FINA 652

Private Equity
Class I
Introduction to the Private
Equity industry

Todays class
What is an LBO? Introduction
Some LBO mega-deals
Recent evolution

Terminology: Venture Capital versus

Private Equity
How big is Private Equity?
Who are the main Private Equity firms?

Impact of Private Equity on financial

markets

Some well-known LBOs

Large LBOs

Large LBOs
Announced

February 2007
January 2007
June 2006
November 1988
December 2006
December 2005
November 2005
June 2006
May 2006
March 2005
5

Final price

$43.8 b
$39 b
$33 b
$25 b
$16 b
$15 b
$ 14.5 b
$13.7
$12.7 b
$11.4 b

What about Europe?

Biggest deal in 2007
Alliance boots 17.8 Billion euros
In comparison in 2008
Angel trains for 4.5 Billion euros

2006-2007 The heyday of the

buyout business
Multibillion-dollar deals were announced almost
every week: of the 10 largest buyouts in history, 9
have been completed in this period
The leveraged buyout model has evolved into a
powerful mechanism for corporate transformation.
For investors, private equity often constitutes an
interesting alternative asset class.
Buyouts are not, however, without critics and do
feel the pain of the financial crisis
7

European PE & the

financial crisis
According to the august 2010 review by
Bowne :
value H1 2008 saw a total of e56.5bn from 559
deals,
Down 57% on H1 2007 in value terms
down 20% on H1 2007 in volume terms

2009 continued this down trend with a

rebound post summer 2009

European PE & the post

financial crisis
Since 2008 appetite for PE have increased
(in terms of fund raising and deals)
European buyout deals comprise 34% of
all private equity-backed buyout deals on
average across 2006-2014 YTD (source
Prequin)

Private Equity reputation:

Barbarians at the gate?
Private equity

Barbarians in the dock

Mar 1st 2007. From The Economist print edition

The 1980s are back. Once again, omnipotent and fabulously rich financiers are
storming huge public companies. And once again, they are being denounced as
asset strippers prepared to wreck companies and lives in their desire for
personal gain.
http://www.economist.com/node/8776229?story_id=E1_RSSGNNJ

10

Private Equity firms as locusts

Franz Mntefering, then head of the
SPD, Germanys Social Democratic party,
attacked the behaviour of certain financial
firms whose profit-maximising strategies
were a long-term threat to our
democracy. He described them as
swarms of locusts that fall on companies,
stripping them bare before moving on.

Criticism of Private Equity

Criticism of the Private Equity industry centers on three
charges:
1. Private Equity destroys jobs and runs businesses in
bare-bones frugality, neglecting investment and growth
opportunities
2. Private Equity unfairly benefits from tax breaks on
interest payments
3. Private Equity is non-transparent and secretive, partly
because it wants to conceal the exorbitant amount of
money it makes

What is Private Equity?

Venture Capital versus Buyout

What some people say about

private equity
is just bad
equity
is
completely
illiquid
means high
risks

Source: Capital Dynamics

is all about
IPO
you mean
venture capital

Private equity

means high
retuns

has low
correlations

What is Private Equity?

It used to be quite easy to define what
was and was not a private equity
investment: any equity investment in a
company which is not quoted on a stock
exchange.
Private Equity investments build value in
private that is, not publicly traded
companies.
Venture capital investments are made in
young, start-up companies.
Buyout investments are made in (usually)
mature, public companies, that are acquired
and taken private, restructured and then sold.

Private Equity versus Venture Capital

In Europe, the asset class as a whole is
called Private Equity, and it is broadly
subdivided into buyout and venture
capital (or just venture).
In the US the asset class as a whole is
usually called venture capital and
buyouts (particularly large ones) are
often referred to as private equity.

Defining Private Equity

The National Venture Capital Association:
www.nvca.org
The Venture Capital IndustryAn Overview
Venture capital investing has grown from a small investment
pool in the 1960s and early 1970s to a mainstream asset
class that is a viable and significant part of the institutional
and corporate investment portfolio.
Recently, some investors have been referring to venture
investing and buyout investing as "private equity investing."
This term can be confusing because some in the investment
industry use the term "private equity" to refer only to buyout
fund investing.

