Private Equity

Private equity refers to a type of investment aimed at gaining significant, or even complete, control of a company in the hopes of earning a high return. As the name implies, private equity funds invest in assets that either are not owned publicly or that are publicly owned but the private equity buyer plans to take private. Though the money used to fund these investments comes from private markets, private equity firms invest in both privately and publicly held companies. The private equity industry has evolved substantially over the past decade or so. The basic principle has remained constant: a group of investors buy out a company and use that company's earnings to pay themselves back. What has changed are the sheer numbers of recent private equity deals. In the past ten years, the record for the most expensive buyout has been broken and re-broken several times. Private equity firms have been acquiring companies left and right, paying sometimes shockingly high premiums over these companies' market values. As a result, takeover targets are demanding exorbitant prices for their outstanding shares; with the massive buyouts that have made headlines around the world, companies now expect a certain premium over their current value. One example is Free-scale Semiconductor, who turned down a deal that paid a nearly 30% premium over its market value, holding out for a sweeter package, which it received. The sheer number of these high-priced deals that have occurred in recent years have led some to question whether this pace is sustainable in the long run. This could turn out to be a self-fulfilling prophecy; as concerns grow and people become less eager to invest in private equity deals, firms won't be able to raise the money to fund their acquisitions, essentially crippling the industry.

Who Is Impacted by Private Equity?

Commercial banks

Bank of America (BAC), Citigroup (C), and J P Morgan Chase (JPM) are among the largest lenders to

private equity firms. These are the main firms who have been stuck with the high-yield bonds that investors are increasingly reluctant to buy. A decline in private equity would lead to big losses for these lenders, since they're already sitting on over $40 billion in unsellable debt.[1] Investment banks

Goldman Sachs Group (GS), Merrill Lynch (MER), Morgan Stanley (MS), Lehman Brothers Fin SA (LEH),

and other investment banks have been offering billions of dollars in bridge loans, which can be used to cover the costs of a private equity acquisition until permanent funding is found. These loans haven't been used that often in the past, but as private equity firms find it harder to raise capital by other methods, they could start drawing upon these loans, leaving investment banks with billions of dollars of loans. With the current state of the debt market, these banks could have trouble finding secondary buyers, meaning that they'd be stuck with heaps of unwanted loans. Also, investment banks are heavily involved with the underwriting of debt and securities for acquisitions

and IPOs. These services bring in hefty fees for I-banks, and any decrease in demand for private equity-related services would negatively impact revenues. Last men standing As the number of private equity deals has increased, the targets of acquisitions have primarily been small- to mid-size companies. While larger companies are technically fair game, some are just much too large to be seriously considered as possible acquisitions. Due to their size, large corporations such as these have benefited from the privatization in their respective industries. As smaller companies are taken private, investors wanting exposure to the industry are left with fewer options in terms of stocks; the remaining companies are seeing higher demand (and higher prices) for their stocks.

Exxon Mobil (XOM), Royal Dutch Shell (RDS), and ChevronTexaco (CVX) are potential beneficiaries of

private equity deals involving small- to mid-sized oil refineries.

Piedmont Natural Gas Company (PNY), Northeast Utilities (NU), and Sempra Energy (SRE) may benefit

from a host of global private equity transactions in natural gas.

Private Equity Goes Public

Blackstone Group (BX) is one of the first private equity firms that has gone public with a recent initial public

offering in June 2007. China took a $3 billion stake before the IPO, which amounts to approximately 10% of the company's value. Blackstone manages about $800 billion in capital, ranking it as one of the top private equity firms by assets. Most market observers remain optimistic that Blackstone will deliver strong value to shareholders over time, given their excellent investment record since the company's inception.

KKR--a leading private equity firm originally known as Kohlberg, Kravis, Roberts--announced in early July,

2007, that it was planning to go public. KKR is famous for its involvement in high-profile buyouts, including the $45 billion buyout of TXU in February 2007. According to their filings with the SEC, the company said it would sell up to $1.3 billion in common equity units and use proceeds to expand the business. It was reported later that same month that poor conditions in the debt market could delay KKR's IPO, as the firm is finding it more difficult to arrange financing for its deals.

What is private equity?

