How do private equity investors create value?
How do private equity investors create value? An Australian study of 2007 exits
About the studies Global study
Local study
The global study selected the largest 100 companies for evaluation based on entry enterprise value, to avoid bias that would skew the sample toward successful deals. The sample included 53 exits in Germany, France, the UK and other European nations, 44 in the US and Canada and 3 in Australia and Asia.
Our local review encompassed 13 of the 20 exits in the Australian market. Whereas globally the study focused on the largest 100 exits, the Australian component focused on all exits with entry enterprise value greater than A$50m. Despite this difference in deal size, the studies utilised a common methodology and the findings focus on financial and operational metrics which are not size specific. Hence, the Australian results are directly comparable to the global outcomes.
The study is built on public data and detailed interviews with 70 of the 100 sample companies participated in the 2007 study. They spoke openly about their management of these former portfolio companies. Their responses to questions fleshed out the thinking and process behind the numbers, and were carefully evaluated in a context of objective market data. Some of the deals were not viewed as successful – enabling the study team to delve deeper into the industry’s approach to challenges and market shifts.
This report provides hard data on the deal performance of Australian private equity, combining detailed financial performance with qualitative drivers and influences.
2
How do private equity investors create value? An Australian study of 2007 exits
Australia’s first private equity performance report The impact of the private equity (PE) phenomenon hit Australia later than the other western economies of Europe and North America. In 2005, while the global market soared, PE only contributed to 8% of Australia’s mergers and acquisitions (M&A). However, Australia has since caught up quickly, with PE accounting for 27% of this activity in 2007.
One of the consequences of Australia playing catch up is that, until now, assessments of local PE performance have been largely anecdotal. While commentators have extrapolated from global studies, their conclusions have been implied, not proven. But now, for the first time, this report provides hard data on the deal performance of Australian PE, combining detailed financial performance with qualitative drivers and influences. This local study was conducted in parallel with Ernst & Young’s annual global private equity study, using a consistent methodology. Thus, we are also able to draw meaningful comparisons with global performance, to understand the relative maturity, commonalities and differences between Australia and the global PE market. This will provide a view of future developments for our market based on the global trends.
This report gives our private equity clients objective performance comparisons and market benchmarks, and provides insight into the likely characteristics of successful PE firms, which prove very helpful in the current tighter economic conditions. Yet its findings have a broader audience than the PE market. They inform public interest in how PE firms achieve superior investment returns. Moreover, the PE practices revealed in the study – from portfolio management to incentive structures – are relevant to the corporate domain. We trust you find this assessment of calendar 2007 Australian exits insightful, timely and relevant. Bryan Zekulich Oceania Managing Partner, Private Equity Ernst & Young
How do private equity investors create value? An Australian study of 2007 exits
1
Executive Summary In 2007 PE firms invested $3.8 billion, or 27%, of total M&A value in the Australian market. However, in the second half of the year, the industry was buffeted by the credit crunch and mounting economic uncertainty. This is likely to result in fewer 2008 exits and longer holding periods for the portfolio companies. Continuing above market returns will require PE firms to deliver increased profitability and stronger balance sheets.
Yet, as our studies revealed, the PE business model has essential strengths that should continue to create value for portfolio companies, despite market conditions. By every measure, the data shows PE firms outperforming their public counterparts. In Australia, with an average holding period of 3.5 years, PE exits grew earnings before interest tax depreciation and amortisation (EBITDA) at 36% compound annual growth rate (CAGR) – nearly five times the public benchmark. The studies’ findings counter the myth that cheap debt and cost cutting are the chief drivers of PE prosperity. PE firms proved their ability to sell businesses for much more than their original investment, using strong management, new organisational structures and well aligned, powerful incentives.
Their market nimbleness, adaptability to changing conditions, broad experience with varied investment rationales, and increasing prowess at operational improvements all combined to accelerate business growth. These real business improvements, along with PE’s focus on proactive buying and selling and its disciplined approach to organisational governance, built real value. While today’s market poses serious challenges, the facts and findings of the Australia and global 2007 studies strongly argue that PE investors do have the skills to add value to their portfolio companies and the PE industry has sustainability well beyond the credit crunch.
Figure 1: PE buy-outs in the Australian M&A market
AU$Billion 15
12
9
6
3
0 2005
2006
PE buyout value
2007
H1 2008
Total M&A value
Source: Mergermarket
2
How do private equity investors create value? An Australian study of 2007 exits
Highlights PE generates strong and sustainable growth • Private equity deals out-performed public
company benchmarks in Australia, both in terms of growth in Enterprise Value and EBITDA • Earnings improvements were primarily
driven by top-line growth, rather than financial engineering and cost reductions The Australian market is showing signs of maturity • Secondary buyouts are increasing and
expected to continue as a proportion of PE exits
The rationale for investing matters • The greatest growth in Enterprise Value
(EV) came from proactively growing the core business • The lowest growth came from
finding and investing in growth sectors or opportunities Working with management, getting involved in the business and being flexible are key PE traits • Quality management teams underpin
success – PE firms tend to retain existing management, invest significant time to get them comfortable with PE’s approach and align incentives • Exiting at the right time is key – PE
demonstrates the flexibility to sell early if the conditions are right or to hold on for the long term where necessary
How do private equity investors create value? An Australian study of 2007 exits
3
Private equity generates strong and sustainable growth In 2007, Australian businesses sold by PE firms outperformed public companies, more than doubling the value created as measured by both enterprise value and profits. In doing so, Australian PE held its own against Germany, the best European performer, and the United States (US).