Terminology in US vs. Europe

Europe
buyout

Private
Equity
venture capital

U.S.A.
Private equity
(= buyout)

venture capital

Venture
Capital

IUM courses

Private equity
(buyout + spec
situations)

venture capital

FINA 652: this course

FINA 651 Venture Capital &

Entrepreneurial Finance

Buyout as Private Equity

Buyout investments are made in (usually) mature, public
companies, that are acquired and taken private, restructured
and then sold.

From Brealey-Myers, page 905:

Leveraged buyouts (LBOs) differ from ordinary acquisitions
in two immediately obvious ways. First, a large fraction of the
purchase price is financed by debt...
Second, the company goes private and its shares no longer
trade on the open market. The LBOs stock is held by a
partnership of (usually institutional) investors and is often
referred to as private equity.
When the buyout group is led by the companys management,
the transaction is called a management buyout (MBO).

Private equity itself is a

diversified asset class
Investments with high value
creation potential
Investments into closely
held non quoted companies
Controlling influence and
proactive ownership
Investments with a typical
horizon of 3 to 7 years

Source: Capital Dynamics

Growth
expansion

Special
situations

Secondary

Distressed

Private equity
universe
Mezzanine
debt

Turn-around
capital
Venture
capital

Buyout
MBO/MBI

PE as a diversified asset class 1

22

PE as a diversified asset class 2

23

Private Equity returns

* But see later our discussion of Private

Equity returns

LBO returns
According to the data collected by
Thomson Financial and the National
Venture Capital Association, for the period
1985-2005 the average net annual return
for the buyout industry was 13.3%, while
the S&P 500 returned 12.1% a year, on
average.
However, the top quartile buyout funds
have generated net annual returns in
excess of 40% during the 20-year period.

LBO return characteristics

26

What is an LBO?

27

What is an LBO?
The typical view since the 1980s was:
Acquiring companies showing underperformance
Aligning Management interests with potentially large
incentives
Cutting all unnecessary costs, revisiting
Adding substantial amount of debt (as much as can be
supported by the business)
Waiting 5 years and sell!

What is an LBO?
What is an LBO? How does it work?
Lets ask one of the best experts.

Henry Kravis (KKR)

1969 Started in Bear Stearns in the corporate finance

department. Under Jerome Kohlberg he learned "bootstrap"
acquisition.
1976 Founded KKR with Kohlberg and George Roberts
Participated in first Public to private deals
1988 won bid for Nabisco, largest LBO in history (until 2006)
2007 Largest LBO (again) TXU for deal estimated at $43.8 B

Barbarians at the Gate

The battle for the control of RJR Nabisco
between CEO Ross Johnson and
Kohlberg, Kravis & Roberts (KKR) in
October-November 1988.
The battle ended with the LBO of RJR
Nabisco by KKR, valued at $25 billion,
the largest in history until July 2006 (HCA
was valued at $33 billion).

Barbarians at the Gate

Main characters:
Ross F. Johnson, President and CEO, RJR Nabisco
Charlie Hugel, Chairman of the Board, RJR Nabisco
John Greeniaus, President and CEO of Nabisco

Henry Kravis, Senior Partner, Kohlberg Kravis Roberts

& Co.
George R. Roberts, Senior Partner, Kohlberg Kravis
Roberts & Co.
Peter Cohen, President Shearson Lehman Hutton
Jim Robinson, Chairman of the Board American
Express

What is an LBO? Debt

From Barbarians at the Gate:
Henry Kravis: Everyone benefits when
management takes over.
Some of the money we borrow. Some we raise
from the public sale of securities. We pay off
the debt incurred in buying the company with
cash from its ongoing operations. And by
selling off pieces of the business.
Debt can be an asset. Debt tightens a
company.

