Transcript Slide 1

How has Private Equity been ?!
Dr. Rüdiger Stucke
May 30, 2013
[email protected]
+44 (0)75 4526 3333
DR. RÜDIGER STUCKE
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Over 8 years of experience in research on private equity
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Close cooperations with some of the major LPs and selected GPs
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Some of the most influential research studies on private equity
Background
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Research Fellow at Oxford University, U.K., since 2009
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Full-time research on private equity
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Co-teaching private equity for corporate executives (since 2008), MBA/EMBA students (2008-10)
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Visiting PhD at Oxford University, U.K., 2007-2008
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Doctoral student (PhD) at Paderborn University, Germany, 2005-2008
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Full-time research on private equity
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Dissertation "Financial Engineering and Structuring in Leveraged Buyouts" (Summa cum laude)
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Department of Banking and Finance, co-teaching (2005-07):
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BSc level: Financial Institutions and Capital Markets, International Corporate Finance
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MSc level: Banking Management, Management Consulting
Diploma student (BSc & MSc) at Paderborn University, Germany, 1999-2004
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Economics, Business Administration and Computer Science (Top 1% - First class honors with distinction)
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Part-time work experience in investment banking and management consulting
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THE PRIVATE EQUITY LANDSCAPE
Institutional investors /
Limited partners (LPs)
Fund managers /
General partners (GPs)
Private equity funds
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Public pension funds, corporate pension funds
University endowments, foundations
Insurance companies, banks, fund of funds
Family offices, HNWI
Sovereign wealth funds, government entities
• About 50 premier LPs, 250 large LPs, 1500 relevant LPs
• Different preferences, appetite and access
• Return expecations: 60%: > +400bps, 30%: +200-400bps
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Limited partnership agreement (LPA)
Limited liability re committed capital
Capital commitments of 95-99%
Co-investment opportunities
• Institutional Limited Partners Association (ILPA)
• ILPA guidelines with best practices
Portfolio companies
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THE PRIVATE EQUITY LANDSCAPE
Institutional investors /
Limited partners (LPs)
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Corporate equity: venture, growth, buyout, restructuring
Corporate debt: mezzanine, distressed
Real assets: real estate, infrastructure, energy, timber, etc.
Second tier: primary fund of funds, secondary fund of funds
• About 250 major GPs, 750 large GPs, 2000 further GPs
• About 10k institutional funds with $4tn, 20k overall
Fund managers /
General partners (GPs)
Private equity funds
• Investment period: 5-6 years of capital calls
• Overall lifetime: 10-12 years until fully realized
• Quarterly reporting of net asset values, IRR, TVPI, etc.
• Fund management fees: 1.5-2.0% per annum
• Carried interest: 20% if IRR above hurdle (8%)
• Further deal fees (partly offset management fees)
250
Cumulative distributions
200
150
Cumulative capital calls
100
50
Portfolio companies
Net asset value
0
Dec1995
Dec1996
Dec1997
Dec1998
Dec1999
Dec2000
Dec2001
Dec2002
Dec2003
Dec2004
Dec2005
Dec2006
Dec2007
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THE PRIVATE EQUITY LANDSCAPE
Institutional investors /
Limited partners (LPs)
Fund managers /
General partners (GPs)
• Entry: growth, corporate divestiture, family succession, P2P
• Holding: typically 3-6 years, multiple rounds or recaps
• Exit: trade sale, IPO, secondary sale, other
• Co-investment by management
• GPs monitor as company directors
• Goals: increase EBITDA, repay (peak) debt, sell better
Simple LBO model (best case)
D 200
Private equity funds
EBITDA 100
Multiple 6x
D 400
EV = 600
E 200
E 1000
TVPI = 5x
IRR (5y) = 38%
EBITDA 150
Multiple 8x
EV = 1200
Leveraged finance
Senior debt
Portfolio companies
Junior debt
• Revolving credit facility
• Bank term loan tranche (A)
• Institutional term loan tranches (B, C)
• Second lien term loan
• Mezzanine facility
• Unsecured / subordinated notes
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INSTITUTIONAL INVESTORS
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Trends in asset allocation to private equity
30%
25%
Family offices
20%
15%
Endowments
Foundations
10%
Public pension funds
Private pension funds
5%
Insurance companies
0%
2008
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2009
2010
2011
2012
Asset allocation sentiment in 2013 and beyond
Corporate PE
PE Real Estate
PE Infrastructure
100%
90%
27%
80%
33%
43%
39%
58%
70%
62%
Increase Allocation
60%
Maintain Allocation
50%
40%
59%
48%
Decrease Allocation
50%
30%
52%
38%
20%
10%
13%
19%
2013
Long-term
0%
Source: Preqin.
