5 private equity

7/27/2019 5 Private Equity

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Private Equity

Hemchand J


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Private Placement

Private placement can be made both by

companies that have already gone public in

the past and by those that have not.

Private placement is the act of placing a new

issue of shares with a group of selected

financial institutions.

Though the intention of private placement is

fund raising, they are sometimes made to

accommodate certain strategic objectives.


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Private Equity and Investment Banking

Over the years, private equity has thrived forinvestment banks as a major service area inhelping companies raise equity capital privately.

Private placement market for equity is large.Venture capital and Private Equity funds are twopopular types of institutional equity investments,there are other investors such as Mutual Funds,

FIIs, banks and insurance companies, most ofwhom are collectively known as QualifiedInstitutional buyers (QIBs).


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Private Placements

Private placements are mostly organized byinvestment banks acting as arrangers.

Companies also issue equity capital to their

promoter groups, working directors, employeesand group companies. Such allotments alsoamount to private placements. But they do notconcern investment bankers. In the context of

private equity, it would be to bring in externalinvestors such as a QIB, strategic partner or a

joint venture investor.


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Venture Capital

Venture capital is rightly called as financing

of innovation. It is the financing of start up

businesses with a view to grow them into

large commercially successful business. It is

defined as capital for investment which may

easily be lost in risky projects, but can also

provide high returns; also called risk capital.


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Venture Capital

The term start up typically refers to the early

stage in the life of a company that has been

formed to set up a technology backed

business venture or a technology

development venture with an intention to

commercialise the same. Venture capital

involves significant risk taking on the part ofthe venture capitalist since young businesses

are subject to high rates of mortality.


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PIPE

Private Investment in Public Equity occurs

when private investors take a sizeable

investment in publicly traded corporations.

This usually occurs when equity valuations

have fallen and the company is looking for

new sources of capital. When private equity is

infused into a listed company it could beclassified as PIPE investment. Initially it was

associated with the kind of last resort capital.


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PIPE

Private: It is a private placement transaction

between a limited group of investors and a

listed company.

Investment: It is a direct investment in a

company. It involves purchase of securities in

the primary market.

Public: It is used by a listed company.

Equity: It is an equity or equity linked

investment.


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Private Investment in Public Equity

Private Equity in unlisted companies applies to

early stage and later stage unlisted companies.

Usually when the company is in early stage, a

debt convertible is structured so that it can be

converted into equity as and when the

company achieves pre set milestones.

Other alternatives are preference capital orconvertible preference shares.


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PIPE placement

PIPE placement is identical to that for unlistedcompanies except that it is made by a listedcompany. Listed companies suffer from

several constraints including regulatoryrestrictions.

Qualified Institutional Placement (QIP) isexactly similar to PIPE except that it should bemade only to QIBs. The issue should be onlyfor pure equity or convertible instruments.


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Valuation

Valuation methodologies for private equity

deals can be broadly classified as follows:

The transaction multiple approach which uses

certain capitalization factors such as revenue

or Profit after tax or Operating Profit (EBITDA)

or a market multiple such as the PE ratio (in

the case of listed companies) to arrive atpresent valuation of a company.


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Discounted cash flow method

This method uses free cash flow approach and

tries to arrive at the present value of a

company based on estimated future cash

flows discounted at the expected rate of

return for equity investors. The method is

appropriate for companies with a stabilized

cash flow model. If this method is used, themultiplier method may then be used as a

cross check to ensure that this method is not

over optimistic.


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Valuation vs. Pricing

For unlisted companies, raising capital , equity

valuation arrived at is relevant and not the

price per share. Price per share is not

important until the company reaches IPOstage.

The price per share varies based on issued

capital at the pre issue stage. Price per sharemay not be a corrected indicator of value.


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Valuation guidelines

As per Government guidelines the share

price is calculated under two methods; the net

asset value method and the Profit Earning

Capacity Value (PECV) method and fair value isdetermined as follows:

Fair value = (NAV + PECV)/2


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The NAV method

The computation of NAV should be based on

the latest available audited balance sheet.

If there is a fresh issue of shares being

contemplated either for cash or otherwise,

the FACE VALUE of the fresh issue equity

capital is added to the existing net worth in

determining NAV.


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The PECV method

The PECV (Profit Earning Capacity Value) will

be calculated by capitalizing the average of

the after tax profits (average 3 years) at the

following rates:

15% in the case of manufacturing companies

20% in the case of trading companies.

17.5% in the case of intermediate companies,

i.e companies whose turnover from trading

activity is between 40% and 60% of total.


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PECV method

If additional issue of shares is involved, the

end use of the funds has to be considered to

ascertain the generation of return on such

capital. The return shall be computed asfollows:

Profits from fresh issue = (Fresh Capital *

Existing PAT) /2 * Existing Networth.


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PECV method

The above profits shall be added to the

existing profit after tax and the total shall be

divided by the expanded capital base to arrive

at the future maintainable earnings per share.

If the fresh capital is not proposed for any

revenue generating activity, no return should

be assumed there from. However, expandedcapital base shall be considered for

determination of earnings per share.


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IllustrationBased on Assets

From the Liability side (in lacs)

Existing Equity capital 1131.10

Share Premium 1235.19 Free Reserves 3051.44

Total 5417.73

Less Misc.expenses 10.96 Adjusted Net worth 5406.77


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From the Asset Side

Fixed Assets 5701.21

Net Current Assets 5527.89

Capital Work In Progress 1266.25 Investments 151.00

Total Assets 12646.35

Less Debenture Redemption res. 0 Long Term Liabilities 7239.58

Adjusted Net worth 5406.77


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Illustration

Face Value of Proposed Capital 507

Proposed Net Worth 5913.77

Existing Shares 113.11 No.of new shares 50.70

Total no.of shares (Post issue) 163.81

NAV Per share 36.10


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Based on Earnings

Operating profit for previous years

PBT Weight Wt*PBT

212.25(2003-4) 1 212.25 543.78(2004-5) 2 1087.56

1397.40(2005-6)3 4192.20

Average profits 915.34 Tax at normal rate 274.60

Average PAT 640.73


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Calculation of PECV

Average PAT 640.73

Contribution from fresh issue 30.04

Expected Future Profits 670.78 Total Shares post issue 163.81

EPS Post Tax 4.09

PECV at 8% capitalization 51.19 Fair value 36.10 + 51.19 average = 43.64

Less Dividend 2 = 41.64(As per CCI formula)

5 private equity

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