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Leveraged Buyouts – An Overview
Dan KatsikasChief Financial Officer, Bear Stearns Merchant BankingDecember 8, 2006
Agenda
IntroductionOverview of Private Equity Firm & Fund StructuresAnatomy of an LBOKeys to Successful BuyoutsCase Studies
Selected BSMB Investments
Alternative investments comprise over 20% of the investment market
Real Estate6.7%
Hedge Funds7.7%
Traditional investments78.6%
Private Equity7.0%
North America% of Total Assets
Source: Russell Survey on Alternative Investing 2005-2006 based on 327 large organizations managing tax-exempt assets
What is private equity?
Investing in securities of a company, usually not public, through a negotiated processIncludes investments in the following categories:
Venture Capital
• Equity capital for the creation or expansion of smaller companies, usually in high tech or emerging industries• Investment across separate stages: seed stage, second stage, third stage, late stage
Buyout
• Equity capital for the acquisition of larger and mature companies with established cash flows• Investments are financed using a mix of debt and equity
Special Situations
• Equity capital for financially and/or distressed companies
Mezzanine
• Debt capital between equity and debt for acquisition of refinancing transactions• Participating in equity appreciation through conversion features such as warrants, etc.
The basics of buyouts
Raise capital in limited partnershipsFind businesses with strong cash flow potentialReduce risk by a high degree of control and legitimate access tonon-public informationPrudent use of leverageAlign interests with management through significant incentives, triggered upon a liquidity eventIlliquid asset class, requires a long term commitmentPotential profits realized through various exit strategies: initial public offerings (IPOs), trade sales, refinancings
Evolution of the private equity industry
Overheated stock market
Tech / Telecom bubble
Abundant fundraising
Economicboom
Non U.S. buyouts
Valuation decline
Tighter credit
Asset deflation
Recession
Significant corporate
restructuring
Robust financing markets
Strategic buyers on the sidelines
Record low interest rates
Larger buyouts and mega funds
DevelopingHY market
More sophisticated financial
engineering
Increasing deal size
Growing M&A
Loan market
Club deals
Under exploited balance sheets
Underperforming economy
Metromedia
Recapitalization through equity
markets
Multiple contraction
Recession
HLT regulation
Improving economic fundamentals
Source: JP Morgan
Managing wealthy Americans’ money
Primarily new ventures
Infancy
Growth
Roaring
Recession
Rebirth and bull market
Recession
Resurgence
Pre-1980 Early 80s Late 80s Early 90s Late 90s 2000-2001 2002-Q306 YTD
Record levels of private equity funds have been raised increasing the buying power of investors
94
160173
7 14 2032 33
55
95 105
173
106
6850
0
25
50
75
100
125
150
175
200
225
250
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 3Q06YTD
U.S.($ in billions)
Source: Morgan Stanley, The Private Equity Analyst
230
Annualized
As a result, major private equity firms continue to grow in size, expanding the buying power of mega-funds
Selected closed U.S. funds($ billion)
Private equity funds currently fundraising ($ billion)
(1) Blackstone plans to raise an additional $4.4bn to reach a total of $20bn(2) Includes $5bn publicly traded investment vehicle; excludes €4.5bn European fund Source: Buyouts Magazine, Private Equity News, JPMorgan