36%
7%
9%
4%
2%
2013
Long-term
2013
Long-term
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INSTITUTIONAL INVESTORS
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Regional allocation to private equity in 2013
80%
73%
72%
68%
70%
59%
60%
50%
41%
North America
36%
40%
Europe
32%
27%
30%
Asia and RoW
20%
7%
10%
0%
North American LPs
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European LPs
Asian & RoW LPs
Interest in corporate private equity strategies in 2013
60%
51%
50%
40%
28%
30%
23%
20%
23%
23%
14%
7%
10%
11%
0%
Small to
MidMarket
Buyout
Source: Preqin.
Venture
Capital
Large to Distressed Growth Mezzanine
Mega
Debt
Buyout
Secondary Primary
Fund of
Fund of
Funds
Funds
6
400
350
300
250
200
150
100
50
0
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350
Source: Preqin.
Europe
Buyout
Venture
Asia
Debt
Real Estate
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
United States
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
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1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
PRIVATE EQUITY FUNDS
Fundraising by region
$bn
Rest of World
Fundraising by (selected) sub-asset classes
$bn
Real Assets
300
250
200
150
100
50
0
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PRIVATE EQUITY FUNDS
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Invested capital at NAV and uncalled capital
3,500
$bn
Unrealized Value
Uncalled Commitments
3,000
2,500
2,500
2,000
2,000
1,500
1,500
1,000
1,000
500
500
0
0
$bn
Other
Infrastructure
Distressed Debt
Venture Capital
Real Estate
Buyout
Unrealized
Value
End End End End End End End End End End End End Sep
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
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Uncalled
Commitments
Amounts of capital called and distributed by buyout funds per year
500
450
400
350
300
250
200
150
100
50
0
476
$bn
409
404
366
345
306300
292
288
253
201210
209
174
143
2005
2006
2007
2008
Capital Called
Source: Preqin.
392
2009
2010
2011
Sep 2012
Capital Distributed
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PRIVATE EQUITY FUNDS
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Vintage year IRRs for U.S. Buyout, Venture and Real Estate funds
120
U.S. Buyout
U.S. Venture
U.S. Real Estate
100
80
60
40
20
0
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
-20
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Vintage year PMEs for U.S. Buyout, Venture and Real Estate funds
4.5
U.S. Buyout
U.S. Venture
U.S. Real Estate
4.0
3.5
3.0
2.5
2.0
1.5
1.0
0.5
1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Source: Preqin.
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PORTFOLIO COMPANIES
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Volume and number of U.S. and European Leveraged Buyouts
250
500
Number
Volume
450
200
400
350
150
300
250
100
200
150
50
100
50
0
0
98
99
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01
U.S. Buyout ($bn)
Source: S&P LCD.
02
03
04
05
European Buyout (€bn)
06
07
08
09
U.S. Buyout (#)
10
11
12 1Q13
European Buyout (#)
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PORTFOLIO COMPANIES
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Purchase price multiples and equity fractions
12
60%
EV/EBITDA
%
10
50%
8
40%
6
30%
4
20%
2
10%
0
0%
1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 1Q13
U.S. Buyout (PPM)
Source: S&P LCD.
