Competitive advantage
• Industrial competence
• Willingness to invest in the
• future
• Experience of driving change

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The Nordic buy-out market
Private equity in the Nordic region, while
well-established, still relatively small compared
to more mature markets
Drivers of the growth of private equity in the
Nordic region
Maturity and sizes of different private equity
markets

• Continuous corporate restructurings
• Private company ownership succession issues
• Large public equity market with some inefficient
  pricing of smaller/odd shares
• Significant share of mid-sized companies with
  ambitions and potential for geographical expansion

USA, 4,9 25 years
Private equity ownership as of GDP
UK, 2,9 15 years
Nordic region, 1,410 years
Germany, 0,45 years
Years of professional and sophisticated buy-out
market
Private equity in the Nordic region, as of GDP,
could very well double in the next 5-10 years
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The Nordic buy-out market
Market development and split of investment size
Nordic MA and buy-out markets 1998-2002
Nordic buy-out size per deal (EUR M) 1998-2002
EUR 250 M

EUR 50-250 M

EUR 25-50 M

EUR 5-25 M

EUR lt5 M

The buy-out market in the Nordic region, to some
extent follows (with a lag) the MA market, but
in some aspects is more volatile, and has
increased its share of the MA market The
majority of buy-outs in the region are in the EUR
50-250 M range
Source Initiative Europe
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The buy-out market creation of value
Some perspectives on the returns in European
private equity
IRR () comparison48 European funds 1995-2001
and EQT
IRR () over time, market vs 148 European funds
1986-2001
Equity market returns Dow Jones European
Large Cap Index Risk adjusted - 800 pb for
illiquidity
Source 148 private equity funds analysed as
part of the McKinsey Excellence in European
Private Equity Initiative. EQT Numbers refer to
exited gross IRR to date 1994-2004.

• Top private equity funds have significantly
  outperformed public equity markets
• Furthermore, there is a significant gap
  decisively separating the top firms from the rest
  of the industry

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The buy-out market creation of value
Which private equity firms are successful?
Who raise successful successor funds?146
European funds 1986-2001
While there are many successful approaches and
strategies in buy-out funds, a clear conclusion
is that historic track record is a very good
indicator of superior performance
Source 148 private equity funds analysed as
part of the McKinsey Excellence in European
Private Equity Initiative
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The buy-out market creation of value
Breakdown of value creation by top quartile
funds star deals
Value creation in star deals is through company
out-performance
Source 148 private equity funds analysed as
part of the McKinsey Excellence in European
Private Equity Initiative
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The buy-out market creation of value
Analysis of realised top quartile funds by deal
source
Analysis of 189 realised deals of top quartile
funds (1984-2001)
Source
Investment performance
Pooled IRR,
Privatisations provided significant returns, but
were few in numbers
Source 148 private equity funds analysed as
part of the McKinsey Excellence in European
Private Equity Initiative
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The buy-out market creation of value
Analysis of deal duration
Deals realised between 1984-1994,
Deals realised between 1995 and 2001,
0-1.5 years 1.5-3 years 3-5 years 5
years
Duration
Arbitrage and interim plays are decreasing in
importance, highlighting the necessity of
industrial strategies
Source 148 private equity funds analysed as
part of the McKinsey Excellence in European
Private Equity Initiative
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The buy-out market creation of value
What has created superior returns in Swedish
buy-outs (1990-1998)?
No/weak evidence
Supporting evidence
Type of seller
?
Type of exit
?
?
Strategic initiatives and restructuring
MA activity
?
Driving sales growth and margin improvement
?
Aggressive leverage
(?)
Choice of industry
?
Clearly, just as is the case in rest of Europe,
an industrial approach and actual contributions
to a portfolio company is what has generated
superior returns in Swedish buy-outs
Forsberg, Karam (1999) The Minting Machines -
An empirical study of the institutional returns
on Swedish buy-out returns Investments
1990-1998, Stockholm School of Economics
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EQT

• EQT is a private equity group with a unique
  industrial approach to developing mid-sized
  growth companies in Northern Europe
• EQT serves as an active owner and works in close
  co-operation with the management of the companies
  it acquires, to develop and implement
  value-enhancing strategies
• Founded in 1994, approximately 5 B in equity
  under management in five funds