Enterprise value (EV)
In 2007, EV for Australia’s PE exits grew at an impressive CAGR of 21%, almost double that of public companies at 11%. If we include two outliers*, this differential increases, with PE EV CAGR rising to 32% p.a. This is consistent with the EV for the top 100 global PE exits of 24%, double the respective public benchmark.
As building business value is the ultimate goal of all business owners, EV, representing the market worth of a company, is the key metric for the purposes of this study. Usefully, we can readily gauge EV of exits against public company benchmarks.
Figure 2: EV growth in Australia
32%
21% 11% Public company benchmark EV CAGR
Private equity
EV CAGR (including outliers)
Source: Ernst & Young study * Note: Private equity performance is shown in the graphs both including and excluding two outliers – deals with significant growth with EV CAGRs in excess of 250%
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How do private equity investors create value? An Australian study of 2007 exits
Figure 3: EV growth by country 2007
32%
21%
24%
29%
29%
29%
20%
13%
7%
24% 18%
12%
14% 2%
17%
12%
11%
9%
16%
22%
7%
20%
12%
-2% Total
Australia Germany
France
Public company benchmark
Southern Europe
USA
Northern Europe
UK
Private equity outperformance
Source: Ernst & Young study
EBITDA Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA) is an important driver of EV. In Australia, despite slowing acquisitions, which are a significant component of PE earnings growth, PE exits grew EBITDA at 36% CAGR – nearly five times the public benchmark of 8% CAGR. Earnings growth was driven primarily by expanding top-line revenue. Almost three quarters of EBITDA growth came from organic revenue growth (43%) or acquisitions (28%) with cost reductions and operating efficiencies only accounting for 20%. This data substantiates the (sometimes disputed) claim that PE does not rely purely on financial engineering or market movements – it generates real sustainable business growth.
Figure 4: EBITDA growth in Australia 2007
60 50 9%
40
Organic revenue
30
36%
20%
43%
Acquisitions
20 Cost reduction/restructuring 20%
10
28%
8% 0
Public company benchmark EBITDA CAGR
Other
Private equity EBITDA CAGR (including outliers)
PE EBITDA contribution
Source: Ernst & Young study
How do private equity investors create value? An Australian study of 2007 exits
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The Australian market is maturing Better returns were generated when buying private business. The global study shows that secondary buy-outs also generate significant value. This is a market now emerging in Australia.
Private provenance fares best While all acquired businesses prospered in PE hands, relative to public company benchmarks, the studies found PE firms made far less impact when they bought out listed companies. In Australia, the study revealed returns on private purchases were significantly higher than on those bought from public companies. This is consistent with our global study, which also found those bought from private owners did best.
Secondary buyouts do well under PE ownership Unlike Australia, where none of the exits were originally purchased from other PE investors, secondary buyouts made up 32% of the 2006-07 global exits, compared to just 19% originally bought from public stockmarkets. Despite public perceptions, the global study found that such acquisitions do well in the care of a second PE owner – growing EV by an average 27%. This is good news for Australia, where the secondary market is just starting to emerge. In 2007, 23% of exits were sold to secondary buyers, comparable to Europe in 2005. Based on global trends, we can expect this nascent secondary market to expand. In the secondary market, when smaller funds have created value by fine-tuning management, they tend to exit the business, rather than taking it to the next level. This offers larger funds, with the capacity to create global scale or leverage distribution channels, new acquisition opportunities.
6
How do private equity investors create value? An Australian study of 2007 exits
“When there’s a good opportunity to sell, take it … even if you think there is still value in the business and had planned on holding longer.”
Market impact 2007 was the top of an extraordinary market both in Australia and globally. Asked to explain exits that realised more than expected, PE investors in both studies most often cited favourable market conditions. Indeed, some PE firms took advantage of the hot market to accelerate exits. In Australia 50% of the participants admitted to exiting sooner than planned. A few, suspecting prices were ‘too good to be true’ and perhaps anticipating the downturn, joined the exit stampede.
The ability to select favorable exit timing and to be nimble sellers is vital for PE success. “When there’s a good opportunity to sell, take it,” said one investment manager, “even if you think there is still value in the business and had planned on holding longer.” That said, selling at a time of high transaction multiples is just one side of the story. Even correcting for market fervor that drove up prices, both studies demonstrate significant value creation from good management.
How do private equity investors create value? An Australian study of 2007 exits
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The rationale for investing matters In addition to calculating key performance metrics, the studies tracked each exit across a vast number of criteria: by hold period, investment rationales and internal growth initiatives amongst others. Analysing this data further reveals the story of PE value creation.
