The Private Equiteer - Latest Comments

Re: Methods for private equity firms to exit investments

Investment banking Chicago — Fri, 15 Oct 2010 21:52:55 -0000

When you can see in the future that your investment will not really work. It is better that you do exit on it. Those listed above are really the common ways how to exit a investment. Thanks for this really nice article.

Re: What Sellers Need to Know About Private Equity Firm Structures

Mike Gasparro — Thu, 07 Oct 2010 15:57:18 -0000

Good question. Yes, there is a difference. It is really a perspective issue. Un-drawn obligations refer to the amount a specific LP has committed to, but not yet provide to the fund. Dry powder is a term that applies to the actual fund (or GPs) and is the amount of capital the fund has remaining to invest.

Re: What Sellers Need to Know About Private Equity Firm Structures

Guest — Thu, 07 Oct 2010 15:05:39 -0000

is there a difference between "un-drawn obligations" and "dry powder"?

Re: How to calculate capex from financial statements

Company Off Lease Equipment — Sat, 28 Aug 2010 04:18:38 -0000

Why do people think that a stateowned oil company that would make gas cheap and employ 1000s is evilCommunism?

Re: 5 Major differences between strategic and financial buyers

Joe Huguelet — Thu, 19 Aug 2010 11:46:16 -0000

Mike,

Interesting topic, thanks for starting it.

From our perspective we have always felt some PE's would fare well if that acted more like strategic buyers. I know this is a sensitive subject and may even be a bit controversial. Let me elaborate:

Many PE's have evolved by taking advantage of opportunistic situations. They may not have platforms or compelling ways to grow the business or add much value to it. The model may be as simple as buy low, sell higher (hopefully). I worked for one for years whose mantra was a "a shameless pursuit of a dollar for a dime". That worked well for a long time. Times may be changing.

Strategic buyers as you clearly articulated, have synergy opportunity that provides value that may not be easily obtained by others. Historically they may have paid more in recognotion of this. Not always the case though in today's environment.

We are most commonly enagaged by strategic buyers to help them duirng the integration due diligence, planning and execution phases of the transaction. Together we work to maximize the value of the synergy opportunities and minimize the risk. ROI is enhanced significantly when this is done right.

My comment about PE's acting more like strategic buyers simply means that those that move beyond opportunistic rationale for buying and consider synergy will put themselves in a position to maximixe the value of their investment. Platforms are increasingly more common and and for good reasons. Focusing on sectors that you can become well versed in and looking for ways to leverage synergy seem to be key components in adding value and achieving results. Yet, even many PE's with platforms we talk to don't look at integration with the same passion as some strategics.

We have always thought the work we do for strategic buyers could easily be applied to financial acquisitions under circumstances where the PE believed that synergy can drive value and that proper integration may be a key to achievng it. Yet, from our eyes only a minority of PE's consider external help for integration (when there is something to integrate) and instead rely on less than objective perspectives of their business to integrate who may not have a lot of experience at it. That seems to be taking inordinant risk.

History has shown us that many deals fail to reach financial or organizational objectives and that the systemic root for that failure is inability to integrate properly. The M&A world could contribute to turning around the economy if every deal done going forward was a resounding success.

I am interested in the PE perspective on this topic and invite constructive criticism of my thoughts and analogy.

Re: 5 Major differences between strategic and financial buyers

georgiatanasov — Sun, 15 Aug 2010 03:56:52 -0000

Well spotted about the different approaches to the back office. I have an additional question regarding all of these differences, if I may. What would the difference be if your strategic buyer is a PE portfolio company? What about when PE firms trade portfolio companies?
Thank you in advance.
-Georgi

Re: Accretion/Dilution: What Is It And Does it Matter?

Jordan Elpern-Waxman — Sun, 25 Jul 2010 22:58:40 -0000

I think that Sebasm is right here and makes an excellent point. I'm not a big fan of accretion/dilution mostly for the reasons listed in the post (too short of a time frame, accounting manipulations, etc), but Sebasm has pointed out an additional flaw that I have not seen addressed in all of the articles I've on the subject: accretion/dilution is all about the flows to the shareholders and has nothing to say about the rate at which those flows (whether cash or accounting) will be discounted.

The closest accretion/dilution comes to taking into account changes in the cost of capital is through projected changes in interest expenses, but as far as I can tell it doesn't have any way to factor the changes in the cost of equity capital. I'm also not aware that analyst EPS estimates factor cost of capital at all - they may forecast "risk" of some sort through probability weighting multiple scenarios, but this is not the same as Beta-based costs of capital under the CAPM. Additionally, relying on the availability or accuracy of analyst EPS estimates isn't really relevant to the question, since Sebasm is essential asking about the change to the *value* per share, not the earnings. To the extent that the target's business differs from that of the acquirer, it could have a significant change on the beta used to determine the acquirer's cost of capital. Put in less theoretical terms, it could significantly change the peer set against which the acquirer is compared. One example is the United Online acquisition of FTD (http://paidcontent.org/article/419-united-onlin...). Yahoo Finance may still be categorizing UNTD as an ISP, but they get 60% of their business from selling flowers.

