Private Equity: Current Environment, Trends and Expectations Private Equity: Current Environment, Trends and Expectations Materials for Discussion May 26, 2011 Eliot Kerlin, Bud Moore
AGENDA I. Current Environment II. III. IV. Recent PE Trends Future of the Industry Contact Information -1-
EXECUTIVE SUMMARY Coming on the heels of a couple lean years, the mergers and acquisition ( M&A ) environment was active in 2010 While multiple factors drove the decline, financing markets were one of the primary external forces Almost all companies now have a blot on their record to sell through While memories of the recession are fresh, multiple factors are now creating a more robust M&A environment. There is a growing capital overhang pressuring financial sponsors to execute transactions Strategics are accumulating cash due to the now positive effects of operating leverage forced on them during the recession Lenders are ready to lend While the economy has not fully recovered (read: hope /upside to buyers), the next 24 months could be a very good time for companies looking for monetization events -2-
TOTAL US M&A ACTIVITY A recovery in the financing markets resulted in a general upturn in overall US M&A activity in 2010, following two years of steady decline. Quarterly transaction activity has been relatively consistent since rebounding in Q4 2009. Sponsor transactions have been a large contributor to the increase as firms once again begin to deploy capital. Middle market deals(defined as deals <$1.0B) also gained share in terms of deal volume and value. Buoyed by reinvigorated financing markets, LBOs posted their best quarter in over two years in Q4 2010. Mega-buyouts, however, remained scarce, with only two deals topping $5 billion in 2010. TOTAL US M&A ACTIVITY ($ in Billions) BREAKDOWN BY SIZE (Value of Deals) ($ in trillions) $1.60 $1.40 $1.20 $1.00 $0.80 $0.60 $0.40 $0.20 $0.00 $1.52 $1.51 (31%) CAGR 28% $1.16 16 (21%) $0.80 8% $0.92 $0.73 $0.79 $0.56 2003 2004 2005 2006 2007 2008 2009 2010 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% 18% 30% 24% 28% 28% 21% 21% 41% 40% 41% 45% 33% 34% 38% 47% 41% 45% 52% 36% 36% 31% 31% 49% 42% 23% 29% 35% 28% 24% 27% 27% 32% 23% 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Value of Deals < $1 billion $1 Billion < Value of Deals < $10 billion Value of Deals > $10 billion Source: Thomson Reuters as of 12/31/10-3-
MIDDLE MARKET MORE ATTRACTIVE In 2010, M&A activity in the middle market increased 54.9% and 48.4% in terms of total value and deal volume, respectively. Note that the Average Deal Size has dropped since in 2007, driven by a shift from large financially engineered LBO s toward smaller platforms with greater transformational upside. US MIDDLE MARKET M&A ACTIVITY 2000 Q1 2011 ($ in Billions) Number of Deals 8,000 6,781 $50-250M <$50M Deal Value Avg. Size 07:$103M Avg. Size 10: $60M Deal Value ($ Billions) $500 6,000 6,090 400 4,000 4,625 4,009 4,233 4,524 4,461 4,535 4,514 4,742 4,104 300 200 2,000 1,459 Deal 1,284 Value 100 Number of Deals $250-750M $50-250M <$50M Deal Value 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Q1 '10 Q1 '11 512 296 289 314 403 424 534 624 420 263 454 109 116 1580 1,580 1009 1,009 889 1064 1,064 1218 1,218 1268 1,268 1293 1,293 1331 1,331 1196 1,196 782 1101 1,101 216 260 4,689 3,320 2,831 2,855 2,903 2,769 2,708 2,559 3,126 3,059 4,535 1,134 908 $462 $279 $258 $291 $351 $364 $419 $465 $356 $235 $364 $81 $92 Source: Dealogic; William Blair Research -4-