Primary investment rationale predicts success PE success differed widely depending on its primary investment rationale. In both studies, nearly all companies were acquired for one of three underlying investment rationales: 1. Accelerate growth from the core business 2. Buy and build 3. Invest in a growth sector/opportunity While the relative proportion of these rationales was broadly consistent between the studies, performance outcomes were strikingly different.
Accelerate growth from core business This was the top performing rationale in Australia, demonstrating PE’s capability to take an existing business and focus and improve from the core. In one example, PE’s contribution to business growth spanned a wide range of factors. PE provided access to growth capital, provided and encouraged a strategic and commercial approach rather than the previous conservative mindset and provided guidance on manufacturing strategies and a bolt-on acquisition. Such opportunities may proliferate in troubled economic times, when unwanted business assets find their way to market.
Figure 5: Primary investment rationale in Australia
EV CAGR
33%
92.2% Accelerate growth from the core business
25%
76.4%
Buy and build Invest in growth sector/opportunity
42%
8.4%
Proportion of deals Source: Ernst & Young study
8
How do private equity investors create value? An Australian study of 2007 exits
Buy and build
Growth sector or specific opportunities
The second best performing rationale in Australia (and the top performer globally) was ‘buy and build’, where roll-ups rely on M&A to add value to portfolio companies. An example from the Australian portfolio was PE expanding a small west coast business through acquiring 13 smaller businesses over 18 months. In this case, PE’s M&A skill set was vital for success and resulted in a much larger, more stable business with a footprint across all of Australia.
Investing in a growth sector or specific opportunity was the most common rationale in the global study, outperforming public benchmarks in EV by 12%. However, in Australia, although a similar proportion nominated this as their primary rationale, performance was below the public benchmark. This may be due to tight economic conditions slowing growth in the targeted sectors, or perhaps reflects in part the generalist, rather than specialist, nature of Australia’s PE market.
How do private equity investors create value? An Australian study of 2007 exits
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Driving step-change in value How does PE do it? Private equity investors bring a unique ownership model and an effective toolkit to the job.
The PE ownership model has a straightforward goal: to build as much business value as possible within a defined timeframe, typically three to five years. To that end, PE establishes an ownership structure in which key managers are incentivised to share the ownership vision and are motivated to maximise value. This is so powerful that, in some of the most successful deals, changing the ownership structure in this way was all it took to recharge the business. Of course, other interventions are sometimes required. In this case, the studies found PE brings a highly effective set of tools.
Proactive buying Buying well continues to be a key element of PE success. The global study found 82% of the 2007 sample companies were originated proactively via relationships with the target’s management, calls from the PE firm’s network or company and sector tracking. Sector focus is very important in the global market, creating advantage when buying and owning. The Australian sample highlights a less mature profile – with infrequent sector focus tracking or other proactive methods. Instead, investors relied on calls from existing networks to provide acquisition opportunities. Across both studies early, broad and thorough due diligence, with a full scope analysis of financial and non-financial issues, drove superior performance. As one Australian PE investor put it, “Getting industry experts involved in due diligence was valuable. It helped us to better understand and evaluate the business.”
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How do private equity investors create value? An Australian study of 2007 exits
“We didn’t just provide a new plan, we were actively involved in the business and working with management…”
Incentives and management
Business improvement and growth
According to the Australian study, management was key. The relationship with target management was important from the outset. In many cases, senior management with good reputations were a highly attractive component of the investment. Having the right people in place with the right motivations is vital.
Business improvement was critical to top PE exit performance in 2007. For the 2007 global exits, portfolio company ownership was marked by strategic, management and operationally savvy strategies. Focus on organic growth was an important element, with geographical expansion, improved selling and new products having a measurable impact. PE investors also achieved growth through acquisitions and restructuring.
The first thing most PE investors did was to retain senior managers capable of driving value and replace those not up to the task, often installing teams they worked with previously. They then quickly established incentives that motivated these managers to ‘think like owners’. Evaluating existing managers early on – and deciding on whether to retain them several months before closing on a buy deal – emerged as a best practice in the study. Reflecting on lessons learned, a common thread among former PE investors was: “we should have changed management sooner.”
Governance PE investors employ a unique, hands-on governance model. It includes constant and keen oversight, defined goals and timing, disciplined decision-making and rich resources. “We were all over the details,” recalled one Australian investor. Said another, “We didn’t just provide a new plan, we were actively involved in the business and working with management…it was challenging but fun!”
How do private equity investors create value? An Australian study of 2007 exits
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Outlook In tough economic times, PE should still maintain an advantage given its ability to outperform public companies. It also provides an opportunity to buy well, particularly for those PE firms with funding capacity.
Private equity has prospered in the booming M&A market of the past three years. That world of seemingly infinite opportunity is gone for now. PE firms can expect to hold investments longer and to see slower or negative valuation multiple growth. Both these factors will reduce returns on future exits. In the short term macro-economic uncertainty and the impact of a worldwide slowdown of profit growth make for an even murkier picture. In this environment, Australia’s PE firms will need to hone their portfolio management practices – particularly for troubled investments given the increasing scrutiny of banks, media, unions and governments. And selling well will be trickier, involving longer timeframes and adjusted expectations.
