Private Equity FindingsInsights from the world’s best privATE EQUITY RESEARCH ISSUE 1 AUTUMN-WINTER 2009 INSIDE FROM CREDIT BUBBLE TO ZOMBIE COMPANIES -What’s next for private equity? BETTER BOARDS What can public companies -learn from private equity? QUICK FLIPS OR LONG HAUL? -The truth about buy-outs BUSTED BRANDS Can the top GP names win -back the banks? ANNUAL COLLER PRIZE Best case study, best management report INCLUDING CONTRIBUTIONS FROM: BOOTH SCHOOL OF BUSINESS l COLUMBIA SCHOOL OF BUSINESS l HARVARD BUSINESS SCHOOL LONDON BUSINESS SCHOOL l STOCKHOLM SCHOOL OF ECONOMICS l UNIVERSITY OF FLORIDA Private Equity Findings Contents Foreword indings come from a rigorous examination of the Editorial Board facts. Through their discovery, data is transformed to create knowledge that others do not have. Professor Viral Acharya BY THE NUMBERS FExpected and unexpected, they are the culmination of 4 Defaults on the up. Corporate venture capitalists prove their worth. The Jeremy Coller cutting-edge research. They dispel popular misconceptions, incredible shrinking predictions of sovereign wealth fund assets Professor Francesca Cornelli making us better informed in areas we think we know or Professor Eli Talmor want to know more about. Professor Eli Talmor Housed within London Business School, the Coller Institute AFTER THE CREDIT BUBBLE of Private Equity has as its primary mission the establishment 6 Steven Kaplan, Laurent Haziza and Tom Dean on zombie credits, defaults, of a world-renowned research centre and debating forum on private equity. Key to our success is creating a bridge commitments to private equity and future return prospects between the practitioner and academic worlds. Professor Viral Acharya Private Equity Findings is a significant addition to our HEAD TO HEAD: IN IT FOR THE LONG HAUL? communication channels and a key initiative in achieving this vision. By synthesising the world’s leading academic 10 In contrast to popular opinion, buy-out houses generally invest for the long term, research in a refreshingly designed format, we hope that according to research by Sorensen, Strömberg and Lerner Findings not only appeals to the academic and practitioner communities, but reaches all with an interest in learning more about the deeper issues relevant to this industry. ROUNDTABLE: THE PERFECT BOARD Findings are integral to our Annual Symposium; the 12 Research shows that private equity houses routinely create more effective boards Institute’s flagship event. This first issue features some of than public companies. A panel of experts explains why the research presented in June 2009: • the effect of the 2007-09 crisis on private equity’s future; • why private equity creates better boards than other forms BEYOND THE ABSTRAct: it’s all aBOUT THE BRAND of corporate ownership; Published by Bladonmore (Europe) Limited Reputation has been a key factor in securing the best debt deals from banks. So • incentives of private equity funds to do long-term 17 Editor: Vicky Meek investments versus quick flips; what happens now in the wake of the credit crisis? Managing Editor: Sean Kearns • the role of fund-level reputation in driving outperformance We are grateful to the scholars who have contributed to Sub-editor Lynne Densham this issue, and particular thanks must go to our Executive COLLER INSTITUTE OF PRIVATE EQUITY NEWS Art Director: Owen Thomas Director, Ann Iveson, who has been instrumental in creating 22 Revealed: winners of the prestigious Annual Coller Prize for student research, plus Designers: Ivelina Ivanova, this publication. coverage of the second annual Symposium Oliver Smee We hope Findings enriches your knowledge of private equity and look forward to receiving your feedback. Production Manager: Andrew Miller Publisher: Siân Mansbridge Publishing Director: Sophie Hewitt-Jones James Carey James Group Managing Director: Richard Rivlin Professor Eli Talmor Professor Viral Acharya T: +44 (0)20 7631 1155 Chair Academic Director 2007-2009 Coller Institute of Private Equity Illustrations: E: [email protected] Coller Institute of Private Equity 2 3 Private Equity By the numbers Findings LPs TO SCALE BACK GP RELATIONSHIPS WHAT’S IN AN IRR? LPs’ plans for their number of active LPs’ plansGP re forlation theirships number in 2 ye ofars’ active time Faced with capital constraints and a more LPs’ plans for their number of active risky investment climate, LPs are exhibiting GP relationshipsGP relationships in 2 years’ time % of CVC-backed IPOs with highly a clear ‘flight to quality’ in their selection of reputable underwriter GPs, according to Coller Capital’s latest Global Private Equity Barometer. 36% 34% $ $ l Some 31% of LPs expect to commit to 100 100fewer private equity funds over the next two $ years – up from a consistent 10% in previous Barometers. 