Colin C. Blaydon

English

Research Papers in Economics

1 Center For Private Equity and Entrepreneurship 2007
Overview of the Private
Equity Sector
Economics of Private Equity Investment
Center for the Study of Innovation and 
Productivity
Federal Reserve Bank of San Francisco
October 19, 2007
Colin C. Blaydon
Professor of Management and Dean Emeritus
Center for Private Equity and Entrepreneurship
Tuck School of Business at Dartmouth2 Center For Private Equity and Entrepreneurship 2007
Presentation objectives
• Provide an overview of the role of Private 
Equity in the economy
• Explain the structure and history of the 
industry
• Describe the key participants and players
• Highlight forces that are shaping the 
industry3 Center For Private Equity and Entrepreneurship 2007
What is Private Equity?
Narrow Definition: “Equity investments in non-public 
companies”
• Key sub-sectors:
o Venture capital – focuses on investing in new companies 
with high growth rates
o Buyouts – the purchase of a controlling interest of a 
company or a business unit of a company by an outside 
investor often with substantial borrowed capital (in a 
leveraged buyout ) or a management team (in a 
management buyout)
Broad Definition: includes Private Investment in 
Pubic Equities (PIPEs), Mezzanine, Distress, Hedge4 Center For Private Equity and Entrepreneurship 2007
Limited Partners
• Pensions
• Endowments
• Foundations
• Wealthy
individuals
•Other 
institutions
Private Equity
Firms
• Venture capital
• Buyout
Corporate 
Investors
Angel 
Investor
s
Funds 
of Funds
Advisors:
•Gatekeepers
•Placement agents
Industry key players collaborate to 
make investments
Portfolio 
Companies
Other Service 
Providers:
• Consultants
• M&A advisors
• Underwriters
• Lawyers5 Center For Private Equity and Entrepreneurship 2007
Funds flow back to LPs after 
liquidity events
M&A
IPO
Entrepreneurs
Managers
Other investors
Cash / 
Shares
20%
Profits
Profits
80%
Clawbacks
Returned capital
Limited Partners
• Pensions
• Endowments
• Foundations
• Wealthy
individuals
Private Equity
Firms
• Venture capital
• Buyout
Entrepreneur
s & Portfolio 
Companies
Capital
Invested Capital
Invested 100+%
Transaction fees6 Center For Private Equity and Entrepreneurship 2007
The private equity model
• Concentrated governance
– Small involved board
– Direct consultation
– Strong management incentive (ownership)
• Absence of public market “earnings myopia”
• Source of value
– Multiple expansion (“buy low, sell high”)
– Leverage
– Cash flow improvement
• Iconic test: Chrysler and Cerberus7 Center For Private Equity and Entrepreneurship 2007
Structure of a buyout: capitalization
• Debt (~70% of overall cap structure)
– Bank debt
• Two types:
– Revolving credit facility – (i.e. Revolver) can be paid down and 
re-borrowed as needed
– Term debt (senior and subordinated)  w/ floating rates 
– Mezzanine debt
• Two types:
– High yield (typically public markets) 
– Subordinated notes (typically banks, institutions, private equity funds)
• Other key features:
– Warrants
– Payment-In-Kind (PIK) toggle allows no interest payment and increase in 
principal
• Equity (~30% of overall cap structure)
– Common stock
– Preferred stock8 Center For Private Equity and Entrepreneurship 2007
The role of financial innovation 
and market structure
• Impact of ERISA and the “Prudent Man”
clause
• Junk bonds (1980s)
• Securitized debt: CLOs, CDOs (2000s)
• Pattern:
imitators innovation
excess and 
overshoot
correction
and
modification
down cycle (recession,  defaults)9 Center For Private Equity and Entrepreneurship 2007
The perfect storm
• Economic recovery (2002+)
• Debt market expansion (2002 – July 2007)
• LBO expansion (2003 – July 2007)
• PE industry institutionalization (2006+)
• Confidence crisis and backlash10 Center For Private Equity and Entrepreneurship 2007
Multiple expansion11 Center For Private Equity and Entrepreneurship 2007
Debt market expansion
• Expanding debt multiples
• Lower interest rates
• Vanishing terms
• Securitization (CLOs)
• Falling default rates12 Center For Private Equity and Entrepreneurship 2007
Multiple expansion13 Center For Private Equity and Entrepreneurship 2007
Leveraged loans outstanding14 Center For Private Equity and Entrepreneurship 2007
Covenant-lite loans15 Center For Private Equity and Entrepreneurship 2007
CLO structures become popular16 Center For Private Equity and Entrepreneurship 2007
Default rates at historical lows
Source: Standard & Poor’s Leveraged Commentary & Data.  As of August 2007.
U.S. Corporate Market Default Rates
0.00%
1.00%
2.00%
3.00%
4.00%
5.00%
6.00%
7.00%
8.00%
Asian
Contagion
(Oct 97)
Russian
Default/
LTCM
(Oct 98)
Nasdaq
Meltdown
(Mar 00)
Sept 11 
(Oct 01)
Adephia
Default
(Oct 02)
GM/Ford
Downgrades
(May 05)
Liquidity
Squeeze
(Sep 06)
Subprime
Contagion
(July 07)
By Principal Amount
By Number
D
e
f
a
u
l
t
 