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In spite of the challenges, the proven ability of Australia’s PE market to outperform public companies on key metrics strongly suggests the industry can manage a slowdown and position itself to advantage when the market returns. Indeed, the study highlights some potential bright spots and opportunities. For one thing, although PE has grown in Australia, it has not penetrated as far as it might. The best PE investors have proven they can deliver superior profits, value and investment returns. Yet in such sectors as mining services, energy and financial services, PE-owned businesses make up only a tiny percentage of the overall market capitalisations.
How do private equity investors create value? An Australian study of 2007 exits
PE will need to be as nimble as possible, pushing well packaged opportunities into a warmed-up market.
Moreover, for some companies, uncertain economic conditions have created a very good buying time. 2008 is akin to 199091, when values were also depressed and liquidity hard to get. These circumstances create interesting acquisitions: basically sound assets, temporarily distressed, in which people have lost faith. Such deals can be more complex, and PE may have to put in more equity than before or use mezzanine finance, but these opportunities have the potential to yield high long-term value.
New exit routes may also offer opportunities to realise value. Secondary buyouts are increasing. Sovereign wealth funds and infrastructure investors could become a stronger presence. For these buyers, PE will need to be as nimble as possible, pushing well packaged opportunities into a warmedup market. Where this isn’t possible, PE flexibility on exit timing will allow firms to wait until liquidity returns to the market before selling their best businesses.
How do private equity investors create value? An Australian study of 2007 exits
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Our studies indicate that the PE value creation model is powerful and sustainable over the long term. Near term questions, of course, remain in an environment in which it is more difficult to sell, to own, and to buy. These more challenging market conditions are likely to polarise the Australian PE market. Winners will be those with both the resources to take advantage of buying opportunities and the ability to manage their existing portfolio, despite the tough market. At the other end of the spectrum, those funds previously relying on M&A activity to create value will struggle to deliver decent returns.
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As the slowing market forces PE to focus more on ownership and delivering value through organic growth, it will grow a new pool of experienced Australian managers who will be deployed into other companies. Thus, PE firms will start building their franchise outside the investee portfolios. As exit volumes contract in 2008 and potentially beyond, fundraising is predicted to weaken and fund returns will decline. But when the market recovers, Australia’s PE firms will be poised with a basket of better businesses ripe for exit.
How do private equity investors create value? An Australian study of 2007 exits
How do private equity investors create value? An Australian study of 2007 exits
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About Ernst & Young Private Equity Services
With success comes change and private equity now faces a new set of challenges. Private equity firms are now larger, more influential and higher profile than ever before. In Australia and New Zealand private equity funds have more than doubled in value over the last three years. Sustaining fund investment, entering new markets, sourcing and closing increasingly complex deals and creating value in portfolios are now critical to achieving optimal returns. To help our clients achieve their potential in this new environment Ernst & Young brings professionals from Assurance, Advisory Services, Transactions and Tax to help address their investment, transaction, and portfolio needs and to help deliver the returns their stakeholders expect.
Leadership Team Sydney Bryan Zekulich Oceania Managing Partner, Private Equity and Partner, Transactions Advisory Services
Tel: +61 2 9248 5833 [email protected]
Simon Tonkin Partner, Tax
Tel: +61 2 8295 6680 [email protected]
Doug Bain Partner, Assurance Advisory Business Services
Tel: +61 2 9248 4554 [email protected]
Robert Arvai Partner, Business Advisory Services
Tel: +61 2 9248 4276 [email protected]
Melbourne Jo Barker Partner, Transaction Advisory Services
Tel: +61 3 8650 7505 [email protected]
Brisbane David Ward Partner, Transaction Advisory Services
Tel: +61 7 3011 3270 [email protected]
Perth Peter Magill Partner, Transaction Advisory Services
Tel: +61 8 9217 1330 [email protected]
Adelaide Angus Blackwood Partner, Transaction Advisory Services
Tel: +61 8 8417 2041 [email protected]
New Zealand Andrew Taylor Partner, Transactions Advisory Services
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Tel: +64 9 308 1069 [email protected]
How do private equity investors create value? An Australian study of 2007 exits
How do private equity investors create value? An Australian study of 2007 exits
17
Ernst & Young Assurance | Tax | Transactions | Advisory About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 130,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve potential.
For more information, please visit www.ey.com/au © 2008 Ernst & Young Australia. SCORE No. AUNZ00000021 This communication provides general information which is current as at the time of production. The information contained in this communication does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Ernst & Young disclaims all responsibility and liability (including, without limitation, for any direct or indirect or consequential costs, loss or damage or loss of profits) arising from anything done or omitted to be done by any party in reliance, whether wholly or partially, on any of the information. Any party that relies on the information does so at its own risk. Liability limited by a scheme approved under Professional Standards Legislation.
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S0818355
Australia
About the studies Global study
Local study
The global study selected the largest 100 companies for evaluation based on entry enterprise value, to avoid bias that would skew the sample toward successful deals. The sample included 53 exits in Germany, France, the UK and other European nations, 44 in the US and Canada and 3 in Australia and Asia.
