Alert

January 2009 Fear and Greed

Weil News By Doug Warner ([email protected]) and Michael Weisser (michael. n The 2009 Edition of Best [email protected]) Lawyers in America named our following partners in the areas Let’s cut to the chase. This past year was an annus horribilis for the private equity of Leveraged , Private industry. The financial crisis that started with the credit crunch in the summer of Equity Law or Private Funds Law: 2007 and accelerated with the collapse or bailout of numerous financial institu- Christopher Aidun, David Duffell, Shukie Grossman, David Kreisler, tions worldwide in the fourth quarter of 2008 left many victims in the private Steven Peck, Charles Robins, equity industry in its wake. Jay Tabor, Jeffrey Tabak, Doug Warner, Glenn West, James Pundits have recently predicted that this financial crisis would result in a secular Westra and Barry Wolf change in the market for private equity with a significant percentage of private n Weil Gotshal advised Lehman equity funds going out of business and the industry materially shrinking. On the Brothers Holdings Inc. in other hand industry leaders have reminded investors that historically some of the connection with the management best private equity deals have been struck when times were gloomiest. Stephen of Neuberger Berman and Schwarzman reportedly recently stated that he was a “raging bull” on private certain of its alternative asset equity. Guy Hands reportedly pointed out that if Wall Street had worked on a businesses “carry basis,” as private equity sponsors do, Wall Street may have avoided many of n Weil Gotshal advised NBC the transactions that have contributed to the current financial crisis. We are Universal Inc. in connection with the consummation of the $3.5 similarly bullish about the private equity industry and the vitality of the private billion acquisition of The Weather equity business model. Channel by NBC Universal Inc., and This article looks back on trends we saw in the industry in 2008. It also contains some predictions as to what awaits the industry in 2009 and beyond. n Weil Gotshal advised Partners in connection with its $290 million going private Trends in 2008 acquisition of eTelecare Global Some of the trends we saw in the private equity market in 2008 included: Solutions, Inc.

n n Weil Gotshal advised Getty A Difficult Fund Raising Environment– The fund raising environment Images Inc. in connection with its atrophied in 2008. New funds had difficulty raising any capital and seasoned $2.4 billion public-to-private sale funds had difficulty reaching their targeted amounts of capital. Traditional LPs to Hellman & Friedman found themselves unable or unwilling to make new commitments given that n Weil Gotshal advised WL Ross & their allocations to alternative investments ballooned above their target alloca- Co. in connection with its $1.1 billion tions due to the so-called “denominator effect” of the decline in value of their acquisition of Option One Mortgage stock and bond portfolios and due to the drought in distributions by private Corporation from H&R Block equity funds to LPs. Certain LPs also had issues with funding their current n Weil Gotshal advised Advent commitments and formally or informally communicated to sponsors a desire to International Corporation in connection with its acquisition of defer capital calls to help them with cash flow issues or to reduce the overall size Hudson Group’s business of their commitments to the funds. Sponsors responded in various ways to n Weil Gotshal advised Avista retain the goodwill of LPs as well as to discourage the selling by LPs of their LP Capital Partners in connection interests on an already distressed secondary market. , for example, with the $4.1 billion acquisition reportedly offered a “pre-packaged default” option to LPs whereby they would of the ConvaTec business unit of release LPs from 40% of their commitments in exchange for the LPs giving up Bristol-Myers Squibb Company

 Private Equity Alert January 2009

25% of the upside on their current sponsors were able to complete in healthy portfolio companies. The funded capital and paying full 2008 were all equity deals or deals name of the game for troubled management fees on their original where equity represented a majority portfolio companies was keeping commitment. TPG, on the other of the . them alive through equity cures, hand, reportedly offered to release credit agreement amendments, n Significant Decrease in LBO all LPs from up to 10% of their revolver drawdowns, PIK toggle Volume – The private equity capital commitments, reduce their exercises and debt exchange offers. industry suffered a 69% collapse in by a tenth and not For healthy portfolio companies, the value of sponsor-backed buyouts to draw down more than 30% of an sponsors focused on add-on worldwide from 2007 and investor’s total commitment in acquisitions and opportunistic accounted for just 8% of worldwide 2009 without advisory committee buybacks of discounted debt. Many M&A transactions in 2008 approval. portfolio companies filed for compared to 18% in 2007. The bankrupty protection in 2008 and n The Great Fire Sale – This past year decline affected all sectors of the many remain on Standard & Poor’s witnessed a great fire sale by LPs of market, including mid-market “weakest links” list as most at risk interests in private equity funds, buyouts, and was a function of the of default. including brand name funds, at lack of available debt, the erosion of

