Posted: May 2008

While the current global economic downturn has seen large end deals drying up in the US and Europe, despite the economic difficulties in the West there is fierce competition to become a key player in the fast growing Asian region.

In recent months, financial institutions including Morgan Stanley, J.P.Morgan Chase & Co. and Deutsche Bank AG have moved heavyweight rainmakers to Asia where dealflow has scarcely been affected in anticipation of an acceleration of growth and deal activity in the region.

The mood of the region recognises that global financial difficulties may see growth rates in India and China shaving off even as much as 2pc but given existing 10pc p/a current rates the outlook remains positive.

In the absence in Europe of opportunities for the mega-buyout funds to put capital to work existing funds are increasingly targeting these territories.
In addition local funds are raising money at astounding levels. According to the Emerging Markets Private Equity Association a record $59 billion was raised by emerging market private equity funds last year, up 78% on 2006. Of this amount, almost half the fresh capital raised went to commitments in emerging Asia.

Financial institutions and private equity funds like Morgan Stanley¹s planned Indian private equity unit who are entering the market at this late stage may however find that it is more difficult than they had thought to break into this highly regionalised and idiosyncractic market. Those with a strong track record and heritage in the region will be better placed to take advantage of the market opportunity as they have already built up their networks and understand the complexities of investing in the region.

Barriers to entry that will provide obstactles to new entrants to the region are based around language, cultural understanding, regulatory issues; and an awareness that Asia is not one homogenous market but full of markets at varying stages of evolution (e.g. Hong Kong and Japan are very different from Malaysia and Indonesia).

Posted: April 2008

The UK press over the weekend and yesterday covering private equity¹s initial response to Sir David Walker¹s voluntary guidelines on transparency has been less than eulogistic.

Those firms, Terra Firma, Bridgepoint and Permira which have produced annual reviews have been adjudged to have met the Walker guidelines with varying levels of enthusiasm/disclosure. Some have been criticised for not having produced anything at all as yet.

Terra Firma, which has been held up as best in show so far, produced a heavily designed 120-page review, including:

€ an executive summary
€ a letter from the CEO
€ some general information about Terra Firma € a financial summary € highlights of 2007 € a statement of commitment to openness € a political message about their contribution to the UK € their views on the outlook for 2008 € a statement on their investment strategy and separately on how they create value € the resources available to them € a description of their general business environment € statements on corporate social responsibility and governance € a reminder of the alignment of interest with stakeholders and the risks inherent in their investment approach € reviews of all of their portfolio companies and financial information on all of their funds.

They also include details of executive remuneration, a balance sheet, a profit and loss statement, all of which go beyond the Walker guidelines.

This is the benchmark against which Annual Reviews will be judged, at least for the moment. It is important that every private equity fund manager operating in the UK is very clear about its intentions here, notwithstanding varying differences in size of funds under management.

Posted: April 2008

Figures for Q1 2008 UK mid-market M&A activity have just been released*, and they show that overall, deal volumes remained 15% down on Q1 2007, continuing the trend of January and February 2008. Perhaps surprisingly, average transaction values remained relatively strong compared with Q1 2007 ­ which may, in part account for the decline in volumes, and could continue to limit activity in Q2.

In Q1 2008 there were 367 disclosed deals under £500m compared with 432 for Q1 2007, a decline of 15%. The total value of these deals fell significantly, from £18.8bn to £11.8bn, a decline of 37%. However, given the less marked fall in volumes, average transaction values remained only slightly down on Q1 2007. Under £50m, the average deal was £10.6m in Q1 2008 compared with £11.1m in Q1 2007; in the £50m-£250m space this figure was £105.7m compared with £116m in Q1 2007; and in the £250m-£500m space the figure was only marginally down on Q1 2007 at £358.6m versus £363.7m.