Our local review encompassed 13 of the 20 exits in the Australian market. Whereas globally the study focused on the largest 100 exits, the Australian component focused on all exits with entry enterprise value greater than A$50m. Despite this difference in deal size, the studies utilised a common methodology and the findings focus on financial and operational metrics which are not size specific. Hence, the Australian results are directly comparable to the global outcomes.
The study is built on public data and detailed interviews with 70 of the 100 sample companies participated in the 2007 study. They spoke openly about their management of these former portfolio companies. Their responses to questions fleshed out the thinking and process behind the numbers, and were carefully evaluated in a context of objective market data. Some of the deals were not viewed as successful – enabling the study team to delve deeper into the industry’s approach to challenges and market shifts.
This report provides hard data on the deal performance of Australian private equity, combining detailed financial performance with qualitative drivers and influences.
2
How do private equity investors create value? An Australian study of 2007 exits
Australia’s first private equity performance report The impact of the private equity (PE) phenomenon hit Australia later than the other western economies of Europe and North America. In 2005, while the global market soared, PE only contributed to 8% of Australia’s mergers and acquisitions (M&A). However, Australia has since caught up quickly, with PE accounting for 27% of this activity in 2007.
One of the consequences of Australia playing catch up is that, until now, assessments of local PE performance have been largely anecdotal. While commentators have extrapolated from global studies, their conclusions have been implied, not proven. But now, for the first time, this report provides hard data on the deal performance of Australian PE, combining detailed financial performance with qualitative drivers and influences. This local study was conducted in parallel with Ernst & Young’s annual global private equity study, using a consistent methodology. Thus, we are also able to draw meaningful comparisons with global performance, to understand the relative maturity, commonalities and differences between Australia and the global PE market. This will provide a view of future developments for our market based on the global trends.
This report gives our private equity clients objective performance comparisons and market benchmarks, and provides insight into the likely characteristics of successful PE firms, which prove very helpful in the current tighter economic conditions. Yet its findings have a broader audience than the PE market. They inform public interest in how PE firms achieve superior investment returns. Moreover, the PE practices revealed in the study – from portfolio management to incentive structures – are relevant to the corporate domain. We trust you find this assessment of calendar 2007 Australian exits insightful, timely and relevant. Bryan Zekulich Oceania Managing Partner, Private Equity Ernst & Young
How do private equity investors create value? An Australian study of 2007 exits
1
Executive Summary In 2007 PE firms invested $3.8 billion, or 27%, of total M&A value in the Australian market. However, in the second half of the year, the industry was buffeted by the credit crunch and mounting economic uncertainty. This is likely to result in fewer 2008 exits and longer holding periods for the portfolio companies. Continuing above market returns will require PE firms to deliver increased profitability and stronger balance sheets.
Yet, as our studies revealed, the PE business model has essential strengths that should continue to create value for portfolio companies, despite market conditions. By every measure, the data shows PE firms outperforming their public counterparts. In Australia, with an average holding period of 3.5 years, PE exits grew earnings before interest tax depreciation and amortisation (EBITDA) at 36% compound annual growth rate (CAGR) – nearly five times the public benchmark. The studies’ findings counter the myth that cheap debt and cost cutting are the chief drivers of PE prosperity. PE firms proved their ability to sell businesses for much more than their original investment, using strong management, new organisational structures and well aligned, powerful incentives.
Their market nimbleness, adaptability to changing conditions, broad experience with varied investment rationales, and increasing prowess at operational improvements all combined to accelerate business growth. These real business improvements, along with PE’s focus on proactive buying and selling and its disciplined approach to organisational governance, built real value. While today’s market poses serious challenges, the facts and findings of the Australia and global 2007 studies strongly argue that PE investors do have the skills to add value to their portfolio companies and the PE industry has sustainability well beyond the credit crunch.
Figure 1: PE buy-outs in the Australian M&A market
AU$Billion 15
12
9
6
3
0 2005
2006
PE buyout value
2007
H1 2008
Total M&A value
Source: Mergermarket
2
How do private equity investors create value? An Australian study of 2007 exits
Highlights PE generates strong and sustainable growth • Private equity deals out-performed public
company benchmarks in Australia, both in terms of growth in Enterprise Value and EBITDA • Earnings improvements were primarily
driven by top-line growth, rather than financial engineering and cost reductions The Australian market is showing signs of maturity • Secondary buyouts are increasing and
expected to continue as a proportion of PE exits
The rationale for investing matters • The greatest growth in Enterprise Value
(EV) came from proactively growing the core business • The lowest growth came from
finding and investing in growth sectors or opportunities Working with management, getting involved in the business and being flexible are key PE traits • Quality management teams underpin
success – PE firms tend to retain existing management, invest significant time to get them comfortable with PE’s approach and align incentives • Exiting at the right time is key – PE
demonstrates the flexibility to sell early if the conditions are right or to hold on for the long term where necessary
How do private equity investors create value? An Australian study of 2007 exits
3
Private equity generates strong and sustainable growth In 2007, Australian businesses sold by PE firms outperformed public companies, more than doubling the value created as measured by both enterprise value and profits. In doing so, Australian PE held its own against Germany, the best European performer, and the United States (US).
