Description
A credit crunch (also known as a credit squeeze or credit crisis) is a reduction in the general availability of loans (or credit) or a sudden tightening of the conditions required to obtain a loan from the banks.
Mesirow Financial Private Equity Credit crisis impact on private equity
Presented to
TEXPERS
May DeBolt 12, 12 2008 Bob Linda Jordan Senior Vice President Managing Director 312-595-6825 404-881-2814 [email protected] [email protected]
Goals for this presentation
I. II. Present an overview of the various p private equity q y strategies g Describe the events which led up to the current difficulties in the credit market
III. Explain how private equity investors are adapting to the new environment IV. Provide expectations for private equity going forward V. Offer recommendations for institutional investors
2
Private equity overview
Private equity is a privately negotiated investment, typically in a private company, ranging from early-stage technology start-ups to buyouts of established companies.
Private Equity
Venture Capital
Leveraged Buyout
Special Situations
Financing for startup and emerging growth companies, typically in the healthcare & information technology sectors
Equity sponsorship of leveraged buyouts and growth capital for mature, cash flow generating businesses
Subordinated / mezzanine debt, distressed debt, operational turnaround and industry-focused investments
3
Venture capital overview
$ Inves sted
Seed Start Up
2nd Round
3rd Round
4th Round
Expansion
Pre-IPO
Exit Point
? Capital typically provided to earlier stage companies to finance growth. ? Most venture capital firms specialize on either early stage financing, where capital is generally used to develop a new product or technology, or later stage financing where capital is generally used for expansion of sales & marketing marketing. ? Venture capitalist generally focused on companies in the information technology and life science sectors. Cleantech has more recently become a significant area of focus.
4
Leveraged buyout overview
? Equity capital provided to facilitate the acquisition or recapitalization of a company. ? Target companies typically have predictable cash flows. ? A leveraged buyout fund leads the transaction and provides the equity capital, while mezzanine funds typically provide subordinated debt financing. ? Variations of the LBO strategy include buy-and builds, take privates, and growth buyouts.
40% Senior Debt Typically supplied by commercial banks
Post-LBO Balance Sheet
25%
Subordinated Debt
Typically supplied by mezzanine funds, high yield bond investors or hedge funds Supplied by leveraged buyout funds
35%
Equity
5
Special situations overview
? Mezzanine / Subordinated Debt – A hybrid of debt and equity financing typically used to finance leveraged buyouts or expansion of existing companies. Mezzanine financing is debt capital that gives the lender the rights to convert to an ownership or equity interest in the company if the loan is not paid back in time and in full. It is generally subordinated to debt provided by senior lenders such as banks and venture capital companies. ? Distressed Debt – Distressed debt investors scour the market for undervalued debt securities of companies undergoing financial distress. They purchase debt at deeply discounted prices and adopt various strategies to enhance the debt’s value.
6
Market sub-asset class allocations
1999-2001
2002-2004
2005-2007
20% 54% 46% 80%
15%
85%
Venture Capital Funds
Buyout and Other Private Equity Funds
Source: Private Equity Analyst. U.S. funds only, excluding fund-of-funds, as of January 2008.
7
Types of private equity funds
Direct Investment Funds A direct investment fund invests directly into underlying operating companies Fund-of-Funds A fund-of-funds commits capital to a broad range of direct investment funds
Fund-of-Funds
Direct Investment Fund
Venture Capital Funds
Buyout Funds
Special p Situations Funds
10 – 40 Portfolio Companies
Hundreds of Portfolio Companies
8
Private equity firms had very limited direct exposure to subprime mortgages and related structured securities
? Buyout and venture capital firms are generally not in the business of buying debt securities, rather they invest in the equity of operating companies ? Some value-oriented private equity firms have recently made investments in the fallout of the subprime mortgage crisis; but these have been limited and presumably at attractive distressed valuations – Mortgage originators, bond insurance, equity infusions into banks, hung debt held by Wall Street ? However, the broader credit market disruption is creating unique challenges and opportunities for private equity investors
9
Golden age of the buyout
35% 27% 25% 19% 15% 1-year re eturn 14% 19%
1-Year Buyout IRR vs. S&P 500
29% 25% 25%
25%
5%
2%
-5% 5%
-4% 4%
-15%
-14%
-25%
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Buyout 1-Year Pooled IRR
S&P 500 1-Year Total Return
10
Source: Thomson VentureXpert, May 2, 2008. Pooled net IRR for all U.S. buyouts. Source: Standard & Poor’s. 12-month total return for S&P 500.