distressed prices. Advisory firm EBITDA at many target companies n The Law of Gravity – Private equity Cogent Partners recently reported and the difference in price expecta- sponsors discovered in 2008 that that pricing for LP interests in the tions between sellers and buyers. they were not immune to the secondary market declined to an economic reality affecting the average of 61% of NAV in the second We are bullish about the economy generally and some were half of 2008 compared to 85% in the faced with difficult decisions as to first half of 2008. The distressed private equity industry and the whether to lay off employees or pricing has both to do with uncer- vitality of the private equity scale back offices and global tainty over valuations for business model. ambitions. A number of private investments made by 2005, 2006 and equity sponsors did lay off 2007 vintage funds at or near the employees and close offices in 2008 n Continued Unraveling of Boom Era and headcount in the industry is top of the credit cycle, as well as a LBOs – A number of sponsors found significant supply-demand imbalance likely to continue shrinking in 2009. themselves in litigation with sellers between sellers and buyers. and lenders in 2008 over the Predictions for 2009 n A Great Sucking Sound – That great continued unraveling of some of Some of our predictions for the sucking sound you heard in 2008 the mega LBOs announced in 2007. private equity market in 2009 include: was of leverage leaving the system From cases like URI and Huntsman,

as Wall Street banks, CLOs, CDOs, buy-side sponsors learned a number n Sponsors Continue to Manage LP hedge funds and mid-market of lessons, including making sure Liquidity Issues – We would expect lenders all largely shut down their that your reverse termination fee is that certain other sponsors will lending operations to private equity the seller’s sole and exclusive follow the lead of Permira and TPG sponsors and others. Lenders were remedy against you and that it is in 2009 in accommodating LP unwilling to originate new loans dangerous to rely on a material liquidity issues to both retain the due to concerns regarding their own adverse effect clause to walk away goodwill of LPs as well as to relieve solvency and the dampening effect from a transaction. The overriding some of the pressure on LPs to sell of performing senior leveraged lesson for sponsors is that careful LP interests in the secondary loans trading in the 60s and 70s in drafting and good lawyering do market. We would also not be the secondary market. This was matter when a deal doesn’t work surprised if certain sponsors face the notwithstanding the good news out as planned. prospect of LP defaults on capital that the pre-credit crunch leveraged calls in 2009. We would also expect loan overhang declined from a peak n Tending Your Garden – By the in 2009 to see the continued strong of $237 billion in July 2007 to second half of 2008, the primary interest by LPs in secondary sales of approximately $15 billion by year activity of many sponsors was their LP interests both to address end. Many of the buyouts that focusing on both their troubled and liquidity and rebalancing issues.

Weil, Gotshal & Manges llp  Private Equity Alert January 2009

n Reduced Private Equity Activity leveraged companies, such as banks, Looking Beyond the Abyss Continues – We don’t expect any acquisitions that are structured to Although there is still abundant fear quick or vigorous rebound in preserve existing leverage and in the market we agree with the private equity activity, particularly additional equity investments in private equity industry leaders who buyouts, in 2009. There are no existing portfolio companies. We believe that the market for the next signs that any significant lending also would expect that sponsors may 12 to 24 months will prove, in activity to sponsors to fund buyouts more frequently partner with hindsight, to have been a great market will resume in 2009. Wall Street strategic investors to enhance their to deploy capital before the pendulum banks are still paralyzed with fear access to whatever leverage is swings again and there is too much available and to engage in hostile and are mostly focused on capital chasing too few attractive transactions. We will probably also managing their existing assets and investment opportunities. Despite the see an increase in seller financing in their solvency rather than on absence of easy credit and still some 2009 to address funding issues as originating new leveraged loans. divergence in valuation between well as earn-outs to address Sponsors also are fearful about the sellers and buyers, deals can still get valuation issues. fate of many of their existing done but private equity sponsors will portfolio companies and a lot of n Return to Their Knitting – LPs have need to be creative in originating and their near term focus will be complained about style drift at structuring those deals. Sponsors who consumed by salvaging value from some private equity sponsors. We are still greedy to make new invest- their existing portfolio rather than would expect sponsors to return to ments in 2009 and 2010 are likely to making new investments. We also their core competencies and shut be rewarded. don’t anticipate any significant down activities and offices not key increase in private equity activity by A recent study by Coller Capital to their operations. We would also hedge funds and sovereign wealth indicated that LPs still believe in the expect a continued reduction in funds. Many hedge funds are more private equity model as 97% of headcount in the industry in 2009. focused on managing their own surveyed LPs expected to maintain or increase their allocations to private liquidity due to actual or potential n A World of Distress – There will be redemption requests rather than on opportunistic buying opportunities equity. Similarly, the private equity making new illiquid investments. in the current environment to savvy model is still an attractive model to Sovereign wealth funds have capital investors with distressed expertise. management teams that want the to invest but have not to date made This can range from negotiated opportunity to both grow a business a significant number of direct acquisitions inside or outside of in partnership with active owners and investments in buyouts. bankruptcy to “loan-to-own” create their own personal wealth. The strategies. private equity model, based on the n Sponsors Focus on Different Types principles of active oversight of of Transactions – With the debt n Regulatory Shoes to Drop – It seems portfolio companies by sponsors, the markets largely closed, new invest- likely that regulatory changes alignment of interests of sponsors ments by sponsors will be targeted at affecting private equity sponsors with management and LPs and the transactions that require little or no will come out of the current payment of carry to sponsors only incremental leverage. For example, financial crisis. A number of upon realization of profits is still one we would expect that the investment regulatory initiatives have already of the best business models out there. mix will shift to transactions such as been announced in Europe. In the PIPEs, investments, US, it would not be surprising to see portfolio company add-on acquisi- renewed attempts to regulate tions that can be funded with private investment managers and existing credit facilities or additional changes in the tax treatment of equity, investments in inherently .