Enterprise value (EV)
In 2007, EV for Australia’s PE exits grew at an impressive CAGR of 21%, almost double that of public companies at 11%. If we include two outliers*, this differential increases, with PE EV CAGR rising to 32% p.a. This is consistent with the EV for the top 100 global PE exits of 24%, double the respective public benchmark.
As building business value is the ultimate goal of all business owners, EV, representing the market worth of a company, is the key metric for the purposes of this study. Usefully, we can readily gauge EV of exits against public company benchmarks.
Figure 2: EV growth in Australia
32%
21% 11% Public company benchmark EV CAGR
Private equity
EV CAGR (including outliers)
Source: Ernst & Young study * Note: Private equity performance is shown in the graphs both including and excluding two outliers – deals with significant growth with EV CAGRs in excess of 250%
4
How do private equity investors create value? An Australian study of 2007 exits
Figure 3: EV growth by country 2007
32%
21%
24%
29%
29%
29%
20%
13%
7%
24% 18%
12%
14% 2%
17%
12%
11%
9%
16%
22%
7%
20%
12%
-2% Total
Australia Germany
France
Public company benchmark
Southern Europe
USA
Northern Europe
UK
Private equity outperformance
Source: Ernst & Young study
EBITDA Earnings Before Interest, Taxes, Depreciation and Amortisation (EBITDA) is an important driver of EV. In Australia, despite slowing acquisitions, which are a significant component of PE earnings growth, PE exits grew EBITDA at 36% CAGR – nearly five times the public benchmark of 8% CAGR. Earnings growth was driven primarily by expanding top-line revenue. Almost three quarters of EBITDA growth came from organic revenue growth (43%) or acquisitions (28%) with cost reductions and operating efficiencies only accounting for 20%. This data substantiates the (sometimes disputed) claim that PE does not rely purely on financial engineering or market movements – it generates real sustainable business growth.
Figure 4: EBITDA growth in Australia 2007
60 50 9%
40
Organic revenue
30
36%
20%
43%
Acquisitions
20 Cost reduction/restructuring 20%
10
28%
8% 0
Public company benchmark EBITDA CAGR
Other
Private equity EBITDA CAGR (including outliers)
PE EBITDA contribution
Source: Ernst & Young study
How do private equity investors create value? An Australian study of 2007 exits
5
The Australian market is maturing Better returns were generated when buying private business. The global study shows that secondary buy-outs also generate significant value. This is a market now emerging in Australia.
Private provenance fares best While all acquired businesses prospered in PE hands, relative to public company benchmarks, the studies found PE firms made far less impact when they bought out listed companies. In Australia, the study revealed returns on private purchases were significantly higher than on those bought from public companies. This is consistent with our global study, which also found those bought from private owners did best.
Secondary buyouts do well under PE ownership Unlike Australia, where none of the exits were originally purchased from other PE investors, secondary buyouts made up 32% of the 2006-07 global exits, compared to just 19% originally bought from public stockmarkets. Despite public perceptions, the global study found that such acquisitions do well in the care of a second PE owner – growing EV by an average 27%. This is good news for Australia, where the secondary market is just starting to emerge. In 2007, 23% of exits were sold to secondary buyers, comparable to Europe in 2005. Based on global trends, we can expect this nascent secondary market to expand. In the secondary market, when smaller funds have created value by fine-tuning management, they tend to exit the business, rather than taking it to the next level. This offers larger funds, with the capacity to create global scale or leverage distribution channels, new acquisition opportunities.
6
How do private equity investors create value? An Australian study of 2007 exits
“When there’s a good opportunity to sell, take it … even if you think there is still value in the business and had planned on holding longer.”
Market impact 2007 was the top of an extraordinary market both in Australia and globally. Asked to explain exits that realised more than expected, PE investors in both studies most often cited favourable market conditions. Indeed, some PE firms took advantage of the hot market to accelerate exits. In Australia 50% of the participants admitted to exiting sooner than planned. A few, suspecting prices were ‘too good to be true’ and perhaps anticipating the downturn, joined the exit stampede.
The ability to select favorable exit timing and to be nimble sellers is vital for PE success. “When there’s a good opportunity to sell, take it,” said one investment manager, “even if you think there is still value in the business and had planned on holding longer.” That said, selling at a time of high transaction multiples is just one side of the story. Even correcting for market fervor that drove up prices, both studies demonstrate significant value creation from good management.
How do private equity investors create value? An Australian study of 2007 exits
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The rationale for investing matters In addition to calculating key performance metrics, the studies tracked each exit across a vast number of criteria: by hold period, investment rationales and internal growth initiatives amongst others. Analysing this data further reveals the story of PE value creation.
