IVCA Event Summary: How Private Equity Firms Create Value

IVCA Event Summary: How Private Equity Firms Create Value

September 23, 2008

CHICAGO - “ Ernst & Young partner Brad Kuntz on Sept. 18, 2008 showcased how private equity transactions favorably compared to public deals in 2007 and explored how firms can best create value. The Ernst & Young 2007 global private equity study examines the year's 100 largest private equity exits in Europe, North America and Asia.

While the credit crunch that emerged in 2007 has created obvious and profound volatility in the public markets and economy at large, its impact in 2007 was only just being felt by private equity investors and their portfolio companies.

While private equity exits in 2007 were lower than their recent peak in 2006 (which were noted as - œvery frothy times- ), Kuntz's presentation revealed relatively strong returns fueled by high EBITDA growth and short holding periods.

In 2007 with the help of highly leveraged debt, Kuntz showed how private equity-backed exits grew at 28 percent as opposed to public company performance, which grew by six percent.

The primary engine for this growth was outperforming revenue on the part of the companies that led to EBITDA growth. Private equity-backed companies also experienced higher employee growth and productivity on an EBITDA basis. Productivity on a strict revenue basis was higher for public companies in 2007.

- œMost of their value came from growing businesses,-  Kuntz said. He says deals under $500 million (typically in the telecom and technology sectors) were the highest performing. Overall, companies in the energy sector generated the highest private equity return on exits in 2006 to 2007. Kuntz added: - œThere are serious supply and demand issues.- 

In terms of deal flow and where investment opportunities are coming from, relationship-sourced deals (particularly those that came by way of management) outperformed deals that were the result of other inbound methods. While not always the preferred method for the buyer, auctions also performed well as those coveted deals were typically of a higher quality than others.  

In terms of assessing the quality and type of revenue that led to higher performance, organic revenue as opposed to that obtained via acquisition appeared to drive the highest returns in 2006 and 2007. The quality of the team and its initial plan also has a significantly positive impact as opposed to installing a new team and plan along the way.

Kuntz showed that the more stable the management, the higher and faster the return.

Value is also created when planned out after a deal. When analyzing 2007 exits, Kuntz noted that the IPO (while providing the highest value growth) was the least common path to liquidity. He also showed how the frequency and size of leveraged dividends increased in 2007.

Kuntz closed with comments dealing with the wreckage of the current crunch and offered advice on - œhow to deal with the aftermath- . An investment strategy should study and compare the impact closed liquidity is having on various sectors and deal sizes. Firms should take inventory of their strategies for deal sourcing and explore partnering opportunities.

Ways to improve value include a greater emphasis on post-deal value creation as well as increased attention on existing portfolio companies. Kuntz added that all potential exit routes should be explored.

Now in its third year, Ernst & Young's 2007 global private equity study reaffirms earlier findings that the largest businesses owned by private equity outperform public company benchmarks and that private equity investors create real value in their portfolio businesses.

Based on a combination of market data, detailed interviews with private equity investors responsible for the 100 largest exits and analysis drawing on hundreds of data points over three years, the 2007 study has assembled a rich picture of private equity performance and method. In greater detail than ever, it explores the sources of private equity success.

Kuntz leads Ernst & Young's commercial due diligence business in the Americas. His group provides market, customer, industry and business diligence and advice to clients engaged in transactions. Kuntz has extensive experience serving private equity and corporate clients. He is a co-leader of the North American study team on how private equity investors create value.