Joseph V. Rizzi Amsterdam Institute of Finance December, 2015 Sponsor Based Leveraged Acquisition Market Overview and Participants Transaction: Buyout, Acquisition or Recapitalization Leverage: Resulting in highly leveraged (i.e., non investment grade) obligor FD/EBITDA > 3X Subject to market availability and pricing (function of risk appetite Deal Types: Acquisition Recapitalization Refinance PTP (Public to Private) STS (Sponsor to Sponsor, aka Pass the Parcel) PE Importance: Provides 1/3 of all I/B Revenues and up to 25% of M&A Amsterdam Institute of Finance December, Near Record 2007 pre crisis $3.2T U.S. - 48% ROW - 52% Drivers Cash Balances Low Rates Exhausted Cost Cuts and Buybacks - Activist Pent-up Demand Positive Response Confidence Rising Stock Prices Increase in Shareholder Activism PE: Dog that didnt bark Strategic Acquirers crowd-out Lowest % of M&A in years Reflects dearth of larger PTP deals Volume down 2015 v double digit M&A increase Average deal size: 375 mln v 600 mln peak PPX: 14X + Strategic; 10X + PE Drop in cash in favor of stock/stock + cash All cash rebound since August, 2015 correction Amsterdam Institute of Finance December, Mega Deals (>10B) Record $1.19T Return of Strategic Acquiror Drivers Increased Stock Prices Management confidence; Stock as Currency Positive Shareholder Reaction: Pre Crisis Reaction Pre Crisis: Negative 2012 1H15: 3-4% 3Q15: Source: S&P Capital IQ Amsterdam Institute of Finance December, 20154 TargetAcquirerSize $ BG GroupRoyal Dutch 61B AllerganTeva 40.5B PerrigoMylan 35.6B BaxaltaShire 33.7B ChubbACE 28.5B CablevisionAltke 18.1B P&G Co BeautyCoty 16.9B O2 PLCHutchison 15.3B Alcatel LucentNokia 13.7B DelhalzAhold 11.6B Amsterdam Institute of Finance December Reduced Investor Risk Appetite Pricing Structuring Arrangers: Troubled syndications with more upward flex Issuers/Acquirers: Reluctance to acquire or use stock PPX: Too early to tell Amsterdam Institute of Finance December, Factors Deal Size Timing Price Financing Consideration Buyer Execution Type Tests Best Owner Iron Law Amsterdam Institute of Finance December, 20157 (Euro/B) 9M Country (Portfolio Concentrations %) Germany21 UK17 France11 Netherlands10 Spain 8 European PE Dry Powder (Euro/B) 300B Euro Focused Fundraising : 9 mos 2015 87B v 108B in 2014 Key Buyout Stats 9/30/15 PPX 9.3 Eq%41.8 FDX 4.8 Source: S&P Capital IQ Amsterdam Institute of Finance December, Leveraged Loans 9 Mo Continued Sluggishness Change Buyouts17 16 5% M&A12 21 29 37 Leverage Regulatory Restrictions Staying Below 5X : 4.8X Cov Lite: 45% of all Euro LL 2L: Weak Issuance CLO: Flat (66B v U.S. $414B AUM) HYB: 40% Off Prior Year Mez: Replaced by HYB, unitranche and 2L Equity: 40% + Forwarded Calendar: Stronger in U.S. PPX: 9X v 10.3X in U.S. Amsterdam Institute of Finance December, 20159 Represent 50% of institutional loan investors U.S.:$417B AUM Euro:$ 65B AUM Restructure following great recessions: CLO2.0 Losses/Outflows Dodd Frank Retention Rules Driving force beyond 2L and Cov Lite Trading Amsterdam Institute of Finance December, QuestionFramework 1. How will transaction achieve our goal?Acquisition Strategy 2. Which companies are good targets?Strategic Fit Search Screen 3. Best transaction types?M&A v Alliance JV and Minority Interests 4. Available Synergies?Scale, Scope and Skill Strategic and Due Diligence 5. What is target worth to us and potential bidders? DCF, Comps (trading, transaction) ROV 6. Target assessment?Shareholder value Economic profit, other 7. Risks?Cost of Capital Analysis Sensitivity, Scenario and Simulation 8. Deal Structure?Asset v Stock Cash v Stock Fixed v Contingent 9. IntegrationAbsorption v Preservation Symbiosis v Holding 10. NegotiationsPlanning and Strategies Amsterdam Institute of Finance December, CEO only believer: headstrong; magazine cover effect Only revenue synergies with no investment plan Prefunctory Due Diligence Reservation price changes during bidding Must close deal Failure to identify why buyer is best owner Emphasis on time, effort, cost and reputation sunk into deal Amsterdam Institute of Finance December, Timeline Stone Age Bronze Age Silver Age Golden Age Back-to-the-Future Maturity ( ) ( ) ( ) ( ) ( ) ( ?) Cottage Industry KKR Fund proliferation Goes global Shakeout/consolidation Exits Bootstrap deals High Yield Represents 40% higher equity levels Fund Raising of M&A