Primary investment rationale predicts success PE success differed widely depending on its primary investment rationale. In both studies, nearly all companies were acquired for one of three underlying investment rationales: 1. Accelerate growth from the core business 2. Buy and build 3. Invest in a growth sector/opportunity While the relative proportion of these rationales was broadly consistent between the studies, performance outcomes were strikingly different.
Accelerate growth from core business This was the top performing rationale in Australia, demonstrating PE’s capability to take an existing business and focus and improve from the core. In one example, PE’s contribution to business growth spanned a wide range of factors. PE provided access to growth capital, provided and encouraged a strategic and commercial approach rather than the previous conservative mindset and provided guidance on manufacturing strategies and a bolt-on acquisition. Such opportunities may proliferate in troubled economic times, when unwanted business assets find their way to market.
Figure 5: Primary investment rationale in Australia
EV CAGR
33%
92.2% Accelerate growth from the core business
25%
76.4%
Buy and build Invest in growth sector/opportunity
42%
8.4%
Proportion of deals Source: Ernst & Young study
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How do private equity investors create value? An Australian study of 2007 exits
Buy and build
Growth sector or specific opportunities
The second best performing rationale in Australia (and the top performer globally) was ‘buy and build’, where roll-ups rely on M&A to add value to portfolio companies. An example from the Australian portfolio was PE expanding a small west coast business through acquiring 13 smaller businesses over 18 months. In this case, PE’s M&A skill set was vital for success and resulted in a much larger, more stable business with a footprint across all of Australia.
Investing in a growth sector or specific opportunity was the most common rationale in the global study, outperforming public benchmarks in EV by 12%. However, in Australia, although a similar proportion nominated this as their primary rationale, performance was below the public benchmark. This may be due to tight economic conditions slowing growth in the targeted sectors, or perhaps reflects in part the generalist, rather than specialist, nature of Australia’s PE market.
How do private equity investors create value? An Australian study of 2007 exits
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Driving step-change in value How does PE do it? Private equity investors bring a unique ownership model and an effective toolkit to the job.
The PE ownership model has a straightforward goal: to build as much business value as possible within a defined timeframe, typically three to five years. To that end, PE establishes an ownership structure in which key managers are incentivised to share the ownership vision and are motivated to maximise value. This is so powerful that, in some of the most successful deals, changing the ownership structure in this way was all it took to recharge the business. Of course, other interventions are sometimes required. In this case, the studies found PE brings a highly effective set of tools.
Proactive buying Buying well continues to be a key element of PE success. The global study found 82% of the 2007 sample companies were originated proactively via relationships with the target’s management, calls from the PE firm’s network or company and sector tracking. Sector focus is very important in the global market, creating advantage when buying and owning. The Australian sample highlights a less mature profile – with infrequent sector focus tracking or other proactive methods. Instead, investors relied on calls from existing networks to provide acquisition opportunities. Across both studies early, broad and thorough due diligence, with a full scope analysis of financial and non-financial issues, drove superior performance. As one Australian PE investor put it, “Getting industry experts involved in due diligence was valuable. It helped us to better understand and evaluate the business.”
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How do private equity investors create value? An Australian study of 2007 exits
“We didn’t just provide a new plan, we were actively involved in the business and working with management…”
Incentives and management
Business improvement and growth
According to the Australian study, management was key. The relationship with target management was important from the outset. In many cases, senior management with good reputations were a highly attractive component of the investment. Having the right people in place with the right motivations is vital.
Business improvement was critical to top PE exit performance in 2007. For the 2007 global exits, portfolio company ownership was marked by strategic, management and operationally savvy strategies. Focus on organic growth was an important element, with geographical expansion, improved selling and new products having a measurable impact. PE investors also achieved growth through acquisitions and restructuring.
The first thing most PE investors did was to retain senior managers capable of driving value and replace those not up to the task, often installing teams they worked with previously. They then quickly established incentives that motivated these managers to ‘think like owners’. Evaluating existing managers early on – and deciding on whether to retain them several months before closing on a buy deal – emerged as a best practice in the study. Reflecting on lessons learned, a common thread among former PE investors was: “we should have changed management sooner.”
Governance PE investors employ a unique, hands-on governance model. It includes constant and keen oversight, defined goals and timing, disciplined decision-making and rich resources. “We were all over the details,” recalled one Australian investor. Said another, “We didn’t just provide a new plan, we were actively involved in the business and working with management…it was challenging but fun!”
How do private equity investors create value? An Australian study of 2007 exits
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Outlook In tough economic times, PE should still maintain an advantage given its ability to outperform public companies. It also provides an opportunity to buy well, particularly for those PE firms with funding capacity.
Private equity has prospered in the booming M&A market of the past three years. That world of seemingly infinite opportunity is gone for now. PE firms can expect to hold investments longer and to see slower or negative valuation multiple growth. Both these factors will reduce returns on future exits. In the short term macro-economic uncertainty and the impact of a worldwide slowdown of profit growth make for an even murkier picture. In this environment, Australia’s PE firms will need to hone their portfolio management practices – particularly for troubled investments given the increasing scrutiny of banks, media, unions and governments. And selling well will be trickier, involving longer timeframes and adjusted expectations.