Private equity is essentially a way to invest in some asset that isn't publicly traded, or to invest in a publicly traded asset with the intention of taking it private. Unlike stocks, mutual funds, and bonds, private equity funds usually invest in more illiquid assets, i.e. companies. By purchasing companies, the firms gain access to those companies' assets and revenue sources, which can lead to very high returns on investments. Another feature of these private equity transactions is their extensive use of debt in the form of high-yield bonds. By using debt to finance acquisitions, private equity firms can substantially increase their financial returns. The debt used in buyouts has a relatively fixed cost, so if a private equity fund's return on assets (ROA) is greater than this cost, the fund's return on equity (ROE) is higher than if it hadn't borrowed money. The same principle applies in reverse, however, making these leveraged buyouts potentially very risky; if the acquired company's ROA is lower than the cost of the debt used to buy it, then the private equity fund's ROE is less than if hadn't used debt. The firm would lose money on the investment and still have to pay back the loans, a situation similar to having negative equity in the housing market. While private equity firms sometimes pay themselves back using the acquired company's profits, this isn't their principal moneymaking area. Actually, clauses in private equity deals known as covenants, which assure such repayment, have become increasingly rare in recent years. Rather than making money from guaranteed minimum dividends, etc., private equity firms have been generating most of their profit from the "exit event", or the time when they either sell the company to another private entity or return it to the public markets, presumably for a higher price than they paid originally. Especially with their heavy use of leverage to acquire companies, private equity firms can make a substantial profit in this way. One example is the acquisition of Hertz Global Holdings (HTZ), the car rental company. When Ford Motor Company (F) decided to sell the company in 2005, private equity firms Clayton, Dubilier, and Rice, Inc., Carlyle Group, and Merrill Lynch Global Private Equity stepped in to buy the company. When the deal was completed in December of 2005, the firms had put up $2.3 billion in equity, and the acquired Hertz had taken on

$12.5 billion in debt. Just eleven months later, Hertz was returned to the public markets with an IPO; even before the exit, Hertz paid $991 million to the firms in special dividends, $25 million to each for "acquisition services", and $2.25 million in other various fees. After the IPO, the three firms received another round of special dividends valued at around $427 million and $15 million to terminate standing agreements. Now, the three firms hold a combined 91.9 million shares of Hertz, valued at almost $2.1 billion (up 43% since the IPO in November of 2006). Merrill Lynch made out particularly well; in addition to its private equity firm doubling its investment in a year, the firm itself collected advisory fees for both the acquisition and the IPO and now holds 75 million shares of Hertz in addition to its private equity division's 32 million.

What drives private equity?

Raising Capital Why would a company agree to sell a part of its interests to a private equity firm? There may be several reasons. First, the company may need a large inflow of capital for long-term productivity investments such as research and development. Rather than waiting several quarters (or years) to gather sufficient capital, the company may choose to sell part of its interests in exchange for the ability to pursue development projects sooner. This may be especially true of highly time-sensitive industries such as technology (e.g. software, telecommunications, and Internet services), where a few quarters may make a critical difference in a companys ability to gain (or maintain) a market advantage. Increasing Regulation of Public Markets Second, given the increasing regulation and scrutiny in the public markets over the last several years, some companies may wish to avoid having their destinies controlledor at least heavily influencedby public shareholders. In a public company, shareholders have the right to cast votes with regard to any number of issues critical to the company. In a private equity transaction, such rights typically do not exist. Accordingly, a company can raise capital without relinquishing operating control to external shareholders. Nevertheless, a private equity firm does retain some control, such as the ability to influence the composition of management teams. Often, a private equity firm may take an interest in a company on the condition that the company install new managementwhich ideally will improve operating results and drive profits. Effect on Public Markets For stock market investors, the real question is how the private equity market has affected public markets and what its likely effects will be in the future. Many analysts argue that the increase in private equity deals has actually benefited some aspects of the stock market; the reason is that, with so many companies going private, its become harder for public investors to gain exposure to industries where private equity has been especially influential. Smallto mid-size firms in the energy and finance industries are prime examples. With the increase in private equity deals,

the availability of publicly traded shares of such companies has decreased. This decrease in supply has caused the remaining shares to increase in price; as there are fewer available, each becomes more valuable.

