Achieving genuine value improvement in difficult economic times

1

• Achieving genuine value improvement in difficult
  economic times
• Moderator Nikki Brown
• Panellists
• John Peacocke, Next Capital
• Nigel Bingham, Pencarrow
• Kerry McIntosh, Ironbridge
• David Moore, ANZ Specialised Lending

2
Embedding Value
Deal screening
Deal structuring
Portfolio monitoring
Exit
On track
Watchlist - proactive approach
Needs work - restructuring, turnaround
3
(No Transcript)
4
Achieving genuine value improvement in a
difficult environment from the perspective of
new deal screening and due diligence John
Peacocke, Next Capital
5
Next Capital

• Next I 265m fully deployed
• Next II 285m looking to invest
• Target
• Australia and NZ, enterprise value 50m-250m
• Expansion capital and small-mid buyout
• Back strong management over 4-5 years
• Origins Formerly Macquarie private equity, late
  1980s
• Results 5 funds, 40 realised deals, average IRR
  30

6
Deal screening A People business

• Management must be Champions
• Experienced sector, cycle, successes, failures
• Capable of growth and complexity
• Actively seek us as partners always a tension
• Market position strong, defendable
• Cash reliable cash flows
• Growth market and business, particularly
  expansion capital
• Exit rely on resilient competitive position, not
  on exit markets
• The right jockey right horse right race

7
Deal flow Lower average quality
1. Good businesses
2. Stressed, Distressed
3. Listed assets, P2P

• On sidelines
• Dream of 07
• Less ready credit, de-leveraging
• Earnings pressure X Perceived lower multiples
• Few data points
• Great bolt-ons
• Improving over last quarter

• Few good deals
• Banks assertive but patient (2/3rd reviewed,
  1/3rd more security)
• Grabbing the rug, not pulling it
• Fees on fees
• Optionality
• Improve, unwind or implode (2nd round crunch)?

• Fully priced
• Uncertain earnings
• Management OK, Boards reluctant
• Prefer deeply discounted issues
• Survival, not EPS

8
Whats new? Not much

• Same circus, different tent
• Great people Collaborative partnership
  experience through the cycle
• Dont chase value
• Pay the right price keep some headroom
• High growth forecasts X High exit multiple X High
  gearing Negative equity in a downturn
• Act quickly stay across the detail act early
  and often
• The wash up
• Optimistic going into next cycle patience
• Fewer PE managers in 3-5 years?

9
Achieving genuine value improvement in a
difficult environment active management of a
mid-market portfolio Nigel Bingham, Pencarrow
10
Value Creation Drivers

• Leverage
• Dependent on credit availability. Can work both
  ways.
• Operational improvement
• Sales growth, margin growth, working capital
  improvement, etc
• Real focus for mid-market
• Multiple expansion
• Dependent on fund vintage
• Icing on cake if can grow business

11
Mid-market approach

• Define investment thesis
• How attractive is the business?
• How will we grow and improve it? Front office
  harder to fix than back office.
• How will we make it more attractive to a future
  owner and who would that owner be?
• Undertake due diligence
• Confirm investment thesis
• Confirm deal structure, capital structure and
  management ownership
• Agree 100-day operating plan
• Provides momentum for rolling 100-day plans
• Execute plan
• Exit

12
Plan Execution Elements

• Alignment of management with PE owner
• Fill in management gaps (eg, new CFO)
• Board reporting and governance
• IT system upgrade (esp, accounting, CRM)
• Organic growth initiatives (eg, greenfields
  expansion, distribution rollout)
• Business model improvement (eg, China sourcing)
• Bolt-on acquisitions and realising synergies
• Cost reduction and working capital improvement
  initiatives

13

• Achieving genuine value improvement in a
  difficult environment
• Restructuring from sows ear to silk purse
  
• Kerry Mcintosh, Ironbridge

14
Ironbridge

• Fund I closed Sep 2004, A450m, fully invested
• Fund II closed Oct 06, A1.05b
• Target
• Australia and NZ, enterprise value 250m-750m
• Target strong market dynamics, attractive market
  position or growth profile and
• Back strong management over 3-5 years
• Team
• Four partners based in Sydney
• Total team of 22, including 13 Investment Team
  members
• Two dedicated NZ Investment Team members
• 5 dedicated Portfolio Team members, focused on
  portfolio company improvement

15
Restructuring

• Adverse economic conditions combined with high
  leverage levels and asset prices in 2006 and 2007
  have led to numerous restructurings in 2009 with
  more to come
• Critical skills for GPs to have as investors will
  focus on track record in turning around difficult
  situations
• Situation generally flagged well in advance
• Timing of engagement is critical
• Deferring trigger event for as long as possible
  lets you scope the problem and allows for
  economic recovery
• Crisis required to win serious concessions from
  all stakeholders

16
Three Categories Based on Severity
1. Covenant Waiver
2. Restructuring
3. Insolvency

• Covenant reset over limited period
• May involve cash fees and margin resets
  (stretches liquidity)
• Can be accompanied by equity cure

• New injection of equity required
• Flexibility to mark to market liabilities against
  future cash flows
• Significant communication with stakeholders to
  achieve consensus
• Medium term view on value recovery

• Sponsor unwilling or unable to cure monetary
  breach
• Banks accelerate and take control
• Notable value destruction for all stakeholders

Key Objectives Liquidity, Headroom, Deleverage
17
Making The Best of A Bad Situation

