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2. the Private Equity Market and Business Model Norwegian School of Economics Bergen, Spring, 2021 Operating Performance in Private Equity Is Private Equity a Superior Ownership Model in Creating Operational Value in Norway? Didrik Vier Simensen & Joachim Herman Koren Supervisor: Thore Johnsen1 Master of Science in Economics and Business Administration NORWEGIAN SCHOOL OF ECONOMICS This thesis was written as a part of the Master of Science in Economics and Business Administration at NHH. Please note that neither the institution nor the examiners are responsible − through the approval of this thesis − for the theories and methods used, or results and conclusions drawn in this work. 1 We wish to extend our gratitude to our supervisor, Thore Johnson, for his interest in our work and sound advice. We are also thankful for valuable guidance and inputs from NHH professors Finn Kinserdal and Carsten Bienz. Finally, we would also like to thank Argentum and Per Fredrik Johansen at Menon Economics for great discussions and cooperation. 2 Abstract While the net returns provided by Private Equity (PE) funds to its investors is a debated topic in relation to diminishing alpha and justification of fees and other fund expenses, we seek to determine if PE ownership has a positive impact on the operating performance of Norwegian portfolio companies. Additionally, we seek to identify potential operating performance differences between industry specialized and generalist PE managers and between deal types (source of entry). By applying an extensive and unique dataset consisting of 214 Norwegian buyouts occurring between 2000-2015, we find that PE in Norway generates a significantly higher growth in sales and EBITDA compared to companies not backed by PE. We also identify improvements in working capital efficiency. However, we find no evidence of improvements in operating profitability (ROA). Examining the subcomponents of ROA provides some evidence of improvements in asset turnover which are offset by a negative development in margins. Our findings do not support a positive industry specialization effect. Examining deal types, we find evidence of improvements in margins and operating profitability for public buyouts, also relative to private-to-private buyouts. In contrast, private-to-private buyouts appear to be more growth- oriented, clearly outperforming their benchmark in sales growth. The overall findings imply that revenue and EBITDA growth appears to be the main focus and driver behind value creation in Norwegian portfolio companies, rather than cutting costs and focusing on margins. Our findings also suggest that PE ownership provides advantageous differentiated support for growth and expansion buyout candidates (typically private companies) and for margin improvement buyout candidates (typically public companies). Table of Contents 1. Introduction .....................................................................................................................6 2. The Private Equity Market and Business Model .........................................................9 2.1 The Private Equity Market ................................................................................................ 9 2.1.1 The Global Market Development .................................................................................................. 9 2.2 The Private Equity Business Model ................................................................................ 11 2.2.1 Company Selection ...................................................................................................................... 13 2.2.2 Price to Intrinsic Value ................................................................................................................ 14 2.2.3 Deal Structuring ........................................................................................................................... 14 2.2.4 The Exit Strategy ......................................................................................................................... 15 2.2.5 Improving The Portfolio Company’s Operating Performance .................................................... 16 2.3 Specialized vs Generalist PE Funds ................................................................................ 17 3. Literature Review .........................................................................................................19 3.1 Value Creation Framework ............................................................................................. 19 3.1.1 Financial Engineering .................................................................................................................. 20 3.1.2 Governance Engineering ............................................................................................................. 23 3.1.3 Operational Engineering .............................................................................................................. 24 3.2 PE Deal Types, Strategic Focus and Specialization Effects .......................................... 29 4. Empirical Research .......................................................................................................35 4.1 Research Design ................................................................................................................ 35 4.2 Data .................................................................................................................................... 36 4.2.1 Databases Applied ....................................................................................................................... 37 4.2.2 Data Due Diligence ..................................................................................................................... 38 4.2.3 Sample Description ..................................................................................................................... 42 4.3 Operating Performance Metrics ..................................................................................... 47 4.4 Construction of the Control Group ................................................................................ 51 4.4.1 Implementation of Propensity Score Matching ........................................................................... 53 4.5 Empirical Setup ................................................................................................................ 63 4.5.1 Operating Performance ................................................................................................................ 63 4.5.2 Specialization Effect .................................................................................................................... 65 4.5.3 Deal Type .................................................................................................................................... 67 5. Empirical Results ..........................................................................................................68 4 5.1 Operating Performance ................................................................................................... 68 5.1.1 Development in Return on Assets ................................................................................................ 70 5.1.2 Development in Return on Sales .................................................................................................. 71 5.1.3 Development in Asset Turnover .................................................................................................. 71 5.1.4 Development in Sales .................................................................................................................. 72 5.1.5 Development in EBITDA ............................................................................................................ 73 5.1.6 Development of Working Capital ................................................................................................ 73 5.1.7 Regression Analysis ..................................................................................................................... 74 5.2 The Effect of PE Specialization ....................................................................................... 78 5.3 Deal Types ......................................................................................................................... 84 5.4 Limitations ........................................................................................................................ 91 6. Conclusion ..................................................................................................................... 92 References .............................................................................................................................. 94 Appendix .............................................................................................................................. 105 List of Tables Table I - Buyout Distribution by Industry and Investment Year ……………..……………44 Table II - Buyout Distribution by Deal Type and Investment Year …………..……...........45 Table III - Distribution by Outcome ……………………………..……………..………….46 Table IV - Bias Reduction in Covariates …………..……....................................................62 Table V - Post-Buyout Performance of All Buyouts …………..……..................................69 Table VI - Regression Analysis for All Buyouts …………..……........................................76 Table VII - Performance by Specialized PE…………..……................................................79 Table VIII
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