TheSpring first 2008 in a series of Wharton Private Equity Reviews Wharton Private Equity Review HARNESSING T H E WINDS OF CH ANGE http://knowledge.wharton.upenn.edu SPONSORS PRIVATE EQUITY SERVICES Spring 2008 Wharton Private Equity Review HARNESSING T H E WINDS OF CH ANGE CONTENTS Following the Era of Large Buyouts, Private Equity Funds Find New Ways to Compete Page 2 Now that credit has dried up, the future of large private equity buyouts has become uncertain. Today, buyout firms are looking to compete in middle-market and foreign deals and, in many cases, are teaming up with strategic buyers and corporations in new types of transactions. According to PE firm partners and other industry experts, the economic downturn has also paved the way for a resurgence Executive Editors in distressed investing, as lenders and investors alike begin to adjust to new pricing realities. Teoman Ozsan (WG’09) Private Equity Abroad: Despite the Credit Crunch, Opportunities Manoneet Singh (WG’09) Page 6 Sumit Sinha (WG’08) in Developed Markets Are Waiting With the collapse of credit markets, private equity funds are increasingly willing to tread into unknown Marketing Team territory to find new deals abroad. While international buyers continue to increase their presence in the U.S., opportunities for investment in Europe and Asia are equally abundant, according to private Karina Danilyuk (WG’09) equity experts. Although individual markets have their inherent challenges, adopting a global strategy Dimple Khurana (WG’08) may be one approach to weathering the current economic slowdown. Advisory Board Will Changes in Taxation Affect the Competitiveness of U.S. Private Equity? Page 9 Michael Kopelman (WG’05) Principal, Edison Venture At the 2008 Wharton Private Equity Conference, the topic of taxes sparked a lively debate. According Dean Miller (WG’99) to a panel of private equity and legal experts, U.S. congressional proposals to raise taxes on the PE Managing Director, Novitas Capital industry could hurt it significantly, and perhaps even force it to move offshore. Given the forthcoming U.S. elections, the debate on carried interest may be moot for the time being, but the panelists agreed Vinay Nair Senior Fellow, Wharton Financial that it’s a hot-button issue. Institutions Center Stephen Sammut (WG’84) Setting up Shop: What Does It Take to Establish a Senior Fellow, Wharton Health Care Private Equity Firm in Today’s Market? Page 12 Systems and Lecturer, Wharton Entrepreneurial Programs and Venture Establishing a private equity fund as a founding partner is the objective of thousands of practitioners Partner, Burrill & Company across the industry. With the market continuing to mature, what are the hurdles, and what will it take Jason Wright (WG’00) to successfully start a private equity shop going forward? A leading private equity fundraising advisor Partner, Apax Partners and two leading investors with extensive experience advising and backing new private equity firms discussed these issues with members of the Wharton Private Equity Club (WPEC). Carlyle Group’s David Rubenstein: ‘The Greatest Period for Private Equity Is Probably Ahead of Us’ Page 18 David Rubenstein is co-founder and managing director of The Carlyle Group, the Washington, D.C.-based private equity firm with more than $70 billion in assets under management. In March, members of the Wharton Private Equity Club (WPEC) interviewed Rubenstein about the ongoing credit crisis, the industry outlook, the rise of sovereign wealth funds and why private equity is “one of the greatest exports of the United States.” Following the Era of Large Buyouts, Private Equity Funds Find New Ways to Compete Nothing symbolized the most recent the loans they did write. “The next $10 billion deal feels years away,” Daly said. private equity boom better than huge buyouts, deals so big that private equity sponsors teamed The only constant was sellers’ high expectations up to pull off the transactions in so-called about the value of their businesses, noted Daly, consortium — or “club” — deals that spurred talk who participated in a panel discussion about of $100 billion transactions. large buyouts at the 2008 Wharton Private Equity Conference. In the face of the current economic Now that credit has dried up, the future of large turmoil, however, those expectations have private equity buyouts has become uncertain. begun to drop. The buyout business is cyclical, Limited by the lack of available debt financing, he added, noting other industry boom-and-bust buyout firms are looking to compete in middle- periods — in the late 1980s, the late 1990s and market and foreign deals and, in many cases, again from 2002 through the end of 2007. The are teaming up with strategic buyers and public markets experience the same ups and corporations in new types of transactions. Not downs, he said. surprisingly, the economic downturn has