Buyout fundraising surged to record highs
? Fundraising during 2007: – 6 buyout funds raised LP commitments >$5 billion – 2 buyout funds raised LP commitments >$20 billion (Blackstone & Goldman Sachs) Capital Committed to U.S. Private Equity Funds
$235B
$245B
$155B
$149B $99B $59B
$91B
$93B $45B $50B
1999
2000
2001
2002
2003
2004
2005
2006
2007
Q1-2008
Venture Capital Funds
Source: Private Equity Analyst. U.S. funds only, excluding fund-of-funds.
Buyout and Other Private Equity Funds
11
Credit market expansion fueled the buyout boom ? Historic low interest rates in 2002-2004 led investors to reach for yield y
? Rising investor demand for junk bonds as default rates moderated after 2002 ? Structured finance expansion revolutionized the leverage loan market – CDO and CLO share of new loan volume rose from 10% in 1998 to 59% in 2007 ? Loosening of structural terms (“covenant-lite”, PIK toggles) Leveraged loan market new issuances
$612B $4 9 $479B $501B
$689B
$320B $273B
$310B $218B $240B $
$329B
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Source: Credit Suisse. $US denominated non-investment grade bank debt. CLO/CDO data from JPMorgan.
12
Loose credit markets enabled ever larger buyout transactions ? Leveraged g buyout y volume hit a series of new records, led by y an expansion p in deal size
? Increasing market concentration: 20 deals accounted for ~80% of 2007 LBO volume Top-10 Top 10 largest buyouts ever
Target BCE TXU Equity Office HCA RJR N Nabisco bi Harrah’s First Data Alltel Hilton Hotels Clear Channel Date 2007 2007 2006 2006 1998 2006 2007 2007 2007 2006 LBO Sponsor Providence, MDP, OTPP KKR TPG, KKR, TPG Goldman Blackstone Bain, KKR, Merrill KKR Apollo, TPG KKR Goldman, TPG Blackstone Bain, TH Lee Deal value, in billions $46.8 44 4 44.4 38.9 32.7 31 1 31.1 27.4 27.0 26.9 26.7 25.7
Source: Buyouts January 2008 & Private Equity Analyst January 2008.
13
July 2007: The music stops…
? June 2007: Leveraged g loan market p peaks – $400 billion+ backlog of LBO-related loan and bond commitments – Loan sizes never previously digested by the junk markets – Spreads at all time lows and leverage levels at all-time highs ? July 2007: Sub-prime mortgage crisis triggers concerns in the broader credit market and a global repricing of risk – Demand for buyout-related debt evaporates – Macro fears: Recession Recession, inflation inflation, weak dollar dollar, consumer weakness – Banks, brokers and hedge funds experience liquidity/capital issues $600B – CLO formation dries up
$500B
? Q1-2008: – Bank debt and high yield new issues declined by 76% versus prior year – LBO volume declined 65% versus prior year
$400B $300B $200B $100B
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q1-08 Q1 08
U.S. LBO Deal Volume
(1) Source: S&P LCD and Thomson Financial.
14
Leverage multiples and purchase prices on the decline
Buyout leverage multiples will decline in 20087.4x 8.0x
7.0x 6.0x 5 1x 5.1x 5.0x 4.0x 3.0x 2.0x 1 0x 1.0x 0.0x 1998 1999 2000 2001 2002 2003 2004 2005 2006 Q1'07Q2'07Q3'07Q4'07 2008 4.7x 4.9x 4.3x 3.7x 4.1x 4.4x
Average multiple of trailing EBITDA for large leveraged loans 6.1x
5.4x 5.7x 5.9x 6.0x
50 5.0x
? Underwriters have started writing new commitments, but credit markets effectively closed for very large deals ? LBO sponsors will need to contribute more equity (35-40%) ? Wider spreads; tighter covenants ? Higher quality companies with stable cash flows will get financing
12.0x 10.0x
Average LBO Purchase Price/LTM EBITDA 10.3x
9.4x 8.3x 8.1x 8.1x 8.0x 7.3x 6.7x 6.3x 6.8x 6.7x 6.9x 8.7x ?
