Francisco Partners Case [PDF]

Zitiervorschau

Private Equity

Course Objectives – Regarding Leveraged Buyouts:

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A broad overview of Private Equity from a Leveraged Buyout perspective

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Not all the details; a framework for key issues, drivers and dynamics

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Some practical exposure to assessing Private Equity opportunities and issues

London Business School

1/28/2007

Dwight Poler

1

Private Equity Class One: Francisco Partners and Fund Formation

Agenda:

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The Private Equity “Eco-System”

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The “Deal Process”

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The Fundraising Environment and Key Dynamics

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Francisco Partners: Establishing a New Fund

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Wrap-up of Issues

London Business School

1/28/2007

Dwight Poler

2

Private Equity Investment Alternatives for investors/LPs Spectrum of Investments

Lower Risk Lower Return

Cash

Higher Risk Higher Return

Debt

Other Fixed Income

Public Equity

Private Equity Other Esoteric

Inv Grade

Real Estate

Blue Chip

LBOs

Junk

Project Finance

[Hedge Funds]

Venture Capital Commodities

Derivatives

Growth Stocks

Consider sources of “Risk”:

Other specialist risks

Volatility

Illiquidity

Uncertainty

Market

Underlying Asset

Information availability

Company

Deal Structure

Lack of experience

Capital Structure

Security

Note : Private Equity deals can involve all forms of investments above, and incorporate all forms of risk mentioned

London Business School

1/28/2007

Dwight Poler

3

Private Equity Private Equity “Eco-System” The Players

The € Flows

$£€

Fund

Manager

Investors:

Individuals (as investors, pensioners); Institutions (Endowments, Foundations)

Limited Partners: (“LPs”)

Investment Mangers (Pension Managers, Funds of Funds, Family Offices) – Pension/ endowment Mangers: Typically salary-based, some bonus – Fund of Funds: Typically management fee (%of AuM) and often carry – Family Offices: Mix both payment models

Advisor

Fund

Manager

Company

London Business School

[“Gate Keepers”]:

[Advisors to Investors or Limited Partners; typically on fee basis]

General Partners: (“GPs”)

Fund Mangers LBO Funds

VC Funds

Hedge Funds

“Target” Companies:

Mature

Early Stage

Public

(“Portfolio” Companies)

Companies

Companies

Companies

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Private Equity The Deal Process Team

Fund Raising

Sourcing Selection

Deal Execution

Post-Acquisition Value Creation

Exit/Liquidity

Capabilities

Team

Relationships

Diligence

Earnings growth

IPO

Experience

Track record

Criteria

Financing

CF liberation

Trade Sale

Judgment/Trust

Strategy/ Resources

Resources/ Oppty Cost

Negotiation

Multiple Expansion

Recapitalization

Energy

Documentation

Investment Returns Cost+[80%] of profits

Carry to GP

London Business School

[20%] of profits

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5

Private Equity Private Equity “Eco-System” Summary

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Who: ¾

Investors - > LPs - > GP - > Companies - > Investors ¾Consider objectives and incentives for each party?

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How: ¾

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Raise Fund > Source > Screen > DD/Execution > Post-Acquisition > Liquidity Event ¾Which stages are most important?

Caveats: ¾

theory v reality; art v science

London Business School

1/28/2007

Dwight Poler

6

Private Equity Significant Growth in Funds Raised

Estimated Available Capital for Investment

$160 $140

135

$120 $100

90

95

95 80

$80

70

$60 $40 $20 $0

10 1998

15

1999

2000

2001

2002

2003

2004

YTD 9/05

Source : Private Equity News

London Business School

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7

Private Equity Key Drivers of Growth in PE Funds Raised:

Consider Asset Allocation Model for Investors/LPs … Key Drivers of the increase in PE fundraising: 1. High public and private equity returns created a higher base against which to apply asset allocation % (a bigger “pie” to allocate) 2. Existing LPs increasing weighting of alt assets in model (a bigger “slice of the pie”) 3. New LPs using alt assets class as part of asset allocation model (more “pies”) 4. Need to deploy large gains/dividends received