With a track record and a mission of delivering
superior returns over time Total realised IRR of
100 or 5x capital invested
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EQTs business concept
The business concept can be split in three
distinct stages
?
?
?
Realize value created
Identify value creation potential
Drive value creation processes
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What are we looking for?
EQT has a distinct approach to selecting
investments with a focus on finding/driving growth

• High quality companies, in attractive industries,
  that can serve as platforms for growth
• WHY?
• Growth the only way to create long term values
• Growth allows
• Operational improvements
• Multiple expansion
• Easier exit

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What are we looking for?
Companies/situations where EQT can contribute as
an active hands-on owner

• EQT has experience and know-how of
• Improving value chain position (re-positioning)
• Accelerating internationalisation of regionally
  strong players
• Attracting excellent operating managers
• Driving and accelerating MA structurally
  changing an industry
• Developing family-owned companies/divisions into
  capital market-oriented corporations

• Sleeping beauties companies with development
  potential not addressed (Thule,
  Brukens, Dahl, Com Hem)
• Families/corporations seeking partners for the
  development of their companies (Duni, Perlos,
  Tradex, Sabroe, Plantasjen)
• Non-core divisions in large corporations(Ballings
  löv, Flexlink, HemoCue, Salcomp, Nederman,
  Dometic)
• Privatisations(Stjärn-TV, IHI, Com Hem)

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Clear division of labour no side-tracking is
allowed
EQTs Corporate Governance Model

• Manage day-to-day operations
• Report to the Board

Management

• Appoint and evaluate key managers and supplement
  managers when needed
• Define and monitor strategic plans
• Share and expand international network

Board of Directors

• Oversee strategic development and evaluate new
  initiatives
• Appoint and evaluate the Board and evaluate
  performance of Company
• Appoint new Board members if necessary
• Constant focus on impact on exit and ensuring
  maximum value
• Initiate and lead the exit process
• Assisting management in financing processes and
  MA work

EQT
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Case TAC (1/2)
TACTAC is a world leading supplier of open
systems for Building-IT, controlling the indoor
environment and access control Employees 700
(1998) to 2,200 (2003) Year acquired 1998,
auction from Incentive AB

• Investment Rationale
• Expand on strong market position in the Nordic
  countries
• Stable cash flow through extensive after market
• Potential to become a true global player
• Leader in open systems, a pre-requisite for
  integration

Industrial Acceleration

• Strategy
• Grow sales by leveraging new product platform
• Improve efficiency pricing
• Drive consolidation to extract synergies from
  acquisitions

• People
• New top management
• New mix of competencies
• Highly involved board leadby Göran Lundberg (ex
  ABB)

• Incentives
• Extensive financial incentives to more than 100
  employees
• Strong support from the board and EQT to
  expand the business

TAC was a non-core business in a conglomerate,
with very strong product portfolio in an industry
that was still very much in its infancy With
significant resources (both capital and
know-how), EQT could aggressively grow and
develop TAC as the industry was developing and
consolidating
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Case TAC (2/2)
The results sales grew by more than 400 and
EBITDA by 1 000
Operational development during EQTs 5-year
ownership period Sales growth 400EBITDA
growth 1 000
Investment results 4x money invested Gross IRR
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Value Creation of equity value
Margin expansion
41
Sales growth
67
Debt pay down 3
Multiple expansion 4
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Analysis of value creation in all of EQTs exits
Value Driver
of Equity Created1
Sales growth
Margin expansion
Strategic re-positioning (multiple expansion)
7
Debt pay down
Proof of our strategy and focus!
(1) As of 2004/04. Excludes Orrefors Kosta Boda
which was converted to shares in Royal
Scandinavia Group prior to exit.
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Conclusions
The key learnings from this presentation are

• Private equity and buy-out funds fill an
  increasingly important role as grease in the
  global economy, providing
• Liquidity and flexibility regardless of business
  cycles
• A willingness and competence to address
  difficult situations as companies and
  industries evolve
• Buy-out funds are an institutionalized evolvement
  with several predecessors, specialized for the
  purpose of being a professional temporary owner
  and developer of businesses
• Private equity and buy-out firms have been
  successful in creating significant value,
  primarily by growing and developing companies in
  evolving industries
• When successful, buy-outs are important parts of
  the global economy, driving
• Increased focused and efforts on long-term value
  enhancing strategies and initiatives (such as
  RD)
• Industrial development and transition
• Increased employment as companies grow
• Increased tax base as number of employees are
  increased and unemployment is lowered