Private Equity Outlook

David Smoot Managing Director Private Equity Outlook

• LBO industry has boomed in the past five years − Strong returns and preservation of capital through the cycle − Best-returning investment strategy across private equity alternatives • Credit bubble fueling the LBO boom burst in July 2007 − Bubble inflated by historically low default rates and mispricing of risk − Allowed mega-deals, especially large “public-to-privates” to happen − Deal volumes have fallen dramatically since • Credit markets are stabilizing but deal-making will be much more difficult − Leverage and debt pricing being reset to 2004 levels − Renewed focus on middle market as mega deals are priced out of reach • Despite the slowdown, the LBO industry is still raising record amounts − Nearly $250 billion in fresh committed capital raised each year from 2006 – 2008E − Plenty of dry powder remains

2 Attractive Industry: IRRs Have Been Favorable Through the Cycle…

IRR by Fund (1)

(%) 60 53.8 50.7

41.0 42.5 40 35.3 32.2 31.0 26.4 39.3 41.9 25.4 24.8 20.3 31.6 32.8 18.4 17.9 20 24.6 23.6 27.1 19.1 19.9 18.6 7.4 13.5 13.1 15.1 5.9 0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 Net IRR Estimated Gross IRR

(1) Capital-weighted IRRs by total fund size based on reported net IRRs from the state retirement systems of California (CalPERS and CalSTERS), Colorado (ColPERA) and Oregon (OrePER). Estimated Gross IRR based on 1.5% and 20% carry. Total sample size: 127 funds with $258Bn of 3 invested capital representing ~80% of total LBO fund capital deployed. …Offering Upside with Capital Preservation

Distribution of Returns by Capital Invested: All Funds 1990 – 2003 (1) Total = $258.1Bn Capital Invested ($Bn) 50.9 50.0

40.0 34.6 30.7 31.2 30.0 22.6 18.2 20.1 20.1 20.0 15.8 10.6 10.0 2.0 1.3 0.0 Net IRR (%) <(20)(10)0 5 10152025304050>50 Est. Gross IRR (%) <18<82 7 14202733395264>64

(1) Capital-weighted IRRs by total fund size based on reported net IRRs from the state retirement systems of California (CalPERS and CalSTERS), Colorado (ColPERA) and Oregon (OrePER). Total sample 4 size: 127 funds with $258Bn of invested capital representing ~80% of total LBO fund capital deployed. Public Pension Returns Buoyed by LBO Investing

Public Pensions: IRRs by Alternative Investment Strategy (1990—2003) (As of March 31, 2006) Total Capital Capital-Weighted Invested Total # IRR (%) ($Bn) of Funds

LBO 20.2 24.2 198

Weighted 14.4 41.1 548 Average

HY / Mezzanine 13.7 2.1 45 & Distressed

Secondary 10.8 2.1 48 Interests

Growth 7.1 5.2 94 Equity

Venture Capital 2.0 7.5 163

036912151821

(1) Based on data reported by CalPERS, CalSTRS, ColPERA and OrePERS. 5 Robust Credit Markets Allowed More Aggressive Transactions Higher Debt Multiples Seemed Reasonable Given Higher Purchase Prices

Average Large LBO Leverage Multiple (1) Multiples Paid in Selected 2007 LBOs x Avg. LTM EBITDA 7.3 Station 7.0 Casinos 18.6 x

Asurion 17.5 x 5.8 5.3 5.4 4.8 Nuveen 16.7 x 4.6 4.2 4.1 4.0 Laureate 16.6 x Education

Biomet 16.4 x

Alliance 16.3 x Data

First Data 15.3 x

CDW 15.2 x 2000 2001 2002 2003 2004 2005 2006 1H07 Failed Closed Deals Deals Since Since 6/1(2) 6/1 0 3 6 9 12 15 18 21

Source: Morgan Stanley Internal, Wall Street Research Source: MergerMarket

(1) S&P LBO Review, includes Issuers with PF EBITDA of more than $50MM 6 (2) Failed Deals includes funded bridges, pulled or postponed Historically Low Credit Losses Created Sense of Infallibility…

Annual Default Rates Annual Credit Losses B3-Rated Subordinated Debt B3-Rated Subordinated Debt (%) (%)

