The Industrial Sector Through the Eyes of a Private Equity Investor September 21, 2006 1
The im portance of private equity ~ 70% of you work for companies that have been touched by private equity. Not Touched by P rivate Equity 30.0% Touched by P rivate Equity 70.0% 2
Agenda • How and why does private equity impact you? – Why is private equity important? – How does private equity work? • How important is the industrial sector to private equity? • What does private equity look for in industrial companies? • What does a private equity firm look like? 3
Historical Perspective on Private Equity The private equity industry has grown dramatically over the last 30 years and now has a major impact on all sectors of the economy. Driven by Michael Milken (Drexel Burnham Lambert), Private Numerous leveraged “Barbarians Private equity funds record-size buyouts first at the equity funds raise over funds raised account for the Gate; ” KKR raise over $200bn; (e.g. Blackstone Group ($15.6B) AT&T largest acquires $50bn in a stock Texas Pacific broken up percentage of RJR Nabisco single year market Group ($14.3B) NASDAQ by U.S. high yield bond – largest for the first bubble Permira Advisers formed regulators issuance LBO to date time bursts ($14.1B)) 1971 1978 1983 1984 1986 1987 1989 1994 1996 1997 2000 2004 2006 Kohlberg First private Black Netscape Asian Google $32bn deal Kravis, equity Monday & Yahoo financial IPO; for HCA Roberts & transaction over (S&P founded crisis announced; Carlyle Co. (KKR) $1bn (Wometco loses over largest Group Founded Enterprises) 20% in private raises one day) equity deal $10bn in history “Thirty years ago, the private equity industry was not really an industry at all. Today, private equity is mainstream, sophisticated and huge. It accounted for about $200bn worth of deals in 2005, and the vast majority of that sum was spent on buy-outs of established companies” -The Financial Times Sources: Meketa Investment Group; Buyouts Magazine 4
Private Equity in the Press “Private-equity firms now possess more than $2 trillion in buying power. This year they have bought some of the world’s best-known brands, worth more than $347 billion, twice last year’s pace and roughly equal to the gross domestic product of Belgium. Private-equity firms spent $12.3 billion for Univision last month; $22 billion for Kinder Morgan in May; as much as $14 billion for General Motors’ finance unit, G.M.A.C., in April; and $17.4 billion for Albertsons, the grocery chain, in January.” -The New York Times “Increasing emphasis lies on improvements in the fundamental performance [ through] motivation of employees and managers of the acquired business [ and] direct involvement of the acquiring buy-out group in the transaction. Importantly, some of these improvements persist even after the buy-out group re-sells the business.” -The Financial Times “Private money is also playing a growing role in mergers and acquisitions, an area long dominated by companies. So far this year, buyout funds have been involved in 24% of mergers and acquisitions by value, according to Thomson Financial, up from the 14% in 1988, the peak of the previous buyout boom.” -Wall Street Journal 5
Size of the Private Equity Market Relative to GDP Despite coming down from their peaks, the rates of private equity investment as a percentage of GDP and as a percentage of total M&A activity are still well above historical averages. P rivate Equity Investment P rivate Equity Investment as a % of U.S. M&A Market as a % of U.S. GDP 2.0% 20.0% 1.5 15.0 1.0 10.0 0.5 5.0 0.0 0.0 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 0 1 2 3 4 5 6 7 8 9 0 1 2 3 4 5 9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 0 9 9 9 9 9 9 9 9 9 9 0 0 0 0 0 0 1 1 1 1 1 1 1 1 1 1 2 2 2 2 2 2 Source: Meketa Investment Group 6
LBO volum e and returns have surged in recent years Deal volum e is up sharply LBO transactions by US-based firms $200B 150 Annualized 100 50 Q1 0 95 96 97 98 99 00 01 02 03 04 05 06 Source: Buyouts Newsletter, Thomson Venture Economics; Bain & Company 7
New cycle of fund raising: Leads to a capital overhang Capital raised vs. Creates a capital deal volume (equity portion) overhang of more than $200B $200B $200B implying a lot of capital left to be 174 invested 150 150 100 100 Equity 63 invested 55 42 50 50 35 35 35 24 23 18 17 12 6 5 0 0 92 93 94 95 96 97 98 99 00 01 02 03 04 05 Note: Capital raised includes foreign funds raised by US-based LBO firms 8 Source: Buyouts Newsletter, Bain LBO fund database, S&P LCD