R
a
t
e
 
(
%
)17 Center For Private Equity and Entrepreneurship 2007
Rise of LBOs
• Early returns (leveraged recaps for equity 
dividends)
• Expanding deal volume and size
• LBO fundraising expansion
• Club deals and mega deals
• PE industry institutionalization18 Center For Private Equity and Entrepreneurship 2007
Quick dividend payouts
Source:  Cambridge Associates19 Center For Private Equity and Entrepreneurship 2007
November-06 Equity Office $ 36.0 billion 
July-06 HCA 33.0 
March-07 TXU 31.8 
April-07 First Data 29.0 
November-06 Clear Channel 26.7 
October-88 RJR Nabisco 25.1 
September-06 Freescale Semiconductors 17.6 
April-06 GMAC (Financing Unit) 14.0 
May-06 Kinder Morgan 13.6 
March-06 TDC AS 12.9 
June-06 Univision Communications 12.1 
March-06 SunGard Data Systems 11.0 
August-06 Royal Philips Elec. NXP Semi Conductor 
Business
10.5 
January-06 VNU NV  9.7 
March-06 GMAC Commercial Holdings  Corp. (Mortgage 
Unit)
9.0
Source: Buyouts, News Clipping, and Press Releases
Historical deal sizes20 Center For Private Equity and Entrepreneurship 2007
Deal size increases21 Center For Private Equity and Entrepreneurship 2007
Source: Dealogic. *Acquisitions by private equity firms & add on transactions by portfolio companies. As of April 2007.
$0
$50
$100
$150
$200
$250
$300
$350
$400
$450
2000 2001 2002 2003 2004 2005 2006 YTD
2007
U.S. Europe Asia-Pacific Other
U
S
 