Sebasm: I'm doubly impressed with the question coming from a first-year undergrad. I couldn't find your other comment, but feel free to reach out if you want to discuss any other related topics. With my full name I'm pretty easy to find on the internet.

Re: Accretion/Dilution: What Is It And Does it Matter?

The Private Equiteer — Sat, 17 Jul 2010 00:35:09 -0000

Agree 100% Sebasm, that anything financial must be risk-weighted. Generally when analysts look at EPS though, they're looking forward. You'd rarely use EPS from last year. So if we talk about 2011 EPS, it's a forecast that "should" take risk into account. But as I mentioned in my last response, while it helps to work towards targets in a strategic sense, it's futile to rely on forecasts.

The one thing to keep in mind in private equity is that good returns come from selling an investment for more than you paid. That increase in price doesn't always means there's an increase in value. Buffett may say that "price is what you pay, value is what you get", but he's talking about long-term investing. In private equity, "price is what you pay, and price is what you get." Value helps, but it's far from the decider of returns.

Re: The earnings multiple valuation method

The Private Equiteer — Sat, 17 Jul 2010 00:19:31 -0000

Hey Sebasm611, great to hear from you . I've actually heard from a few people in Columbia; look forward to making it there some time next year.

I agree, theoretically DCF takes more into account, but multiples and DCF suffer from the same problem, which is "garbage in, garbage out". The discount rate in a DCF affects the value greatly, yet it's about as the most arbitrary as all financial metrics.

This is going to sound somewhat cynical, but the calculated financial value of a business is pretty trivial in private equity. It's based on past metrics and any attempt to include the future is futile. In university you want to believe it's as formulaic as the professors suggest, but it just isn't.

The real-life drives of good returns in private equity are purchase price, sale price and leverage. Sales growth matters, and so does profit growth, but we're mostly talking about legacy businesses in PE. Buying in at 4 times compared to 8 times and selling at 12 times compared to 6 times makes a big difference. All of the financial models and DCF calculations in the world won't predict the manipulation of a great purchase/sale price.

All the best S - just my opinion :)

Re: Accretion/Dilution: What Is It And Does it Matter?

Sebasm611 — Thu, 15 Jul 2010 13:57:20 -0000

I made a long comment before on the valuation by earning multiples, I don't want to sound like a DCF junkie but I'll make a point again in making a comparison to what would happen to value in the DCF analysis.

I think Accretion / Dilution is definitely not even close to be a indication of value creation (or destruction) because it leaves out the principle of risk-adjusted and time-weighted (discounted) returns necessary to measure value creation or destruction.

So, for instance, lets say (to cite your example) 3M buys company ABC and earnings get around 1% accretive, but bought a Colombian company, so the risk of those pro-forma earnings also carry a lot more risk, and for that 1% increment in EPS 3M paid a 15x multiple, there would be clearly value destruction.

Sorry if I didn't get your point, as I stated before I'm a first year undergrad in Colombia and I don't have the knowledge of you wall st guys.

Re: The earnings multiple valuation method

Sebasm611 — Thu, 15 Jul 2010 02:20:19 -0000

First of all... I want to congratulate you for this blog, I find it most interesting to read. I'll be posting some comments.

Now, about the topic... I find the multiple approach a very dangerous approach because of the reasons it's actually used. I should point out also that a DCF valuation, if done right, should yield the same value that the multiple approach and vice-versa.

One of the reasons the multiple approach is so widely used, which in my opinion make the multiple approach dangerous is "because it's easy" and don't have to calculate all the inputs the DCF have. Another is the misuse of the multiples, for example, the P/Sales or P/EBITDA used when earnings are negative is a mistake because price is an equity value and sales is a pre-debt firm value, there's no possible sensible interpretation possible because I'm leaving out all debt incidence in value.

Another is the argument for those comparable companies, because to have the same multiple, the company must have the same amount of debt, same growth, same revenues, etc... than the average.

So the conclusion for me would be, if multiples are to be used... then it'd be good to make a DCF valuation also just to support the multiple, know what am I selling and make adjustments to the company Vs the comparables and arrive to a fairer value.

Again congrats and thanks for the blog...
1st year undergrad from Colombia.

Re: The economics of bolt-on acquisitions

BR PE — Wed, 16 Jun 2010 03:03:09 -0000

Far too many shops are snapping up bolt-ons too soon and forget that a bolt-on can only truly be useful once the core investment has begun to flow. Unless the primary is primed to boom then I think bolt-ons, no matter how successful they are in their own right, are an unrewarding pursuit.

