Transcript Slide 1

Private Equity and Narratives
Agenda
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PE industry
Positions of EVCA and BVCA
PE Narratives in the Hearings
Findings from the Academia
Effects by Interventions
Case Analysis : AA, Cases in Korea
Implications
Conclusion
How they work?
Kinds: VC, buyout, mezzanine/hedge fund/PE mutual fund/crossover
Process: fund raising, investment, monitoring & value addition, exit
• UK has been a centre of trade and finance historically and has successfully pulled in
in capital and human resources of high quality.
• 0.5% of GDP (4.9BP) in 2003 holding 60% of EU hedge funds
Management Intervention by PE
Hard Strategy
Soft Strategy
Suggestions to C.
Governance
Request on
profit sharing
Request on
asset mgt
Intervention in
investment
Pension Funds
Mutual Funds
Hedge Funds / Private Equity Funds
Hostile
M&A
Trend in the PE Industry
• Large institutional investors and financial service
companies have increasingly set up PEFs
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Goldman Sachs, Merrill Lynch, Morgan Stanley, CalPERS
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Fund of Funds and Event-Driven Funds are 45%
Increasing scale both in LBO and hostile M&A by PE
No differentiation in business model by fund types
Diversified investment into emerging markets
• Increasing pressure from the public
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Intensifying regulation ex. registration of general partners in hedge funds
by FSA (Financial Service Authority)
Business Development Company (BDC) : open to the public and tax benefits
Strong Fund Activism
• Funds are prescriptive, strategic, and aggressive
• This type of funds consists of 5% and 7.5BD of all funds
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140 cases (90%) with 5% of ownership in US occurred for the last 3 years
• Influencing decisively in the M&A, more than 60%
successful rate with institutional investors
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CalPERS Effectives
ex. TCI (the Children’s Investment Fund, UK), Third Point (Star Gas CEO)
• Backgrounds
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Intensive and focused investment with low costs in monitoring
No regulation on the management
Incentive pay structure
Central Issues Regarding PE
Management of PE funds
- Financial engineering vs. value extraction vs. creation
- Lack of Transparency, accountability
- Fee and Carried Interests for the managers
• Tax Rate
• Public Interests and Welfare
– Impact on employment / job destruction through value extraction
Role in the market
Improvement in CG, management, and shareholders’ right
- Contribution to economic growh, stability and efficiency in resources
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Conflicts of interest between PE partners and other investors
Conflicts of interest between PE partners and companies
Short investment horizon
– less emphasis on long-term growth
Higher leverage creates higher risks and vulnerability
PE Firms on value creation
• Higher postinvestment
performance
“We have 30 million pensioners in our
pension funds and millions of them are in
the UK. For instance, we have at least one
million local government employees, past
and present, who invest in our funds, and
we have produced world-class returns for
them in an era when pension fund deficits
are a big issue. I believe that is a big
positive for the country.”
“Our firm has produced over £2 billion of
value for UK pension funds over the past
three years”
• Job creation
“My experience in private equity in this
country has been only positive….. £250
million into a brand new bio-ethanol plant in
Teesside which has created 800 jobs”
“In terms of jobs, the most important
safeguard for jobs
is to build successful companies, and that
is what
private equity does.”
PE Firms on value creation (Contd.)
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Active involvement provides
strategic advice and credibility
– Positive from the company
perspective (EVCA survey)
– Ensuring healthy cash flow
– New product development
– Gaining market acceptance
– Employing highly trained personnel
“…managed to double sales in a company in
Sheffield in four years and we still have the
same number of people in that company. By
doing so we have created a low-cost world
leader in that industry by making it productive.
We have the same number of people with
double the sales.”
“The Alliance Boots story is all about
growth. There are loads of unexploited
potential…”
Summary of positions of witnesses
• Arguments for PE
– Active role of PE partners in running the
company
– Shorter chain of ownership
– Reduced reporting requirements
– Management incentives
– Job creation through sustainable growth in
the companies
BVCA and EVCA
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A sense of ownership is at the heart of private equity philosophy.
• Growth
Over the past five years, jobs and sales in private-equity backed
companies have grown faster than in FTSE 100 and FTSE 250
companies
Exports and investment have also grown faster than the national
average
Over 90% of companies in which private equity has invested say that
without private equity their business either would not exist or would have
grown far less rapidly
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Strategic business advice, financial advice and practical support.
