Joseph V. Rizzi Amsterdam Institute of Finance October, 2014 Sponsor Based Leveraged Acquisition...

Joseph V. RizziJoseph V. RizziAmsterdam Institute of FinanceAmsterdam Institute of Finance

October, 2014October, 2014

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:

AcquisitionRecapitalizationRefinancePTP (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 October, 2014 2

7 Year High – 1.77TU.S. - 41% ROW - 59%

DriversCash Balances Low RatesExhausted Cost Cuts and BuybacksPent-up Demand Positive ResponseConfidenceRising Stock Prices

Increase in Hostile T/O

20% of total v single digits post crisis

PE: Dog that didn’t bark – Strategic Acquirers crowd-out

20% of total v 27% 4 year average

Reflects dearth of larger PTP deals

Volume up 6% 2014 v double digit M&A increase

PPX: 14X+

Drop in cash in favor of stock/stock + cashAll cash at lowest level since 2001

Averages reflect return of the “big deal”

Amsterdam Institute of Finance October, 2014

3

Activity1H14 1H13

Volume ($B) 1,768 1,023

Size (> 10B) 9 19 Return of Strategic Acquiror

Holcim – LaFarge April, 2014: $39.5B

Numericable – SFR March, 2014: $23.3B

Facebook – WhatsApp February, 2014: $19.5B

Suntory – Beam January, 2014: $15.7B

Bayer – Merck Cons May, 2014: $14.2B Drivers

Increased Stock Prices – Management confidence; Stock as Currency

Positive Shareholder Reaction: One Day Indexed Buyer Stock Price Reaction

1H14 2.9%

2H13 3.6%

1H13 3.1%

2012 1.8%

2011 .3%

2010 .3%

2009 <1.9%>

2008 <1.3%>

Source: S&P Capital IQAmsterdam Institute of Finance

October, 2014 4

FactorsDeal SizeTimingPriceFinancingConsiderationBuyerExecutionType

TestsBest OwnerIron Law


(Euro/B)

7/31/14 38.8

2013 63.7

2012 29.0

2011 43.9

2010 39.4

2009 9.0

2008 69.3

2007 152.3

2006 164.5 Country

UK 28.57%

France 19.10%

Germany 12.59%

Netherlands 10.83%

Spain 6.45% European PE Dry Powder (Euro/B) – European Focused

Fundraising

7/31/14 225 58.4

2013 190 88.8

2012 175 73.8 Key Buyout Stats – 7/31/14

PPX 9X

Eq% 35%

FDX 5X Source: S&P Capital IQ


European LL Volume:Highest Level Post Crisis June/JulyYTD Volume €59.5B up 19% same period 2013/LYIncludes M&A and PE

Leverage Up: 5X+

Return of Cov-lite: Reduced Terms

2L Increasing

CLO:Returning – 6 Mo 16 v 20 for YE13Costs dropped from E+200 2013 to E+100 1H14

MEZ N/A: 2L Wipeout

HYB (7/31/14): €61.3B v €47.2B LY


Question Framework1. How will transaction achieve our goal? Acquisition Strategy

2. Which companies are good targets? Strategic FitSearch Screen

3. Best transaction types? M&A v AllianceJV and Minority Interests

4. Available Synergies? Scale, Scope and SkillStrategic and Due Diligence

5. What is target worth to us and potential bidders?

DCF, Comps (trading, transaction)ROV

6. Target assessment? Shareholder valueEconomic profit, other

7. Risks? Cost of Capital AnalysisSensitivity, Scenario and Simulation

8. Deal Structure? Asset v StockCash v StockFixed v Contingent

9. Integration Absorption v PreservationSymbiosis v Holding

10. Negotiations Planning and Strategies


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


9

Stone Age Bronze Age Silver Age Golden Age Back-to-the-Future Maturity

(1974-84) (1985-90) (1990-2000) (2002-07) (2008-2012) (2013 - ?)

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?