Re: Life in a startup

AHVenture — Thu, 10 Jun 2010 11:16:03 -0000

Pleasure to read that ! But how long was the maturation process before crossing the Rubicon ?

Re: Life in a startup

johnmccarthy — Fri, 14 May 2010 08:15:27 -0000

Welcome!

Re: Should we treat firms that sign up to the UNPRI as suspicious?

The Private Equiteer — Tue, 27 Apr 2010 22:18:44 -0000

Agreed Lake; I must have been feeling especially outraged that day.

Though I'm not sure if you're talking about my reference to alcoholism or slavery. Because while the alcoholism reference is an analogy, the slavery one isn't. The UNPRI actually "suggests" (even that's too strong a word for the UN) you don't invest in businesses that employ slaves (especially of the younger variety).

Re: Is mezzanine capital the current answer for entrepreneurs?

Mike Gasparro — Tue, 27 Apr 2010 14:40:55 -0000

Good question. I was referring to the U.S. middle market. The structure and pricing terms were a general guideline. There is going to be significant variability by country, industry, deal size and even company to company.

Mike
http://www.axialmarket.com/blog/

Re: Should we treat firms that sign up to the UNPRI as suspicious?

Lake Dawson — Tue, 27 Apr 2010 12:40:33 -0000

I appreciate your view and even agree with your argument. However, I do question your decision to use such a powerful analogy (and graphic) to make a rather rudimentary point. In this case, I would suggest you choose your words more carefully.

Re: Is mezzanine capital the current answer for entrepreneurs?

HKR — Mon, 26 Apr 2010 13:11:44 -0000

Hi,

For the terms of mezzanine financing, are you taking the UK industry as reference? I know that mezzanine financing is under-developed in the US (as they have a higher historical rate for bonds, which are cheaper) but these terms seem low (all of them actually). This is maybe linked to country specific terms.
In France, you would see these:
- max senior debt: 4.0x. Max mezz gearing: 5.0x
- Cash interest on senior mezz: 12%-15% (note that in France, senior mezz is usually only cash pay)
- Interest on Junior mezz (PIK + cash): 18% (allocation may vary) + some warrants

That is at least what I saw

Re: Carried Interest 2.0

HKR — Mon, 26 Apr 2010 12:58:21 -0000

I remember a certain fund (still in activity) where there was no hurdle and direct carry was hit as long as investment came at cost.. Fund was oversubscribed.
Good old pre-2008 times I guess.

Re: Life in a startup

Jose Seispaque — Sun, 25 Apr 2010 22:12:14 -0000

Congrats, man.

Re: Carried Interest 2.0

Mark — Wed, 14 Apr 2010 23:43:31 -0000

Yeah, I realize I'm way out there. I'm not a big fan of using the IRR to structure a preference as it causes problems down the road for under-performing funds (though, admittedly, under-performance itself creates proportionately larger issues). Some firms need fairly heroic exits to clear the hurdle, let alone participate in the catch-up and full carry. I prefer MOC. Why not have a 1.15x hurdle, then 15/85 carry below 2x (gross), and 20/80 from 2x to 2.5x and 30/70 for 2.5 and above? It seems like many firms underwrite to 2x, which, net of fees, doesn't get the L.P.'s very much. But, the number "2" is optically better than "1.anything". So I can't say I'm surprised. I say take the risks. As a customer, I'd pay $10 for a burger if it tastes like $20

Re: Carried Interest 2.0

The Private Equiteer — Tue, 13 Apr 2010 22:56:31 -0000

Sounds like you're throwing down the gauntlet Mark. It sounds like you're suggesting that "performance" fees should reflect "performance". Sounds a bit absurd, if you ask me.

Did you ever read my post about how Buffett structured them when he started his fund? Here's the link http://www.theprivateequite...

He had a 50% carry above a 4% hurdle AND a negative 25% carry below. Now that's confidence in your competence.

Re: Carried Interest 2.0

Mark — Mon, 12 Apr 2010 17:22:38 -0000

I thought what was at issue was "penalizing" GP's for UNDER-performance while providing a meaningful incentive to take more risk. There are several funds with premium carry but few, if any, that also penalize the GP for substandard returns (as per the example above) or overly-conservative investments. The PE is right, GP's are experts at mitigating downside risk. As an LP, this is tremendously frustrating as we work with an asset allocation that demands we take MORE risk with our private equity allocation and swing for the fence while "managing" portfolio risk via other asset classes.

Re: Carried Interest 2.0

The Private Equiteer — Thu, 08 Apr 2010 01:41:04 -0000

I though it was a preferred 7% out of 25%, not 7+25 = 32% carry. Either way, my mistake. And yes, that would be too audacious even for PE.

Re: Carried Interest 2.0

The Private Equiteer — Thu, 08 Apr 2010 01:33:11 -0000

You're right Steve, my mistake.