LBO purchase prices expected to decline
8.0x 6.0x 4.0x 2.0x 0.0x
? Repricing in private market mirrors sell-off in public markets ? Slowdown in activity as seller expectations lag market realities ? Much smaller deal sizes
1998 1999 2000 2001 2002 2003 2004 2005 2006 Q1'07Q2'07Q3'07Q4'07 2008
15
Source: Leverage multiples (for LBOs $250M - $499M) and purchase price multiples from S&P LBO Review. Buyout deal volume from Thomson Financial Mergers & Acquisitions Review.
Renewed interest in credit-driven private equity strategies
Mezzanine / Subordinated debt: ? LPs should benefit from pullback of competing financing sources – BDCs/Hedge funds: less liquidity for new loans, more scrutiny of public portfolios – Lower L senior i l lending di multiples l i l should h ld mean greater utilization ili i of f mezzanine i ? Mezzanine pricing has improved: – Pre-credit crunch: low-teens IRRs – Post-credit Post credit crunch: high-teens high teens IRRs ? Flight to quality? – Mezzanine fundraising has averaged ~7.5% of buyout capital raised – $9.2 billion of mezzanine raised in 2007 (2nd highest ever) = 4% of buyout capital – $22.3 billion of mezzanine raised in Q1-08 ? Sponsored mezzanine activity will likely slow along with buyout activity
Source: Private Equity Analyst. Note that GS Mezzanine Partners V accounted for $20B of Q1-08 mezzanine fundraising.
16
Renewed interest in credit-driven private equity strategies
Distressed debt: ? Long-anticipated increase in default rates will likely be realized in 2008 – Peak leverage multiples in 2006-2007 – Slowing economy ? Capital overhang for distressed debt investment strategies? Default Rates likely to increase in 2008
12.8%
14% 12% 10% 8% 6%
9.8%
5.1% 4.1%
4.7% 3.4% 3 % 1.2% 0.8%
4% 2% 0% 1996 1997 1998 1999 2000 2001 2002 2003 2004 1.2% 1.3% 1.6%
?
0.5% 2007
2005
2006
Default rates
Source: Edward Altman, New York University.
17
Venture capital relatively well insulated from the credit crisis ? Stable investment environment
– – – – – Normalized VC investment pace of $25-30B per year Rational early stage valuations, but upward pressure on later-stage financings Key areas of VC interest include software, IT services, biotech & medical devices Growing interest in Clean technology /alternative energy Growing interest in emerging markets, in particular China and India
? Exit environment – M&A provides primary path to liquidity – Valuations for M&A exits of VC-backed companies have nearly tripled since 2003 – Average IPO valuations in 2007 similar to levels last seen in 2001 – Market volatility during 1Q-2008 has temporarily closed IPO window for emerging technology companies – Experienced managers are budgeting for recessionary declines in IT spending Venture capital investment by industry & stage
Information Technology 44% Biotech & Medical Devices 33%
by $ invested for Q108
Expansion Stage 40%
Other 23%
Seed & Early S Stage 23%
Later Stage 37%
Source: PricewaterhouseCoopers, Q1-2008 MoneyTree Report.
18
Favorable market dynamics for venture capital investment Sustainable increase in VC Stable early-stage
$125B
investment
9,000 8,000
.
$100M Me edian Pre-Money Valuation ($M)
valuations
.
$100B
$105B
7,000 6,000
.
VC Investme ent ($M)
$75B
, 5,000 4,000 3,000 $41B
Number of f deals
$75M
$50M $41M $25M
$50B
$25B $22B $0B 2000 2001 2002 2003 2004 2005 $20B $22B $23B
$26B
$29B
2,000 1,000 0
2006
2007
$5M $0M 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007E First Round Later Round
Venture Captial Investment ($B)
Number of Deals
Venture-backed IPO activity slowed in 2008 300 $700M
. Average post-offer eq quity value ($M) $600M $636M $500M $400M $397M $300M $285M $200M $100M $0M 2000 2001 2002 2003 *2004 2005 2006 2007 Q1 2008 $294M $241M 100 50 0 $535M $419M $623M 250 200 $390M 150
Venture-backed M&A provides majority of exits $200M 380
$160M Average exit valua ation ($M)
Total # o of IPOs .