Weil, Gotshal & Manges llp  Private Equity Alert January 2009

Beijing Steven Xiang Back Issues of Private Equity Alert are available online at www.weil.com +86-10-8515-0558 Recent Articles: James Westra European Regulatory Initiatives Affecting Private Equity Sponsors and Hedge Funds +1-617-772-8377 Budapest Buying Assets out of Bankruptcy in the US and the UK David Dederick Breaking Up Is Hard To Do − and Must Be Done Carefully +1-361-302-9100 Round Up the Usual Suspects Dallas Glenn West A Modest Proposal by the Fed +1-214-746-7780 Knee-Deepening Insolvency Frankfurt Gerhard Schmidt Happy Birthday Mr. Borrower +49-69-21659-700 China’s Private Equity Landscape Akiko Mikumo In the PIPEline +852-3476-9008 SPACs – Exit Opportunities for Private Equity Sponsors? Peter Feist +852-3476-9100 District Court Dismisses Antitrust Suit Against Private Equity Bidders Ignorance of the FCPA Is No Excuse Michael Francies +44-20-7903-1170 PBGC Ruling Extends Control Group Liability to Private Equity Fund Marco Compagnoni Private Equity Market – The Good, the Bad and the ? +44-20-7903-1547 144A Equity Offerings – Potential New Liquidity Option for Sponsors Gerhard Schmidt Recent Securities Law Amendments May Increase Sponsor Liquidity +49-89-242430 New York Shopping for Distressed Companies Thomas Roberts Sir David Walker Publishes Guidelines for Disclosure and Transparency in +1-212-310-8479 Private Equity Barry Wolf +1-212-310-8209 A Rock and a Hard Place Doug Warner The Pre-Budget Report – The UK Private Equity Industry Heaves a Collective +1-212-310-8751 Sigh of Relief Paris Opportunistic Purchases of Portfolio Company Debt David Aknin +331-44-21-9797 Qualifying as an Excluded Party in a Go-Shop – Can You Wake Up Late But Still Say You Prague Were On Time? Karel Muzikar +420-2-2140-7300

Private Equity Alert is published by the Private Equity Group of Weil, Gotshal & Manges LLP, Providence 767 Fifth Avenue, New York, NY 10153, +1-212-310-8000. The Private Equity Group’s practice includes David Duffell +1-401-278-4700 the formation of private equity funds and the execution of domestic and cross-border acquisition and investment transactions. Our fund formation practice includes the representation of private equity fund sponsors in organizing a wide variety of private equity funds, including buyout, , Steven Xiang distressed debt and real estate opportunity funds, and the representation of large institutional +86-21-6288-1855 investors making investments in those funds. Our transaction execution practice includes the Silicon Valley representation of private equity fund sponsors and their portfolio companies in a broad range of Craig Adas transactions, including leveraged buyouts, merger and acquisition transactions, strategic investments, +1-650-802-3020 recapitalizations, minority equity investments, distressed investments, venture capital investments Warsaw and restructurings. Pawel Rymarz Editor: Doug Warner ([email protected]), +1-212-310-8751 +48-22-520-4000 Deputy Editor: Michael Weisser ([email protected]), +1-212-310-8249 Washington, DC Robert Odle +1-202-682-7180 ©2009. All rights reserved. Quotation with attribution is permitted. This publication provides general information Wilmington and should not be used or taken as legal advice for specific situations that depend on the evaluation of precise factual circumstances. The views expressed in these articles reflect those of the authors and not necessarily the E. Norman Veasey views of Weil, Gotshal & Manges LLP. If you would like to add a colleague to our mailing list or if you need to +1-302-656-6600 change or remove your name from our mailing list, please log on to http://www.weil.com/weil/subscribe.html or e-mail [email protected]. www.weil.com

Weil, Gotshal & Manges llp