BUYER CATEGORY SUMMARY The Sponsor community continues to be an important part of US M&A activity, and has seen its share increase in recent months as firms ramp up new platform and add-on acquisition activities. PE-backed transactions peaked at ~20% of total M&A in 2007, before declining to 12% by 2009. Experienced a recovery in 2010 as the credit markets improved and valuations fell. The industry s share is expected to grow in the next 12-18 months due to $490B of capital overhang. Following a challenging investment climate in 2008 and 2009, private equity groups re-entered the market in the summer of 2010 (both as buyers and sellers), resulting in a 63% Y/Y increase in total deal value. PERCENT OF TOTAL M&A ACTIVITY US PRIVATE EQUITY DEAL VALUE ($ in Billions) 80% Foreign PE Deals Public Private $800 $652 60 600 $581 (60%) 40 20 400 200 $133 $86 $97 $132 $249 $333 $215 +63% $177 $290 PE Deals 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 LTM 12% 9% 11% 12% 15% 14% 17% 20% 18% 12% 13% 14% 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Thomson Reuters as of 12/31/10-5-
M&A BY TOP INDUSTRIES The distribution of domestic transactions by industry was largely unchanged from 2009 to 2010, although private equity activity in certain sectors escalated The fastest growing private equity M&A categories 2008-2010 were Food / Beverage and Healthcare, Key troubled sectors that have experienced a decline in sponsor M&A include Finance and Telecom. Cyclical industries (e.g. construction) have been slow, but will start to pick up once the trough has passed. Going forward, we expect many firms will start to develop an industry focus or theme, in an attempt to improve deal sourcing and create a story for future fund raising. TOP INDUSTRIES BY VOLUME Q4 2009 TOP INDUSTRIES BY VOLUME Q4 2010 Real Estate, 3% Retail, 4% Consumer Staples, 3% High Technology, 19% Retail, 3% Real Estate, 5% Consumer Staples, 4% High Technology, 19% Materials, 8% Materials, 9% Energy & Power, 9% Media, Entertainment & Telecom, 11% Energy & Power, 10% Media, Entertainment & Telecom, 9% Industrials, 10% Healthcare, 11% Industrials, 10% Healthcare, 9% Financials, 13% Consumer Products & Services, 9% Financials, 11% Consumer Products & Services, 10% Source: Houlihan Lokey Equity Research -6-
MULTIPLES BY TRANSACTION SIZE Transaction values in 2010 were slightly above the 10-year average of 9.1x, driven by a both strategic and private equity acquirers looking to deploy capital following the recession. Multiples for attractive, middlemarket companies have experienced a dramatic increase due to increased competition among sponsors. U.S. EV / EBITDA MIDDLE MARKET MULTIPLES 13 <$50M $50-250M $250-750M Middle Mrkt Avg. Peak ( 05-07): 10.1x Trough (2009): 7.1x Reduced premium paid for large targets 10 8 5 3 Multiple by Size $250-750M $50-250M <$50M 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 LTM 8.3X 8.3X 9.4X 9.2X 10.5X 10.3X 11.0X 9.9X 7.9X 9.4X 10.9X 10.8X 7.3X 7.4X 7.3X 6.8X 8.6X 10.5X 9.6X 11.6X 10.1X 7.2X 9.7X 9.4X 5.5X 6.1X 8.0X 7.2X 7.7X 7.0X 8.9X 8.8X 7.2X 3.9X 8.1X 7.7X Source: Dealogic; William Blair Research -7-
IMPROVED CREDIT MARKETS Although leverage remains below 2007 levels, multiples increased year-over-year in 2010. Generally, large LBOs in particular have commanded higher multiples, with the most aggressive LBOs carrying leverage upwards of 6.0x. LARGE CORPORATE LEVERAGE LARGE LBO LEVERAGE 6.0x 4.0x 4.3x 4.3x 4.4x 4.9x 3.7x 4.1x 3.9x 7.5x 5.0x 4.9x 5.3x 5.4x 6.2x 4.9x 4.0x 4.7x 2.0x 3.1x 3.6x 3.9x 44x 4.4x 3.3x 4.0x 3.6x 2.5x 3.3x 4.0x 4.7x 54 5.4x 4.1x 3.7x 4.4x 0.0x 2004 2005 2006 2007 2008 2009 2010 Senior Leverage Subordinated Leverage 0.0x 2004 2005 2006 2007 2008 2009 2010 Senior Leverage Subordinated Leverage MIDDLE MARKET CORPORATE LEVERAGE MIDDLE MARKET LBO LEVERAGE 6.0x 4.0x 4.8x 41x 4.1x 4.3x 4.4x 4.3x 3.4x 3.7x 6.0x 4.0x 4.3x 4.7x 4.7x 5.6x 4.5x 3.3x 43x 4.3x 2.0x 3.5x 4.0x 4.0x 4.4x 3.6x 2.9x 3.2x 2.0x 3.5x 4.3x 4.2x 5.2x 3.7x 2.5x 3.4x 0.0x 2004 2005 2006 2007 2008 2009 2010 0.0x 2004 2005 2006 2007 2008 2009 2010 Senior Leverage Subordinated Leverage Senior Leverage Subordinated Leverage Source: Houlihan Lokey Equity Research -8-