$176M 340 320
$120M $112M $102M $80M $63M $40M $52M $83M $96M
$125M
300 280 260 240
5 IPOs
56 Exits
$0M 2001 2002 2003 2004 2005 2006 2007 Q1 2008
220 200
Average valuation at IPO
# of venture-backed IPOs
Average exit valuation
# of VC-backed M&A exits
19
Sources: VC investment data from PriceWaterhouseCoopers and NVCA through 4Q-2007; VC-backed IPO data from Thomson Financial through 12/31/07 (excludes 2004 IPO of Google); VC-backed M&A data from NVCA through 12/31/07 (only accounts for deals with disclosed values); VC valuation data from VentureOne through Q2-2007.
# of VC-backe ed acquisitions
360
Strong recent performance across subasset classes
Venture Economics pooled net IRRs as of December 31, 2007
30% 25.3% 25% 20.4% 20% Po ooled Net IRR 15.5% 15% 14.0% 12.4% 10% 9.5% 8 6% 8.6% 8 6% 8.6% 18.3% 16.7%
5%
0% 1-Year 3-Year Buyouts 5-Year 10-Year 20-Year
Venture Capital
Source: Thomson Financial Venture Economics as of May 2008.
20
Private equity return expectations
Buyout funds will feel short term impact of credit market disruption ? Long-term return expectations remain attractive for top-quartile private equity – 400-600 basis points over long-term S&P 500 ? Unsustainably high buyout returns will return to earth – Recent vintage PE portfolios may experience modest write-downs as fair value is fully reflected – Increase in defaults, loss rates for buyout managers that utilized excessive leverage – Drawdown pace will slow; return to normalized pace of 20-25% per year – Longer holding periods expected; dividend recaps no longer an option – New buyout investments will feature lower risk capital structures ? First-quartile funds will continue to outperform median returns by a wide margin
Pooled net IRRs as of December 31, 2007 All U.S. Private Equity First Quartile U.S. Private Equity S&P 500 1-Year 25.3% 28.7% 5.5% 3-Year 13.0% 16.0% 8.6% 5-Year 13.3% 16.9% 12.8% 10-Year 10.8% 17.0% 5.9% 15-Year 14.4% 20.2% 10.5%
Source: Thomson Financial Venture Economics as of May 2008. Total return for S&P 500, including reinvestment of dividends.
21
Recommendations for institutional investors
Disciplined portfolio construction will mitigate expected volatility ? Diversification by vintage year Commitments to private equity partnerships made over a three three- to four four-year year period Recommended SubSub Asset Class ? Diversification by sub-asset class Diversification Venture capital, buyout, mezzanine, restructuring/turnaround/distressed g debt, special p situations ? Diversification by manager Rigorous selection process to access top-tier private i t equity it partnerships t hi ? Diversification by geography The U.S. and Western Europe are most proven private equity markets
Buyout 40% Venture Capital 25% Special Situations 15% International 20%
22
Recommendations for institutional investors
Attractive private equity investment opportunities in the wake ? Venture capital: Maintain allocation to top-tier U.S. VC managers of the credit crisis – Relatively well-insulated from credit crisis – Very short list of oversubscribed VC firms will continue to dominate PE returns ? Buyout: Core portfolio of middle-market, with limited exposure to largest managers – Carefully assess quality of lending relationships, deal flow and ability to impact cash flow growth ? Special situations: Selective exposure to mezzanine, distressed debt, turnaround strategies – Control turnaround strategies attractive, provided manager has demonstrated operational capabilities ? Experience matters! Emerging private equity managers have under-performed
Pooled net IRRs as of December 31, 2007 First-time Funds Follow-on Funds 1 Year 1-Year 8.8% 25 9% 25.9% 3 Year 3-Year 5.6% 13 8% 13.8% 5 Year 5-Year 8.2% 13 9% 13.9% 10 Year 10-Year 5.6% 11 6% 11.6% 15 Year 15-Year 8.3% 15 5% 15.5%
Source: Thomson Financial Venture Economics as of May 2008. Relative comparison likely exaggerated by survivorship bias.