European Buyout (PPM)
U.S. Buyout Equity
European Buyout Equity
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PORTFOLIO COMPANIES
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Defaults of institutional issuers by year of debt origination (317 / 5286 = 6%)
70
35%
Volume
$bn
Number
%
60
30%
50
25%
40
20%
30
15%
20
10%
10
5%
0
0%
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
(27) (66) (106) (189) (166) (138) (115) (163) (287) (454) (535) (576) (549) (138) (150) (436) (525) (666)
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Lagging 12m default rate in indices by number of issuers
18%
U.S. LLI
European LLI
Global LLI
16%
14%
12%
10%
8%
6%
4%
2%
Source: S&P LCD.
10/2010
09/2010
08/2010
07/2010
06/2010
05/2010
04/2010
03/2010
02/2010
01/2010
12/2009
11/2009
10/2009
09/2009
08/2009
07/2009
06/2009
05/2009
04/2009
03/2009
02/2009
01/2009
12/2008
11/2008
10/2008
09/2008
0%
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GENERAL SPIRIT OF RISK MANAGEMENT IN PRIVATE EQUITY
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Strong focus on alignments of interests via sharing of risks and returns
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Limitation of downside via risk sharing
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Stimulation of upside via return sharing
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In contrast to public equity: Avoiding the separation of ownership and control
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Formula: "Skin in the game" plus "sweet upside" along the PE value chain
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LPs want GPs to materially co-invest in their funds and deals
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Partners within GPs may have to privately co-invest in the particular deals they manage
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In addition LPs agree to share 20% of profits in terms of success
And may receive disproportionately higher participation in shared profits from those deals
GPs want management to co-invest in companies at the end of the capital stack
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Equivalently, the upside is much higher if everything goes by plan
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Split of fund equity into preferred stock and true equity which captures all upside
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Alternatively, contractual arrangement (options, warrants, sweat equity, etc.)
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In leveraged buyouts, debt has some additional disciplinary effect
How much skin in the game for most effective bahviour?
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RISKS FACED BY INSTITUTIONAL INVESTORS
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General risk for institutional investors
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Allocation and exposure to private equity, systematic risk and illiquidity risk, currency risk, etc.
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Current research estimates for buyout and venture fund beta: 2.5 – 3.0
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Buyout fund alpha about 0, venture fund alpha slightly positive (1990s driven), PE RE alpha negative
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Positive alpha for buyout and venture deals before fees and carry
Regulation of certain types of institutions
Investing into the better funds
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Performance persistence has decreased over the past decade in the buyout area
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Probability of two consecutive top-quartile funds by the same buyout manager is 25%
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Even worse: identifying a top-quartile fund in the middle of its lifetime when the successor is raised
Access to the better (upcoming) funds and managers
Getting the incentives right
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Fees are meant to keep the fund and business running
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Carried interests are meant to make fund managers rich
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LPs seek lower fees as funds grow in size
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Reduction in percentage terms: 2% => 1.25%
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Reduction following investment period and when successor fund has started
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Offset of further fees charged by GPs to companies
Whole fund versus deal level carry, escrow accounts, key man provisions and vesting carry, etc.
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RISKS FACED BY PRIVATE EQUITY FUNDS & FUND MANAGERS
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General risks for private equity fund managers
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Strategic: Diversification versus specialization
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Operational: Raising follow-on funds, team persistence, carry pool, number of investments, etc.
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Deal related: Sourcing attractive opportunities, overpaying, investment strategies, right structures, etc.
Risks inherent to specific investment stages
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Venture capital (early stage, balanced, late/expantion)
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High idiosyncratic risk – business plan and management
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9 in 10 VC investments do not return invested capital
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High systematic risk – economy wide downturn
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Risk staging through several funding rounds
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Dilution risk – contract design
Leveraged buyouts and restructuring
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High systematic risk due to high levels of financial leverage
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High risk of overpaying (most deals go through auctions)
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Collaboration with (new) management
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Right growth or restructuring strategy
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Collaboration with co-sponsoring GPs
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Exiting mega deals
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