London Business School

1/28/2007

Dwight Poler

8

Private Equity Key Drivers of Growth in PE Funds Raised:

BUT: Consider impact of these changes on deal economics

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Number and size of funds

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Supply and demand of deals to invest money

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Types of LBOs pursued (sectors, geographies, sizes)

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Deals are getting larger and opening up new markets

8 out of the 10 largest buyouts ever were done in 2005 London Business School

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Private Equity Key Drivers of Growth in PE Funds Raised:

2001-03: Equity gains and cash receipts have declined last few years …

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LPs rushed for “Top Quartile” funds

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Weak performers, even big names suffered

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Very high barriers to change in the industry?

2005: … LPs coming back strongly now

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GPs returning significant capital to LPs in drive to raise new funds

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LPs interest is increasing PE exposure

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Funds are getting much larger to expand buying market

London Business School

1/28/2007

Dwight Poler

10

Private Equity Key Drivers of Growth in PE Funds Raised

Current LP Issues/Initiatives:

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Disclosure and standardization of information: transparency to compare; potential to commoditize the returns

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Alignment of incentives with LPs: management (fund size and fees) and performance (coinvest and carry)

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Flight to quality: dogs lose funding; stars ever more over-subscribed

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Growth of “Secondary Funds”: ¾ buy existing interests/commitments in GPs from Sellers ¾ provide liquidity (getting IN and getting OUT) that did not formerly exist for LPs

London Business School

1/28/2007

Dwight Poler

11

Private Equity Francisco Partners Case: Setting up a New Fund

Why did Stanton leave TPG?

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Personal reasons/opportunities

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Market opportunity

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Was it a smart move or not?

London Business School

1/28/2007

Dwight Poler

12

Private Equity Does a Tech LBO fund make sense? No

London Business School

Yes

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13

Private Equity Does a Tech LBO fund make sense? No

Yes

Underlying assets too volatile

Some Tech companies are less volatile Address volatility with capital structure (or are some less volatile?)

Has never been done …

Expanded applications of Private Equity to meet risk/return spectrum

Public markets provide cheaper capital for growth companies …

Sometime public markets unavailable; or situation too complex

¾ Future of PE involves addressing “untapped” risks (sector, geography) where degrees of risk can be isolate ¾ Technology LBOs must alleviate another risk of “charge” an incremental premium ¾ Lenders (getting low return) will only lend if some truly low risk cash flows/assets can be isolated

London Business School

1/28/2007

Dwight Poler

14

Private Equity IF the fund makes sense, will Francisco succeed?

¾ How clear is the market opportunity: How big a market?

What growth?

¾ Competitive environment: Who else is competing for each deal? ¾ What is their strategy? ¾ ¾

How will they compete with others:

What scope: Europe as well as US? FP competitive advantage? How valuable Sandy R; Sequoia?

¾ Specialist vs Generalist Fund: What are the pros and cons?

London Business School

1/28/2007

Dwight Poler

15

Private Equity Key Issues for LPs to focus on …

How will the potential LPs look at the opportunity?

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All same issues Francisco considered as to how to succeed ¾

Market opportunity; strategy/focus; competitive advantage

Plus:

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Team: How strong/experienced? How will the team gel/work together?

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Performance: How to assess Stanton’s track record? (Sourcing? Execution? Relative to a levered index? Which index?)

