Private Equity – An Alternate Source of Capital
Private Alternatives to the Public Markets
How to Survive and Grow in a Capital Constrained Environment
A Private Conference on May 16, 2001
Sponsored by: Windsor Group Investment Banking Deloitte & Touche Holland & Knight LLP Holland & Knight Consulting
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Agenda
• Introduction to SKM (A Brief SKM Commercial)
• State of the Capital Markets (Ugly)
• Private Equity as an Alternative Source of Capital (A Viable Option)
• Overview of Saunders Karp & Megrue (A Longer SKM Commercial)
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
SKM Overview
• Founded in 1989 • Market Leader in Private Company Recapitalizations and Growth Company Buyouts • Selectively Pursue Buy-&-Build Strategies • Over $1.7 Billion of Equity Capital Raised • Fund I = $300 Million
• Fund II
= $516 Million
• Fund III = $943 Million • 2 Distinct Investment Teams Focused on the Entire Middle Market • Successfully Executed over 50 Investments in Last Seven Years
• High Quality Group of Limited Partners
• Rely, to a Lesser Extent, on the Public Capital Markets
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
State of Capital Markets
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Current market conditions have made accessing the capital markets more difficult
• Factors effecting how you grow your company, capital formation, capital investment and M&A activity are all struggling • Economy • Public equity market • High yield market • Senior bank market • Need to pursue non-traditional sources to access growth / liquidity capital
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Economy
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Turbulence in the Stock Market is the Result of Changes in the Macroeconomic Climate
• Industrial production fell in April for the seventh consecutive month, the longest stretch since 1982 • Economy lost more jobs in April than at any time in the last decade, leading to highest unemployment levels in two-and-a-half years • Persistent erosion in current and expected profitability across all sectors • Retail sales reports showed a drop in sales at U.S. retailers during March • Consumer confidence, as measured by Consumer Sentiment Index, has dropped 19% since November 2000 • Lay-offs impacted 545,000 employees during the first 3 months of 2001 at over 4,500 companies
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Public Equity Markets
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
After a Sustained Period of Growth, Major Stock Market Indices Have Fallen from Peak Valuations Over the Past Year
DJIA and S&P 500 Performance, May 1998 - May 2001
150.0%
NASDAQ Performance, May 1998 - May 2001
300.0% 250.0% 200.0% 150.0% 100.0% 50.0%
5/4/98 7/4/98 9/4/98 1/4/99 3/4/99 5/4/99 7/4/99 9/4/99 1/4/00 3/4/00 5/4/00 7/4/00 9/4/00 1/4/01 3/4/01 11/4/98 11/4/99
125.0%
100.0%
5/4/98
7/4/98
9/4/98
1/4/99
3/4/99
5/4/99
7/4/99
9/4/99
1/4/00
3/4/00
5/4/00
7/4/00
9/4/00
1/4/01
3/4/01
11/4/98
11/4/99
11/4/00
5/4/01
DJIA
S&P 500
Nasdaq
SAUNDERS KARP & MEGRUE
11/4/00
5/4/01
75.0%
Private Equity – An Alternate Source of Capital
The Equity Capital Markets Continue to Suffer a Hangover From the Slump in Technology Stocks and a Slowing Economy
Equity Indices Performance, May 2000 - May 2001
140% 120% 100% 80% 60% 40% 20%
05/00 06/00 07/00 08/00 09/00 10/00 11/00 12/00 01/01 02/01 03/01 04/01 05/01
SAUNDERS KARP & MEGRUE
+3% - 12 % - 41 %
DJIA
S&P 500
Nasdaq
Private Equity – An Alternate Source of Capital
As Performance of Stock Market Indices Remain Flat, Access to the the IPO Markets Has Been Curtailed
LTM IPO Underwriting
80 70 60 50 40 30 20 10 0 0
Apr-00 May-00 Jun-00 Jul-00 Aug-00 Sep-00 Oct-00 Nov-00 Dec-00 Jan-01 Feb-01 Mar-01
64 50 50
33 22
30
28
28 21 10 6 8
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
The Slowdown in the IPO Market Has Disproportionately Impacted the Ability of Smaller Deals to Come to Market
IPO Volume
60
Transactions)
(No. of
40 20 0 Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Jan Feb Mar Apr Below $50 mm
2000
$50-99 mm
Above $100 mm
2001
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Change in capital allocation model to large companies has left majority of small cap stocks „orphaned‟ in the public markets
Mutual funds‟ focus on liquidity and efficient capital deployment renders small and mid-cap stocks unattractive Lack of institutional interest exacerbated by small floats and lack of research coverage Narrow market interest has left many profitable and solidly growing companies without access to capital Valuations do not reflect healthy operating track records In many cases, small and mid-cap companies behave like private companies with the burdens of being public
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
High Yield Markets
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
High Yield Capital Market Conditions are also Challenging, as Highlighted by Accelerating Default Rates and Lower Volumes
Moody’s Trailing-12-Months Default Rate
14.0% 12.0% 10.0% 8.0% 6.0% 4.0% 2.0% 0.0%
Jan-91 Jan-92 Dec-92 Dec-93
Annual High Yield New Issue Volume
$160,000
$ 141,437 $ 116,285
Millions of Dollars ((# of Issues)
% of Principal Outstanding % of Issuers
$140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $0 (35) 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
As of May 2001.