15.6 15.2 14.0
10.0 10.08.0 7.8
6.5 6.0
$0.0
$2.0
$4.0
$6.0
$8.0
$10.0
$12.0
$14.0
$16.0
$18.0
$20.0
Blac
ksto
ne (
1)
TPG
Perm
ira
Apo
llo
Bain
Cap
ital
War
burg
Pin
cus
Firs
t R
eser
ve
MD
P
JC F
low
ers
16.515.0
10.0 9.0 8.0
$0.0
$2.0
$4.0
$6.0
$8.0
$10.0
$12.0
$14.0
$16.0
$18.0
$20.0
$22.0
KKR
(2)
Car
lyle
Gol
dman
Sac
hs
Thom
as H
. Le
e
Prov
iden
ce
21.520.0
Growth in fund size has driven growth in LBO volume and average deal size
* YTD as of 11/13/06** Based on S&P sample setSource: Thomson Financial; Standard & Poor’s
U.S. LBO Volume Average LBO Size**($ in millions)
389
540
716 706
972
1,102
$0
$200
$400
$600
$800
$1,000
$1,200
2001 2002 2003 2004 2005 1H06
12 25 25
75
142
271
$0
$30
$60
$90
$120
$150
$180
$210
$240
$270
$300
$330
2001 2002 2003 2004 2005 2006YTD*
0
100
200
300
400
500
600
700
$ in billions Number of deals
310
Annualized
Increased competition and capital have driven up purchase prices
Price / Adjusted EBITDA
5.9 5.8
6.3 6.6
7.5 7.6 7.6
6.3
6.8 6.76.9
8.0
8.5 8.5
6.46.7
6.9
7.5
8.18.4 8.4
0.0x
1.0x
2.0x
3.0x
4.0x
5.0x
6.0x
7.0x
8.0x
9.0x
10.0x
2000 2001 2002 2003 2004 2005 1H2006
<250M $250mm to $499mm >$500mm
Source: Harris Williams, Portfolio Management Data
Drivers of increased multiples
Macroeconomic growthQuality of businessesIncreased efficiency in marketCompetitionAvailable leverage
Leverage levels have been creeping up along with valuations
Source: Lehman Brothers, Standard & Poor’s
Average total debt / EBITDA
6.0
5.0 5.0
4.2 4.1 4.0
4.64.8
5.35.0
5.6
0.0x
1.0x
2.0x
3.0x
4.0x
5.0x
6.0x
7.0x
1997 1998 1999 2000 2001 2002 2003 2004 2005 1Q06 2Q06
Large LBO (>50M EBITDA)
Average: 4.9x
Average debt multiples of middle market LBO loans
3.53.4 3.4
3.12.8 3.1 3.0 3.0
3.4
3.9
0.1 0.2
0.10.5
0.90.3
1.3 1.2
0.70.8
0.6
0.7 0.8
0.8
0.4 0.6
0.0x
1.0x
2.0x
3.0x
4.0x
5.0x
1997 1998 1999 2000 2001 2002 2003 2004 2005 1H2006
1st Lien Debt 2nd Lien & Other Sr. Debt Sub Debt
Source: Portfolio Management Data, Standard & Poor’s
For the years ended December 31, 1997-2005 and the quarter ended June 30, 2006
Private equity players have become more competitive with strategic buyers in terms of acquisition multiples
Source: Harris Williams, Portfolio Management Data
5.96.4
6.7 6.77.3
8.7 8.5 8.5
0.0x
1.0x
2.0x
3.0x
4.0x
5.0x
6.0x
7.0x
8.0x
9.0x
10.0x
<$100mm $100mm to$249mm
$250mm to$499mm
>= $500mm
Sponsor Strategic
Price/Adjusted EBITDA MultiplesFor the Year Ended December 31, 2000
Price/Adjusted EBITDA MultiplesFor the Trailing Twelve Months Ended October 31, 2005
6.1
7.2
7.9 8.0
6.8
7.5
8.3
9.8
0.0x
1.0x
2.0x
3.0x
4.0x
5.0x
6.0x
7.0x
8.0x
9.0x
10.0x
<$100mm $100mm to$249mm
$250mm to$499mm
>= $500mm
Sponsor Strategic
∆ of 1.8x∆ of 2.3x ∆ of 0.4x
∆ of 0.3x
Firm and Fund Structures
Private equity firms
Fund structures• Committed capital, partnership structures• Run by General Partner and Management Company• How do PE firms make their money?
Management FeesCarried InterestTransaction Fee splitsPrincipal co-investment
• Waterfalls• Firm structures
CEO, COO/CFODeal TeamsOperating Partners
ManagementCompany
ManagementCompany
General Partner
Domestic Fund, L.P.
OffshoreFund, L.P.
Internal Co. Investment Vehicle
Private equity firms - Structure
Fees
Portfolio Companies
Carried Interest
Employees GeneralPartner
GeneralPartner
DomesticFund, L.P.
DomesticFund, L.P.
OffshoreFund, L.P.
OffshoreFund, L.P.
Internal Co-investmentVehicle
Internal Co-investmentVehicle
Portfolio CompaniesPortfolio Companies
How do PE firms differentiate themselves?