DECLINE IN DISTRESSED SITUATIONS Defaults reached a high in April 2009, stabilizing at 10.7% by 2009 year-end end and declining to 5.1% as of December 2010 Distressed M&A followed a similar path, but with a 6 month lag that peaked in the summer of 2009. 2010 bankruptcies / distress deal volume is down, but still higher than historical averages. The large number of credit facility amend-and-extends in 2008 and 2009 prevented a market meltdown. Despite the recent improvements, many businesses (particularly sponsor-led LBOs from 2007) remain overleveraged and may require some type of restructuring once covenants begin to step down. Will banks be less forgiving this time when the music stops? LEVERAGED LOANS IN PAYMENT DEFAULT DISTRESS M&A ACTIVITY (Number of Deals) 12.5% 400 400 10.0 9.9 10.0 10.7 8.3 300 323 330 271 7.5 7.0 7.4 5.0 61 6.1 61 6.1 5.1 200 163 194 3.6 3.7 120 2.5 2.6 1.9 0.6 100 42 46 47 73 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 Q1-10 Q2-10 Q3-10 Q4-10 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Default Rate 7.0% 9.9% 10.0% 7.4% 2.6% 3.6% 1.9% 0.6% 3.7% 10.7% 8.3% 6.1% 6.1% 5.1% Deal Value $4.0 $31.7 $49.3 $46.0 $30.0 $8.7 $6.0 $18.1 $43.1 $83.7 $89.9 Source: Dealogic; William Blair Research -9-
AGENDA I. M&A Market Update II. III. IV. Recent PE Activity Future of the Industry Contact Information -10-
STATE OF THE PRIVATE EQUITY SITUATION OVERVIEW The state of the private equity industry is vastly improved from a low point in mid 2009, in which new deals where limited and portfolio companies were distressed. Still, the market remains challenged for several reasons, and the next 24 months will be critical in determining the groups and strategies capable of raising future funds. KEY OPPORTUNITIES Investing at the Trough: Historically speaking, funds that have deployed capital coming out of a recession have created strong gains for investors. We appear to be in the time now. Opportunities to Exit: As the markets improve, private equity groups are able to get liquidity on older investments either through a complete sale or dividend recapitalization. Better Quality Assets: During the downturn, there were limited attractive targets as most teams choose to focus on operations. Beginning in June 2010, sellers began to test the market and have shown a willingness to sell. Availability of Debt : The credit markets have experienced a significant improvement in recent quarters, and are allowing sponsors to offer more attractive valuations without sacrificing returns. KEY CHALLENGES Competitive Landscape: The sponsor community grew significantly from 2005 to 2007, and as a result, there are a number of middle-market groups with a large amount of capital targeting the same set of companies High Valuation Multiples: As a result, valuation multiples have returned to near previous highs, despite continued softness in quarterly earnings and lower leverage ratios. Offsetting Peak Deals: Across the industry, many of the transactions completed in 2006 and 2007 at the height of the market are generating g poor returns, and must be offset by the remaining capital. Economic Uncertainty: Although the market appears to be healing, many cyclical sectors have yet to rebound, which makes it difficult to value new deals and an obstacle in getting full value for portfolio platforms. -11-
The image cannot be displayed. Your computer may not have enough memory to open the image, or the image may have been corrupted. Restart your computer, and then open the file again. If the red x still appears, you may have to delete the image and then insert it again. OVERVIEW OF ECONOMIC CYCLE The Private Equity industry remains in the early stages of recovery from a time in which (i) new deal volume plummeted, (ii) portfolio companies faced multiple challenges and (iii) the credit markets offered limited meanings of financing. -12-