• Financial
• Injecting new money is very valuable and buys you
  more than a seat at the table
• Force recognition of mark to market value of
  liabilities to reduce gearing and priority in
  capital structure
• Take advantage of lenders desire to exit for
  opportunistic debt purchases at below par
• Maximise leverage provided by new money to buy
  headroom, amortisation and term concessions
• Operational
• Need to identify what is wrong and fix it quickly
• Powerful catalyst for operational change which
  can be difficult to initiate in better times
• Need to reconsider cost base
• Look to all stakeholders for concessions

18
Key Issues

• Coherent groups of well organised banks prevent
  aggressive restructurings seen in US and Europe
  can make it difficult to deliver to benchmarks
  expected by LPs
• Laminated capital structures make it difficult to
  reconcile the competing demands of creditors
  makes for a long drawn out process
• Tax environment in Australia/NZ combined with
  IFRS treatment of debt forgiveness makes
  structuring a challenge
• Not all banks are equal and it can be hard to
  achieve a unanimous outcome

19

• Private Equity Deal Restructures Banking View
• (and Current Deal Trends)
• David Moore
• Director, Specialised Lending, ANZ

20
Setting the Restructuring Scene

• Banks committed to supporting their clients
  businesses through difficult times.
• Many leveraged businesses underperforming, will
  breach or is expected to breach covenants, and
  may need additional equity along with the
  restructuring of their debt.
• The risk appetite of Banks reduced, cost of
  funding has increased, and risk profile of the
  borrower deteriorated.
• Some International Banks keen to exit given the
  opportunity.
• Margins increase and conditions tighten as part
  of the restructure but the size of equity
  injection will drive extent.

21
We are all in the same boat
22
Tough but Fair
(Banks) have been criticised for behaving
brutally in credit rollover negotiations and for
rationing credit But they have also been opting
more than they have in the past for unofficial
work-outs instead of receiverships and
liquidations.
Syndey Morning Herald 29/09/09 Malcolm Day
23
Restructure Outcomes
Trends
Influencing Factors

• Covenants replaced by perf. to budget test for
  6-24 months.
• Increased Margins (not to Market).
• Part back-ending restructure fees.
• Temp. turn off of amort with Sub debt moving to
  full PIK.
• New DD Financial, Commercial, Management
  Board ability.
• Distributions turned off and sweep increased.
• Steering committees for large syndicates.
• Duration of process.

• Business sustainability and market position.
• Quality of Board and Management.
• Relationship with Sponsor and Co.
• Sponsor commitment and ability to inject equity.
• Normalisation of deal acceptable de-leveraging
  by maturity.
• Syndicate size strength of facility agent.
• Foreign participants looking to exit?
• Early engagement by the co. and sponsor to work
  with funders.

24
PE vs. Other Sponsors

• May be restrictions on additional equity support
  from Fund.
• More averse to dilution (and less equity to
  dilute).
• Cant provide explicit support from larger group.
• Generally at the higher end of the risk spectrum
  (higher leverage).
• More complex structures and larger syndicates.
• BUT
• Often better/more extensive due diligence.
• Sponsors hands on, willing to undertake
  independent / 3rd party reviews and make
  difficult decisions re management team.
• Strong and experienced Boards.
• Management interest aligned.
• Recognises long term benefits outweigh cost of
  the restructure.

25
New deals
Metrics/Terms
Opportunities

• Stressed groups exiting good subsidiary
  businesses.
• Multinats selling NZ businesses to focus on core
  business.
• Owners that pulled the sale in 2007 back in the
  market.
• Partial Buy-Outs.
• Demographics of NZ owners will still drive exits.
• Returns on historical deals (06/07) companies
  from traditional drivers.
• New Deal Returns benefit of multiple uplift in
  future periods.

• Lower EBITDA multiples (3.0x)
• Sized of historical performance difficult
  economic environment.
• Equity increased to 40-50.
• Senior Margins up (4.0 ).
• Limited appetite for normalisations.
• Synergies are an equity upside.
• Increased scheduled amortisation vs. reliance on
  Cash Sweeps.
• Funding terms Shorter (3 years)
• Underwrites exception to the rule.
• Fewer lenders in the market.

26

• Private equity statistics for Australasia
  2007-2008

27
2008 private equity exit study an overview

• For the second year in Australia, and the fourth
  internationally, Ernst Young has continued its
  research into the largest PE exits
• Our study highlights that whilst the volume and
  value of exits in 2008 fell, returns remained
  strong, underpinned by a continued high level of
  PE outperformance

Oceania EBITDA growth vs. public companies PE
exits 2007-2008N 22 excludes 2 outliers in
each of 2007 and 2008
28
Return to fundamentals

• Our study highlights that in Australia, organic
  revenue initiatives had a significant impact on
  EBITDA growth, with selling initiatives
  implemented for 67 of exits (e.g. product
  variations improved customer service and
  quality and sales force effectiveness)

• Operating model changes were also a key driver of
  core improvement, with operational efficiency
  improvements having the greatest impact (e.g.
  operating model simplification, outsourcing key
  functions, tailoring performance metrics and
  incentivisation to plan and strategy)

Australia Frequency of pricing and improved
selling initiatives PE exits 2007-2008
Australia Frequency of core improvement
initiatives PE exits 2007-2008
29
Return to fundamentals (contd)

• Working capital improvements are also an
  important component of value creation, with
  approximately half of European exits and 25 of
  Australian exits having identified working
  capital improvements
• Examples include revised commercial agreements
  with customers suppliers, process improvements
  and implementation of cash focussed KPIs
• Greater emphasis on operational effectiveness and
  performance improvement will be more critical
  than ever to drive value
• Trend Growing importance of industry knowledge
  and sector experience combined with robust GP
  risk management functions where investments are
  strongly aligned with GPs overall strategy