The most significant fact to emerge from the data is the increasing weakness at the larger end of the mid-market compared with the much greater resilience being shown elsewhere. In the £250m-£500m space, deal volumes in Q1 2008 were just 40% of those in Q1 2007, at 8 compared with 20. Deal values were correspondingly down, at 39.4% of Q1 2007 totals - £2.9bn compared with £7.3bn.

Given that debt providers are increasingly risk averse, the marked decline in volumes and values at the larger end of the mid-market comes at little surprise. Perhaps more surprising is that the sub-£250m space is remaining buoyant, albeit down when compared with strong data from Q1 2007. Mid-market deals are continuing to get done, and as the figures for average transaction values show, with competition for high quality businesses intensifying, values are holding up.

Whether these trends will continue into Q2 2008 is hard to predict at this early stage, but the picture going into the second quarter is far less gloomy than some analysts had predicted at the start of 2008.

Posted: March 2008

As new media is replacing old media at a faster pace than ever before, successful investors will need to identify which media assets are going to out-compete and outlive their peers. To some extent this has always been the case, but now there are other factors at play.

As media shelf lives shorten, companies may find themselves attracting fewer investors and generating lower revenues and earnings. With the arrival of the Œnext big thing¹ media companies will either need to invest heavily in R&D to keep some skin in the game, or have to buy into the Œnext big thing¹ periodically ­ all with the knowledge that the new technology / format has built-in obsolescence, and that they are effectively acquiring it more on a leasehold than a freehold basis.

As a result, identifying industry trends is now more important than ever before. Investing in media is becoming more akin to investing in pharmaceuticals, where companies have to spend significant sums on R&D / acquisitions to keep one step ahead of the competition, while existing drugs get superseded or fall out of patent.

The current Œnext big thing¹ is being driven by a combination of new technology / development of new brands / new communities i.e. broadband + videocam = online communities. In even two years time will Facebook, MySpace, YouTube and Bebo still exist? With the same investor base? And more importantly, will any or all of them be making money?

Posted: March 2008

It is perhaps interesting to reflect that the market¹s continuing fascination with the surplus or deficit of FTSE 100 pension schemes, on a moment by moment basis, extends only to valuation and not liabilities.

According to a recent report from Aon Consulting, almost half the UK¹s defined benefit pension funds ended 2007 in surplus. Thanks to favourable market conditions, coupled with improved fund management, the total aggregate pension deficit of the FTSE 100 fell from £40bn at the start of the year to a much improved £2bn by the end of 2007. The improvement is ascribed partly to the increased use of active management, with liability-driven investment strategies, diversified growth funds and complex assets classes being employed as well as favourable equity markets and rising interest rates having an impact on corporate bond yields. In addition, FTSE 100 companies also contributed c. £7bn to reduce their deficits further.

While we can see what¹s in the pot at a given point the fundamental problem that still faces both UK public companies and the public sector is that, for most schemes, the calculation of liabilities is made using out of date longevity assumptions. To deliver pensioners to full pension security at a more cautious Œbuy-out¹ valuation, which implies more optimistic assumptions, would increase the current £2bn deficit of FTSE 100 companies dramatically. In addition, in 2008, with the economic environment likely to be far less favourable than in recent years and potentially more volatile, we may see a reversal of fortune even on an FRS17 basis.

Point in time valuation needs to be married with properly cautious analysis of liabilities to identify when a pension becomes truly fully funded and the pensioners¹ annuities safe.

Posted: February 2008

With the outlook both for private equity and the debt market more uncertain than for many years, the fact that activity in the secondaries market remains strong comes as little surprise. Traditionally secondaries are counter-cyclical to the primary market, since a downturn in the private equity industry often provides the motivation for investors to sell their assets via the secondaries market. As financial institutions in Europe and the US ­ in particular banks but also insurers and asset management companies ­ are being seriously downgraded, they are casting a keen eye over their portfolios, and that is helping to drive secondaries activity. In February CalPERS (California Public Employees¹ Retirement System) sold a $3bn portfolio of private equity assets to a consortium of five secondaries investors, and where CalPERS leads, others often follow.