London Business School

1/28/2007

Dwight Poler

16

Private Equity Assessing Stanton Returns

Company

Sector

Date of Investment

GT Com

Telco

Apr-96

118

29

130

130

4

49.8%

Paradyne

Telco

Aug-96

179

52

201

490

9

110.6%

Globespan

Telco

Aug-96

6

5

28

527

110

311.4%

Zilog

Semis

Feb-98

405

114

-

325

3

77.2%

ON Semiconductor

Semis

Aug-99

1,780

338

-

2,000

6

492.6%

2,488

537

358

3,472

6

TOTAL Investments

Total EV

Capital Invested

Realized Proceeds

Total Value

Mult of Cost

Gross IRR

Source: Josh Lerner & David Gallo: HBS No.200-063

London Business School

1/28/2007

Dwight Poler

17

Private Equity Measuring Performance:

Dave Swenson, famed CIO of Yale Investment Office, suggests looking at buyout fund performance relative to levered public equity

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To do so: ¾

For each TPG investment, take equity position, equal to enterprise value, in the relevant NASDAW index

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Fund the difference between the TPG equity contribution and EV with debt, borrowed at 12%

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In 12/99, cash out the indexed position and pay down debt

How does remaining equity value compare with TPG investments?

London Business School

1/28/2007

Dwight Poler

18

Private Equity Example: Zilog

How good was the 2.9x return on Zilog?

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¾

¾

Invest the original Zilog EV ($405M) and invest in NASDAQ same period ¾

$114M of equity

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$292 (remainder) in debt

In Dec 99, sell whole position at current index value, pay off debt ¾

NASDAQ increased by 3.06x from 2/98 to 12/99

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Value of EV $405 thus went to 1238

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Pay off $292 of debt accruing at 12% = 359.3

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Total equity value is 879, a 7.7x increase in equity value!

In fact, a levered NASDAQ returned significantly more than Zilog

London Business School

1/28/2007

Dwight Poler

19

Private Equity Consider Investment in NASDAQ, same period, same leverage … Enterprise Value Invested in NASDAQ

Holding Period

Apr-96

GT Com

3.67

118

Paradyne

3.33

Globespan

3.33

Zilog

1.83

ON Semiconductor

0.33

Company

Aug-96

Feb-98

Aug-99

Dec-99

Total Levered Debt Payback NASDAQ

530

134

397

129.5

179

871

186

685

490.3

6

29

2

27

526.7

1,237

358

879

325

2,770

1,498

1,272

2,000

3,260

3,471.5

3,233

2,944.8

405

1,780

Total leveraged Investments – Without Globespan (VC Deal)

London Business School

Total From Stanton

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20

Private Equity Performance Assessment and GP Selection:

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Thus, a levered NASDAQ would have produced a higher return than the strategy of levered tech buyouts (ie. excluding Globespan VC deal)

¾ ¾

Much of Stanton in fact “market driven” multiple arbitrage plays

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¾

Important for LPs to understand “source” of returns ... ¾

Multiple arbitrage: Sold at higher multiple than bought, on same earnings

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Debt paydown: Same earnings, but cash flow paid down debt to create equity value

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Operating earnings improvement: Increased earnings (pays debt, sell at multiple)

And tie that to the stated strategy/team of GP; and objectives of LP ¾

Multiple arbitrage: Market timing play

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Debt paydown: Old style LBOs (mostly competed away in today’s market)

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Operating earnings improvement: Need “value added” team/experience

Stanton’s ability to “pull the trigger” consistently not to be undersold

London Business School

1/28/2007

Dwight Poler

21

Private Equity Key Issues for LPs to focus on …

¾ Other risks?

What are they?

¾ Worth investigating Francisco further?

London Business School

Would you invest?

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Private Equity Key Terms of the Fund

¾ Which terms are most critical for LPs to focus on? ¾ How should Francisco consider its terms in light of other funds? ¾ Which are most important for the GP to defend?