35 25 23.1 29.1 21.2 30 28.4 20 24.8 25 15.5 14.5 15 13.3 20 18.0 17.3

15 10 11.8 7.9 11.0 11.3 7.3 10.2 10.3 6.4 6.6 6.3 10 8.2 8.3 5.5 5.4 7.4 4.44.9 4.6 5.7 5 5.3 5 3.9 3.4 2.42.5 1.1 2.3 2.1 1.9 0.4 1.0 0 0 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 87 88 89 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06

Source: Moody’s 2007 Annual Default Study. Credit losses are estimated annually by multiplying subordinated debt recovery rates against B3-Rated corporate default rates. 7 …But Sentiment Changed Overnight

Large Institutional Loan Spread Monthly High Yield New Issue Volume and Price 2007 YTD ($MM) $ BPS 35,000 104 378

103 356 30,000

102 334 25,000 101 312

100 290 20,000

99 268 15,000 Market 98 Capitulates 246

97 224 10,000

96 202 5,000 95 180 6/1/2007 6/22/2007 7/19/2007 8/9/2007 9/4/2007 0 Jan Feb Mar Apr May Jun Jul Aug Sept Loan Spread (1) Average Price of Large Institutional

Source:LCD Source: SDC / Thomson

(1) Assumes 3-year weighted average life 8 Leveraged Loans Overhang the Market… (1)

Total Leveraged Loan pipeline estimated at over $254Bn

Leveraged Loan Forward Pipeline – ($MM)

Borrower Expected Deal Size Borrower Expected Deal Size

1 TXU Corp. 26,100 24 Houghton Mifflin 2,620 2 BCE Inc. 23,050 25 Hologic 2,550 3 Clear Channel Communications 19,525 26 United Rentals 2,500 4 Alltel 15,500 27 Ceridian 2,300 5 Basell 14,000 28 Bausch & Lomb 2,225 6 Sallie Mae 12,500 29 Telesat 2,200 7 Chrysler Automotive 12,000 30 Tribune 2,105 8 Cablevision 9,230 31 URS 2,100 9 Harrah’s 9,000 32 Guitar Center 1,815 10 Avaya 6,000 33 The Finish Line 1,600 11 Penn National Gaming Inc. 5,100 34 Teleflex 1,500 12 Mylan 4,850 35 Bombardier 1,400 13 Gerdau Ameristeel 4,600 36 Sequa Corp. 1,350 14 Alliance Data 4,400 37 Darden Restaurants 1,200 15 Affiliated Computer Services 4,005 38 Sandy Creek Energy 1,181 16 CDW 3,700 39 Source Interlink 1,180 17 Federal-Mogul 3,500 40 Reddy Ice 1,100 18 U.S. Foodservice 3,300 41 LKQ Corp. 1,090 19 Station Casinos 3,200 42 American Standard 1,000 20 Merna RE 2,800 43 Total for Deals Under 1,000 29,045 21 Graphic Packaging International 2,800 Total 253,911 22 Nuveen 2,690

(1) Sources: LCD News; Prospect News; Deal.com. 9 …As Does the High Yield Forward Pipeline (1)

Total High Yield pipeline estimated at over $97Bn

High Yield Forward Pipeline – ($MM)

Borrower Expected Deal Size Borrower Expected Deal Size

1 BCE 11,300 11 Clear Channel Communications 2,600 2 TXU Corp. 11,250 12 Affiliated Computer Services 2,515 3 First Data Corp. 9,000 13 Alliance DataSystems Corp. 2,210 4 Alltel Communications 7,700 14 Tribune Co. 2,100 5 Basell 7,000 15 Avaya Inc. 1,700 6 Cablevision 6,225 16 Ceridian Corp. 1,400 7 Harrah’s Entertainment Inc. 6,025 17 Allison Transmission 1,100 8 Intelsat Holdings 5,110 18 Bausch & Lomb 1,050 9 United Rentals Inc. 4,000 19 Total Announced Under 1,000 11,254 10 HD Supply 3,800 Total 97,339

(1) Sources: LCD News; Prospect News; Deal.com. 10 Impact of the Credit Market Correction… Less Leverage…Costs Higher…Returns Lower Unless Prices Adjust