PE ACQUISITION ACTIVITY As corporate earnings trough and credit markets improve, many firms have started to increase acquisition activity, which has also led to more competition and higher multiples. During the economic downturn, the industry reduced the amount of capital deployed despite record fund raising, resulting in a large overhang. US PRIVATE EQUITY ACQUISITION ACTIVITY 2000 YTD 2011 ($ in Billions) Number of Transactions 2,000 1,500 1,000 902 >$750M Middle Market Undisclosed 1,907 1,796 1,401 1,396 1,052 Deal Value PE on sidelines: (85.4%) Decline 942 1,184 PE Recovery: 92.8% Increase Deal Value ($ Billions) $500 400 300 500 521 612 742 254 296 200 100 Number of Deals >$750M Middle Market Undisclosed Deal Value 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 YTD-10 YTD-11 12 8 17 24 48 49 91 108 27 14 49 11 10 523 256 324 369 522 619 710 589 547 442 435 98 85 367 257 271 349 482 733 995 1,210 822 486 700 145 201 $65.8 $30.6 $61.0 $76.1 $151.1 $186.9 $477.1 $466.5 $100.2 $69.8 $134.6 $16.6 $30.0 Source: Dealogic; William Blair Research -13-
ABILITY TO FINANCE IMPROVING The ability to finance leveraged buyout transactions has improved during the past 18 months, but remains well below the peak year of 2007. Senior debt (1 st lien) has increased back above 3.0x, from a low of ~2.5x in mid-2008. Total leverage is generally in the ~4.00x 4.25x range, with a emphasis on recurring revenue industries. During Q1-11, the market has continued to improve with healthy businesses garnering 4.5x and above. Equity as a percentage of transaction value saw an increase to an all time high in 2009, but declined in 2010 with the return of bank financing and less stringent lender closing conditions. MIDDLE MARKET DEBT FINANCING PERCENT EQUITY CONTRIBUTION 5.0X 4.0 3.0 40X 4.0X 3.7X 3.8X 39X 3.9X 4.2X 4.3X 4.4X 4.9X 3.8X 40X 4.0X 3.9X 40X 4.0X 50.0% 40.0 30.0 30.0 34.2 29.6 36.1 31.0 36.3 36.7 40.8 32.4 37.9 31.5 35.4 29.9 34.1 32.1 30.3 40.2 38.3 46.5 38.3 43.8 36.6 33.0 2.0 20.0 1.0 10.0 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Q4-10 0.0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Q1-11 Sub. Debt Other Sr. Debt Second Lien First Lien <$50M EBITDA >$50M EBITDA Source: Houlihan Lokey Equity Research -14-
DEBT PRICING REMAINS HIGH Interest spreads on highly leveraged loans remain ~150 bps above historical averages, driven a relaxation of credit quality among recent issuances and shift towards lower-rated loans. Moreover, in many instances, lenders continue to require LIBOR floors, which where first implemented during 2008 and 2009. AVERAGE PRICING OF HIGHLY LEVERAGED LOANS 600bps 542 400 200 288 299 347 348 334 326 329 318 301 301 268 389 10 Yr Avg: 300bps 2010a Avg: 450 bps 315 295 278 244 227 225 224 203 191 187 196 199 176 175 168 176 165 172 250 231 313 253 386 364 488 487 469 449 436 417 491 0 Q2 '00 Q4 '00 Q2 '01 Q4 '01 Q2 '02 Q4 '02 Q2 '03 Q4 '03 Q2 '04 Q4 '04 Q2 '05 Q4 '05 Q2 '06 Q4 '06 Q2 '07 Q4 '07 Q2 '08 Q4 '08 Q2 '09 Q4 '09 Q2 '10 Q4 '10 LiborFloorBenefit Spread over Libor Source: Dealogic; William Blair Research -15-
GROWTH IN NEW PLATFORMS As firms look to deploy 2006-20072007 vintage year funds that will expire during the next 24 months, we have seen a significant increase in new platform investments, fueled by (i) better quality of available assets, (ii) lower valuation expectations among sellers, and (iii) recovery in the credit markets. NEW PLATFORM VS. ADD-ON ACQUISITIONS 2000 YTD 2011 ($ in Billions) Number of Deals Add-on Platform 2,000 1,796 1,907 1,500 1,401 588 687 1,396 1,000 500 0 902 261 521 194 641 327 2000 2001 612 163 449 2002 742 227 515 2003 1,184 410 473 1,052 942 297 425 313 1,208 1,220 991 923 755 629 759 254 164 90 2004 2005 2006 2007 2008 2009 2010 YTD-10 296 176 120 YTD-11 % Add-On %Platform 28.9% 37.2% 26.6% 30.6% 28.2% 29.3% 32.7% 36.0% 33.9% 33.2% 35.9% 64.6% 59.5% 71.1% 62.8% 73.4% 69.4% 71.8% 70.7% 67.3% 64.0% 66.1% 66.8% 64.1% 35.4% 40.5% Source: Dealogic; William Blair Research -16-