Returns and track record
26.8%
12.4%
7.3%
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
Above Median Private Equity Manager All Private Equity S&P
NB: 10-year returns through 12/31/05.Source: Lehman Brothers, Thomson Venture Economics/National Venture Capital Association’s Private Equity Index
Above median PE
vs. S&P: + 1950 bps
All PE
vs. S&P: + 510 bps
Other Differentiating Factors
Diversity of team• Operating Partners and Deal Executers
Sector focus
Access to proprietary deal flow
Depth of experience• Investing across multiple cycles
Speed to close• Dedicated lines of credit/all equity closes
Anatomy of an LBO
Anatomy of an LBO
What is an LBO?Who is a good LBO candidate?Who are the players?• Private equity firms
Co-investors
• Acquisitive companies• Senior lenders
Acquisition debt and revolvers
• Subordinated lendersHedge Funds
• Company management
Key factors in executing an LBO
Industry and company dynamicsA stand-alone investment thesis
ValuationLeverage availableExit strategyManagement, management, management!
Extensive Due Diligence
Example: Gator Industries, Inc.Dollars in thousands
Assumptions:Acquisition price (6.0x 2005 EBITDA) $ 1,200.0Date of investment 12/31/05Hold period 5 yearsSale price (6.0x 2010 EBITDA) 1,650.0Sale date 12/31/10Financable leverage (4.5x 2005 EBITDA) 900.0Financable equity commitment 300.0Assumed total cost of debt 13.0%
Company Financial Projections:
2005A 2006 2007 2008 2009 2010 CAGR$ 1,250.0 4.6%
6.6%
5.9%
275.0(75.0) 200.0
-
200.0(80.0)120.0
75.0(70.0)(20.0)
$ 105.0
$ 1,200.0
260.0(70.0) 190.0
-
190.0(76.0)114.0
70.0(70.0)(18.0)
$ 96.0
Revenues$ 1,000.0 $ 1,050.0 $ 1,100.0 $ 1,150.0
EBITDADepreciation/Amortization
200.0(50.0)
215.0(55.0)
230.0(60.0)
245.0(65.0)
EBIT 150.0 160.0 170.0 180.0
Interest expense, net - - - -
Pre-tax income 150.0 160.0 170.0 180.0Taxes (at 40%) (60.0) (64.0) (68.0) (72.0)
Net income 90.0 96.0 102.0 108.0
Depreciation/Amortization 50.0 55.0 60.0 65.0Capex (60.0) (60.0) (65.0) (65.0)Changes in working capital (10.0) (12.0) (14.0) (16.0)
Free Cash Flow $ 70.0 $ 79.0 $ 83.0 $ 92.0
Example: Gator Industries, Inc. - UnleveredUnlevered Case:
2005A 2006 2007 2008 2009 2010
Pro-forma transaction adjustments:
(Investment)/Sale proceeds (1,200.0) - - - - 1,650.0 Net cash to sponsor $ (1,200.0) $ 79.0 $ 83.0 $ 92.0 $ 96.0 $ 1,755.0
Status quo pre-tax income 150.0 160.0 170.0 180.0 190.0 200.0
-200.0(80.0)120.0
75.0(70.0)(20.0)105.0
-190.0(76.0)114.0
70.0(70.0)(18.0)
96.0
Interest expense - - - -Pro-forma pre tax income 150.0 160.0 170.0 180.0
Taxes (at 40%) (60.0) (64.0) (68.0) (72.0)Pro-forma net income 90.0 96.0 102.0 108.0
Depreciation/Amortization 55.0 60.0 65.0Capex (60.0) (65.0) (65.0)Changes in working capital (12.0) (14.0) (16.0)Pro-forma free cash flow 79.0 83.0 92.0
1.46Times equity returned13.2%IRR
Example: Gator Industries, Inc. - LeveragedLeveraged Case:
2005A 2006 2007 2008 2009 2010
Pro-forma transaction adjustments:
(Investment)/Sale proceeds (300.0) - - - - 750.0 Net cash to sponsor $ (300.0) $ 8.8 $ 12.8 $ 21.8 $ 25.8 $ 784.8
Status quo pre-tax income - 160.0 170.0 180.0 190.0 200.0
(117.0) 83.0
(33.2)49.8
75.0(70.0)(20.0)
34.8
(117.0) 73.0
(29.2)43.8
70.0(70.0)(18.0)
25.8
Interest expense - (117.0) (117.0) (117.0) Pro-forma pre tax income - 43.0 53.0 63.0
Taxes (at 40%) - (17.2) (21.2) (25.2)Pro-forma net income - 25.8 31.8 37.8
Depreciation/Amortization 55.0 60.0 65.0Capex (60.0) (65.0) (65.0)Changes in working capital (12.0) (14.0) (16.0)Pro-forma free cash flow 8.8 12.8 21.8
2.62Times equity returned24.5%IRR
Other Considerations of Buyout
Management equity rolloverOption incentivesShareholders AgreementControl and governance (BOD)Tax structures• C-Corp versus LLC• Preferred versus common
Keys to Success
