SPE CIAL EDITIO N

IIMK’S FINANCIAL
NEWSLETTER
5TH SEPTEMBER 2008

FROM FY DESK
INSIDE THIS ISSUE:

Team FY welcomes you to Back to the newsletter, we

MEZZANINE 1 the fourth issue of its in-
CAPITAL house newsletter. We at FY
LEVERAGED 2 believe in dabbling with the
BUYOUTS latest in the financial space.
In keeping with this we bring
KOHLBERG 2
KRAVIS ROB- to you the latest from the
ERTS & CO world of Private Equity.
With entrepreneurial ven-
PRIVATE EQ- 3 tures on a surge in India,
UITY IN SME private equity is poised to
play a strategic role in fund-
FIN-CTIONARY 3 ing such activities in the
country.
FIN-TERVIEW 4 of KKR taking over RJR
The theme of this newsletter
WITH RAHUL
MUKIM, ICICI is in tune with the National
VENTURE level finance summit
FIN-TERESTING 5 ―Arthanomics‖, organized by
PAST —
team FY from September 6-
BARBARIANS
AT THE GATE 7 2008. Arthanomics will
bring together the who's who
of Investment Banking and
Private Equity in India. The
summit will form a melting
pot for the most relevant
issues which need to be ad-
dressed.
FIN WATCH
cover some of the technical
aspects of Private Equity like
mezzanine financing and
leveraged buyouts and then
discuss the relevance of Pri-
vate equity players in the
still unexplored area of
Small and Medium Enter-
prises (SME). We bring to
you the profile of KKR, the
"head honcho" in Private
Equity and then go on to
discuss the finteresting past
Nabisco. An interview with
Rahul Mukim of ICICI Ven-
tures enlightens on the nitty
gritties of the present day
market place.
Caption describing picture or
Lastly, we thank you for all graphic.
the suggestions and critics
for the newsletter and we
shall try to incorporate the
same in our further editions.
Wishing you a happy read-
ing !

 1$ = Rs. 44.26
MEZZANINE CAPITAL –PALLAV CHATURVEDI (PGP12)

 Inflation 12.40% equity: it attracts principally

“While the Credit Crunch has
caused headaches for pri-
vate equity firms and night-
 BSE –
mares for some investment
banks ... expectations are
that mezzanine capital ...
will soar in coming quarters”
Source: Reuters
Mezzanine capital is a very special-
ized branch of lending which has
most of the attributes of a loan cou-
pled with a few characteristics of
a rate of interest (like a loan)
but may also have the right
to convert into equity on a
sale or flotation; or it may
have a guaranteed (modest)
equity element. It is gener-
ally subordinated to debt
provided by senior lenders
such as banks and venture
companies. This type of debt
generally offers interest rates
two to five percentage points
higher than that on senior
debt.
Mezzanine finance tends to
be used when bank borrow-
ing limits are reached and
the firm cannot or will not
issue more equity. It is a
form of finance which per-
mits the firm to move be-
yond what is normally con-
sidered acceptable debt/
equity ratios (gearing or lev-
erage levels).
Contd. on pg. 3
 IIMK’S FINANCIAL NEWSLETTER Page 2

LBO(LEVERAGED BUYOUT) -SHRINIVAS VAZE(PGP12)

LBO (leveraged Buyout):
It‘s a type of acquisition in
which the acquiring firm
provides major part of capital
through borrowings. In many
cases, the assets of company
to be acquired are used as
collateral to obtain the funds.
Thus if a company A wants
to acquire company B, it will
borrow money from market
to seal the deal.
An LBO can take place as a
hostile takeover of a com-
pany by its competitor, or by
a financial firm. In both
cases, debt is raised from
various institutional investors
and banks. In case of LBO
by a financial firm, the firm
acts as an intermediate inves-
tor. The institutional inves-
tors give funds based on
credit rating of the acquiring
firm. When the acquired
company goes public, or is
sold to some other party, the
firm realizes its profit.
Rationale:
The leverage, in ―LBO‖ is
debt taken for investment. If
rate of return on assets for a
company is greater than debt
interest rate, leveraged fi-
nance is beneficial. E.g. com-
pany A can have a secured
loan against the company B‘s
fixed assets at much lower
interest rate. During their peak
time in 70‘s, LBO gave returns
as high as 30-100%.
Risk:
If, however company B is not
performing, the LBO fails.
The leverage magnifies profit
and losses equally, making
LBO a high risk high gain
instrument. The risk can be
measured by various ratios
like EBTIDA (Earnings Be-
fore Tax, Interest, Deprecia-
tion and Amortization) to cash
interest ratio, debt to equity
ratio etc.

