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Introduction to
Private Equity
Errol DanzigerDanziger Capital Partners LLP
October 2011
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This Presentation covers
Three Topics…
• What is private equity?
• How does private equity differ from other investment models?
• How does private equity boost corporate performance and enhance investor returns?
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Wealth Creation through Private Equity
• Wealth creation through the private equity investment model can be impressive, and sometimes even spectacular
• Although average private equity returns have been shown to track but not exceed the S&P 500, some private equity investments have greatly outperformed other types of investment
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KKR’s Acquisition of Duracell
1.82.4
7.8
0
1
2
3
4
5
6
7
8
$ billions
Investor value
Acquisitionprice
Bank depositat 5%
Selling price
Source: McKinsey
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Desai Capital’s Acquisition of Sunglass Hut
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Value
Operatingimprovements
Leverage
Industry gain
Market gain
Cost
Source: McKinsey
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Scale of Private Equity Investment Globally
Source: TheCityJK
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Scale of Private Equity Investment in the United Kingdom
Source: TheCityJK
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Features of Private Equity
• Target companies are taken private
• Acquisitions are financed with debt capital
• Investors are entrepreneurs, private equity specialists, high-net worth individuals, and institutions
• Agents are appointed to manage target companies
• Private equity is a form of financial innovation
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Objectives of Private Equity Investment
• Improvements in operating efficiency
• Increases in manufacturing and service productivity
• Increases in shareholder value
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The Private Equity Investment Model
• Resolves public company conflicts of interest
• Helps overcome the failure of public company controls
• Conflicts of interest in the public company have notbeen controlled by –
1. Internal controls, including boards of directors
2. Product markets
• but have been controlled to some extent by capital markets
• Activist investors have intervened and the result has been the development of private equity
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The Strategy of Private Equity
Fund founded by specialist investors
Raises debt and equity capital
Buys out listed and unlisted targets
Takes the listed targets private
Restructures the targets
Exits through sale or IPO
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The Structure of Private Equity
1. Funds
2. Debt
3. Partnership
4. Manager-held equity
5. Institutional investors
6. Management incentives
7. Decentralisation
8. No cross-subsidisation
9. Limited lifespan
10. Targets taken private
The legal and economic structure is made up of these factors and elements
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Public Company Structure Diagram
Director pay: performance sensitivity is small
CEO pay:performance sensitivity is small
Headquarters staff in the 1,000s
Divisional head pay:performance sensitivity is tiny
Board of Directors
CEOCorporate Headquarters
Division1
Division2
Division3
Division4
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Private Equity Structure Diagram
CEO pay:performance sensitivity is big
Headquarters staff in the 10s
LBO target CEO pay:performance sensitivity is big
Partnership Headquarters
LBO target1
LBO target 2
LBO target 3
LBO target4
Limited Partnership
Buyout Fund
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Private Equity Investment Targets
1. Poor management
2. Under-investment
3. Over-investment
4. Strategic neglect
5. Inadequate debt financing
6. Excessive debt financing
7. Incorrect financing mix
8. Excessive cash holdings
9. Excessive conglomeration
Private Equity pursues corporate targets that are underperforming or are undervalued, and that have these features:
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How Private Equity Boosts Corporate Performance
1. Assets in place
2. Redeployment
3. Operating efficiency
4. Tax burden
5. Capital maintenance, working capital
6. Expected growth
7. New investments
8. Existing assets
9. Period of high growth
10. Cost of financing
11. Less discretionary
12. Operating leverage
13. Financing mix
14. Matching
15. Non-operating assets
16. Acquisitions
By focusing on the following factors -
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Features of Private Equity Target Performance
1. Target shareholders gain from leveraged buyouts of target companies
2. Private equity gains are not at made at the expense of other constituencies
3. Leveraged buyouts boost target operating efficiency
4. Private Equity gains are not subsidised by tax system through interest deductibility
5. Private Equity targets taken private are seldom taken public again
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How Private Equity Achieves Outperformance
1. Cash retention is minimised and excess cash is distributed promptly to investors
2. Capital structure is optimised to minimise cost of capital
3. An operating plan is developed and followed rigorously
4. Target company management is heavily incentivised to perform
5. Target company directors play an active and ongoing role in operational management
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Thank you!Thank you!Thank you!Thank you!