Illustrative Example: $2.5Bn ($MM) Today June 07 Sponsor Equity $1,150 $700 % Equity Contribution 45% 27% Expected IRR 20% 35%

Total Debt ― Senior (TLB) 850 L+400 (98) 1,300 L+275 (par) ― Sr. Uns. Nts. 500 12.5% 300 8.5% ― Sr. Sub. Nts. – 200 9.5% ― Total Debt $1,350 $1,800 Leverage Statistics ― Bank Debt / LTM EBITDA 3.5x 5.0x ― Total Debt / LTM EBITDA 5.5x 7.0x Underwriting Best Efforts Firm / Bridge

Implied Sponsor WACC (1) 12.9% 9.2%

(1) Assumes cost of equity is equal to 20%. 11 …Public to Private Activity Has Slowed Dramatically

Global Public to Private Transactions (1) $Bn

500 448 450 405 400 350 300 250 200 150 107 107 100 53 32 50 17 28 0 2001 2002 2003 2004 2005 2006 1H2007 3Q2007

(1) Greater than $100MM 12 The Market Has Begun to Stabilize Leveraged Loan and High Yield Market Technicals Calm

High Yield 8 Index Price and Spread LCDX Index Price and Spread T+ (BPS) $ L+ (BPS) $

590 102 400 101

101 100 540 100 350 99 99 490 98 98 300 97 440 97

96 250 96

390 95 95 94 200 340 94 93 93 92 150 290 91 92

240 90 100 91 06-1 07-20 08-14 08-28 09-14 10-1 06-1 06-15 06-29 07-17 07-31 08-14 08-28 09-12 10-1

Price Spread Price

Source: Morgan Stanley Source: Morgan Stanley

13 PE Fundraising Continues Unabated

Leveraged Buyout Fundraising Volume $Bn

300

270 250+ 247 240 221 210 82 173 180 160 150 120 105 106 95 94 90 68 164 55 60 50 32 33 20 30 7 14

0 (2) 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 YTD 2008E (1) 2007

(1) The Private Equity Analyst 2007; includes only amounts closed during the given period; annualized 14 (2) Morgan Stanley 2008E Fundraising Environment

Target Fund Firm Partnership Strategy Size ($Bn) 1 Blackstone Group Blackstone Capital Partners VI Global buyout 25.0 2 KKR Fund 2008 Global buyout 25.0 3 Texas Pacific Group TPG Partners VI Global buyout 20.0 4 Carlyle Group Carlyle Partners VI U.S. buyout 17.0 5 Apollo Management Apollo Investment Fund VIII U.S. buyout 15.0 6 Bain Capital Fund XI U.S. buyout 15.0 7 Warburg Pincus Private Equity XI Global buyout 15.0 8 PAI Partners PAI VI Global buyout 13.4 9 CVC Capital Partners CVC European Equity Partners V European buyout 13.4 10 Apax Europe VIII Global buyout 13.4 11 Madison Dearborn Partners Madison Dearborn Capital Partners VI Global buyout 10.0 12 Thomas H. Lee Partners Thomas H. Lee VII Global buyout 8.0 13 Clayton, Dubilier & Rice Clayton, Dubilier & Rice VIII Global buyout 7.5 14 Charterhouse Capital Partners Charterhouse Capital Partners IX Global buyout 6.0 15 Bridgepoint Bridgepoint Euro Private Equity V European buyout 5.5 16 Kelso & Company Kelso Investment Associates IX U.S. buyout 5.0 17 Welsh, Carson, Anderson & Stowe Welsh, Carson, Anderson & Stowe XII Global buyout 5.0 18 TA Associates TA XI LP Global buyout 5.0 19 Oak Hill Capital Partners Oak Hill Capital Partners IV U.S. buyout 5.0

Source: Park Hill Group, Private Equity Intelligence 15 “Middle” Market vs. Mega Fund? Typical Portfolio Construction