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In spite of the challenges, the proven ability of Australia’s PE market to outperform public companies on key metrics strongly suggests the industry can manage a slowdown and position itself to advantage when the market returns. Indeed, the study highlights some potential bright spots and opportunities. For one thing, although PE has grown in Australia, it has not penetrated as far as it might. The best PE investors have proven they can deliver superior profits, value and investment returns. Yet in such sectors as mining services, energy and financial services, PE-owned businesses make up only a tiny percentage of the overall market capitalisations.
How do private equity investors create value? An Australian study of 2007 exits
PE will need to be as nimble as possible, pushing well packaged opportunities into a warmed-up market.
Moreover, for some companies, uncertain economic conditions have created a very good buying time. 2008 is akin to 199091, when values were also depressed and liquidity hard to get. These circumstances create interesting acquisitions: basically sound assets, temporarily distressed, in which people have lost faith. Such deals can be more complex, and PE may have to put in more equity than before or use mezzanine finance, but these opportunities have the potential to yield high long-term value.
New exit routes may also offer opportunities to realise value. Secondary buyouts are increasing. Sovereign wealth funds and infrastructure investors could become a stronger presence. For these buyers, PE will need to be as nimble as possible, pushing well packaged opportunities into a warmedup market. Where this isn’t possible, PE flexibility on exit timing will allow firms to wait until liquidity returns to the market before selling their best businesses.
How do private equity investors create value? An Australian study of 2007 exits
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Our studies indicate that the PE value creation model is powerful and sustainable over the long term. Near term questions, of course, remain in an environment in which it is more difficult to sell, to own, and to buy. These more challenging market conditions are likely to polarise the Australian PE market. Winners will be those with both the resources to take advantage of buying opportunities and the ability to manage their existing portfolio, despite the tough market. At the other end of the spectrum, those funds previously relying on M&A activity to create value will struggle to deliver decent returns.
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As the slowing market forces PE to focus more on ownership and delivering value through organic growth, it will grow a new pool of experienced Australian managers who will be deployed into other companies. Thus, PE firms will start building their franchise outside the investee portfolios. As exit volumes contract in 2008 and potentially beyond, fundraising is predicted to weaken and fund returns will decline. But when the market recovers, Australia’s PE firms will be poised with a basket of better businesses ripe for exit.
How do private equity investors create value? An Australian study of 2007 exits
How do private equity investors create value? An Australian study of 2007 exits
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About Ernst & Young Private Equity Services
With success comes change and private equity now faces a new set of challenges. Private equity firms are now larger, more influential and higher profile than ever before. In Australia and New Zealand private equity funds have more than doubled in value over the last three years. Sustaining fund investment, entering new markets, sourcing and closing increasingly complex deals and creating value in portfolios are now critical to achieving optimal returns. To help our clients achieve their potential in this new environment Ernst & Young brings professionals from Assurance, Advisory Services, Transactions and Tax to help address their investment, transaction, and portfolio needs and to help deliver the returns their stakeholders expect.
Leadership Team Sydney Bryan Zekulich Oceania Managing Partner, Private Equity and Partner, Transactions Advisory Services
Tel: +61 2 9248 5833 [email protected]
Simon Tonkin Partner, Tax
Tel: +61 2 8295 6680 [email protected]
Doug Bain Partner, Assurance Advisory Business Services
Tel: +61 2 9248 4554 [email protected]
Robert Arvai Partner, Business Advisory Services
Tel: +61 2 9248 4276 [email protected]
Melbourne Jo Barker Partner, Transaction Advisory Services
Tel: +61 3 8650 7505 [email protected]
Brisbane David Ward Partner, Transaction Advisory Services
Tel: +61 7 3011 3270 [email protected]
Perth Peter Magill Partner, Transaction Advisory Services
Tel: +61 8 9217 1330 [email protected]
Adelaide Angus Blackwood Partner, Transaction Advisory Services
Tel: +61 8 8417 2041 [email protected]
New Zealand Andrew Taylor Partner, Transactions Advisory Services
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Tel: +64 9 308 1069 [email protected]
How do private equity investors create value? An Australian study of 2007 exits
How do private equity investors create value? An Australian study of 2007 exits
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Ernst & Young Assurance | Tax | Transactions | Advisory About Ernst & Young Ernst & Young is a global leader in assurance, tax, transaction and advisory services. Worldwide, our 130,000 people are united by our shared values and an unwavering commitment to quality. We make a difference by helping our people, our clients and our wider communities achieve potential.
For more information, please visit www.ey.com/au © 2008 Ernst & Young Australia. SCORE No. AUNZ00000021 This communication provides general information which is current as at the time of production. The information contained in this communication does not constitute advice and should not be relied on as such. Professional advice should be sought prior to any action being taken in reliance on any of the information. Ernst & Young disclaims all responsibility and liability (including, without limitation, for any direct or indirect or consequential costs, loss or damage or loss of profits) arising from anything done or omitted to be done by any party in reliance, whether wholly or partially, on any of the information. Any party that relies on the information does so at its own risk. Liability limited by a scheme approved under Professional Standards Legislation.
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