The Impact of Private Equity Investors on Their Portfolio Companies
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The Impact of Private Equity Investors on their Portfolio Companies Mike Wright Centre for Management Buyout Research Nottingham University Business School www.cmbor.org Centre for Management Buy-out Research Identified emergence of UK buy-out and private equity market early 1980s Organised first European buy-out conference in 1981 Centre for Management Buy-out Research (CMBOR) Established in 1986 at Nottingham University Business School To examine developments in UK & European buy-out markets in comprehensive and independent manner 25 years of research into MBO/MBIs Established world leading database of buy-outs Currently >25,000 buy-outs in UK and Europe Number of publications generated from database including: UK Quarterly Review and European MBO Review Academic Articles Private Equity & Portfolio Companies 1600 200000 1400 180000 160000 1200 140000 1000 120000 n 800 100000 illio m umber N 600 80000 € 60000 400 40000 200 20000 0 0 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Number Value (€m) From Folklore to Science Summarize main themes from over 100 studies covering US and Europe (Gilligan and Wright, 2010) Performance, growth and their drivers Role of Boards Employment and employee relations Asset sales, Longevity and distress Source: CMBOR Do Buyouts Improve Firm Performance? Buy-outs improve profitability Operating profitability of PE backed buy-outs greater than for comparable non-buyouts by 4.5% over first three buy- out years Industry specialisation of private equity firm important Similar evidence from France & NL BUT Public to Privates [PTPs] Emerging US and UK evidence suggests accounting returns on 1990s/2000s deals are not as great as for 1980s deals [Guo et al., 2009; Weir et al., 2008] Source: CMBOR/Barclays Private Equity/Deloitte Do Buyouts Improve Firm Performance? Buy-outs improve productivity Total factor productivity (TFP) assessed 36,000 UK manufacturing establishments 4,877 experienced MBO between 1994-8 MBO establishments were approx. 2% less productive than comparable plants before transfer ownership After MBO substantial productivity increase [see also Davis et al., 2009 for US] Does PE Affect Growth & Investment? Refocusing & divestment greater than non-buyouts Buy-outs improve entrepreneurial actions New product development Role of private equity firms CAPEX & R&D mixed evidence Divisional buyouts greater growth in sales, efficiency & profits (Meuleman et al., 2009) PE backed buyouts increase patent cites (Lerner et al., 2008) Strategic control systems enable growth What Drives Performance Changes? Management team shareholding has largest impact on equity returns After adjusting for management selecting an attractive deal Paying a lower price gives greater scope for greater equity for management Gains in LBOs > Gains in Leveraged Recapitalizations What is the role of PE and the Board? Active PE firm monitoring important Industry specialism & experience of deals done Boards: in PE buyouts active, non-bureaucratic boards that help lead strategies to create value in listed corporations accompany management’s strategy and tend to focus on risk management What is the role of PE boards in distress deals? Listed corporation non-executive directors appear generally less involved than boards in PE-backed buyouts when restructuring becomes necessary PE firm boards more rigorous and timely in distress PE firms have an important role in restructuring distressed portfolio firms and their strategies even following debt/equity swaps Listed corporations can face greater problems in injecting new cash as they need to issue a formal investment proposal [Wilson, Wright, Cressy, 2010] Does PE adversely affect employment & wages? Years relative to year of deal Variables t + 1 t + 2 t + 3 t + 4 t + 5 MBO Employment -2.28% 2.96% 7.46% 21.43% 26.02% MBI Employment -10.22% -9.70% -11.10% -3.35% -5.02% Source: Wright et al. (2007)/CMBOR Employment Now many studies – employment effect contingent Davis et al. (2008) employment grows more slowly & declines more rapidly in PE until t+4; greenfield growth (US) Boucly et al. (2009) 3 years following LBO, targets grow faster than peers by 13% (France) (Amess & Wright, 2007, 2010; Amess, Girma & Wright, 2008) (UK) Majority of deals increase employment after initial fall Employment growth in MBOs higher than non-LBOs but lower in MBIs Buyouts whether PE or not no different employment change compared to matched firms M&A has more negative effect than PE on employment Wage growth in MBOs & MBIs, lower than non-LBOs What is Impact of PE Buyouts on Employee