$
 
b
i
l
l
i
o
n
s
(114) (82) (111)
(150) (178)
(338)
(740)
(307)
(annual aggregate)
Global Financial Sponsor Buyouts
LBO deals expand 22 Center For Private Equity and Entrepreneurship 2007
Private equity fundraising increases23 Center For Private Equity and Entrepreneurship 2007
Mega funds appear24 Center For Private Equity and Entrepreneurship 2007
Fund Manager Target Closed 
Goldman Sachs $10.0BN $20.0BN
KKR $15.5BN $18.5BN
Blackstone $13.5BN $15.6BN
TPG $14.0BN $15.2BN
Carlyle 17.0BN $15.0BN
Apollo $10.0BN $10.1BN
Thomas H. Lee $9.0BN $8.0BN
Hellman & Friedman $8.4BN $8.0BN
Bain Capital $8.0BN $8.0BN
Madison Dearborn $10.0BN $6.5BN
Total $115.4BN $124.9BN
Largest funds of 2006 - 2007 25 Center For Private Equity and Entrepreneurship 2007
Syndicates use purchasing power26 Center For Private Equity and Entrepreneurship 2007
Apollo……………………………………. Credit Lyonnais
Blackstone……………………………. Peoples Bank Of China
The Carlyle Group………………… Abu Dhabi Government
Thomas H. Lee Partners………. Putnam Investments/
Marsh & McLennan
Fortress Investments…......... Nomura Holdings Inc.
Investor Investor LBO Firms LBO Firms
PE firms seek liquidity27 Center For Private Equity and Entrepreneurship 2007
Euronext
NASDAQ
Feeder to U.S.-based 
fund 
Market 
Cap*
$2.2BN
Type
Euronext
Close-end debt 
fund
Feeder to U.S.-based 
fund
NYSE
Sale of  Management 
Company
$1.6BN
$7.3BN
NYSE
Sale of  Management 
Company
$2.2BN
$3.9BN
Euronext Euro 1.1BN Feeder to U.S.-based 
fund
Date Listing
2007
2006
2004
2006
2006
2005
PE goes public (IPOs)28 Center For Private Equity and Entrepreneurship 2007
Apollo Advisors
Bain Capital
The Blackstone Group
The Carlyle Group
GS Capital Partners
Hellman & Freidman
JPMorgan Partners
KKR
Madison Dearborn
Providence Equity Partners
Silver Lake Partners
Texas Pacific Group
Thomas H. Lee Partners
Welsh Carson Anderson & Stowe 
Warburg Pincus
Managing
Multiple 
Funds
Sold
Minority
Interest
Captive of 
Financial
Institution
Independent
Mono-Line
Boutique
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Public 
Capital
•
•
•
• •
•
•
•
Evolution of PE firms: a new “bulge 
bracket”29 Center For Private Equity and Entrepreneurship 2007
Backlash, confidence crisis, 
correction
• Backlash
– Envy, ignorance, injustice
– Tax proposals
– Union activism
• Confidence crisis
– New mega deals “hung up” or on hold
– CLOs terminated or restructured30 Center For Private Equity and Entrepreneurship 2007
Delayed or canceled leveraged loan 
transactions
Source: JP Morgan
Borrower Loan amount Purpose Delayed / Pre-funded Cancelled
($ in millions)
Chrysler - CarCo $10,000 LBO $10,000
Allison Transmission $3,500 LBO $3,500
US Food Service $3,465 LBO $3,465
Service Master $3,350 LBO $3,350
Calpine $3,000 Refi $3,000
Targa Resources $2,475 Div Recap $2,475
Home Depot Supply $2,200 LBO $2,200
EPCO Holdings $1,700 Refi $1,700
Bombardier Recreation Products $1,400 Div Recap $1,400
Border Group $1,325 Refi $1,325
US Investigations $1,255 LBO $1,255
Evraz Oregon Steel Mill  $1,200 Refi $1,200
Enterprise GP Holdings $1,200 Refi $1,200
Source InterLink $1,180 Acq $1,180
Laureate Education $1,150 LBO $1,150
Collective Brands $1,075 Acq $1,075
Tower Automotive $910 Dip Exit / LBO $910
Hunt Refining $760 GCP $760
Myers Industries $685 LBO $685
Vertrue $660 LBO $660
DAE Aviation $657 Acq $657
Integra $595 M&A $595
BISYS $565 LBO $565
GSI Group $475 LBO $475
Intertape Polymer Group $460 LBO $460
RadNet $445 Refi $445
CCS Medical $430 Refi $430
Alliant Insurance $420 LBO $420
Dayton Superior $410 Refi $410
VNU $400 Acq $400
Symbion $375 LBO $375
Oxygen Media $345 Refi $345
Stoneridge $300 Refi $300
Eagle Picher $290 Refi $290
Stolle Machinery $250 Div Recap $250
Oreck $200 Refi $200
SGS International $194 Reprice $194
Escort $124 Div Recap $124
Oneida $120 Div Recap $120
39 Deals $49,545 $36,987 $12,55831 Center For Private Equity and Entrepreneurship 2007
$26.1
$23.1
$1 5.5
$1 8.5
$1 4.0
$8.0
$1 2.5
$9.0
$7.3
$6.0
$5.1
$1 0.0
$4.9
$3.4
$7.1
$4.4
$4.1
$2.5
$4.3
$ 11.3
$1 2.4
$7.7
$2.6
$7.0
$9.0
$4.0
$6.0
$6.2
$6.0
$5.1
$2.9
$3.8
$2.2
$2.5
$4.0
$1 .7
$23.2
$21 .1
$21 .0
$1 7.0
$1 6.5
$1 5.0
$1 3.5
$1 2.0
$1 0.2
$1 0.0
$7.8
$6.0
$6.5
$6.6
$6.6
$7.2
$7.1
$0.0 $5.0 $10.0 $15.0 $20.0 $25.0 $30.0 $35.0 $40.0