KOHLBERG KRAVIS ROBERTS & CO. -GAURAV SHARMA (PGP12)

Origins
Widely recognized as the leader and
―head honcho‖ in the Private Equity
world, KKR is one of the largest in-
vestment and merchant banking house.
With almost 60 billion dollars in assets
under management and numerous re-
cords, it‘s also regarded as a company
which almost made leveraged buyout a
household term.
The story begins in 1965, eleven years
before KKR was formed. Jerome Kohl-
berg, who was in charge of corporate
finance at Bear Stearns, developed a
new method called ―bootstrapping‖
which the world now knows as Lever-
aged Buyout (LBO). Kohlberg was of
the opinion that if a few investors ac-
quired a stake in a company and fo-
cused exclusively on improving its
management and profitability, then
they could do a better job than thou-
sands of shareholders who had little
time and scant knowledge. He per-
fected this concept between ‘65 and
‘76 along with his two protégés,
George Roberts and his cousin Henry
Kravis.
Strategy
Simply put, the KKR strategy consists
of three basic steps: Get an Investment
bank to help raise money for a lever-
aged buyout. Then, restructure the
company, sell off underperforming
assets and reduce costs. Finally, sell
the more efficient and attractive com-
pany for a massive profit. KKR usu-
ally has a target investment period of
7 years though on occasions it has
gone beyond 10 years.
Advantages
KKR‘s reputation coupled with their
industry relationships and network,
helps them secure deals easily. Their
diversified portfolio consists of both
start-ups and established firms in all
kinds of industries. By keeping a long-
term focus and leveraging on its enor-
mous expertise, KKR brilliantly
manages all its portfolio companies.
Big Deals
In 1989, KKR materialized the larg-
est leveraged buyout in history, the
31 billion dollar takeover of RJR
Nabisco. This was dwarfed by the
2007 buyout of the energy company
TXU for 45 billion dollars, also by a
KKR led consortium. KKR also
completed many multi-billion dollar
deals like First Data ($29 bi), TDC
($15 bi), and Alliance Boots ($25
bi) etc.
Future Plans
Initially seen as a company obsessed
with hostile takeovers, KKR has
now engaged in an image rebuilding
exercise. They are increasingly redi-
recting their energies towards a buy-
and-build strategy.
KKR recently announced that it‘s
coming out with an IPO. Though
this could hardly be called ideal
timing, KKR seems determined to
go through with it.
For the interested, we recommend
the books ―The Money Machine‖
and ―Barbarians at the Gate‖ written
in the KKR context. In fact the latter
was also made into a for-TV movie
by HBO. An overview of the RJR
deal and the controversy it evoked is
provided overleaf.
 SPECIAL EDITION Page 3