Relations? Occupational pension schemes: increase but shift to defined contribution schemes based on investment performance and contributions open to new members Increase in regular team briefings; Internal promotion as norm; work organised around team working for the majority of the staff; Formal grievance procedure; incentive pay schemes; non- managerial training Little change in union representation; 2/3 unions in favor neutral towards buyout More consultative committees, more influential; increased focus on employment issues and especially on discussing company’s future Evidence of direct meetings between PE firms and employee representatives [Bacon et al., 2008a, b] What is Impact of PE Buyouts in Different Social Contexts on Employee Relations? Differences in Portfolio company context All contexts show increase in new high performance work practices (HPWPs) after buyout; significant differences between contexts disappear after buyout Differences in PE firm origin Buy-outs backed by Anglo-American firms are as likely to introduce HPWPs (except for more financial incentives) as those backed by non-Anglo-American PE firms, suggesting some adaptation to local institutional contexts. Time-scale PE investment results in greater increases in HPWPs longer the anticipated time to exit. The impact of PE on HPWPs is affected more by length of the investment relationship (heterogeneity of PE firm effect) than the countries where PE is going to or is coming from [Bacon et al., 2010a, b] What is the Extent of Asset Sales? Substantial sell-offs mainly in few large & PTP deals Partial Sale Year CE UK No. Val. (€m) No. Val. (£m) 2000 36 420 78 4352 2001 30 51 94 8905 2002 32 2644 69 4837 2003 35 922 76 2974 2004 49 2938 73 8619 2005 54 2236 99 9145 2006 44 3786 72 6688 2007 49 6472 60 5379 2008 30 5654 44 495 Number & value of partial sales small share of deal volume and value Do PE Deals Involve Short Term Flipping of Assets? 80 70 70 60 60 50 50 40 40 £50‐500m 30 30 Over £500m 20 20 avge months to exit to avge months 10 10 0 0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Source: CMBOR Overall increasing time to exit but heterogeneous longevity (see also Stromberg, 2008) Secondary buy-outs take longer to exit PE-backed MBOs IPO sooner; those backed by active PE exit sooner & perform better Can PE provide a role in distressed firms? Receiverships Increasing Source of Buy-outs 120 1200 100 1000 80 800 60 600 million Number £ 40 400 20 200 0 0 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 2007 2009 Total Number Total Value (£m) What is happening to Leverage & Pricing in PE Buyouts? 60 50 Dramatic fall in senior 40 debt in financing structures in 2008 30 20 over above £10m 10 deals 0 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Substantial increase Equity Mezzanine Debt Loan Note Other Finance in senior debt pricing Type of Senior Debt 04 05 06 07 08 above LIBOR, especially for less Tranche A 225 218 224 217 285 traditional layers Tranche B 275 250 262 265 338 Tranche C 327 283 308 303 396 Note: Data shows basis points above LIBOR Does Higher Leverage Increase Likelihood of Failure? Failed vs non-failed buyouts Failure rate affected by leverage, timing of deal & by default probability on buyout (Wright et al., 1996) PE buyout failure vs non-buyout failure (Wilson, Wright & Altanlar, 2010) 7million firm years 1995-2009 including all UK companies PE-backed buyouts have a significantly better coverage ratio (the ability to pay interest on debt from profit and cash-flow) than non-private equity backed businesses. Leveraged firms [of any kind] more likely to fail After taking into account leverage and other factors: Private Equity backed buyouts post 2003 not significantly different in failure likelihood than non-buyouts Buyouts and buyins without private equity more likely to fail What is the recovery rate in failed PE deals? ? Secured creditors recover 62% average on bankruptcy; 30% sold as going concerns (Citron, Wright, 2008) Recovery rates from failed PE buyouts (63%) more than twice those in failed listed corporations (26-30%) [Wilson,Wright & Cressy, 2010) Dependent on proactive working between PE firms and banks Banks may soon seek to recover value through equity sales, which may increase receiverships or sales to distress funds. Deal Types and Involvement of PE Firms Managerial Managers’ PE Model/ Expertise Innovative Skills Portfolio Mgt Leverage & Constrained Conflicted Buy- Financial Buy-outs outs [weak complements] [strong negative Monitoring substitutes] Lower Leverage Operational Radical Buy-outs & Close Value Buy-outs [strong positive Adding [weak substitutes] complements] Need strategies to grow portfolio firms organically