Agenda • How and why does private equity impact you? – Why is private equity important? – How does private equity work? • How important is the industrial sector to private equity? • What does private equity look for in industrial companies? • What does a private equity firm look like? 9
W hat is private equity? It’s not as glamorous as “Pretty Woman” 10
W hat is private equity? It’s not as ruthless as “Wall Street” 11
W hat is private equity? And it’s a bit more complicated than… 12
W hat is private equity? Private Equity investing is essentially the practice of… 1) raising money to invest 2) investing in companies with strong teams and growth opportunities 3) helping to build and grow companies over time, and 4) eventually, realizing a happy return for all of the shareholders 13
Purpose of Financing Private equity firms use the equity that they have raised from limited partners along with debt (collateralized by the companies they purchase) to buy portfolio companies. Maximize Returns While Minimizing Optimize Financing Given Market Risk Conditions and Company Situation Capital structure must fit company's Increasing leverage improves returns needs Working capital – Capex – Seasonality Provide a cushion in the instance that things – Add-on acquisitions go wrong – Financing must be "doable" in current market Interest rate pricing – Bond market – Amortization schedule – 14
Value of Leverage Leverage enhances equity returns. 100% Equity 90% Debt/10% Equity 147 147 150 150 57 equity • Debt enhances the Enterprise Value Enterprise Value 100 100 100 100 rate of return on an 10 equity equity investment 147 equity • However, debt also increases the risk to 50 50 100 equity equity holders by 90 debt 90 debt increasing the volatility of returns and risking debt default 0 0 Y ear 1 Y ear 4 Y ear 1 Y ear 4 3 Years 3 Years 13.7% IRR 78.6% IRR 1.5x 5.7x 15
How Private Equity Firm s I nteract w ith Portfolio Com panies Firms have a range of approaches to working with portfolio companies, but often take an active role in supporting them. Berkshire’s interactions with a portfolio Berkshire’s role in a portfolio company company Regular communication focuses on financial Value added resource to our portfolio companies. and strategic metrics. Work with management to build a board of directors. Managers seek our counsel regarding people and organizational issues. Jointly develop a strategic plan for achieving growth, including key resources. We draw on appropriate external professional resources. Jointly establish metrics to measure performance against plan. We provide opportunities for sharing of experiences across Berkshire portfolio Analytic and investment expertise to evaluate major companies. operating and investment decisions such as new capital investments, acquisitions or new market initiatives. 16
Agenda • How and why does private equity impact you? – Why is private equity important? – How does private equity work? • How important is the industrial sector to private equity? • What does private equity look for in industrial companies? • What does a private equity firm look like? 17
The I ndustrial sector represents 1 3 % of GDP & $ 3 .9 T of Gross Output GDP I ndustrial Sector (Value Added) (Gross Output) $19,733B 2003 Revenues ($B) 2003 Value Added $B (GDP) $12,500B $3,894B $4,000B $11,004B Pipelines 31 Mining 51 Pulp/ Paper 88 Agricolture Com puter/ electronic products Aerospace 122 Transp & wareh* Food/ beverage, textile/ apparel Packaging 128 Other* * 10,000 Metals 152 Arts/ entert. I nformation Building Products 228 Construction 3,000 Transportation 243 Wholesale trade Capital Equipment 314 Retail Trade 7,500 Chemicals 331 Education/ health care Power/ utilities 356 2,000 Prof svcs 5,000 Home building 429 Industrial Energy 432 Government 1,000 2,500 Automotive 442 Finance General Manufacturing 547 0 0 Sectors Segments * Excludes truck and rail transportation 18 * * Includes: Wood and non-metallic mineral products, printing and support activities, other services (excluded Government) Source: BEA, Department of Commerce; Bain & Company
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