smaller deals Dry Powder Mega Funds Operating improvements Diversification focus. Increase in PIPE and minority interests? Public PE Firms disappearing returns; lower valuations KKR 3Q15 Loss: 286 mln first since 2011 Carlyle3Q15 Loss: 84 mln Joint Venture 3G/Berkshire Hathaway Amsterdam Institute of Finance December, PE Fund Performance Persistence declining due to competition used to be Access Networks Signaling Crowded (> 5,000) 2,200 funds seeking funds as of 3Q15 Dry Powder 300B LP Selection Issues Strategy Returns Team Terms Relationship Amsterdam Institute of Finance December, Amsterdam Institute of Finance December, Tax Legal Accounting Knowledge Network Management Industry Expertise Corporate Finance Delivery Fund Raising Investing Managing/ Monitoring Exit VALUE Buy Right: PPX Financial Engineering: FDX Operating Improvements: (pf) EBITDA Multiple Expansion: Exit X Private Equity Value Added Private Equity Value Added 16 Amsterdam Institute of Finance December, 2015 USE IRR and MOIC not DCF for valuation Use comparable company multiples to calculate exit values not DCF Use flat hurdle rates (20 25%) not risk adjusted or CAPM based Use market timing not static tradeoff theory to set capital structure Opportunistic Exits Strategic Buyer 50% Financial Buyer 30% IPO 20% Value business model and competitive position over management Emphasize growth or cost cuts Amsterdam Institute of Finance December, CorporatePE ValuationWACC based DCFEquity returns and cost of equity based Debt CapacityInvestment Grade (company determined) Maximum debt capacity (lender/market determined) Residual ValueGrowing PrepExit X Value AddedSynergiesFinancial Engineering SearchFocusedOpportunistic AffordabilityDilutionIRR on required equity Deal SizeLargeDepends Capital StructurePermanentTemporary Debt StructureSimpleComplex FlexibilityNo financial covenantsCov-lite HorizonLong Term5+ years Integration RiskHighLow ThesisStrategicTransaction Amsterdam Institute of Finance December, Sponsor Share CVC 10.50% Apax Partners 5.30% Bridgepoint Capital 5.30% Onex Corp 3.90% Cinven Ltd 3.90% Bain Capital 3.90% Nordic Capital 3.90% Apollo Management 2.60% Wendel Investissement 2.60% Investindustrial 2.60% Clayton, Dubilier and Rice 2.60% 3i pic 2.60% Ardian 2.60% Equistone Partners 2.60% EQT Partners 2.60% Permira 2.60% Antin Infrastructure Partners SAS 1.30% Mid Europa Partners LLP 1.30% Kohlberg, Kravis & Roberts 1.30% Charterhouse Group International 1.30% Source: S&P Capital IQ Amsterdam Institute of Finance December, Up Cycle Spreads Narrow Multiples Increase Leverage Increases Exits Accelerate Fundraising Dry Powder Characteristics Government Bond Rates High Yield Spreads Amsterdam Institute of Finance December, Amsterdam Institute of Finance December, Deal market Disappoint returns Impacts fundraising Deals chase money Superior returns Attracts capital Capital chasings deals Macro Financial Markets Fund manager Carried interest partner General Partner LP A LP B LP C US Investors US Exempt Investors Non-US Investors FUND Investment Hold Co. Operating Entity Bank Bridge finance Syndicate participants Leverage finance syndicate participants Nominee High Yield Investors Mezzanine Investors FLL SLL CLO Hedge funds 22 Amsterdam Institute of Finance December, 2015 NowIn 5 yrs EBITDA of Acquired Firm (c) Sale 8 x EBITDA1,0001,500 Financing Plan: Total Capital Raised1,000 Fees Net Sale Proceeds on Exit1,450 Original Debt 800 Less: Debt pay down over 5 years 260 Debt at end of 5 years Return of Original Equity -200 Net gain to be allocated % to mgmt options 71(a) 20% to general partner % to limited partners 497 (b) Total 710 Amsterdam Institute of Finance December, (a)Share to CEO2% pointsor $14.2 x 1 = $14.2 Share to next 4 senior officers1% pointsor $ 7.1x 4 = $28.4 Share to next 8 key players1/2% pointsor $ 3.6x 8 = $28.4 Total Management share $71.0 (b) Equals a 28.4% compound annual rate of return on investment. (c) Assumes $12 taken out of cost structure immediately and 6.5% growth/year in EBITDA thereafter. Source: Casewriter The Role of Private Equity Firms in Mergers & Acquisitions Transaction Harvard Business School case Rev 10/16/06 - $ millions - Price Value eventually converge, but using price to justify M&A increases overpaying Most valuations are really disguised Pricings Academic Surveys DCF Reality Name Only TV in