ESCALATING EXIT ACTIVITY During the downturn, the PE industry spent a meaningful portion of its resources managing the portfolio, which resulted in delayed exits for many targets. With the recent improvement in earnings and multiples, many groups are now looking to realize returns on these older investments. PRIVATE EQUITY EXIT ACTIVITY 2000 YTD 2011 ($ in Billions) Number of Transactions >$750M Middle Market Undisclosed 500 477 $80 Delayed Platform Exit (manage the portfolio) 429 408 400 391 60 Deal Value ($ Billions) 300 291 253 40 200 165 193 100 105 110 101 66 82 20 Number of Deals >$750M Middle Market Undisclosed Deal Value 0 0 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 YTD-10 YTD-11 12 11 4 12 24 47 28 66 16 12 64 14 10 60 59 62 107 177 223 171 184 105 89 164 26 36 33 40 35 46 90 159 192 227 132 92 180 26 36 $12.0 $11.0 $4.0 $12.0 $24.0 $47.0 $28.0 $66.0 $16.0 $12.0 $64.0 $14.0 $10.0 Source: Dealogic; William Blair Research -17-
RETURN OF DIVIDEND RECAPS After a virtual disappearance during 2008 and 2009, leveraged recaps staged a comeback during 2010 as a result of looser credit and the anticipation of increased capital gains taxes in 2011. Many firms still view this as the best near term liquidity option as valuation multiples remain lower than the 2007 peak.* U.S. SPONSORED DIVIDEND RECAP LOAN VOLUME 1997 2010 ($ in Billions) $40.0 30.0 * Allows firms to return capital to investors without selling at a valuation lower than 2007. $30.9 $25.5 $25.1 $22.9 20.00 $20.4 10.0 $1.5 $0.8 $3.8 $1.1 $1.1 $1.9 $6.3 $1.2 $0.4 0.0 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 Source: Standard & Poor s Q4 10 Leveraged Buyout Review -18-
AGENDA I. M&A Market Update II. III. IV. Recent PE Activity Future of the Industry Contact Information -19-
LEARNING FROM OUR MISTAKES As we emerge from a challenging economic time, it is important that the investment community reflect on the strategies and circumstances that have consistently created problems for us in past. -20-
WHERE ARE WE GOING? The industry experienced a significant amount of new entrants from 2003 2007. Enjoyed record funding raising up until the markets collapsed in early / mid 2008. Situation The vast majority of sponsors did not deploy large amounts of capital during the downturn. Also delayed exiting many platform companies when valuations where low in 2009. Now that financing and earnings have improved, Sponsor-led M&A has escalated. Large overhang of dry powder is leading to more competition and higher valuations for good deals. Complication Despite debt availability, it remains difficult to find proprietary transactions ti and deploy capital. The economic recovery remains uncertain, which has made it difficult to exit cyclical businesses. The fund raising market is weak (although improving), with LP s waiting to commit new capital. Firms appear to be specializing (i.e. industry-focus, operation, etc.) to gain an advantage. Will sponsors be able to deploy capital in the next 12-24 months in deals that generate strong returns? Will this be enough to offset the likely poor returns on deals done at the peak of the market in 2007? Questions Can firms differentiate themselves from other groups in the near term, and will this be effective? What is the right exit timing for older portfolio companies that are still in the early stages of recovery? How much capital will LPs be willing to invest once the next vintage year fund needs to be raised? Hypothesis Despite a challenging competitive landscape, sponsors that have a long track record of successfully executing a differentiated t d strategy t will generate outsized returns in the current market, and will ultimately be the beneficiaries of the LP community s shift towards fewer, proven investment groups. -21-