23
Disclaimer
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24
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doc_999940689.pdf
A credit crunch (also known as a credit squeeze or credit crisis) is a reduction in the general availability of loans (or credit) or a sudden tightening of the conditions required to obtain a loan from the banks.
Mesirow Financial Private Equity Credit crisis impact on private equity
Presented to
TEXPERS
May DeBolt 12, 12 2008 Bob Linda Jordan Senior Vice President Managing Director 312-595-6825 404-881-2814 [email protected] [email protected]
Goals for this presentation
I. II. Present an overview of the various p private equity q y strategies g Describe the events which led up to the current difficulties in the credit market
III. Explain how private equity investors are adapting to the new environment IV. Provide expectations for private equity going forward V. Offer recommendations for institutional investors
2
Private equity overview
Private equity is a privately negotiated investment, typically in a private company, ranging from early-stage technology start-ups to buyouts of established companies.
Private Equity
Venture Capital
Leveraged Buyout
Special Situations
Financing for startup and emerging growth companies, typically in the healthcare & information technology sectors
Equity sponsorship of leveraged buyouts and growth capital for mature, cash flow generating businesses
Subordinated / mezzanine debt, distressed debt, operational turnaround and industry-focused investments
3
Venture capital overview
$ Inves sted
Seed Start Up
2nd Round
3rd Round
4th Round
Expansion
Pre-IPO
Exit Point
? Capital typically provided to earlier stage companies to finance growth. ? Most venture capital firms specialize on either early stage financing, where capital is generally used to develop a new product or technology, or later stage financing where capital is generally used for expansion of sales & marketing marketing. ? Venture capitalist generally focused on companies in the information technology and life science sectors. Cleantech has more recently become a significant area of focus.
4
Leveraged buyout overview
? Equity capital provided to facilitate the acquisition or recapitalization of a company. ? Target companies typically have predictable cash flows. ? A leveraged buyout fund leads the transaction and provides the equity capital, while mezzanine funds typically provide subordinated debt financing. ? Variations of the LBO strategy include buy-and builds, take privates, and growth buyouts.
40% Senior Debt Typically supplied by commercial banks
Post-LBO Balance Sheet
25%
Subordinated Debt
Typically supplied by mezzanine funds, high yield bond investors or hedge funds Supplied by leveraged buyout funds
35%
Equity
5
Special situations overview
? Mezzanine / Subordinated Debt – A hybrid of debt and equity financing typically used to finance leveraged buyouts or expansion of existing companies. Mezzanine financing is debt capital that gives the lender the rights to convert to an ownership or equity interest in the company if the loan is not paid back in time and in full. It is generally subordinated to debt provided by senior lenders such as banks and venture capital companies. ? Distressed Debt – Distressed debt investors scour the market for undervalued debt securities of companies undergoing financial distress. They purchase debt at deeply discounted prices and adopt various strategies to enhance the debt’s value.
6
Market sub-asset class allocations
1999-2001
2002-2004
2005-2007
20% 54% 46% 80%
15%
85%
Venture Capital Funds
Buyout and Other Private Equity Funds
Source: Private Equity Analyst. U.S. funds only, excluding fund-of-funds, as of January 2008.
7
Types of private equity funds
Direct Investment Funds A direct investment fund invests directly into underlying operating companies Fund-of-Funds A fund-of-funds commits capital to a broad range of direct investment funds
Fund-of-Funds
Direct Investment Fund
Venture Capital Funds
Buyout Funds
Special p Situations Funds
10 – 40 Portfolio Companies
Hundreds of Portfolio Companies
8
Private equity firms had very limited direct exposure to subprime mortgages and related structured securities
? Buyout and venture capital firms are generally not in the business of buying debt securities, rather they invest in the equity of operating companies ? Some value-oriented private equity firms have recently made investments in the fallout of the subprime mortgage crisis; but these have been limited and presumably at attractive distressed valuations – Mortgage originators, bond insurance, equity infusions into banks, hung debt held by Wall Street ? However, the broader credit market disruption is creating unique challenges and opportunities for private equity investors
9
Golden age of the buyout
35% 27% 25% 19% 15% 1-year re eturn 14% 19%
1-Year Buyout IRR vs. S&P 500
29% 25% 25%
25%
5%
2%
-5% 5%
-4% 4%
-15%
-14%
-25%
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Buyout 1-Year Pooled IRR
S&P 500 1-Year Total Return
10
Source: Thomson VentureXpert, May 2, 2008. Pooled net IRR for all U.S. buyouts. Source: Standard & Poor’s. 12-month total return for S&P 500.