$ 35,213 $ 8,500 $ 68,076 $ 65,321 $ 40,400 $ 39,200
(690) (650)
$ 100,769
(421)
(364)
(354) $ 50,483
$ 37,473
(208)
(255) (207)
(150) (111)
Dec-94
Jan-96
Dec-96
Dec-97
Dec-98
Dec-99
As of February 2001.
• •
Dec-00
Default rates are trending up towards levels of early 1990s Trends are projected to continue as fallout from aggressive telecom lending continues to shake out (Winstar, ICG)
•
High yield issuance has significantly decreased after the LTCM and Russian debt crises in late 1998
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
While the Fed has Aggressively Slashed Interest Rates in 2001, Spreads for Non-Investment Grade Issuers Remain High
Absolute Yields
16.0%
Spreads
1,000
14.0% B Index
12.72%
900
800
Spread to Worst (bps)
Yield to Worst
12.0%
B Index
1/1/99 10.50%
700
1/1/99 585
752
10.0%
1/1/99 8.04%
9.04%
BB Index
600
500
8.0%
400
6.0%
1/1/99 4.65%
5.20%
1/1/99 339
BB Index
384
300
10-Year Treasury
Apr-99 Apr-00
Apr-99
Apr-00
Apr-01
Jul-99
Jan-99
Jan-00
Jul-00
Oct-99
Oct-00
Jan-01
SAUNDERS KARP & MEGRUE
Apr-01
Jul-99
Oct-99
Jul-00
Oct-00
Jan-99
Jan-00
Jan-01
4.0%
200
Private Equity – An Alternate Source of Capital
High Yield Issuance Has Accelerated Recently As a Result of Interest Rate Cuts but the Market for First Time Issuers Remains Soft
Repeat Issuers First Time Issuers
$15.0
Proceeds Raised in Billions of Dollars (# of Transactions)
$12.0
$9.0
$6.0
$3.0
$0.0
2000 Apr 00 May 00 Jun 00 Jul 00 Aug 00 Sep 00 Oct 00 Nov 00 Dec 00 Jan 01 Feb 01 Mar 01
Year Ended Monthly Avg
Latest 12 Months
% First Time Issues 38.5% 25.0% 27.2% 27.8% 45.5% 38.5%
5.9%
57.1% 42.9% 33.3%
9.4%
15.4% 37.5%
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Investors Have a Strong Bias in Favor of Repeat Issuers and Aftermarket liquidity concerns continue Highly Liquid, Large Bond Issues
to be a major theme in the market
$400 $350
Millions of Dollars (# of Transactions)
Average Transaction Size (1993-2001)
$336.6 $346.8
(111)
Consequently, the size of the average completed transaction spiked dramatically in 1999 and into 2000
$300 $250
$196.5 $229.2 $191.1 $195.2
$284.7
(150)
(354)
$200 $150
$168.5
$168.4
(340) 1993
(212 ) 1994
(202 ) 1995
(338) 1996
(626) 1997
(619)
Transactions of $1.0 Billion or greater have become increasingly common in the market and continue to attract a disproportionate amount of investor interest
While deals of less than $100 million can be completed, investors are increasingly demanding pricing concessions
1998
1999
2000
2001
Issues of $100 million or Less
25.0% 20.0%
As a % of All High Yield New Issuance
15.0% 10.0% 5.0% 0.0%
1992
1993
1994
1995
1996
1997
1998
1999
2000
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Senior Bank Markets
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Mirroring the High Yield Market, the Leveraged Loan Market Has Also Tightened
A significant contraction in leveraged lending began in 2000 and continues into 2001 – Significant consolidation in bank market yields fewer players – Non-performing assets at large domestic financial institutions soared – Economic concerns and weaknesses within certain industry sectors are adversely impacting credit outlook – Banks have responded to the wave of covenant defaults with calls for new equity to both cure default and adjust leverage to current conditions – While the market has recently shown heightened activity from cross-over credits (“fallen-angels”) and add-on financings from seasoned issuers, the overall financing