BVCA and EVCA
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Debt Issue
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What is “Excessive”
More important issues are – Strong management, commitment and growth
Taxation
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increasing international competition
attract talent
encourage enterprise and long term investment
UK as a hub for international PE
Transparency
• Fully negotiated and agreed by all investors
• Flow of information and disclosure is much higher than Public Companyes
• Availability of information to other parties including employees of investee companies
and the wider public:
• UK as a hub for international PE.
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Long term outlook
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Private Equity firms tend to hold on to companies for longer than the average length of time
that institutional investors hold shares.
Principals of PE Narratives
• Investments typically involve a transformational, value-added, active
management strategy.
• Consistent with the risks, private equity can provide high returns,
with the best private equity managers significantly outperforming
the public markets.
• PEF investment is for those who can afford to have their capital
locked in for long periods of time and who are able to risk losing
significant amounts of money. This is balanced by the potential
benefits of annual returns which range up to 30% for successful
funds.
PEF Acronym (SLIM)
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Sourcing, specialty
Long, leverage
Incentive, integrity
Management, monitoring
Findings from the Academia
Performance of PE
“Using a dataset of 1328 mature private equity funds, performance estimates
found in previous research and used as industry benchmark are overstated.
After correcting for sample bias and overstated accounting values, average fund
performance changes from a slight over performance to a substantial
underperformance of 3% per year with respect to the S&P 500 assuming a
typical fee structure, gross-of-fees these funds outperform by 3% per year. We
conclude that the stunning growth in the amount allocated to this asset class
cannot be attributed to genuinely high past net performance.”
Prof. L. PHALIPPOU (University of Amsterdam, Business School)
Quotation from Social Science Research Network website
Change of Ratio in Revenue Share
Development of Capitalism
• The rich get richer, the poor get poorer
• Revenue by rabour share has decreased since 1980s
• Revenue by capital has increased
(average, %)
1959
19973
1979
1989
1996
Labour
68.4
72.6
73.5
71.9
70.8
Capital
18.9
16.9
17.5
19.9
20.8
rent
12.6
10.4
9.0
8.2
8.3
Sum
100.0
100.0
100.0
100.0
100.0
Source : Mishel, Bernstein and Schmitt (1999), http://www.specwatch.or.kr/
Influences by Nick Ferguson
UK Treasury (Gordon Brown)
Decided to widen scope of its investigation
In particular the "carried interest" that allows firms to take 20% of
the profit from selling firms it has managed and treat it as a
capital gain rather than income.
Unions / Hearings
BVCA
"the enemy within"
Urge scrutiny of private equity tax
break (GMB)
Nick Ferguson
Bosses' reward-for-risk claims 'deeply flawed'
"not to make private equity executives very rich but to encourage
investment and entrepreneurship“
(Head, SVG Capital / Chairman, Institute for Philanthropy)
Ronald Cohen’s Initiatives
Chairman of a Treasury fund,
Reporting to Brown
“Capitalism can't create equality of
outcome, so we have to create
equality of opportunity.”
He has made series of policy
recommendations aimed at
creating a sustainable system for
investments in deprived areas.
The inspiration behind Bridges
Community Ventures, armed with
£20m of government money
matched by £20m raised funds.
Eliminate
Raise
Conventional
attitude on the
role of government
Legacy idea on
high figures
Governmental
intervention
Social
offerings
Reduce
Create
Inequality
Access barriers to
better start for the
poor
Social Interest
on Venture
Minds
Role model
Integrity
Money
Power of
Influence
Social
Reputation
AA – P2P Investment Analysis
AA’s principal activity is to provide car breakdown services and
insurance. On 1 October 2004 the AA left the Centrica group following
its acquisition by two leading European private-equity firms – CVC
and Permira. The transaction was valued at approximately €2.7 billion
 AA's EBITDA year ended 31 December 2006 stood at £272.7m.
 5 million members; its businesses also
 Include insurance broking, publishing and a driving school.
UK’s largest personal lines insurance broker
 One of the top 5 insurance brands.
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Evolution of Key Items
Source: FAME
Management’s Narrative
• “Having remoulded the business, our priorities for the
future are to develop our core activities and to seek new
opportunities for growth through acquisition. We also
see great potential for the AA as the leading brand for
motoring-related business online.” - CEO
Job losses and CEO defence.
Employees
10,000
8,000
6,000
4,000
2,000
Employees
2004
2005
“private equity has, in their view,
damaged the company they
love.”
-Award-winning AA patrolman Steve
Thompson
“it as "horrendous" and says it
amounted to "corporate
bullying".
- GMB trade
2006
'amoral asset-strippers after a quick buck'.
Narrative
Rejects the bullying claim and says the company had genuine
performance issues that necessitated the restructure.