Buyout fundraising surged to record highs
? Fundraising during 2007: – 6 buyout funds raised LP commitments >$5 billion – 2 buyout funds raised LP commitments >$20 billion (Blackstone & Goldman Sachs) Capital Committed to U.S. Private Equity Funds
$235B
$245B
$155B
$149B $99B $59B
$91B
$93B $45B $50B
1999
2000
2001
2002
2003
2004
2005
2006
2007
Q1-2008
Venture Capital Funds
Source: Private Equity Analyst. U.S. funds only, excluding fund-of-funds.
Buyout and Other Private Equity Funds
11
Credit market expansion fueled the buyout boom ? Historic low interest rates in 2002-2004 led investors to reach for yield y
? Rising investor demand for junk bonds as default rates moderated after 2002 ? Structured finance expansion revolutionized the leverage loan market – CDO and CLO share of new loan volume rose from 10% in 1998 to 59% in 2007 ? Loosening of structural terms (“covenant-lite”, PIK toggles) Leveraged loan market new issuances
$612B $4 9 $479B $501B
$689B
$320B $273B
$310B $218B $240B $
$329B
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
Source: Credit Suisse. $US denominated non-investment grade bank debt. CLO/CDO data from JPMorgan.
12
Loose credit markets enabled ever larger buyout transactions ? Leveraged g buyout y volume hit a series of new records, led by y an expansion p in deal size
? Increasing market concentration: 20 deals accounted for ~80% of 2007 LBO volume Top-10 Top 10 largest buyouts ever
Target BCE TXU Equity Office HCA RJR N Nabisco bi Harrah’s First Data Alltel Hilton Hotels Clear Channel Date 2007 2007 2006 2006 1998 2006 2007 2007 2007 2006 LBO Sponsor Providence, MDP, OTPP KKR TPG, KKR, TPG Goldman Blackstone Bain, KKR, Merrill KKR Apollo, TPG KKR Goldman, TPG Blackstone Bain, TH Lee Deal value, in billions $46.8 44 4 44.4 38.9 32.7 31 1 31.1 27.4 27.0 26.9 26.7 25.7
Source: Buyouts January 2008 & Private Equity Analyst January 2008.
13
July 2007: The music stops…
? June 2007: Leveraged g loan market p peaks – $400 billion+ backlog of LBO-related loan and bond commitments – Loan sizes never previously digested by the junk markets – Spreads at all time lows and leverage levels at all-time highs ? July 2007: Sub-prime mortgage crisis triggers concerns in the broader credit market and a global repricing of risk – Demand for buyout-related debt evaporates – Macro fears: Recession Recession, inflation inflation, weak dollar dollar, consumer weakness – Banks, brokers and hedge funds experience liquidity/capital issues $600B – CLO formation dries up
$500B
? Q1-2008: – Bank debt and high yield new issues declined by 76% versus prior year – LBO volume declined 65% versus prior year
$400B $300B $200B $100B
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 Q1-08 Q1 08
U.S. LBO Deal Volume
(1) Source: S&P LCD and Thomson Financial.
14
Leverage multiples and purchase prices on the decline
Buyout leverage multiples will decline in 20087.4x 8.0x
7.0x 6.0x 5 1x 5.1x 5.0x 4.0x 3.0x 2.0x 1 0x 1.0x 0.0x 1998 1999 2000 2001 2002 2003 2004 2005 2006 Q1'07Q2'07Q3'07Q4'07 2008 4.7x 4.9x 4.3x 3.7x 4.1x 4.4x
Average multiple of trailing EBITDA for large leveraged loans 6.1x
5.4x 5.7x 5.9x 6.0x
50 5.0x
? Underwriters have started writing new commitments, but credit markets effectively closed for very large deals ? LBO sponsors will need to contribute more equity (35-40%) ? Wider spreads; tighter covenants ? Higher quality companies with stable cash flows will get financing
12.0x 10.0x
Average LBO Purchase Price/LTM EBITDA 10.3x
9.4x 8.3x 8.1x 8.1x 8.0x 7.3x 6.7x 6.3x 6.8x 6.7x 6.9x 8.7x ?
