Antonie Paul Woodbury CEO-CF Presentation March 2011
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Transcript of Antonie Paul Woodbury CEO-CF Presentation March 2011
DEBT:
PRIVATE EQUITY HEAVEN
OR HELL
CEO – CONSULTATIVE FORUM
IESE BARCELONA MARCH 2011
Antonie Paul Woodbury
Introduction
Why is debt important to Private Equity (PE)
How does PE think about debt
What happened to PE debt in the financial crisis
Looking forward
2
Debt
John Maynard Keynes
“If I owe you a pound,
I have a problem; but if
I owe you a million, the
problem is yours.”
3
Debt
D = Debt - means of postponing pain recently very popular with the European Government amongst others
Debt is not bad –debt you cannot repay is very bad
4
What debt does PE use
„Traditional‟ secured bank debt
Junior equity e.g. mezzanine, convertibles
Tradeable debt e.g. securatised debt instruments
Related non-recourse debt structures (cash-flow
based) e.g. “OpCo – PropCo model”
5
Debt
O = Overleverage
The natural state of big PE fund portfolio companies.
Recently countries too
6
An easy way of thinking about it …7
And the bank‟s model changed
Traditionally banks operated under an “originate and hold model”
2002 - 2007 this changed to a an “originate and Distribute model”
Change probably directly related to the rise of securitisation markets
8
Securatisation9
Changing un-rated / unlisted debt into tradable
debt by
combining the debt obligations into a portfolio
(often in tranches) and
issuing tradable debt instruments secured by the
portfolio
Reasons for securatisation‟s10
Availability of
funds
Liquidity
Diversification
(reduces
unsystematic
risk)Note: US market only data
EU securatisation‟s (end 2007)11
And for those who “guaranteed”..
The “quality” of the
securatised debt
product was also
often enhanced
Monolines insurers
– in the US others
e.g. Lehman, AIG,
Fannie Mae
12
Private Equity view
Generally debt is cheaper than equity
Debt is good –particularly if it increases the expected (or hurdle) return on equity
13
Cost of Capital
Cost of Capital (CoC) = CoD + CoE
Cost of Debt (CoD)= (Rf + credit risk rate)(1-T) (i.e.
actual debt cost plus any tax advantage)
Cost of Equity (CoE) = Risk free rate of return Rf + Premium expected for risk βs (RM-Rf)
14
What drives PE - targets
Hurdle – Return target
of fund net of costs
typically IRR 15-20%
Above that PE Fund
(partners) earns
carried interest
15
Private Equity returns
C = Carried interest.
The percentage of the profit on a transaction that goes to the partners of the PE firm.
Sometimes known as 'carry' as in 'too much money to carry'.
16
PE 2008 loan default predication
BCG prediction in 2008 half the worlds PE deals would default - actual outcome significantly better
Sources: Boston Consulting Group 2008; Barwon Investment Partners Sept 2010; Private Equity Council –The Performance of Private Equity - Backed Companies in the „Great Depression‟ 2008 - 2009
17
Significant debt repayment
Clear signs
of debt
reduction in
2009.
Source: SVG Jan 2011
(from sample of large
PE owned companies)
18
Reduction in debt (non weighted average year on year change)
Variable but
declined
significantly
in 2009.
Source: SVG Advisers
Jan 2011 (from sample
of PE owned
companies)
19
Significant deleveraging
Key ratio of
Net Debt to
EBITDA has
changed
from 6.3 –
4.7
Sources: Preqin 4th
Qtr 2010
SVG Advisers Jan
2011
20
Debt maturities extended
Clear signs of debt reduction in 2009
Source: SVG Advisers Jan 2011 (from a relatively sample of PE owned companies)
21
The maturity cliff
Twin trends:
Declining bank
lending
Reduced derivative
market liquidity
22
So is the ambulance still needed?23
High Yield takeouts – one answer
Other reasons it wasn‟t as bad ..
Some top of the cycle debt terms were lax “Cov-Lite”
Low interest rates means locked in low debt costs –if you are lucky
Earnings stabilised / recovered (cost reduction & some top-line growth) – not a consistent experience
Equity injections, debt exchanges, high cost debt refi, IPO‟s – have helped shore up balance sheets
24
Also matters because:
Valuations and fundraising require good deals
available and good exits
Deals done on today‟s 2010 - 11 terms deliver a
base case 12%+ IRR
If average leverage can be increased from c50% to
c70% the return increases to 15%+ IRR
25
Summary
This cycle so far seems a little different:
Approach of Governments, Banks and PE to debt issues
different e.g. low interest costs
relatively high level of dry powder – higher valuations
Pre-downturn deals likely to surprise on the upside!
26
Summary cont …
The use of Debt has
not been a poison pill
for PE
The loss of liquidity,
particularly due to the
reduced securatisation
volumes is an issue
27
Not as simple as Heaven or Hell
What have we learnt?
28
Antonie Paul Woodbury March 2011 [email protected]
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