Also, private equity can boost a company's stock price if people think a buyout is likely. Companies that are perceived as likely targets of private equity buyouts have seen their stock prices rise in anticipation of the transaction. Given recent trends in the private equity industry, investors often feel safe in assuming that private equity firms will pay a hefty premium over a company's market value. This drove up the stock prices for companies such as Martha Stewart Living Omnimedia (MSO) and Radioshack (RSH), which were commonly mentioned as buyout targets. Financing the Private Equity Boom One beneficiary of private equity's strength is certain: the financial firms who structure the deals. Whether they're lenders or underwriters (such as investment banks), a number of financial firms have used their market savvy and extensive industry contacts to ensure that they're in the middle of what has been one of the most profitable trends over the past market cycle. That said, if long-term interest rates continue to rise over the next one to two years, it could become more difficult for financial firms to find the capital and participants necessary to keep private equity deals moving at the same rapid pace.

Has private equity reached its peak?

The subprime-inspired housing slump and its subsequent impact on Wall Street investment banks have somewhat diminished investors' appetite for risk. While the potential returns from a private equity firm's leveraged buyout of a company can be great, investors have begun to realize just how risky the highly leveraged transactions can be. This has been making it increasingly difficult for private equity firms and the investment banks that structure their deals to find people willing to invest in their risky, high-yield bonds.

A number of recent debt offerings, including the debt used in Cerberus Capital Management's buyout of the Chrysler Group, have been postponed or abandoned due to deteriorating conditions in the U.S. debt market. On July 25, 2007, it was announced that Deutsche Bank AG (DB), J P Morgan Chase (JPM), and six other banks were stuck with around $10 billion of loans that they couldn't sell; the debt was used for private equity firm KKR's acquisition of Alliance Boots Plc.[2] This increasingly common occurrence is hitting banks hard; they can either cut their losses and sell the loans on the cheap or wait until conditions improve, neither of which is particularly appealing. As the debt market contracts, companies that were previously touted as LBO targets, including Martha Stewart Living Omnimedia (MSO) and Radioshack (RSH), are seeing their stock prices plummet. The same logic that drove their stocks higher and higher also led to their fall; when investors heard the speculation about a slowdown in private equity, they realized that they might not be able to sell their shares at the premium price they'd been hoping for. Shareholders scrambled to sell their stock while the price was still relatively overinflated. Martha Stewart and Radioshack stocks plunged 25% and 30%, respectively, in just three week

The private equity career market is highly competitive, with MBA's flooding the industry. In 2006, 13% of Harvard Business School MBA graduates went to work for private equity firms, making it the class's most popular choice. Similarly, one tenth of Stanford MBA graduates entered the private equity industry that year. As the buyout boom has restarted in the last couple years, it is getting more and more difficult to find a job at a private equity firm, even with a MBA from a prestigious school. There's the obvious financial incentive, the average salary after graduation for MBAs in private equity is $111,296 and an expected $280,441 after working five years. But also there is the lure of working with other talented business people and playing a big part in shaping a company that other industries just don't offer. Despite 2008's slowdown in the industry, private equity continues to be one of the most desirable industries for MBA graduates. With high financial incentives and impressive performance from private equity firms, a private equity career will continue to be a top destination for young professionals.

Enam Infra Fund gets nod to invest Rs 3,700 cr in India

by www.indiape.com on Fri 11 Feb 2011 12:48 AM IST

Mauritius-based venture capital fund, Enam India Infrastructure, will invest Rs 3,700 crore in Indias infrastructure and energy projects through a dedicated core sector fund. Promoted by Mumbai-based Enam Securities, the Mauritius outfit will bring in foreign direct investment worth Rs 3,450 crore through the fund. The cabinet committee on economic affairs cleared the investment proposal on Thursday. Enam India Infrastructure is a venture capital fund registered with Sebi in September last year and backed by promoters of Enam Securities. The private equity fund will essentially invest 80 per cent in infrastructure like roads,

power, ports and airports. The rest 20 per cent will be invested in allied units connected with infrastructure sector. more
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MakeMyTrip to acquire Singapore-based travel company