TXU (KKR/TPG/GSCP)
BCE (Ontario/Providence/MDP)
Alltel (TPG/GSCP)
Clear Channel (THLee/Bain)
Basell (N/A)
First Data (KKR) 
Sallie Mae (JCFlowers/JPM/BoA)
Harrah's  (Apollo/TPG)
Cablevision (Dolan family)
Hexion Specialty Chemicals (Apollo)
Intelsat  (BC Partners)
Chrysler Car Co (Cerberus)
Mylan Labs (N/A)
Home Depot Supply  (Bain/Carlyle/CD&R)
Penn National Gaming (Fortress/Centerbridge)
Alliance Data (Blackstone)
ACS (Cerberus/Darwin Deason)
United Rental  (Cerberus)
Avaya  (TPG/Silver Lake)
Loan Bond
$35.5
$37.4
Leveraged finance calendar is busy and 
uncertain
Source: JP Morgan32 Center For Private Equity and Entrepreneurship 2007
Correction
• PIK toggle debt disappears
• Covenants reappear
• Debt and enterprise value multiples decline
• Bank senior debt reappears
• Debt interest rates rise33 Center For Private Equity and Entrepreneurship 2007
Covenant light transactions that add 
covenants
Source: JP Morgan
Borrower Sponsor  Covenant Addition
Aeroflex Veritas Capital, Golden Gate Capital Total Leverage Test
Alliant Insurance Blackstone Sr. Sec. Leveraged Test
Appleseeds Golden Gate Capital 1st lien Leverage Test/ Minimum EBITDA
Caritor CVCI Net Leverage Test
CDW Madison Dearborn Sr. Sec. Leveraged Test
Ceva Logistics Apollo Sr. Sec. Leveraged Test
Chrysler - Fin Co Cerberus Debt to Net Worth Test to include 2nd lien
Chrysler - Car Co Cerberus Borrowing Base Test / Minimum Liquidity Test
Container Store Leonard Green Rent Adjusted Sr. Sec. Leverage Test
Express  Golden Gate Capital Leverage Test
First Data KKR Sr. Sec. Net Leverage Test
Good Year EPD Carlyle Sr. Sec. Leverage Test
Gregg Appliances Freeman Sogli Leverage Test
Harlan Sprague Dawley Genstar Investment Group Maintenance Test
Hilite International  Kelso, Blue Capital, Court Square Capital Interst Coverage Test / Leverage Test
Investive NA Total Leverage Test
Medical Media Providence Ventures Leverage Test
Mitel Networks Morgan Stanley Capital, Francisco Partners Maintenance Test
Myers Industries Goldman Sachs Leverage Test
Nelson Education OMERS Capital Partners 1st lien Leverage Test/ Total Leverage Test
Niagara Kohlberg & Co. Leverage Test
RJ O' Brien Spectrum Equity Investors Total Leverage Test
Source Interlink Yucaipa Companies Sr. Sec. Leverage Test
Spirit Finance Macquarie / Och - Ziff Loan to Value Test / Debt Service Coverage
Syniverse GTCR Golder Rauner Maintenance Test
Thomson Learning Apax, OMERS Capital Partners Sr. Sec. Leverage Test
Tower Automotive  Cerberus Interst Coverage Test / Net 1st and 2nd lien Leverage Test
Van Houtte Littlejohn & Co Total Leverage Test
Vertrue One Equity Partners 1st and 2nd lien Leverage Test
White Birch NA Interest Coverage Test
Recent selected maintenance covenant - flexed loans34 Center For Private Equity and Entrepreneurship 2007
Vulture and special situation funds raised 
overnight
“The potential returns on LBO debt at the moment match 
those of equity investments in the buyouts.”
-Blackstone’s Q2 earnings call
Goldman Sachs - Market Dislocation Fund
Lehman Brothers - Special Situation Fund
Oak Tree Capital  - Special Situation Fund
TCW - Special Mortgage Credit Fund
Ellington Management - Vulture Fund
Marathon Asset Management - Vulture Fund35 Center For Private Equity and Entrepreneurship 2007
Credit crunch impact on LBOs
“Some 29 buyout-backed companies with an 
estimated $17.3 billion in publicly-traded 
debt are at high risk of defaulting on those 
obligations, according to a new report from 
ratings agency Standard & Poor's.”
Buyouts Magazine 
Sept. 200736 Center For Private Equity and Entrepreneurship 2007
Outlook for private equity
• New mega deals on hold
• Recent mega deal expected returns diminished
• M&A auction hierarchy shift
– PE owned strategic acquirer
– Stand-alone financial buyer
– Traditional corporate strategic acquirer
• Restructuring of CLO market terms
• Minority private investments
• Private investments in public equities (PIPEs)
• Defaults and distressed investing cycle (S&P)?

Overview of the private equity sector

http://www.frbsf.org/csip/research/200710_Colin_Blaydon.pdf

Overview of the private equity sector

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Research Papers in Economics