outlook for middle market issuers remains difficult
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Since early 2000, Commercial Lenders Have Been Tightening Underwriting Standards for Commercial Loans
•
Change in standards is attributed to:
• • •
Renewed sensitivity to credit risk among lenders following credit market turbulence Continued high delinquency and increase in non-performing assets
Efforts of OCC (Office of the Comptroller of the Currency) to make underwriting practices more rigorous
Percentage of Large Banks Tightening Standards on Commercial Loans vs. GDP Growth
Source: Federal Reserve Board survey of senior loan officers. ‘Tightening’ reflects increasing premiums borrowers have to pay on loans, as well as toughening covenants and upping collateral requirements.
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Decreased Leverage Ratios Reflect Banks‟ Aversion to Risk Stemming from Higher Default Rates
• Deteriorating fundamentals and the inability to service debt requirements have produced a credit crunch. Leverage ratios declined through 2000 to slightly less than 3.0x senior and 4.0x total debt.
Average Debt Multiples of Highly Leveraged Loans
10.0x 9.0x 8.0x 7.0x 6.0x 5.0x 4.0x 3.0x 2.0x 1.0x 0.0x 1987 1988 1989 1990 1992 1993 1994 1995 1996 1997 1998 1999 2000 ME 3/01
4.7 3.7 3.4 3.4 2.6 2.7 2.8 8.8 4.1 7.1 6.7 3.5 3.3 5.3 5.0 2 2.4 5.2 2.5 2.5 1.9 3.6 5.3 5.2 5.8 2.3 5.7 2.1 1.7 1.2 3.3 3.5 3.5 3.3 5.3 4.5 4.0 3.7 1.2 2.9 0.9 2.8
Bank Debt/EBITDA
Non-Bank Debt/EBITDA
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Leverage Multiples, Across all Loan Sizes, Continue to Come Under Pressure
Leverage Trend by Loan Amount
Rolling-Three Month Average Pro Forma Debt/EBITDA Ratio
5.5x
5.0x
4.5x
$500M or more
4.0x
$250-499M $100-249M
3.5x
Less than $100M
3.0x
Excludes Media & Telecom Loans
99 ay -9 9 Ju n99 Ju l-9 A 9 ug -9 Se 9 p9 O 9 ct N 99 ov -9 D 9 ec -9 Ja 9 n0 Fe 0 b0 M 0 ar -0 A 0 pr M 00 ay -0 0 Ju n00 Ju l-0 A 0 ug -0 Se 0 p0 O 0 ct -0 N 0 ov -0 D 0 ec -0 Ja 0 n0 Fe 1 3M E b-0 3/ 1 22 /0 1 M
3ME represents average of previous 2 months and the latest month ended number
ar -9 M
A
pr -
9
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Lenders Continue to Require Larger Equity Contributions From Sponsors
Average Equity Contributed to LBOs
45% 40% 35%
30.0% 31.6% 35.7% 37.1%
30%
25.2%
26.2% 23.7% 22.9%
25% 20% 15%
9.7% 13.4% 7.0%
20.7%
22.0%
10% 5% 0%
1987
1988
1989
1990
1992
1993
1994
1995
1996
1997
1998
1999
1H 2000
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Private Equity
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
The Turmoil in the Capital Markets Has Disproportionately Impacted Small and Mid-Cap Companies
• Equity and debt markets have become increasingly more difficult to access • As a result, increasing numbers of small and mid-cap companies in need of capital are considering private equity • As an alternate pool of capital, private equity is less dependent on the public capital markets
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Private Equity is Defined as an Equity Investment in any Commercial Enterprise that is not Registered for Public Sale
Types of P.E. Investing • Venture Capital – Eearly stage or start-up investment. Highest risk profile, VC investments are relatively small compared to other P.E. classes.