Deal flow is also being helped by the introduction of Basel II in January, which requires financial institutions to hold more capital on their balance sheets to match their liabilities. Banks and other financial institutions are looking to offload some of their private equity investments, as the cost of holding on to them becomes prohibitive.

In addition, the dynamics of the secondaries market are different from those in the primary market. Secondaries deals are often complex ­ sometimes involving various jurisdictions and often involving assets of differing maturities ­ and transactions rely on the secondaries provider having the necessary skill, understanding and relationships required to meet the seller¹s objectives. Secondaries transactions generally involve more mature, and therefore lower risk assets than straightforward private equity deals.

As a result, high quality secondaries deals are still leverageable, albeit at slightly higher prices than in 2007.

According to Private Equity Intelligence, there are 21 new secondaries funds hoping to raise $14bn world-wide this year; around $20bn was thought to have been raised in 2007.

Secondaries are often seen as a bell-weather for private equity.

Posted: January 2008

With the financial markets become increasingly turbulent, it would clearly be foolhardy to think that the private equity industry is entirely immune to its effects. The volatility of the past six months has already seen a significant slow down in deal activity, with buyouts becoming increasingly harder to structure and exit valuations being negatively impacted.

The main question facing mid-market European buyout firms now is just how the economy is set to perform this year. Given current expectations of a recession in the US we can be sure that the European economy, as a whole, will have a rougher time ahead. The current economic environment could, however, provide a more attractive climate for investment. With less competition for deals and better entry valuations, private equity groups could find themselves acquiring assets on more favourable terms. The current losses being made on the public markets make take privates look increasingly attractive. Private equity houses will be eager to take advantage of this environment to acquire cheaper assets both as platform investments or as part of build-up programmes.

The credit liquidity issue will be more manageable for mid-market private equity houses. Debt providers have already responded to the recent turbulence by tightening up lending. As a result, relationship banking has and will continue to be important for mid-market deals to get done. Covenant-lite loans are a thing of the past, with agreements becoming more heavily loaded in an attempt to reduce the financial sponsor’s risk. Fortune will favour private equity groups with real value creation rather than leverage strategies, perhaps putting the mid-market in a favourable position.

Tougher market conditions may well see private equity houses holding onto assets for longer to ensure maximum returns on exit. Anecdotally, mid-market exit valuations, for the moment at least, remain robust. There maybe some negative impact on IRRs but as ever, LP’s will want to see liquidity so holding periods will not be able to go on forever.

We can be optimistic then, that whilst the outlook is far from rosy, the mid-market may prove resilient and fare better than many are predicting.

Posted: September 2007

The interim Walker Report recommends that GPs publish an Annual Review as an important first step in the repositioning of the private equity industry in public perception. Equus’ view is that this Annual Review should be interpreted as an opportunity, rather than a threat for GPs...

The interim Walker Report recommends that GPs publish an Annual Review as an important first step in the repositioning of the private equity industry in public perception. Equus’ view is that this Annual Review should be interpreted as an opportunity, rather than a threat for GPs:

• It represents a chance to target the widest group of stakeholders scrutinising private equity, and to be seen to be surpassing best practice communication on all fronts.
• For those GPs who prefer to retain as much of their privacy as possible it’s a way to be seen to be complying without, in fact, being very much more open.
• For others it can be a way of showcasing their differentiators as part of their fund raising, deal origination and wider communication goals.
• Overall it’s a chance for private equity to redress the balance of public perception in its favour.