PE Fund Performance Persistence – declining due to competitionAccess

Networks

Signaling

Crowded (> 5,000)2,200 funds seeking funds as of July, 2014

Raise $750B

Dry Powder

LP Selection IssuesStrategy

Returns

Team

Terms

Relationship


11


Tax – Legal – Accounting Knowledge

Network ManagementIndustry ExpertiseCorporate Finance Delivery

FundRaising

Investing Managing/Monitoring

Exit

VALUE

• Buy Right: PPX

• Financial Engineering: FDX

• Operating Improvements: (pf) EBITDA

• Multiple Expansion: Exit X

13Amsterdam Institute of Finance

October, 2014

Corporate PE

Valuation WACC based DCF Equity returns and cost of equity based

Debt Capacity Investment Grade (company determined)

Maximum debt capacity (lender/market determined)

Residual Value Growing Prep Exit X

Value Added Synergies Financial Engineering

Search Focused Opportunistic

Affordability Dilution IRR on required equity

Deal Size Large Depends

Capital Structure Permanent Temporary

Debt Structure Simple Complex

Flexibility No financial covenants Cov-lite

Horizon Long Term 5+ years

Integration Risk High Low

Thesis Strategic Transaction


14

Sponsor ShareCVC 10.13%

Carlyle Group 5.06%

Astorg Partners 5.06%

Permira 5.06%

Clayton, Dubilier & Rice 3.80%

Goldman Sachs 3.80%

Montagu Private Equity 3.80%

Advent International 2.53%

Bain Capital 2.53%

Koch Industries 2.53%

Cinven Ltd 2.53%

Apollo Management 2.53%

Bridgepoint Capital 2.53%

Teachers’ Private Capital 2.53%

Investcorp 2.53%

Triton Managers 2.53%

Ardian 2.53%

Electra Partners 2.53%

ATP Private Equity Partners 1.27%

3i pic 1.27%

Source: S&P Capital IQ


15

Up CycleSpreads NarrowMultiples IncreaseLeverage IncreasesExits AccelerateFundraisingDry Powder

CharacteristicsGovernment Bond RatesHigh Yield Spreads


16


Deal marketDisappoint returnsImpacts 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 Investment InvestmentInvestment

Hold Co.

Hold Co.

Operating Entity

Bank

Bridge finance

Syndicate participants

Leverage finance

syndicate participants

Nominee

High Yield

Investors

Mezzanine

InvestorsFLL

SLL

CLO

Hedge funds

18Amsterdam Institute of Finance

October, 2014

Now In 5 yrs

EBITDA of Acquired Firm 125 188 (c)Sale value @ 8 x EBITDA 1,000 1,500

Financing Plan: Equity @ .20 200 Debt @ .80 800

Total Capital Raised 1,000

Fees 30 50

Net Sale Proceeds on Exit 1,450

Original Debt 800 Less: Debt pay down over 5 years 260Debt at end of 5 years -540 540Return of Original Equity -200Net gain to be allocated 710 10% to mgmt options 71(a) 20% to general partner 142 70% to limited partners 497 (b) Total 710


(a) Share to CEO 2% points or $14.2 x 1 = $14.2Share to next 4 senior officers 1% points or $ 7.1 x 4 = $28.4 Share to next 8 key players 1/2% points or $ 3.6 x 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 TransactionHarvard Business School case 9-206-1 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

V x

x

x Average Fit Line

x

x

Asset DCF Comp Comp Other Value Trade Trans (ROV?)

Goose that Lays the Golden Egg Story: Price v Value


20

Stupidity & BiasFantasyCompetitive NecessityOutlook/Information AdvantageSynergiesLower Buyer WACCUndervaluation

ROT: Greater than 40% premium over pre-bid market price is difficult to justify for any sizeable acquisition.


21

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 flowsDiscounted rateTerminal value

LBO Perspective = IRR (Equity discount rate)Projected cash flowsPurchase PriceSale Price (Terminal Value)

Debt PolicyRatings/CorpValue Transfer from LP’s


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


DCF

Net Income+ Dep/Amt+/_ Change in deferred taxes+/- Other noncash items+/- Change in working capital Cash flow from

operations+After tax interest (hypo Ƭ)- CAPEX- Unleveraged FCF


CFADS

Net IncomeDep/AmtChange in deferred taxes Other non cash changesChange in working capitalCash flow from operationsNon interest expense adjustmentCapexCFADS

IRR Equivalent MOIC Over 6 Years

10% 1.8X20% 3.0X30% 4.8X40% 7.5X50% 11.4X


25

Future ValueMarket Size (Year 6) 1,000

Market Share 10%

Revenue 100

Revenue Multiple 5

Value 500

Ownership NeedInvestment (today) 10

Required Return (40%) 7.5X

Expected Exit Value 75

Today’s Ownership RequirementExpected Exit Value 75

Projected Value 500

% Ownership 15%


26


Fixing the Broken Deal – Price and

Structural Flex

Increase spread Recycled

Original issue discount

Eliminate PIK

Reduce debt

Add a subordinate tranche

More equity

Add covenants

Reduce Price

Seller Paper

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Joseph V. Rizzi Amsterdam Institute of Finance October, 2014 Sponsor Based Leveraged Acquisition...

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