MEZZANINE CAPITAL CONTD FROM PG 1 FIN-CTIONARY

Mezzanine financing can basically be done in Bear Hug: An offer made

two ways — Subordinated notes and Preferred ownership component in mezzanine securities directly to the Board of
stock. is almost always accompanied by either cash
interest or PIK interest and in many cases by Directors of a target com-
The rate of return which mezzanine investors both. pany. Usually made to
look for can come from:
Mezzanine capital can be used in the follow- increase the pressure on
Cash Interest — A periodic payment of cash ing: the target with the threat
based on a percentage of the outstanding bal-
ance of the mezzanine financing. Leveraged Buyouts: Here mezzanine capital that a tender off
is used to fill a financing gap between less
PIK interest — Payable in kind interest is a expensive forms of financing (e.g., senior Bootstrapping: Means of
periodic form of payment in which the interest loans, second lien loans, high yield financ- financing a small firm by
payment is not paid in cash but rather by in- ings) and equity. employing highly creative
creasing the principal amount of the security
in the amount of the interest. Real Estate Finance: Used by developers to ways of using and acquir-
secure supplementary financing for develop- ing resources without rais-
Ownership — Along with the typical interest ment projects, often collateralized by the
payment associated with debt, mezzanine stock of the development company rather ing equity from traditional
capital will often include an equity stake in the than the developed property itself. sources or borrowing
form of attached warrants or a conversion fea-
money from the banker
ture, similar to that of a convertible bond. The
may follow.
PRIVATE EQUITY IN SME Hurdle Rate: The internal
NAMRATHA , HARSHAD , KAVEESH(PGP12) rate of return that a fund
must achieve before its
general partners or manag-
Small and Medium development of Capital Mar- in SME‘s, fulfil the handhold-
Enterprises (SME) are impor- kets, maturing of IPO‘s and ing needs in the short run, and ers may receive an in-
tant for the development of development of M&A, exit helps introduce global man- creased interest in the pro-
any economy, particularly a options have also improved. agement practices, corporate ceeds of the fund
growing one like India. SME Another feature of SMEs governance and accountabil-
constitute 95% of industrial which is attractive to inves- ity. Pay to Play : A "Pay to
units in India and 40% of the tors is that their balance
PE firms invested Play" provision is a re-
output. Till 10 years back sheets are too weak to procure
Rs.4000 crore in SMEs in quirement for an existing
Indian industries had to de- enough bank loans to sustain
2007-08 – an increase by 75%
pend on financial institutions the high rate of growth which investor to participate in a
over the previous year – in
for both debt and risk capital. is possible when the company subsequent investment
sectors such as Pharmaceuti-
But strong industrial growth size is small. SMEs essen-
cals, Infrastructure, Transpor- round, especially a Down
and increased domestic de- tially suffer from being nei-
tation, Manufacturing and Round.
mand for goods and services, ther here nor there - they are
Textile. According to esti-
driving key sectors such as too large to receive funding
mates, the potential for PE Wash-Out Round: A
Retail, Entertainment and from Microfinance institu-
funding in Indian SME is
Manufacturing, has attracted tions, and too small to receive financing round whereby
20,000 crore, growing at a
local and global Private Eq- them from commercial banks. previous investors, the
rate of 30% year on year. This
uity (PE) investors. In recent
In India, PE deals in immensely lucrative invest- founders, and manage-
years, India has become one
SMEs are similar to that of ment segment has attracted a
of the most lucrative invest- ment suffer significant
large caps in terms of capital lot of attention from local and
ment options for global PE dilution. Usually as a re-
investment ($5-15 million), global PE funds. The Govern-
firms.
but the similarity ends there. ment has started taking initia- sult of a washout round,
The SME sector is As articulated by R.Srinivas, tives and public sector banks the new investor gains
still un-crowded from a PE Managing Partner of BTS like SBI have come out with a
point of view as it has been India, SMEs require ―hand PE fund for SMEs. majority ownership and
traditionally overlooked by holding like start-ups and control of the company.
investors because of the lim- capital needs like mid-cap
ited exit options. But with the companies‖. PE investments,
 IIMK’S FINANCIAL NEWSLETTER Page 4

FIN-TERVIEW WITH RAHUL MUKIM, ICICI VENTURE –GAURAV SHARMA (PGP12)

What are the essential parameters that
you look at before arriving at an invest-
ment decision in a start-up?
Though ICICI Venture doesn‘t evaluate start
up, I can list down the criteria that a VC
Fund would use to undertake an investment.
VC Funding is essentially the funding of a
concept rather than a company. The robust-
ness and the efficacy of the business plan
needs to be evaluated. This can be done in
any of the following ways:
 Conceptual clarity of the business plan,
 Business model, Scalability of the
model / Technology,
 Quality of the entrepreneur / track re-
cord / managerial capability,
 Sector view and product view,
 Financials – Projections and Attractive-
ness of projections, break even etc.
How has the dilution of the global money
markets affected interest in Private Eq-
uity in India?
The current credit squeeze has certainly
taken a toll on the Private Equity. Firstly,
cheap credit to fund buyouts has become
scarce. Secondly, fund raising by Indian PE
firms has become difficult with liquidity
strains on Limited Partners (these are inves-
tors in PE Funds, Include hedge funds, pen-
sion funds, funds of funds etc.)
Further, the bearish environment created
may impact the number and quality of fund
raising exercise by promoters. Valuation
expectation of promoters may also soften
leading to a positive impact on PE deals.
Generally, it is said that a downside is the
right time for PE investments. This is be-
cause you enter at a lower valuation and
exit when the cycle reached its peak.
What kind of exit options are exercised
in different sectors?
PE Exit options can be bunched IPOs, Stra- Many energy firms, including
tegic sales, Buyback by the promoter / sale Suzlon are private-equity backed.
to another PE investor.
Generally exit options are independent of
the sectors though may be governed by
which sector is hot in the capital markets.
Like during the last boom we saw growth
led by infrastructure, capital goods and
manufacturing. High profile exits like Na-
garjuna Cons, Suzlon happened through an ―During the last
IPO. Further, the kind of exits are also gov-
boom we saw
erned by the type of deals. Exits in buyouts
are normally through strategic sale: For e.g. growth led by
India Value Fund sold Trinethra to AVB
Group, ICICI Venture sold ACE Refracto- infrastructure,
ries to Imerys and Infomedia to TV18. capital goods and
Most of the growth deals, however, are
exited through an IPO. manufacturing‖
Contd. on pg. 5