PRIVATE EQUITY DRY POWDER A significant amount of uninvested private equity capital is driving financial buyers to remain active in uncertain market conditions. Firms whose investment horizon expires in the next 12-24 months, may feel extreme pressure to underwrite to returns that are lower than historical averages. US PRIVATE EQUITY CAPITAL OVERHANG 2003 2010($ in Billions) $160 $155.53 $140 $130.05 $490.26 $500 $120 $400 $100 $96.18 $300 $80 $60 $200 $44.19 $40 $36.10 $100 $20 $17.87 $7.73 $2.62 $0 $0 $ in Billion 2003 2004 2005 2006 2007 2008 2009 2010 *As of 6/30/2010 Cumulative Overhang Under $100M $100M-$250M $250M-$500M $500M-$1B $1B-$5B $5B+ -22-
CLOSING THOUGHTS The M&A market is improving ing fueled by the availability ailabilit of debt financing, attractive targets and willing sellers. Despite the improved market situation, the ability to consummate transactions remains difficult due to a competitive landscape for quality assets. q The Private Equity community has a large amount of un-deployed capital, which h will drive up M&A volume and valuations during the next 2 years. q In an effort to invest their funds, many larger firms have been willing to over-equitizing smaller deals and appear to be underwriting to lower threshold returns. Sponsors that have a long track record of successfully executing a differentiated strategy t will generate outsized returns in the current market. As a result, the next round of major fund raising in 2012 and 2013 will be a flight to quality, with similar LP dollars committed but much fewer groups. -23-
AGENDA I. M&A Market Update II. III. IV. Recent PE Activity Future of the Industry Contact Information -24-
CONTACT INFORMATION Eliot Kerlin Bud Moore Principal Managing Director Insight Equity Valesco Industries ekerlin@insightequity.com i it bmoore@valescoind.com 214-317-9737 214-880-8690 x 106 1400 Civic Place 325 N. St. Paul Suite 250 Suite 3200 Southlake, TX 76092 Dallas, TX 75201-25-
INSIGHT EQUITY OVERVIEW Insight Equity is an $825 million private equity fund that makes control investments in strategically viable, middle market companies underperforming their full potential History: Investment: Focus: People: Philosophy: Established in 2002 by former Bain and Carlyle executives Control equity in complex, storied and family ownership situations Asset intensive and distribution companies in any industry: Automotive and transportation Construction General industrial manufacturing Building products Aerospace and defense Chemicals, pulp and paper Insight Equity s experienced principals have acquired and managed businesses with over $2B in aggregate revenue since 1998. Insight Equity is comfortable in complex or challenging situations and has the ability to execute quickly in circumstances where speed is a priority. Deploy collaborative value creation model to take businesses to the next level -26-
VALESCO INDUSTRIES OVERVIEW History: Investment: Focus: People: Philosophy: Established in 1990, Dallas, TX Control Equity, Minority Equity and Subordinated Debt Investments Select, growth oriented middle market businesses distinguished by Exceptional management teams Positive operating histories Strong visions for the future Each managing director has over 25 years of experience in Private Equity and Sub-Debt investment Commitment to the long-term benefit of the businesses in which we invest -27-