LBO purchase prices expected to decline
8.0x 6.0x 4.0x 2.0x 0.0x
? Repricing in private market mirrors sell-off in public markets ? Slowdown in activity as seller expectations lag market realities ? Much smaller deal sizes
1998 1999 2000 2001 2002 2003 2004 2005 2006 Q1'07Q2'07Q3'07Q4'07 2008
15
Source: Leverage multiples (for LBOs $250M - $499M) and purchase price multiples from S&P LBO Review. Buyout deal volume from Thomson Financial Mergers & Acquisitions Review.
Renewed interest in credit-driven private equity strategies
Mezzanine / Subordinated debt: ? LPs should benefit from pullback of competing financing sources – BDCs/Hedge funds: less liquidity for new loans, more scrutiny of public portfolios – Lower L senior i l lending di multiples l i l should h ld mean greater utilization ili i of f mezzanine i ? Mezzanine pricing has improved: – Pre-credit crunch: low-teens IRRs – Post-credit Post credit crunch: high-teens high teens IRRs ? Flight to quality? – Mezzanine fundraising has averaged ~7.5% of buyout capital raised – $9.2 billion of mezzanine raised in 2007 (2nd highest ever) = 4% of buyout capital – $22.3 billion of mezzanine raised in Q1-08 ? Sponsored mezzanine activity will likely slow along with buyout activity
Source: Private Equity Analyst. Note that GS Mezzanine Partners V accounted for $20B of Q1-08 mezzanine fundraising.
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Renewed interest in credit-driven private equity strategies
Distressed debt: ? Long-anticipated increase in default rates will likely be realized in 2008 – Peak leverage multiples in 2006-2007 – Slowing economy ? Capital overhang for distressed debt investment strategies? Default Rates likely to increase in 2008
12.8%
14% 12% 10% 8% 6%
9.8%
5.1% 4.1%
4.7% 3.4% 3 % 1.2% 0.8%
4% 2% 0% 1996 1997 1998 1999 2000 2001 2002 2003 2004 1.2% 1.3% 1.6%
?
0.5% 2007
2005
2006
Default rates
Source: Edward Altman, New York University.
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Venture capital relatively well insulated from the credit crisis ? Stable investment environment
– – – – – Normalized VC investment pace of $25-30B per year Rational early stage valuations, but upward pressure on later-stage financings Key areas of VC interest include software, IT services, biotech & medical devices Growing interest in Clean technology /alternative energy Growing interest in emerging markets, in particular China and India
? Exit environment – M&A provides primary path to liquidity – Valuations for M&A exits of VC-backed companies have nearly tripled since 2003 – Average IPO valuations in 2007 similar to levels last seen in 2001 – Market volatility during 1Q-2008 has temporarily closed IPO window for emerging technology companies – Experienced managers are budgeting for recessionary declines in IT spending Venture capital investment by industry & stage
Information Technology 44% Biotech & Medical Devices 33%
by $ invested for Q108
Expansion Stage 40%
Other 23%
Seed & Early S Stage 23%
Later Stage 37%
Source: PricewaterhouseCoopers, Q1-2008 MoneyTree Report.
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Favorable market dynamics for venture capital investment Sustainable increase in VC Stable early-stage
$125B
investment
9,000 8,000
.
$100M Me edian Pre-Money Valuation ($M)
valuations
.
$100B
$105B
7,000 6,000
.
VC Investme ent ($M)
$75B
, 5,000 4,000 3,000 $41B
Number of f deals
$75M
$50M $41M $25M
$50B
$25B $22B $0B 2000 2001 2002 2003 2004 2005 $20B $22B $23B
$26B
$29B
2,000 1,000 0
2006
2007
$5M $0M 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007E First Round Later Round
Venture Captial Investment ($B)
Number of Deals
Venture-backed IPO activity slowed in 2008 300 $700M
. Average post-offer eq quity value ($M) $600M $636M $500M $400M $397M $300M $285M $200M $100M $0M 2000 2001 2002 2003 *2004 2005 2006 2007 Q1 2008 $294M $241M 100 50 0 $535M $419M $623M 250 200 $390M 150
Venture-backed M&A provides majority of exits $200M 380
$160M Average exit valua ation ($M)
Total # o of IPOs .