80 30% 80l A fifth of LPs plan to reduce their target trn trn trn allocation to private equity over the next year (vs just 3% to 6% in previous reports). Additional leverage 4 60 Stock market return (same sector, 9.7 6 l The vast majority of LPs (84%) have also time frame and leverage) 12 60 % now refused to re-up with at least one GP in Private equity strategic and operational improvement Summer 2006 Summer 2009 the last 12 months, nearly double the 45% 40 Source: Challenges in a new world: How do private investors create value?, Ernst & Young (2009) Sovereign wealth funds’ forecast assets The amount Jen predicted SWFs would The amount SWFs are now likely to Summer 2006 Summer 2009 found in Coller’s summer 2005 Barometer. 100 40 under management in 2015 – projected in be managing by 2015 in projections put struggle to reach by 2012, following their Increase No change Decrease Source: Global Private Equity Barometer 2007 (assuming inflows of $40bn a year) by together in 2008. He estimated they lost losses from the financial economic crisis20 The largest element of European 80 Increase No change Decrease Stephen Jen, formerly of Morgan Stanley’s about 25% in the first three quarters of 2008, and the fall in oil and commodity prices. private equity returns from exits Global Economic Forum team. with assets falling60 from $3trn at the beginning (Chatham House and Fondazione Eni completed between 2005 and 20 of 2008 to $2.3trn by October that year. Enrico Mattei estimates.) 0 2008 was hands-on involvement % of CVC-backed IPOs with highly CVC-backed THE TRUE VALUE OF CORPORATE VCs 40 % of VC fund-backed with portfolio companies, reputable underwriter % of CVC-backed IPOs withl highly Corporate reputable venture underwriter capitalists (CVCs) are Corporate venture capital versus according to a study by Ernst & 20 0 Institutional investor holdingshighly as a % important of CVC-backed in the early stages of venture capital funds Young. The analysis sought to shares sold in IPOs 0 entrepreneurial companies’ lives, providing determine how much of private 100 % of CVC-backed IPOs with analyst coverage 100 % finance to businesses that wouldn’t receive VC-backed equity’s returns in the period were Defaults set to rise sharply CVC-backed pure venture capital funding because of generated by leverage and how A wall of debt in large European private equity-backed deals 80 their perceived youth and riskiness. much by operational and strategic matures from 2012 onwards. Yet many companies are l At the earliest stages, CVCs provide value 80 improvement, such as add-on 56The percentage of UK exits by private by prompting venture capitalists (VCs) to acquisitions, organic growth and facing a serious refinancing risk, says ratings agency Fitch. equity houses via receivership60 in the co-invest. They also allow companies efficiency gains. The stock market (Em) first half of 2009, according to the access to the public markets at an earlier 60 return captures change in share 60,000 Centre for Management Buy-Out% stage of their development than pure price and dividends received, Research (CMBOR). There were40 no IPOs. VC-backed businesses. % providing a benchmark deal by 50,000 l They can help businesses attract higher deal of companies in the same 40 valuations on IPO. Median CVC-backed sector, country and time weighting. 40,000 20 businesses achieve between 40 and 216 The sample consists of European % percentage points more than VC-backed buy-outs that had an enterprise 30,000 counterparts at the offer price and 20 value of more than €150m at the 0 20,000 between 50 and 300 percentage points on point of acquisition or entry. % of VC fund-backed the first day of trading. Volume of scheduled debt amortisation Volume 10,000 % of CVC-backed IPOs with highly reputable underwriter 1The percentage6 of UK exits by private Source: How Do Corporate Venture Capitalists Create Value for 0 Institutional investor holdings as a % of CVC-backed Entrepreneurial Firms? Thomas Chemmanur and Elena Loutskina, equity houses via receivership in the shares sold in IPOs % of IPOs with Institutional % of IPOs with 0 University of Virginia (2008) highly reputable investor holdings as analyst coverage 2009 2010 2011 2012 2013 2014 2015 2016 2017 first half of 2005, according to % of CVC-backed IPOs with analyst coverage underwriterVC-backed a % of shares sold CMBOR. There were 10 IPOs. in IPOs Source: Fitch (April 2009) CVC-backed l The amount of debt that needs to be their earnings suppressed by lower demand. refinanced in Fitch’s shadow-rated portfolio l Even if companies focus on using free (which mainly includes buy-out deals done cash flow to pay down debt, on average, they in 2006 and 2007) peaks sharply in 2014. will only be able to bring down total debt to l Companies that had expected to just over 5.5x EBITDA, higher than the deleverage naturally over time have seen current average in new deals of 4.5 times. 4 5 Private Equity Analysis Findings of all big public-to-private deals Deals in the last wave have coverage defaulted.