• LBO – Substantial ownership / control interest in an established company, funded by a mix of sponsor equity and borrowings.
• Mezzanine – Intermediate debt capital between equity and senior debt. Debt holder participates in equity appreciation through conversion features such as warrants or options.
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
The Process for Making Private Equity Investments is Similar Across all Asset Classes
• Fund Mechanics o P.E. investment is generally through unquoted funds, which are structured as limited partnerships that have a fixed life of ten to twelve years o Limited Partners – investors; no direct investment decision-making o General Partners – private equity managers; select, monitor and arrange exit strategies for the investments o During the initial funding period, the limited partners will make funds available for investment. The GP will draw down these resources as opportunities arise. o The proceeds of any sales or other disposals of the investments are distributed when they occur rather than at the end of the term of the partnership The Investment Process
•
Origination
Due Dilligence
Investment Decision
Documentation and Closing
Monitoring
Exit
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
The Majority of Investments in Private Equity Funds are By Large Pension Funds and Corporations
Foreign 1% Endow/Foundations 6% Family/Individual 11%
Bank/Insurance 7% Fund of Funds Others 3% 2%
Corporations 11%
Pension Funds 59%
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
LBO Funds Represent a Large Pool of „Un-Deployed‟ Private Equity Capital
Buyouts Funds Raised (In Billions),1992-2000
$60.0 $50.0 $40.0 $30.0 $23.2 $20.0 $11.6 $10.0 $0.0 1992 1993 1994 1995 1996 1997 1998 1999 2000
SAUNDERS KARP & MEGRUE
$55.4 $43.2 $39.4 $34.5
$18.4 $5.9
$5.2
Private Equity – An Alternate Source of Capital
Private Equity IRRs Have Outperformed Public Equity Benchmarks, Driving Increased Commitments to the Asset Class
Mean US Private Equity Returns vs. S&P 500
Fund Type All US Venture All US Buyout US Mezzanine 5 Years 51.2% 18.5% 9.8% 10 Years 27.4% 17.2% 11.0% 20 Years 19.9% 20.1% 11.1%
S&P 500
21.7%
15.0%
13.6%
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
The Tide of the Private Equity Market is Changing
• Prior to March 2000, traditional buyout firms had difficulty attracting interest in their strategies as VCs posted returns far exceeding the 30% targeted by buyout shops As NASDAQ multiples contract and small and microcap firms exhibit recession level valuations, interest in buyouts has rebounded
•
•
Having said that, given the contraction in the public equity markets, „allocations‟ to the entire private equity asset class are down
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
LBO Deal Volume Has Contracted As a Result of Volatile Financing Markets
Actual Buyout Deal Volume (In Billions), 1988-2000
$80.0 $70.0 $60.7 $60.0 $50.0 $40.9 $40.0 $28.9 $30.0 $18.8 $20.0 $10.0 $0.0 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 YTD
SAUNDERS KARP & MEGRUE
$74.4 $63.4
$39.0
$29.4
$15.2 $7.0
$13.0 $9.6 $11.0 $4.8
Private Equity – An Alternate Source of Capital
Multiples for US LBOs Have Contracted While Strategic Buyer Multiples Remain Constant
• Throughout most of the 1990s , the average multiple of EBITDA increased year after year, but then leveled off in February 1999 and has contracted since Restricted access to debt markets in 2000 has contributed to this contraction Multiples paid depend significantly on growth of business, capital requirements and leverage available
• •
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Partnering with a Private Equity Investor
• Huge pool of „un-deployed‟ capital
•
•
Many private equity investors favor small-cap companies
Private equity sponsors can be valuable partners – Expert in accessing capital – Strategic / growth decisions – M&A activity – Attracting management talent – Optimizing exit scenarios
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Saunders Karp & Megrue
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Overview of Saunders Karp & Megrue
A private leveraged buyout fund focused on the middle market
Over $1.7 Billion of Equity Capital Raised
15%
Manufacturing
• Fund I
= $300 Million = $516 Million = $943 Million
16%
Business Services
• Fund II • Fund III
12%
Restaurant
• 25 experienced investment professionals
• High quality group of Limited Partners • Two investment efforts • Saunders Karp & Megure
Industry Experience 20%
Specialty Retail