What is an LBO? The valuation

From Barbarians at the Gate:
Henry Kravis: Why dont I have some
of my people take a look at your
numbers. To get an idea of the value of
the company. Something to base a bid
on.

What is an LBO?
The role of management
From Barbarians at the Gate:
Ross Johnson: Tell me one thing. If we did do this
deal together, who would be in charge? Who would run
the business? How does it work?
Henry Kravis: Ask Don.
Don: I run my company. Henry and his cousin
George are the majority owners, but they maintain a
total hands-off policy.
Ross Johnson: Whats the catch?
Henry Kravis: The catch is: we like people who know
what theyre doing, doing it for us. We think youre one
of those people, Ross.

What is an LBO? After the buyout

From Barbarians at the Gate:
By the end of the 1980s, American businesses piled
up nearly one trillion dollars in debt.
John Greeniaus improved Nabiscos earnings by 40%
in the first six months of the takeover.
RJR Reynolds abandoned Premier cigarettes. Almost
half a billion dollars going up in smokeless smoke.
For his settlement with RJR Nabisco, Ross Johnson
received $53 million (but that was only $23 million
after taxes).

Do LBOs destroy jobs?

From Barbarians at the Gate:
Henry Kravis: Everyone benefits when management
takes over.
We pay off the debt incurred in buying the company
with cash from its ongoing operations. And by selling off
pieces of the business.
Ross Johnson: Thats French for firing people, isnt
it?
Henry Kravis: As few as possible, of course.
Ross Johnson: A few dozens? Ten thousand?
Henry Kravis: As I said, as few as possible.

The main players and deals

Largest Private Equity
firms
Largest buyout deals

Henry Kravis, of KKR

Private equity

A barbarian no more
Mar 30th 2006
From The Economist print edition

After 30 years in private equity, Henry Kravis has become the

acceptable face of capitalism

Steve Schwarzman, of Blackstone

The new king of Wall Street
February 21 2007
From Fortune magazine
With a history-making deal and a headline-making birthday party, Steve Schwarzman
has become the symbol of a new era in finance. And that's always a risky proposition.
By Nelson D. Schwartz, Fortune senior writer

http://money.cnn.com/magazines/fortune/fortune_archive/2007/03/05/8401261/

Large Private Equity funds

41

Other metrics for recent activity

2011 ranking based on the amount of private
equity direct-investment capital raised over a
five-year window
http://www.privateequityinternational.com/pei300

See doc Private Equity firms rankings by money raised over 5

years

 The Blackstone Group

www.blackstone.com

A leading global Investments and Advisory firm

Private Equity Group:
Blackstone has been a leader in the field of private equity
investing since 1987, managing $28 billion through its
Blackstone Capital Partners I, II, III, IV, and V and
Blackstone Communications Partners funds.

Portfolio:
http://www.blackstone.com/private_equity/portfolio.asp?Ord
er=ByTransactionSize

News: 2/1/2007

Equity Office Reaffirms Support for Blackstone Transactio

n

 Kohlberg, Kravis, Roberts & Co.

www.kkr.com

Experience. Global Reach. Value Creation

KKR:
KKR, one of the worlds largest and most successful private
equity firms, has completed buyout transactions that are
among the most complex in history. The firms investment
approach, however, is fundamentally simple: KKR acquires
industry-leading companies and works with management to
grow and improve them and thereby create shareholder
value.

Portfolio:
http://www.kkr.com/investments/index.html

 The Carlyle Group

www.thecarlylegroup.com
Buyout Real Estate Leveraged Finance
Venture & Growth Capital

Company Profile:
The Carlyle Group is one of the worlds largest private
equity firms, with more than $54.5 billion under
management. With 48 funds across four investment
disciplines (buyouts, venture & growth capital, real estate
and leveraged finance), Carlyle combines global vision with
local insight, relying on a top-flight team of more than 400
investment professionals operating out of offices in 16
countries to uncover superior opportunities in North America,
Europe, Asia and Australia.