DCF >60% Value TV calculated using market multiple Venture Capital Valuation Football Field: Flaw of Averages Vx x x Average Fit Line x AssetDCFCompCompOther Value TradeTrans(ROV?) Goose that Lays the Golden Egg Story: Price v Value Amsterdam Institute of Finance December, Stupidity & Bias Fantasy Competitive Necessity Outlook/Information Advantage Synergies Lower Buyer WACC Undervaluation ROT: Greater than 40% premium over pre-bid market price is difficult to justify for any sizeable acquisition. Amsterdam Institute of Finance December, Focus on return: what is the maximum price I can pay based on given set of projections and earn X% return (not risk adjusted)? Tradition Valuation = Projected cash flows Discount rate Terminal value LBO Perspective =IRR (Equity discount rate) Projected cash flows Purchase Price Sale Price (Terminal Value) Debt Policy Ratings/Corp Value Transfer from LPs Amsterdam Institute of Finance December, How much can I borrow (XEBITDA) Usually 4 - 6X depending on market Equity Percentage Required (% of PP) Usually 30% - 45% dependent on market Compare Market PPX IRR Adjustments FD Exit Multiple Equity PP EBITDA adjustment (pro forma EBITDA) Example assume 100 EBITDA FDX 5X Equity % - 35% Affordable bid 7500 or 7.5x EBITDA Amsterdam Institute of Finance December, DCF Net Income + Dep/Amt +/_ Change in deferred taxes +/- Other noncash items +/- Change in working capital Cash flow from operations +After tax interest (hypo ) - CAPEX - Unleveraged FCF Amsterdam Institute of Finance December, CFADS Net Income Dep/Amt Change in deferred taxes Other non cash changes Change in working capital Cash flow from operations Non interest expense adjustment Capex CFADS IRREquivalent MOIC Over 6 Years 10% 1.8X 20% 3.0X 30% 4.8X 40% 7.5X 50%11.4X Amsterdam Institute of Finance December, Future Value Market Size (Year 6) 1,000 Market Share 10% Revenue 100 Revenue Multiple 5 Value 500 Ownership Need Investment (today) 10 Required Return (40%) 7.5X Expected Exit Value 75 Todays Ownership Requirement Expected Exit Value (6)75 Projected Value (6) 500 % Ownership 15% Amsterdam Institute of Finance December, Amsterdam Institute of Finance December, Fixing the Broken Deal Price and Structural Flex Structural Flex Increase spread Original issue discount Eliminate PIK Reduce debt Add a subordinate tranche More equity Add covenants Reduce Price Seller Paper Originators Increase Hold Valuation Convert foreign cash flows into home currency using forecast FX rates; discount using the home rates Majority method due to accounting translation focus Use local cash flows and rates; spot into home currency Terminal value growth rate at local inflation rate Complications Taxes home and foreign Political risk Venz, Russia Inflation and FX rates (A) Forecast foreign currency cash flows (B) Discount rate -same rate for domestic home currency -convert domestic rate to foreign by multiplying risk free rate differential - IRS -local rates (C) Resulting PV is FX convert to domestic/home using spot Amsterdam Institute of Finance December, 33 Amsterdam Institute of Finance December, 2015 Form entity to make unidentified acquisitions within finite time period (e.g. 18 mos) Return funds / cancel commitments if no acquisition occurs Charge fees and get carried interest Conflicts abound Amsterdam Institute of Finance December, Problem for Euro SMEs as banks retreat post crisis Europe over reliance on banks v U.S. % Banks % Non Bank Private Debt Other Europe U.S Private Debt flows into Europe growing $25B Dry Powder Regulators 2019 single market project Amsterdam Institute of Finance December, Does USD appreciation against Euro make Euro zone targets cheap? Pay less for Euro assets But receive less depreciated future Euro cash flows converted back into USD Companies continue to get confused by translation accounting or are they speculating in FX Amsterdam Institute of Finance December, Borrowing in Foreign currency different from home currency Borrower attracted by Foreign currencies with lower rates - carry trade Borrow USD Spot into home currency Risk if home currency weakens against USD unless hedged Taking deal risk Interest rate parity ensures no free lunch Borrow in country where assets and cash flow are located to create natural hedge Beware speculating in FX using company balance sheet Amsterdam Institute of Finance December,