Specifically, by choosing to engage positively in this initiative, the value to GPs should be:

• A generally heightened, more positive profile among the broadest potential group of stakeholders, thereby:
  supporting the overall investment environment for private equity
  supporting deal origination and execution
  validating investors’ choice
  building on the GP’s covenant among debt providers
  attracting best quality talent, including portfolio management, non-executives and investment executives
  building on a GP’s internal ‘esprit de corps’
• The opportunity to showcase core differentiators, including the GP’s investment model, track record and achievements with individual portfolio companies.
• The opportunity to set out a clear direction for each new portfolio company at the beginning of its ownership, and subsequently to demonstrate the value created from the initial investment strategy.
• The opportunity, selectively, to mitigate potential reputational damage arising from difficult investments, by means of early and controlled warning.
• Gradual education of the wider group of stakeholders about the private equity investment model and associated benefits for the economy, the Exchequer and society generally.
• Overall, a perception of being in the vanguard of best practice communication with attendant benefits in protecting the GP’s brand.

Equus has market-leading expertise in helping GPs build successful brands that communicate effectively with target audiences. We suggest that the production of this review should prompt a review of all of your marketing and IR output including brochures, deal flyers, content for the investor day, investor reports and your website which is the principal source of information on your company for all stakeholders and acts as a shop window for audiences such as policy makers, management teams and investors. This exercise will give you the chance to review your brand image and the messages you are communicating to all stakeholders and to ensure that they are in synchronisation. By this, we mean all the communication touch points of your firm’s brand with external audiences, which should be revised to include all of the following:

• Investors existing and potential
• Management teams existing and potential
• Vendors of portfolio businesses
• Potential acquirers of portfolio businesses
• Intermediaries
• Debt providers
• Trade Unions
• The general public, many of whom may also be employees, customers or suppliers
• Government

With respect to the Annual Review we suggest creating a matrix of messages that separately and together speak to the interests of all the stakeholders listed above from vendors to Trade Unions.

We’d like to extend an invitation to you to discuss our thoughts in more detail. For more information please contact:

Piers Hooper – Founder and Managing Partner
Pauline Richards – Managing Partner
Equus
020 7223 1100

Posted: August 2007

Sir David Walker’s recent consultation document on disclosure and transparency in the private equity industry is long overdue. It produced one overriding conclusion: that private equity needs to become more open. The point seems to be that until now, the industry has seen no need to engage with a wider...

Sir David Walker’s recent consultation document on disclosure and transparency in the private equity industry is long overdue. It produced one overriding conclusion: that private equity needs to become more open. The point seems to be that until now, the industry has seen no need to engage with a wider audience – and as a result, it is widely misunderstood and even mistrusted.

We will have to wait until later this year to see the restrictions imposed by the Treasury Select Committee. But one thing is certain: the days of private equity declaring itself accountable only to its investors are no more.

Private equity is now too powerful, and employs too many people for this reluctance to be sustainable. Opening up to greater public scrutiny will help reposition public perceptions of the industry, by showing that private equity takes its obligations to the wider community seriously.

As Paul Myners stated in his submission to the Treasury Select Committee, ‘private equity is more likely to prosper if the industry has a positive image which will encourage others to invest and deal with it and will not cause alarm to employees, trade unions, suppliers, customers, regulators or legislators’.

The issue is that while private equity has grown exponentially in the last ten or so years it has, quite naturally, continued to operate largely behind closed doors. To many external observers it is therefore an unknown quantity, often bracketed with the perceived ‘dodgy’ practices of hedge funds. In some quarters the industry is viewed merely as short-termist, secretive and only concerned with making money for investors – without regard for a company’s heritage, or any sense of responsibility to employees or local communities.

Consequently any negative publicity surrounding perceived asset stripping, albeit relating to a tiny minority of high profile operators, has also been able to tar the entire industry with the same brush.

Private equity firms are directly responsible for the livelihoods of 1.2 million people in the UK, and it is vital – not just for those employees but also for the future success of the industry – that these firms open their doors to the wider community. If the industry embraces this initiative wholeheartedly, in a few years time perceptions could be turned around completely. Is it too far-fetched to imagine that one day employees might even welcome private equity backing, clear in the knowledge that private equity-backed companies grow faster and have more secure longer-term futures?