by www.indiape.com on Fri 11 Feb 2011 12:46 AM IST

India-based online travel services provider MakeMyTrip on Thursday said it will acquire 79% stake in Singapore-based travel agency Luxury Tours and Travel (LTT) for $3 million to expand its presence in markets outside India. The company, which also announced an over two-fold increase in its net profit for the quarter ended December, 2010 at $1.62 million from the same quarter of 2009, said it has the option of increasing the stake in LTT in future. "MakeMyTrip will also invest approximately $0.75 million in addition, in one or more tranches until June 2012, for the subscription of new equity shares to be issued by LTT," it said. Further, the travel portal will acquire from the existing shareholders, their remaining shares in LTT, in three tranches over a three-year period ending June 2014, it said. more
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by www.indiape.com on Fri 11 Feb 2011 12:42 AM IST

Education to get boost on govt reform, PE funds

Indias education sector is likely to see heavy investments from private equity funds over the next couple of years betting on increased government spending and as private players plan expansions, officials said. The sector, pegged at $86 billion, is seeing fresh interest from foreigners and large funds who are pumping in money in services, technology and infrastructure, they added. The education market in India is roughly worth $50 billion in the private sector and all parts of the educational value chain are offering good investment opportunities, said Rajesh Singhal, managing partner of private equity firm Milestone Religare Investment Advisors Pvt Ltd. Private equity investment in the next two-three years should be in the range of $400-$500 million and that should not be a difficult target at all, he added. Currently, investments are to the tune of $200-$250 million, officials say. Milestone Religare recently invested 250 million rupees in an Indian education service firm from its Rs6 billion private equity fund that focusses on education and healthcare. more
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Builders seek PE money for old land payments, more plots

by www.indiape.com on Fri 11 Feb 2011 12:37 AM IST

Real estate developers are depending heavily on private equity (PE) funds to bail them out to make payments for old land acquisitions and to kick off projects at the land-buying stage. With bank loans drying up and cash flows under stress due to dipping sales, PE money seems to be the only source of relief. Two Mumbai-based firms, DB Realty Ltd and Ackruti City Ltd, need to pay up a premium of Rs.802 crore and Rs.330 crore, respectively, in February for the redevelopment of the high-profile Bandra Government Colony project in the city that was allotted to them by the state government last year. The land premium that was to be paid in September 2010 was pushed to February this year according to a 28 January report by Anand Rathi Financial Services Ltd. Both the developers have said that they will need to raise money to make the payments. more
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Wednesday, February 9
by www.indiape.com on Wed 09 Feb 2011 10:49 PM IST

CIL may buy 15% stake in Peabody's Australia assets for $100mn

Coal India Ltd , the world's largest coal producer, may buy up to a 15% stake in US-based Peabody Energy Corp's Australian assets early next fiscal for an estimated USD 100 million (about Rs 450 crore). "It (deal) should not take too long a time. It should be two to three months. We are in the final stages of talks with Peabody Energy for a 15% stake for USD 100 million," an official privy to the development, who did not wish to be named, told PTI. More or less an agreement has been reached on the valuation, the official said, adding, "We will invest in equity and in return, we will get the right for coal offtake." CIL Chairman P S Bhattacharyya, however, refused to comment on the issue. The proposal to buy a stake in Peabody's asset

will be deliberated at a meeting of a sub-committee of the company board on the state-owned firm's foreign acquisition plans, which is likely to take place this month. more
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Sebi wants tighter norms for some deals

by www.indiape.com on Wed 09 Feb 2011 12:08 AM IST

The departing chairman of the Securities and Exchange Board of India (Sebi), C.B. Bhave, proposed changes in key areas related to the capital market, 10 days before the end of his three-year term. In a bid to bring in more transparency in deals between group companies, Sebi will propose that the ministry of corporate affairs tighten norms for all interested parties, including promoters, in such deals. The market regulator said it will recommend to the ministry the amendment of a clause of the Companies Bill, 2009, to prevent interested shareholders from voting on the special resolution of the prescribed related party transaction. The definition of interested party will cover the promoters of companies, Bhave said, while addressing the last board meeting of his tenure that ends on 17 February. The board discussed some of the issues that had arisen out of the earnings fraud at Satyam Computer Services Ltd. Investors wont be allowed to vote on resolutions that involve a conflict of interest. The issue arose when Maytas was proposed to be amalgamated with Satyam. Though the transaction did not materialize eventually, the matter originated from there, said Bhave. more
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Monday, February 7
by www.indiape.com on Mon 07 Feb 2011 11:12 PM IST