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The conclusion of the restructuring programmes in 2005 resulted in leaner
staffing levels and this left us exposed when demand rose above forecast
levels in the early months of 2006. We have responded by increasing the
number of patrols and staff in our call centres to a level that can more
readily absorb such unforeseen spikes in demand. - CEO
Debt
• Initial Debt 1.3 Bn which has grown to 1.8
Bn
Liquidity
Current Ratio
1.20
1.20
1.00
1.00
0.80
0.80
0.60
Liquidity
0.60
0.40
0.40
0.20
0.20
0.00
Current Ratio
0.00
2004
2005
2006
2004
2005
2006
AA lost the contract to maintain Volkswagen fleet vehicles to the RAC. –
http://news.independent.co.uk/business/news/article2430170.ece
Key Figures
Cases in Korea
Funds
Type
Year
Target
Investment
Size
Icahn
Partners
Hedge
2006
KT&G
Share 6.59%
Hermes
PEF, H
2004
Samsung Corp.
20MD
Soberin
PE MF
2003
SK
14.99%
Affinity E.
Partners
PEF
2001
Haitai
Confectionary
106MD
Tiger Fund
H
1999
SKT
6.66%
Carlyle
Group
PEF
2000
Hanmibank
(City Bank)
Loan Star
PEF
Legal
issue
Foregin Ex. Bank
New Bridge
Capital
PEF
1998
Jeil Bank
(S. Charted)
Feature
Partial ownership
through the stock
market
Buy-mgt-sell-leave
Rapidly increasing
style
40%
(2.3 multiples) Buy-out most from the
40%
government
(??)
Buy-keep-resell to
major banks
50%
(3-4)
PE Industry Environments in Korea
Governmental Policy for PE industry
• Introduction PEF by laws (Jan. 2005) with regulatory attitude
• Focus on value addition by PEF(CRC,CRV,VCF,PE M&AF)
- Support for industrial stability through capital market
- Consideration on connecting Private Banking with PE
• Incentives for Institutional Investors such as pension funds
Foreign PE has so far enjoyed with several multiples
• Lack of systematic governance like 5% rule of stock ownership, and
lower developing stage of investment banking
• Relatively favorable toward PE experiencing IMF Foreign Exchange
Crisis
• Increasing acknowledgement on the problems of PE and its
narratives esp. form Loan Star
Implications
• PE has shown asymmetric motivation and skill
and was developed under dark “collusion”
• PE is the aftermath of neo-liberalism in the 80s
and 90s
- Shareholders value, governance, activism
- Over pursuing capital gains following high rate
of return
• New financial engineering in the capital market
development by participants
• Being divergent by markets such as US, EU, etc.
it has made the capital market efficient like
speculators
Conclusions
• PE should comply with its narratives
- Value creation by SLIM, social contribution, etc.
• A new regime for the management of PE
- Increase in transparency and accountability
through market regulation
- New rules regarding stock trades like a 5% rule
• Introduction of a policy to contain greedy
capitalists in alignment of sustainability
• “We do not know about the truth on PE as
outsiders as it has no formalized process”
Thanks.
Decrease in Rate of Returns of Hedge Funds
(%)
Average 17.1%
in the 1990s
30
Average
7.1%
In the 2000s
20
10
0
-5
1990
1992
1994
1996 1998
2000
Source: Hedge Fund Research Inc., Citigroup (2005.9)
2002
2004
Increase of Number and Amount
Hedge Funds
PEF for Stocks
11,300
2,318
$850b
3000
$135b
520
$55b
$130b
1996
2005
1996
Source: Hennessee Group LLC; IFSL. Estimates for 2005, IFSL(2006.3)
2005
The Change in Investment Targets
PEF (%)
Hedge Funds (%)
Others
Buy-out
8
21
67
Expansion
33
Funds of Funds
46
18
Early Stage
Relative Value
Arbitrage 11
33
2000
15
22
Event-Driven
(M&A, CG)
26
Equity Hedge
2005
Source: BVCA, EVCA /Thomson Financial
IFSL. Estimates for 2005, IFSL(2006.10)
Source: Hedge Fund Research, IFSL(2006.3)
The Sources of Investment Fund
Hedge Funds (%)
PEF in Europe(%)
Others
Pensions
17.5
Institutions
24.8
Individuals
48
56
6.0
17.6
Governments
62
44
Individuals
1996
2005
Source: Hennessee Group LLC, IFSL. Estimates
IFSL(2006.3)
9.9
Banks
13.1
11.1
Funds
Insurance
Source: IFSL estimates based on EVCA/Thomson,
etc., IFSL(2006.10)