FOOD FOR THOUGHT

Interesting Links PE News

1. Biggest private Equity Deals
of All time
2. Wall Street, meet small street
3. "PE Investing Is Like A Dat-
ing Game; All Put On Their
Best Behavior"
4. Who‘s Who in private Equity
“We should act like a
public industry. The 1. Companies turn to PEs for
funds are private but M&A funding.
they are so large that we
need to deal with the 2. India story still attracts
public, with labor venture capital funds
unions, with
environmental groups.” - 3. Private equity deals drop in
-Carlyle Group Co- June quarter
founder David
Rubenstein 4. The Largest Private Equity
Indian Real Estate Deal
 SPECIAL EDITION
FIN-TERVIEW WITH RAHUL MUKIM, ICICI VENTURE
If an existing business wishes to ex-
pand, what would be the best way to
finance that? Angel Investors/ VCs /
Loans or should they stick to organic
growth?
Expansion of an existing business in not
determined by the type of investors but
the perception of the cost of capital. An-
gel Investor or a VC would most likely
invest in an early stage company and not
an existing business with sufficient track
record. An existing business has the fol-
lowing options:
 Debt
 Equity through an IPO
 Equity through Private Equity
 Mezzanine Financing
FIN-TERESTING PAST
Barbarians At The Gate
The buyout of RJR Nabisco by Kohlberg
Kravis Roberts & Co in 1989 remains till
date one of the largest private equity deals
of all time. KKR came into being in 1976 as
a result of fallout between its founders
Jerome Kohlberg, Henry Kravis and George
Roberts and their then employer Bear
Stearns. KKR specialized in Leveraged Buy
Out in which acquisition was funded mostly
by issuing bonds and a smaller percent
raised through equity. The 1980s saw a huge
boom in private equity and LBOs and saw a
large number of mega LBO deals among
which the RJR Nabisco acquisition stand
out. Here‘s a brief account of how one of the
most talked about private equity deals hap-
pened.
At the time of the deal Mr. F. Ross Johnson
was the President and CEO of RJR Nabisco,
a maker of cigarettes and food. In October
1988, Mr. Johnson backed by the com-
pany‘s few top executives announced to buy
RJR Nabisco at $75 a share or $17 billion.
This was backed by the investment banking
and brokerage house of Shearson Lehman
Page 5
CONTD FROM PAGE 4
focused funds are in the pipe-
If I were the CFO of an existing busi- line. Though most of these may
ness the evaluation of the best way to be essentially VC funds
fund would depend on: Size of my com-  Larger PEs would focus on lar-
pany, sector, cost of funds, dilution im- ger deals / control / buyouts
pact, security etc.  Education, clean energy are
likely to emerge as attractive
What are the emerging trends in the sectors for investments.
Indian Private Equity and Venture
Capital Industry?
A very broad question. I can summarize
the emerging trends under the following
heads:
 Emergence of sector focused venture
capital funds: Education, life sci-
ences, micro finance, agriculture Agriculture is often touted to be the
next big money spinner
—SUSHANTA DEY(PGP12)
Hutton. This escalated into a takeover bid and
almost all the major PE players dropped their
hat into the ring. These included Morgan
Stanley, Salomon Brothers, Goldman Sachs,
and Merrill Lynch apart from KKR. A fierce
series of negotiations and proposals ensued and
Kravis offered to buy RJR Nabisco at $90 a
share – a price that would not require RJR Na-
bisco‘s management approval. This led to fur-
ther negotiations and RJR‘s management along
with Shearson Lehman Hutton and Salomon
Brothers offered a price of $112 per share.
Kravis then revised his price offer to $109.
RJR‘s board of directors finally accepted
KKR‘s offer on the ground that RJR manage-
ment‘s offer of $112 even though higher,
lacked a ‗reset‘. This meant that the manage-
ment‘s offer was not guaranteed and the final
share price could have been lower than the
quoted price of $112. Also many of the board
members were concerned by Johnson‘s golden
parachute deal and used the ‗reset‘ issue to
close the deal in KKR‘s favour.
 Financially Yours (FY) is

Mail us at fy@iimk.ac.in the finance interest group of

IIMK. The prime objective of
FY is to promote and develop
an interest in the field of fi-
nance. Through a variety of
activities all round the year
like holding sessions, compe-
titions, organizing seminars
for Horizons and manage-
ment events for Backwaters,
FY facilitates the learning
process and encourages
friendly competition among
Mridul M 9946103226 fin enthusiasts.
However, being an „interest‟
Rohit J 9946102149
group our efficient working
Saurabh K 9946102142 depends on the enthusiastic
participation from the stu-
Viral S 9946660709 dents.

We invite articles/interesting facts/write-ups from the readers, this being a platform of sharing knowledge amongst all the fin
enthusiasts. Also, we further look forward for suggestions and ideas for the coming academic year so that we can plan accord-
ingly. Kindly get in touch with any of the FY coordinators for further details.