7%
Telecom
10%
Financial Services
26%
Consumer Products
• SKM Growth Investors
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Investment Parameters
• General: • Invest Exclusively in Established (Non-Venture) Middle Market Companies • Transaction Types: • Private Company Recapitalizations • Growth Buyouts and Investments • Buy-&-Build Strategies • Going Private Transactions • Private Investments into Public Entities • Size and Structure: • $5-$200 Million of Equity Capital Per Investment • Flexible, Creative Structures (Common, Preferred, Convertibles, Sub. Debt) • Flexible as to Use of Proceeds
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
SKM Has an Active Investment History Characterized by Flexible Structures and a Variety of Securities
30
27 57
Platform Company Investments
Add-on acquisitions to the platform companies Executed transactions since 1993
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
®
A TRADITION OF EXCELLENCE A TRADITION OF EXCELLENCE
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
SKM aligns itself with superior management teams who continue to hold significant equity stakes in the business posttransaction
Commonality of economic interests bolster productive working relationship Partnership approach encourages open and cooperative long-term relationships Emphasis on growth rather than financial engineering provides support that allows management to execute a growth plan
25%
Growth-Oriented Acquisitions/Other
Long-term perspective to allow management to fulfill its strategic plan Flexible exit expectations in cooperation with management
75%
Private Company Recaps
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Benefits of a Private Company Recapitalization
OWNER
• Provide Personal Liquidity or Buyout Retiring Partner
• Finance Future Growth or Acquisition • Retain Significant Ownership (15%-30%) • Second “Bite at the Apple” • Remain as CEO/Visionary
SKM
• Qualitative Factors Crucial to Entrepreneur Decision Process
• Entrepreneur Remains Active in Management and a Significant Shareholder • Help Build Infrastructure and Accelerate Growth • Favorable Accounting Treatment
ESTABLISH WINNING PARTNERSHIP
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Buy and Build Case Study - Applied Technology Partners
Company A leading manufacturer and supplier of rubber and injection molded plastic parts, components and closures to industryleading OEMs. Services blue-chip customer base in variety of industries including health & beauty, pharmaceuticals, medical, industrial and automotive. Transaction Acquired Sussex Technology in October 1997 and have since completed nine additional acquisitions in targeted end-use markets. 50% of ATP’s acquisitions have been completely proprietary transactions. Average purchase multiple is 4.9x EBITDA. Investment Thesis Highly fragmented industry with continued outsourcing and supplier base consolidation by OEMs together with ATP’s strong management team create favorable buy and build dynamics. Total Equity Investment by SKM Initial 10/97 (in US$mm) 10.0 2/99 9.3 6/99 9.0 Subsequent 7/99 9.0 4/00 4.7 6/00 9.8 51.9 Total
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Buy and Build Case Study - Applied Technology Partners
Sales
250 200 150 100 50 0 $204.9
$146.0 $58.1 $10.3 1997 1998 1999 2000
(US $mm)
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Recapitalization Case Study – Dollar Tree Stores, Inc.
Company A leading operator of discount variety stores selling a wide assortment of quality general merchandise at the $1.00 price point. The Company operates 1,634 total stores across the United States. In September 1993, SKM invested in Dollar Tree, with the founders of the Company retaining a 50% ownership position. SKM established a capital structure with over 60% equity designed to support the Company’s growth objectives. Dominant retailer at $1.00 price point and favorable trends driving discount retailing. Dollar Tree went public in March 1995 and has completed six subsequent secondary offerings over the past five years.
Transaction
Investment Thesis IPO
Total Equity Investment by SKM Total (in US$mm) 30.8
SAUNDERS KARP & MEGRUE
Private Equity – An Alternate Source of Capital
Recapitalization Case Study – Dollar Tree Stores, Inc. 1
Sales
1,600 (US $mm) 1,200 800 400 0 93² 94² 95 96 97 98 99 00 $168 $232 $666 $439 $1,352 $1,688 $1,074 $847
Notes: 1 Fiscal years ended December 31 2 Do not reflect pooling-of-interests acquisition of Dollar Express in May 2000
SAUNDERS KARP & MEGRUE