London Business School

1/28/2007

Dwight Poler

23

Private Equity Fund Size

Fund size: strategy and execution

¾ Ability to spend within reasonable time ¾ Desired size of portfolio (to manage/add-value) ¾ Implied deal size implications (market opportunity, sourcing, team size/skills) ¾ Over/under-subscription impact

London Business School

1/28/2007

Dwight Poler

24

Private Equity GP Coinvest

GP Coinvest Commitment

¾ Relevant benchmarks/LP alternative views ¾ Realistically available from the GP members ¾ Strategic partners’ investments (Sandy R., Sequoia) ¾ Risk/return for the GP – up/downside risk vs carry “optionality”

London Business School

1/28/2007

Dwight Poler

25

Private Equity Return Economics and Methodology

Return Economics

¾ ¾ ¾

Fund management fee:

base to “pay the bills”

Carry:

performance incentive

Deal fees/expenses:

deal specific return/risk for work done

Calculation Process

¾ ¾ ¾

Preferred return

LP return before GP sharing

Catch-up mechanism

GP catch-up before joint sharing

Clawback mechanism

If later deals worse than early

Other

¾ ¾ ¾

Investment scope restrictions

How much freedom in “blind” pool?

Key man provisions

How important are key guys?

Placement agent costs

Who pays for fund set up?

London Business School

1/28/2007

Dwight Poler

26

Private Equity Key Take-Aways

Private Equity in General:

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Is just a means of providing capital for specific forms of higher risk opportunities

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Typically addresses some combination of risks: ¾

¾

¾

Market, Company, Capital Structure illiquidity

PE often addresses greater uncertainty, BUT … ¾

often with greater information (given resources to pursue)

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offers higher returns for that risk; BUT

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involves greater illiquidity while change is occuring

A difference between PE and hedge funds is illiquidity

London Business School

1/28/2007

Dwight Poler

27

Private Equity Key Take-Aways

Investors Considering New Private Equity Funds

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Seek to optimize the risk/reward curve with PE as higher return opportunity with “less correlated” risk

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Are willing to share fees and profit participation in order to assess, assess and execute on these opportunities

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Have expanded dramatically the PE market: in number and size of funds, in scope of deals and impacted returns

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Given 10 year commitments(!) are increasingly focused on manager selection, alignment of incentives, and accountibiliity

London Business School

1/28/2007

Dwight Poler

28

Private Equity Key Take-Aways

Francisco Partners:

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Reflects a continuing entrepreneurial dynamic of the industry: ¾ Great people need opportunities to grow, direct compensation results

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Is a good example of the future of PE: ¾ Attempt to expand/extend into “untapped” risk/return opportunities

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Provides Investors a new means to generate potentially high returns with “less correlated” risk in portfolio

London Business School

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Dwight Poler

29

Private Equity What Happened?

¾

¾

Francisco held first closing of $1.3BN in July 2000 ¾

Sequoai committed $100mm

¾

75 current and former CEOs committed a total of $300mm

Second and final closing in December 2001 brought total to $2.5BN

London Business School

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Dwight Poler

30

Private Equity First Time Fund Issues

…IF we have extra time!

First Fund Dilemma …

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¾

Investors are most focused on: ¾

track record

¾

proof team can work together effectively

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sound strategy with competitive advantage

¾

….. because they are committing to a “blind fund” for 10 years

But, as new fund without capital, very hard to prove ¾

¾

even harder in todays market where LPs want proven institutions

However, Stanton addressed issues very effectively ¾

differentiated strategy with solid supporting dynamics

¾

scale to compete effectively, with reasonable ability to invest total

¾

key relationships for deal flow and “insider knowledge”

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highly aligned incentives with significant coinvest ($40mm + $100mm)

London Business School

1/28/2007

Dwight Poler

31

Private Equity Francisco Specific Issues:

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Would this “extension” have worked within TPG? Unlikely …: ¾

technology was too different; lack of expertise beyond Stanton

¾

limited value added from “outsiders” to tech space

¾

investment decisions likely to regress to mean

¾

TPG founders would require compensation

¾

Desire (from GP and LPs) to extend “brand” an ongoing dilemma

¾

But, some firms have made successful logical extensions of core skills ¾

Carlyle leveraged global fundraising to international network

¾

Bain Capital leveraged business analysis into hedge and debt funds

¾

Blackstone leveraged advisory business into private equity/RE

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