also paved the way for a resurgence in distressed The latest boom came to an end in the usual way. investing, as lenders and investors alike begin to “What happened was that people got out of hand adjust to new pricing realities. with some of the valuations,” he said. Add to that the subprime meltdown and it signaled the end of the industry’s ability to digest deals like One major difference in the most Blackstone Group’s record $36 billion acquisition recent cycle was the amount of in 2006 of Equity Office, the Chicago-based capital raised. commercial real estate investment trust. One major difference in the most recent cycle was the amount of capital raised, Daly noted. According to Jack Daly, a managing director at The industry has raised about $750 billion Goldman Sachs focusing on large-cap leveraged since January 2006 — an amount which, when buyouts in the U.S. industrial sector, 2007 was a levered, would be enough to finance deals worth “tale of two markets.” In the first half of the year, a significant portion (15%-25%) of the Standard private equity sponsors enjoyed easy access & Poor’s 500. Buyout firms have remained to debt which led to previously unthinkable relatively flush. “There’s still a staggering amount discussions about deals valued at up to $100 of money sitting there,” said Daly, who added billion. By the end of the year, credit markets had that companies will find new ways to make deals contracted and the industry faced a $350 billion work even if there is less debt financing available overhang. Lenders were unable to provide large from lenders. “There is a tremendous amount financings and included extensive covenants on of opportunity. There are still going to be a lot of ways to make that capital work.” 2 Knowledge@Wharton Wharton Private Equity Review A Return to Fundamentals Greg Mondre, managing director of Silver Lake, the technology-focused buyout firm, pointed According to Perry Golkin, a partner at Kohlberg out that the downturn will make 2008 a more Kravis Roberts and a member of the firm’s difficult year to exit from investments. Managers financial services industry team, the markets of recently acquired companies will need to are clearly not deep enough to support pay close attention to operating fundamentals huge private equity deals. Instead, sponsors because those companies are carrying more should focus on smaller transactions, he said. leverage than in the past. One advantage for PricewaterhouseCoopers research shows that the private equity sponsors in this cycle, he added, volume of large buyouts fell off sharply in the is that most large-cap buyout firms have built second half of 2007, but that middle-market deals, up substantial operating groups with in-house valued at up to $1 billion, totaled $355 billion, or expertise to help companies move through the 23% of U.S. transaction volume. downturn. “Our ability to actually work with our Lenders are demanding changes in covenants, costs, restructure operations and drive value Golkin said, which represents a return to more is a huge added benefit going into a time of normal conditions after the boom period marked economic weakness.” by easy loan terms. The revised covenants do not represent “radical change” but do restrict private equity firms’ flexibility, he added. “We had some The largest limiting factor now is that luxury for a little time, but the reality is we will not have the flexibility we were able to negotiate sellers’ expectations have not caught for the last couple of years.” up with the new pricing realities. According to Golkin, rising capital costs will reduce asset prices, and the diminished role of securitized debt funds will also affect private Private equity sponsors also own better equity sponsors. “All of these things are going companies than they did in past downturns, to make it a little more difficult for a buyer, Mondre noted. During the most recent period or sponsor, to structure a deal in a way that’s of private equity expansion, sponsors were able comfortable. You become more nervous.” to acquire an increased number of large, stable The industry will return to fundamentals that companies with leading market positions than in prevailed three or four years ago, he added. the past. Those are the types of companies that “We’re not moving to the Stone Age.” are best able to weather a soft economy. “In any downturn, it is the leaders that come out with the The largest limiting factor now is that sellers’ highest market share and better margins,” he said. expectations have not caught up with the new “The weaker competitors fall by the wayside.” pricing realities. Golkin noted that as deals collapse in the changing financial environment, New Models and Markets the industry is wrestling with the question of what represents a material change in a business On the investing side of the business, a weak that might trigger a breakup fee.