Presentation on Private Equity

They buy companiesand then sell them (hopefully) at a profit in a few years

May 27, 2009

Quick primer on industry jargon:

Private equity firm = financial sponsor (e.g. The Blackstone Group) Strategic investor = corporation (e.g. Walmart) LBO = leveraged buyout

The private equity process

Private equity firms raise funds e.g. ABC Fund I, ABC Fund II Within each fund, the private equity firm is a General Partner (GP). GP directly invests 1% of the fund All other investors are Limited Partners (LP) and they invest 99% of the fund GP LP is an important distinction both for legal purposes and also for understanding how PE process works The fund itself is structured as a limited partnership Funds invest in multiple companies, acquire a controlling stake (usually 100% of equity) IRR threshold is 20-25% depending on size of the fund Lifetime of fund is ~ 5-10 years, this means that all companies in the fund must be sold within this period

PE hiring
Private Equity firms usually setup groups based on Industry and/or Geography Many of the big firms are global Most firms are small with 50-100 investment professionals Some firms separate investment team from portfolio management team At entry level, most PE firms hire investment banking analysts with 2 years of experience Hard to break into industry, best way to do so is through contacts Lucrative and better hours than banking Culture tends to vary by firm most PE guys are ex-bankers so some similarities in culture

PE exits
Exits can be of the following types: IPO Sale to another PE firm Sale to a strategic investor

Any fool can buy a company. You should be congratulated when you sell. -- Henry Kravis, founding partner of KKR

How do private equity firms make money?

How do Limited Partners make money Periodic return on capital (e.g. dividends), 80% of profits Profit on exit, proportionate to investment

How do General Partners make money Management fee of 2% per annum on raised fund Carry or Carried Interest, usually 20% of profits Profit on exit, proportionate to investment

What company makes a good target for a buyout?

Mature Industry Mature Company Strong Management Team Low Leverage Low CapEx Requirements Strong Cashflows Good Exit Options

3-step IRR calculation for PE deals

Step 1 Determine purchase price Determine how much will be paid for using debt vs. equity What is the entry multiple (i.e. EV/EBITDA of x)

Step 2 Project companys cash flows over investment horizon (e.g. over 5 years) Use any excess cash (after operating expenses and interest has been paid) to pay down debt Equity holders receive no cash during these years

Step 3 Assume an exit multiple (i.e. EV/EBITDA of x) Multiply this with EBITDA in exit year (e.g. in year 5) You now have EV. EV outstanding debt = Value of Equity at Exit Using Equity put in from Step 1 and Equity at exit from Step 3, you can calculate IRR of equity investment

Barneys Case Study

Deal size ~ $950 million Financed by 30% equity, 70% debt GPs invest 1% of the equity, LPs invest 99%

Assume 5 year investment horizon 2% management fees per annum Profit sharing among GPs & LPs is 20% and 80% respectively Assume $120mm debt paid down each year & no cash distribution to equity holders during years 1-5 Assume entry multiple (EV/EBITDA) of 8.0x and exit multiple (EV/EBITDA) of 8.5x

1. How much money did the General Partners invest initially? 2. How much money will the General Partners make in management fees on this deal? 3. What is the IRR earned by GPs?

Barneys IRR (for LPs)

D e al v alu e T o tal E qu ity T o tal D e bt E q uity fro m G P s E q uity fro m LP S E n try m u ltiple E x it m u ltip le Y ea r E BIT D A D e bt b eg in D e bt e nd E V a t ex it D e bt a t e x it L P s E q uity v alu e at e x it C F to L Ps IR R -2 82 .1 5 0 0 0 0 8.0 x 8.5 x 0 1 12 0 66 5 54 5 2 1 20 5 45 4 25 3 120 425 305 4 12 0 30 5 18 5 5 120 185 65 1020 65 9 45 .4 5 9 45 .4 5 27% 3 0% 7 0% 950 285 665 2 .8 5 2 82 .1 5

Barneys IRR (for GPs)

D e a l v a lu e D e a l v a lu e T o ta l E q u ity T T o ta DE q u ity o ta l l e b t T o ta l D e b t E q u ity fr o m G P s E q u ity fr o m G P s E q u ity fr o m L P S E q u ity fr o m L P S E n tr y m u ltip le E n tr y m u ltip le E x it m u ltip le E x it m u ltip le Y ea r Y ea r E B IT D A E B IT D A D e b t b e g in D e b t b e g in D e bt e nd D e bt e nd E V a t e x it E V a t e x it D e b t a t e x it D e b t a t e x it G P s E q u ity v a lu e a t e x it G P s E q u ity v a lu e a t e x it M a n a g e m e n t fe e s M a n a g e m e n t fe e s T o ta l C F to G P s T o ta l C F to G P s IR R IR R - 2 .8 5 - 2 .8 5 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 2 8 .0 x 8 .0 x 8 .5 x 8 .5 x 0 0 1 1 2 2 3 3 4 4 5 5 3 0% 73 % 00% 7 0% 950 950 285 62 8 5 65 665 2 .8 5 2 .8 5 2 8 2 .1 5 2 8 2 .1 5

12 0 12 0 66 5 66 5 54 5 54 5

1 20 1 20 5 45 5 45 4 25 4 25

120 120 425 425 305 305

12 0 12 0 30 5 30 5 18 5 18 5

120 120 185 185 65 65 1020 1020 65 65 9 .5 5 9 .5 5 2 2

1 1 .5 5 1 1 .5 5 81% 81%