Portfolio:
http://www.thecarlylegroup.com/eng/portfolio/index.htm
l

 Leveraged Finance U.S. mezzanine

Investment Approach
The Carlyle Mezzanine Partners (CMP) team invests in debt
and equity securities of leveraged buyouts, recapitalizations
and growth financings. CMP pursues a generalist industry
approach and leverages The Carlyle Group's extensive
expertise in industries such as automotive and transportation,
aerospace and defense, media and telecommunications,
healthcare, consumer and basic industrial manufacturing.
CMP primarily invests in senior subordinated notes with
warrants, preferred stock, and minority common equity
securities. Investing in debt securities allows CMP to provide
current income on a quarterly basis.

http://www.thecarlylegroup.com/eng/fund/investment2276.html

Large Private Equity deals: HCA

Private equity

A record-breaking buy-out
Jul 25th 2006
From The Economist Global Agenda

The $33 billion private-equity deal to buy HCA, an American hospitals

group, is the worlds biggest-ever buy-out

The attraction of HCA is reasonably clear. The company owns

and operates 182 hospitals and 94 surgery centres in America,
Britain and Switzerland. Analysts suggest the firm's share price
has languished as bad debts from uninsured patients have
mounted and competition has grown. Though profits are waning,
a healthy cash-flow should help to service new debts. In the
longer term, ageing populations will provide ready-made
customers.

Large Private Equity deals

American property

Quite a performance
Feb 8th 2007
From The Economist print edition

Blackstone wins the battle for EOP, but the

clear victor is the seller

Equity Office Properties (EOP), America's largest

commercial landlord.
cash offer from The Blackstone Group, a private-equity giant
that valued the company at nearly $39 billion (including debt),
There was an alternative bid (slightly higher) but a riskier mix of
cash and shares, from a group led by Vornado Realty Trust,
another listed property company
Check VNO price evolution over the past two years

Large Private Equity deals

Private equity

A private power play

Feb 26th 2007
From Economist.com

A record takeover of a big energy firm. Expect grumbles

In the bear pit of capitalism a little name-calling is an inseparable

part of the show. Private equity has attracted a fair amount of
abuse down the years. As Kohlberg Kravis Roberts and Texas
Pacific Group tie up the worlds largest ever private-equity deal
with a $45 billion (including debt) takeover of TXU, a Texas
energy firm, expect a little more. KKRs acquisition of RJR
Nabisco in 1988, for a long time the worlds biggest and bestknown private-equity deal, earned it the title barbarian. Last
year a leading German politician labelled the entire industry
locusts. More recently a British union leader chipped in with
immoral asset strippers and casino capitalists. But vitriol
aimed at the booming business is largely undeserved.

KKR and TPG buy

February 26, 2007. TXU, one of Americas largest utilities,
on Monday agreed a $45bn (33.8bn, 22.7bn) takeover
by a group led by Kohlberg Kravis Roberts (KKR) and
Texas Pacific Group (TPG), the largest private equity deal
on record.
The two private equity buyers are paying about $32bn in cash,
or $69.25 a share, for TXU, which the utility said represented
a 25% premium to the average closing share price over the 20
days ending February 22. KKR and TPG will also agree to
take on a $12bn chunk of TXUs outstanding debt.
GS capital partners, Lehman Brothers, Citigroup and Morgan
Stanley intend to be equity investors at closing, TXU said in a
statement

http://www.ft.com/cms/s/568f1b4c-c38f-11db-9047-000b5df10621.html
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Major Private Equity deals

KKR deals

TXU -$43.8 (2007)

RJR Nabisco $30bn (1989)
HCA $33bn (2006)
VNU $11.6bn (2006)
TDC 13bn (2006)
NXP (Philips) Semiconductors
$11bn (2006)

TPG deals
Harrahs $17.1bn (2006)
Freescale Semiconductor
$17.6bn (2006)
Univision $12.3bn (2006)
Qantas A$11.1bn (2006)