Management, management, management!Buy rightGrow rightExit rightMitigate risk• Vigilant oversight• Activism• Prudent use of leverage• Structure
Case Studies
Business Description: Producer and marketer of premium air filled bedding products
Investment Rationale:– Category creator– Enormous growth opportunities– High cash flow generation and rapid senior debt
repayment– Compelling retailer economics
Sourcing:– Relationship with management– Met with Aero owner who spent winters in Florida– Trivest closed deal five months after meeting
Structure: Senior and subordinated debt
Value-Add:– Provided deep equity opportunities– Mandated product offering expansion– Shifted advertising focus– Built out finance and accounting departments
Case Study: Aero Products International, Inc.A Trivest Partners, L.P. portfolio company
Date: April-01
Invested: $30mm
Realized: $179mm
Gross IRR: 220%
Multiple: 6.1x
$31
$17
LTM 05/30/01 LTM 11/30/02
EBITDA from Investment to Sale
• Entry Multiple: 5.2x EBITDA• Exit Multiple: 7.6x EBITDA
($ in
mill
ions
)
Business Description: Private label, mall-based specialty retailer of women’s wear-to-work and weekend casual appareland accessories
Investment Rationale:– Non-core division of Limited Brands– Opportunity to rationalize costs and expand– Strong and experienced management team– Attractive and relatively underserved customer base
Sourcing:– Retail industry expertise – Prior success with corporate orphans– Favorable valuation and ability to close quickly– Reputation as value-added partner
Structure: Tax-efficient, seller paper, 30 day close
Value-Add:– Accelerated rebranding– Developed “stand-alone” infrastructure for brand– Developed the accessory store within-a-store concept
Date: Nov-02
Invested: $63mm
Realized: $253mm
Unrealized*: $412mm
Total*: $665mm
Gross IRR*: 124%
Multiple*: 10.6x
* Unrealized value based on NWY’s closing market price of $13.08 as of September 29, 2006.
$97
$46
FYE '02 LTM 7/31/06
CAGR=23%
• Entry Multiple: 3.3x EBITDA• IPO Multiple: 9.1x 2004E EBITDA
($ in
mill
ions
)
EBITDA from Investment to LTM 7/31/06
Case Study: New York & Company (NYSE: NWY)
Business Description: Global leader in the hearing, eye, face, head and respiratory segment
Investment Rationale:– Strong and stable cash flow– Strong management team– Attractive platform with accelerating new product
introduction pace– Increasing margins through productivity improvement– Ongoing distributor consolidation favors leading
suppliers
Sourcing:– Relationship with Seller and past history with
management– Industrial and Consumer Products industry expertise
Structure: Primarily preferred position
Value-Add:– Initiated several cost-saving efforts– Advised on numerous add-on acquisitions and one
business line divestiture– Led recapitalization; returned $68.1 million
CAGR=21%
($ in
mill
ions
)
Case Study: Aearo Technologies
Date: Apr-04
Invested: $80mm
Realized: $338mm
Gross IRR: 125%
Multiple: 4.2x
• Entry Multiple: 6.7x EBITDA
• Exit Multiple 9.5x EBITDA
$85
$58
LTM 12/31/03 LTM 12/31/05
EBITDA from Investment to LTM 12/3/05
The future of private equity
Here to stay• More than 175 funds with > $1 billion of committed capital
Increasing flight to qualityOperational experts on staffLarger fund sizes means access to more companies• Deals exceeding $40 billion are possible
Hedge funds entering marketRegulatory oversight
Announced Target Name Deal size* ($ billion)
2006 $33.0
1988 $30.1
2006 $27.4
2006 $26.6
2006 $17.4
2006 $16.3
2005 $15.3
2006 $15.3
2005 $15.0
2005 $12.5
* Deal size includes equity and debtSource: Morgan Stanley, news runs, Merger Market
• 9 of the 10 largest global private equity transactions have been announced during the past 18 months
• Growing importance of PE consortia
Record sizes of announced deals in recent yearsSponsor(s)