Seminar: introduction to

private equity

Contact
Antoine Parmentier:
[email protected]
+44(0)7809.510.373

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.
3

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
4

Introduction to Private Equity

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

 Structure of private equity participations

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;
8

A diversified asset class

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

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;
10

Venture capital (2/2)

Investment from up to 10m and often prerevenues 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.
11

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);
12

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
13

Buyout (3/3)
Buyout starts at 5 million enterprise value
(EV);
At the bottom end: growth/expansion
capital.

14

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
(liquidation=bankruptcy);
Loans are rated BB and below by S&P based on
usual ratio (debt/EBITDA, EBITDA interest
coverage, etc);
15

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;

16

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.

17

Secondary (2/2)

18

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.
19

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: E+1,042, versus
E+979 in Q2 2008;
20

Mezzanine (3/3)

21

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;
22

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.

23

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
24

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;

25

Why allocate assets to PE ?

26

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...)
27

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.
28

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 10year life;

Restricted information disclosure:

Only LPs have access to the funds performance.

Private equity is an inefficient market

29

 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%
30

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.

31

LBO activity in Europe

32

Geography

33

Sectors

34

European buyout value

European buyout value: 72 billion in Q1-Q3 2008

35

European buyout by region

36

PE as a percentage of GDP

Nordic countries have the most important PE activity;

Benelux figures are impacted by few mega deals.

37

European fundraising activity

38

Funds on the market

39

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;
40

 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

41

Average fundraising

42

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.
43

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.

44

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.
45

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;
46

Fundraising sources

47

 LPs usually invest in home-based funds;

48

 Globally, US is the single largest investor;

In Europe, UK is ahead of anybody;

49

Profile of the LPs

50

The measure of performance

51

Track record

52

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.
53

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;

54

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.
55

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;
56

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.

57

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:

58

Fund of Funds due diligence:

the selection of PE managers

59

Due diligence focus

Quantitative analysis:
Past investments and track record;
Leverage and debt;
Sources of proceeds.

Qualitative analysis:
Team;
Strategy;
Market opportunity
60

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.
61

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 > seek
diversification.
62

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

63

Benchmark analysis
DPI: Distributed Paid In
> Proceeds distributed,
only realized deals;
RVPI: Residual Value
Paid In > Unrealized
value;
TVPI: Total Value Paid
In: Realized and
Unrealized value.
64

Vintage year performance

65

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

66

The worlds biggest private

equity firms

67

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.
68
Source: www.carlyle.com

Carlyle deals

Hertz
Zodiac
Terreal
Le Figaro
VNU

69

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.
70

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;
71

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.
72

KKR deals

Legrand;
Pages Jaunes;
Tarkett;
Alliance Boots;
ProSieben;
TDC;
Toys R Us.
73

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
74

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
75

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/Ernst&Young

76

 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/Ernst&Young

77

Presentations
KKR
Blackstone
Carlyle

78

The mega buyout era

79

Fund growth
PE AUM 1980-2006: 24%CAGR;
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 M&A).
80

 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;
81

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.
82

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.
83

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...)
84

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.
85

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.
86

Disappearance of club-deals
Collusion charges;
Difficulties to share informations;
Tendency to monopolize the control the
control;
Ego-issues.

87

Examples of mega club deals

Target

Value

Buyers

Hospital Corp, of
America

$32.7 billion

Bain Capital, KKR,

Merrill Lynch

Harrahs Entertainment

$27.4 billion

Apollo, TPG

Clear Channel

$25.7 billion

Bain, Thomas H Lee

Kinder Morgan

$21.6 billion

Carlyle, Riverstone,
Goldman Sachs

Freescale
Semiconductor

$17.6 billion

Blackstone, Carlyle,
Permira , TPG

Hertz

$15.0 billion

Carlyle, CD&R, Merrill

Lynch

TDC

$13.9 billion

Apax, Blackstone, KKR,

Permira, Providence
88

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

89

Value creation in private

equity

90

Value creation drivers

EBITDA generation
Multiple expansion
Debt reduction

91

EBITDA generation
EBITDA is generated by:
Sales expansion;
Margin improvement;
Add-on acquisitions;
Organic growth (=GDP growth)