PE investment slows down to $500 mn in Jan: E&Y

Private equity investment slowed down to $500 million in January over the previous month, says a report by Ernst & Young. Infrastructure companies, however, attracted a major chunk of the PE investment in January, which was lower by 9% over about $550 million in December last year, the report said. "There has been a marginal decline in the aggregate investments during the month compared to last month, but activity remains robust compared to January 2010," E&Y Partner (Private Equity) Mayank Rastogi told PTI. The total PE investment in January 2010 was $380 million. However, the total number of deals announced during the month was higher than that in both the previous month and January 2010. In January this year, 28 PE deals were announced, against 26 deals in December and 16 in the same month last year. more
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PE firms bank on tax cover for deal exits

by www.indiape.com on Mon 07 Feb 2011 11:02 PM IST

Private equity (PE) firms are taking tax insurance on exits from investments in order to protect themselves from litigation, having been spooked by the recent travails that have beset acquisitions by HSBC and Vodafone. According to tax consulting firms such as KPMG, Deloitte Haskins and Sells and PricewaterhouseCoopers (PwC), and law firms that help PE firms structure the exits, funds are seeking such cover while negotiating the deals. However, they declined to disclose details of such transactions due to client confidentiality agreements. Funds are actively looking to take some cover regarding uncertainties on the taxation aspect, said Pranay Bhatia, associate partner at legal firm Economic Laws Practice (ELP). In the past one year, he has worked on at least five exits where such insurance cover was taken. There is a lot of uncertainty regarding the Mauritius tax treaty protection in the (proposed) direct taxes code, so we want to protect ourselves from any tax exposure, said a fund manager of a foreign PE fund that invests in India. He declined to be identified. more
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by www.indiape.com on Mon 07 Feb 2011 10:53 PM IST

PE biggies chase healthcare deals

Marquee private equity names are in the reckoning for bigger investments in India's $50-billion healthcare industry. General Atlantic Partners (GAP) and Jardine Rothschild are among the funds that are likely to cut deals with a few emerging healthcare service providers in the coming weeks. General Atlantic, which is shaking off its technology and export focus in India, is holding discussions to buy $100 million, or Rs 450

crore, stake in DM Healthcare spearheaded by Dubai-based medical entrepreneur Dr Azad Moopen. Jardine Rothschild Asia Capital, a private equity joint venture between Jardines and the Rothschilds, is in the fray for $50 million, or around Rs 200 crore, investment in Hyderabad-based Quality Care, which operates a network of 12 hospital under the Care brand. These transactions are part of the ambitious growth capital raising by emerging healthcare networks. Care Hospital-in which the big bull Rakesh Jhunjhunwala and serial entrepreneur and Matrix Labs founder N Prasad are investors-plans to raise Rs 350 crore in equity and debt for doubling beds from 1,700 to 3,200. DM Healthcare is looking at over Rs 600 crore fund-raise to ramp up fast even through acquisitions. more
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PE fund of funds fading due to changes in investor tastes

by www.indiape.com on Mon 07 Feb 2011 10:50 PM IST

Fundraising woes and changing investor preferences are diminishing the influence of private equity fund-offunds managers. No longer can a fund-of-funds manager's decision whether to invest in a fund make or break that fund. In fact, some insiders estimate that 20% of current fund-of-funds managers might not survive because of fundraising problems. According to Preqin, an alternative investment research firm in London, funds of funds accounted for a mere $10.7 billion of the $225 billion raised worldwide by private equity funds in 2010, the lowest total since 2004. In 2009, funds of funds accounted for $27.4 billion. Private equity funds of funds returned 11.6% for the year ended June 30, according to Preqin. The overall private equity internal rate of return for the year ended June 30 was 19.18%.Industry professionals predict that many funds of funds will either merge, close or change investment strategies. more
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