“Middle” Market Fund Mega Fund

Committed Capital ($Bn) 5 20

# Investments 25 – 30 30 – 40

# Partners 12 20

# Investment Professionals 35 60

Average Equity Check (5%) ($MM) 250 1,000

Implied Target Aggregate Value ($Bn) 1 – 2 4 – 5

16 Industry Sized Itself to 2006-2007 Activity Levels

LBO Transaction Volume (1) $Bn

800 Peak? 700

600

500 Peak

400

300 Peak 200 Trough Trough 100

0

1 7 88 90 9 92 93 94 96 97 99 00 01 03 04 05 06 19 1989 19 19 19 19 19 1995 19 19 1998 19 20 20 2002 20 20 20 20 200

YTD U.S. Europe ROW

Source: Thompson Financial 17 …And Tremendous Buying Power Remains Almost $300Bn of Dry Powder Still Seeking Investments

Top Global Funds 22 Uncommitted Capital $Bn 20 1,500 18 1,154 1,000 852 894 25.6% 16 786 24.1% 26.6% 26.1% 14 500 74.4% 73.4% 73.9% 75.9% 12 0 10 2004 2005 2006 YTD 2007 Invested Capital Uninvested Capital 8 Source: Thomson, Morgan Stanley Internal 6 4 2 s s s s s s k s 0 n s k al s s ie e n s s ic s lo A al al ty s e ty al t al ar al ra G) t t ng ce on a) t ds es) ng t t ai i l or i op e) on al one ner ner ner oup i ou p DI ner ner op e) ner op e) ope) ners ner ope) ner op e) ope) ner ncus bor TPG mi Par t CVC) mar at Du bai ant erv ope) KKR hmar t t t ner t t l t Lee t On e em er Apol (Ar t f G SPI it (As berus) edm an Gr

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Ca pi Ont Su m m i odn Jordan erho use (Europe) use erho a Fi man man er Onex Onex Capi e Cap i nvest l t r Pr Madi ment Par nance Conance r Japoni Gr ver The Car The Kel C andover ll l Franci CR Gol CR Ber y Ha(Eur nson Par cks, dber ar Caar pi Advent dic dic lyl Lee Equi Lee s M er And er Fi s I J M er Hel Si Ter est GT Cent B C Part PAI Squa re Capi Squa re ayton, Char es M anagem en t DL EQ T Nor her t on, res nv Go l ee Capi ee Vest CCMP Capi CCMP Apax PaApax r Energy t earns M er earns r Cl um Ar berus Capberus i I -Hi ot dgep oint Oak Hi Oak i ay D ought al eni Leonard Leonard For St The Car The t Br C our ll Cer Oakt Tennenba um Capi Mi Dubai Linds sh, Cars sh, Capi Bear Wel on Lehm an B r Li

Source: Morgan Stanley Internal 18 Private Equity Capabilities within Morgan Stanley

Morgan Stanley

Global Investment Institutional Wealth Management Securities Management

Asset Merchant Fixed Income Alternatives Management Banking & Commodities

AIP FrontPoint (Funds of Commodities Principal (Hedge Funds) Funds) Direct Investing Investments

Real Estate Private Equity Infrastructure Investing

19 Decisions for Private Equity Investors

• Where is the sweet spot now? − Middle market? − Mega funds? − Regional vs. global funds? − Alternatives? (e.g. infrastructure, ) • What are the key points of differentiation for private equity funds? − Dry vs. “wet powder” − Sourcing − Investment acumen − Operating expertise / adding value − Exit • How do I build a portfolio? − − Vintage year diversification − Manager selection

20 David Smoot Biography

David Smoot is a Managing Director in the Private Equity Group of Morgan Stanley. Previously, he was a Managing Director of the Morgan Stanley Principal Investments Group, the Firm’s on- balance sheet private equity investing business. Prior to joining the private equity initiatives of the firm, Mr. Smoot was a Managing Director of the Financial Sponsors Group. Mr. Smoot joined Morgan Stanley’s energy group in 1997 from Salomon Brothers where he was a member of the Global Energy and Chemicals Group. From 2000 to 2003, Mr. Smoot was a member of the Technology Group responsible for coverage of semiconductor, semiconductor capital equipment and wireless infrastructure companies. Mr. Smoot serves on the Board of Directors of McKechnie Aerospace. Mr. Smoot holds a B.A. magna cum laude from Duke University, where he was elected to Phi Beta Kappa. He also earned a J.D. cum laude from Harvard Law School.

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