92

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
93

Debt reduction
= Entry net debt exit net debt

94

Example

95

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.
96

97

98

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.
99

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.
100

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
101

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

102

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

103

 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
104

Presentation
Foxtons: The sale of the century, FT
magazine, June 2008

105

Structure of a Leverage
Buyout transaction

106

Structure of a leverage buyout

Deal structure:
Equity
Debt

Debt is either:
Unsecured
Secured

107

LBO structure

108

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.
109

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: E+414.7bps

H1 2008 PIK spread: E+535.3bps

110

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.
111

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: E+337.48bps
112

Capital structure

113

The loan market:

in 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);
114

Average LBO equity contribution

Less debt available = more equity required to close a deal

115

Loan volume dropped significantly

Banks lending capacities are dry !
Q1-Q3 2008 loan volume: 46.6 billion
Q1 2007 loan volume: 45.75 billion

116

Evolution of capital structure

Back to the classic structure: Senior Debt + Mezzanine

117

Cost of debt
Cost of debt increased significantly in 2008

118

LBO spread

119

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
120

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
121

EBITDA multiples

122

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.

123

The pros and cons of being

private

124

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.
125

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.

126

Rating of public and private Boards

of Directors

127

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 M&A for example);
PE funds stimulate managements ambition and
creativity;
Executive management reports on the progress
of the latest strategic decision implemented.
128

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.
129

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.
130

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.
131

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
132

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
133

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)
134

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.
135

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 subcommittees 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)
136

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.
137

Top priorities

138

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.
139

Credit crisis: impact and

consequences on private equity

140

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

141

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).
142

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;
143

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.
144

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; 145

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;
146

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;
147

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.
148

Consequences
June 2007

June 2008

Top of the cycle

Recession

Prices are too high

Prices are falling. More to go

Risk levels are extraordinary

The risk profile has changed

fundamentally

Liquidity is driving behaviour

Lack of liquidity is driving behaviour

Sellers market

Buyers market but must proceed

carefully and beware the falling knives

No distressed opportunities

Some interesting distressed situations

(and even more to come)
149

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.

150

Recession years are usually good vintage years

151

Recession vs Non-recession

152

Case study: Baneasa

153

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).
154

 Banesa is #1
Fragmented industry,
footwear retailer with
gives M&A
14.4% of the French
opportunity/growth by
market and #2
acquisition
clothing retailer in
France with only 3.7%
of the French apparel
market

155

 45% of OOT footwear

market and 24% of OOT
clothing market

Indication about
competition: Zara, H&M,
Mango, etc are city
centres = Baneasa has a
dominant position where
those competitors are not
present. Zara, H&M,
Mango, etc are thus the
main city centre
competitors;

156

 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

157

 Clothing business:
44% sales and 43%
of EBITDA and
Footwear business:
56% sales and 57%
EBITDA

Well balanced, similar

EBITDA margins in
both segments

158

 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)
159

 Bogdan Novac was

CEO of Baneasa from
2000 to 2003 and
2004 to today.

Good management
team // experienced
CEO

EBITDA has grown

from 231m to 365m
(a CAGR of 16.4%)

Strong performance
over the last years
(since 2003)

160

 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.

161

 French clothing
The actors must gain
market has been
market share to grow:
stable since 2000 with
no organic growth
0.2% CAGR
resulting from industry
growth

162

 Average prices have

decreased by 1.5%
CAGR. Price-volume
elasticity is high with
declines in average
prices driven by the passthrough of purchasing
gains from lower-cost
sourcing (Asia) to endcustomers 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)
163

 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

164

 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

165

 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

166

Between 2001 and 2003, out-oftown 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 citycentre 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.

167

 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 lowerend 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%.

168

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).

169

 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)
170

 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.

171