$176M 340 320
$120M $112M $102M $80M $63M $40M $52M $83M $96M
$125M
300 280 260 240
5 IPOs
56 Exits
$0M 2001 2002 2003 2004 2005 2006 2007 Q1 2008
220 200
Average valuation at IPO
# of venture-backed IPOs
Average exit valuation
# of VC-backed M&A exits
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Sources: VC investment data from PriceWaterhouseCoopers and NVCA through 4Q-2007; VC-backed IPO data from Thomson Financial through 12/31/07 (excludes 2004 IPO of Google); VC-backed M&A data from NVCA through 12/31/07 (only accounts for deals with disclosed values); VC valuation data from VentureOne through Q2-2007.
# of VC-backe ed acquisitions
360
Strong recent performance across subasset classes
Venture Economics pooled net IRRs as of December 31, 2007
30% 25.3% 25% 20.4% 20% Po ooled Net IRR 15.5% 15% 14.0% 12.4% 10% 9.5% 8 6% 8.6% 8 6% 8.6% 18.3% 16.7%
5%
0% 1-Year 3-Year Buyouts 5-Year 10-Year 20-Year
Venture Capital
Source: Thomson Financial Venture Economics as of May 2008.
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Private equity return expectations
Buyout funds will feel short term impact of credit market disruption ? Long-term return expectations remain attractive for top-quartile private equity – 400-600 basis points over long-term S&P 500 ? Unsustainably high buyout returns will return to earth – Recent vintage PE portfolios may experience modest write-downs as fair value is fully reflected – Increase in defaults, loss rates for buyout managers that utilized excessive leverage – Drawdown pace will slow; return to normalized pace of 20-25% per year – Longer holding periods expected; dividend recaps no longer an option – New buyout investments will feature lower risk capital structures ? First-quartile funds will continue to outperform median returns by a wide margin
Pooled net IRRs as of December 31, 2007 All U.S. Private Equity First Quartile U.S. Private Equity S&P 500 1-Year 25.3% 28.7% 5.5% 3-Year 13.0% 16.0% 8.6% 5-Year 13.3% 16.9% 12.8% 10-Year 10.8% 17.0% 5.9% 15-Year 14.4% 20.2% 10.5%
Source: Thomson Financial Venture Economics as of May 2008. Total return for S&P 500, including reinvestment of dividends.
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Recommendations for institutional investors
Disciplined portfolio construction will mitigate expected volatility ? Diversification by vintage year Commitments to private equity partnerships made over a three three- to four four-year year period Recommended SubSub Asset Class ? Diversification by sub-asset class Diversification Venture capital, buyout, mezzanine, restructuring/turnaround/distressed g debt, special p situations ? Diversification by manager Rigorous selection process to access top-tier private i t equity it partnerships t hi ? Diversification by geography The U.S. and Western Europe are most proven private equity markets
Buyout 40% Venture Capital 25% Special Situations 15% International 20%
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Recommendations for institutional investors
Attractive private equity investment opportunities in the wake ? Venture capital: Maintain allocation to top-tier U.S. VC managers of the credit crisis – Relatively well-insulated from credit crisis – Very short list of oversubscribed VC firms will continue to dominate PE returns ? Buyout: Core portfolio of middle-market, with limited exposure to largest managers – Carefully assess quality of lending relationships, deal flow and ability to impact cash flow growth ? Special situations: Selective exposure to mezzanine, distressed debt, turnaround strategies – Control turnaround strategies attractive, provided manager has demonstrated operational capabilities ? Experience matters! Emerging private equity managers have under-performed
Pooled net IRRs as of December 31, 2007 First-time Funds Follow-on Funds 1 Year 1-Year 8.8% 25 9% 25.9% 3 Year 3-Year 5.6% 13 8% 13.8% 5 Year 5-Year 8.2% 13 9% 13.9% 10 Year 10-Year 5.6% 11 6% 11.6% 15 Year 15-Year 8.3% 15 5% 15.5%
Source: Thomson Financial Venture Economics as of May 2008. Relative comparison likely exaggerated by survivorship bias.
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Disclaimer
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