Equus’ guide to being Walker compliant

Equus attended the Treasury Select Committee hearings, and has been monitoring recent events very closely. To coincide with the release of the Walker Report we have produced a comprehensive guide for our clients to ensure best practice is being undertaken at the highest level. If you would like to meet the Equus team to discuss Walker implications please call either Piers Hooper or Pauline Richards on 020 7223 1100.

Posted: March 2007

Recently a number of private equity backed businesses have been sold / exited after a short period of time in the hands of their private equity backers resulting insome commentators disputing whether actual value has been created. Some industry observers have also been pointing the finger at...

Recently a number of private equity backed businesses have been sold / exited after a short period of time in the hands of their private equity backers resulting in some commentators disputing whether actual value has been created. Some industry observers have also been pointing the finger at private equity and voicing concerns that public market investors are being duped into overpaying when portfolio companies are brought back to the public markets.

There are a number of crucial points missing from the debate:

There is nothing wrong with selling a business after holding it for a short period if in that time the business has been materially transformed. 2 examples are shown below. If a business is brought back to the public markets and is overvalued, surely it is the fault of the public market investors that are overvaluing the business. Is a private equity firm somehow not expected to get the best price it can when it comes to exiting one of its investments? If the public markets are overvaluing new IPOs, surely it is public market valuation methodology that needs to be changed?

There is a misconception that there are a raft of private equity backed businesses being brought back to the public markets. This is not the case, the vast majority are sold on to other private equity backers in secondary or tertiary buyouts. According to data from Dealogic, covering 2002 - 2006, the post IPO performance of private equity backed US companies compared to those not pe backed is considerably poorer. In fact, the only year in which private equity backed flotations lagged the market was last year, when their typical share price improvement of 16% was six percent behind other IPOs. Examples of private equity backed businesses having been materially transformed in a short period of time and rightly achieving a good exit outcome for their backers include:

Duke Street Capital's investment in Cox Insurance (npw Equity Insurance) and subsequent sale to AIG. The £570m sale 18 months after DSC acquired the business represented a 70% IRR. During the 18 month investment period the business was transformed, some of the changes include rebranding to Equity Insurance Group and introducing a new senior management team including a proven Chief Executive and Chairman to lead a transformation of the business. ECI Partners investment in Laterooms.com and subsequent sale to First Choice Holidays for £108m. The sale represents an IRR of over 500% and a money multiple of 9x after an investment period of 2 years. ECI introduced new Financial & Commercial Directors and a new Chairman and with its financial backing embarked on a high growth transformation strategy.

Posted: October 2006

The UK media, today in the form of the FT, seems finally to have caught up with what the UK buyout industry has been saying for some time but records as a recent ‘subtle change in rhetoric from its participants’ that it is quite wrong to think of them as financial engineers but rather as superior managers...

The UK media, today in the form of the FT, seems finally to have caught up with what the UK buyout industry has been saying for some time but records as a recent ‘subtle change in rhetoric from its participants’ that it is quite wrong to think of them as financial engineers but rather as superior managers which benefit society by building better businesses.

The FT goes on to suggest that the ‘new’ message from the industry is driven by the anticipation of reduced availability of the debt that has allowed for the financial engineering of recent years, citing a recent Standard & Poor's report, and that if the easy money is going to get turned off it makes sense to argue in advance that you don't really need it.

This on the back of a new BVCA's submission to Gordon Brown stating that:

• companies that have received private equity funding employ 2.8m people"private equity-related activities"
• generate £3.3bn in fees for financial and professional services companies buyout houses bring £8bn of
• funding into the UK every year from abroad and contribute some £26bn in taxes.

It then compares today’s buyout houses with the conglomerates of yesteryear; questions whether private equity is inherently better at running companies; suggests that UK shareholders will reduce the burden of quoted company compliance and pay more to keep talented people in the public arena and concludes that the combination of less passivity on the part of UK plc investors and wider adoption of PE style management techniques may well see the buyout industry fade away.

Best make hay while the sun shines then!