Private Equity and

Venture Capital
Atul Kedia
Buyouts
Sessions 9, 10

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Lifecycle of a Company

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Buyouts
 Buyout funds acquire controlling equity stake in a target, allows to restructure
 Financial characteristics
 Governance characteristics
 Operational characteristics
 Globally, Buyout and LBO terms are used interchangeably
 Most Buyouts are structured as LBOs
 Leveraged Buy-out (LBO) means use of significant amount of leverage to buyout
 Ticket size is generally high (global average: USD 400 – 500 Mio)

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Characteristics of Buyouts

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Equity control
 Majority of economic and voting interests
 Typically,
 >50% shareholding, Or
 Control the composition of Board of Directors, allowing strategic and operational decision-making
 Equity control allows
 Changes to capital structure
 Expand or replace management team of the target company
 Drive operational improvements; differentiate core and non-core businesses
 professionalize the overall business throughout the holding period
 Crucial for exit planning – governance, strategic alignment, addl. spending if required
 Commands ‘control premium’, esp. while ‘taking private’

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Leverage
 Typically, an SPV (/holding company) is created to buyout the target
 Pco’s post-buyout capital structure would consist 50-75% debt (balance is equity)
 Debt capacity depends on
 target’s ability to generate cash flow from operations
 nature of the industry – stability of cash flows
 buyout investor’s reputation
 market conditions
 scenario analysis of risks
 What would be the security for loans?
 Benefits to buyers? Any cons?
 Benefits to sellers?
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Economic Alignment
 Important to align the economic interests of Pco’s management team and the fund
 Management compensation plan
 Meaningful equity stakes
 Substantial upside in the event of a successful exit
 Typically require a significant personal co-investment
 Managers as owners – aligns fund’s goal of maximising financial returns
 Risks for managers:
 What if the business performs poorly?
 Generally managers’ equity stake is subordinated to PE fund’s preferred position in capital
structure

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LBO financing
 Senior Debt
Sources of Uses of
funds funds  Largest portion of debt; issued by bank(s)
 Shortest term (5-8 years); least expensive
 Secured against identified assets
Purchase
Senior Debt  Priority claim in case of bankruptcy
target equity
 Most stringent covenants
 Multiple tranches (one amortising, others bullet)
Refinance Junior Debt
Junior Debt 
net debt
 Private institutional market / high-yield bonds
 Unsecured and subordinated to senior debt
Transaction  Longer maturities (8-10 years)
Equity
costs
 Typically bullet repayment
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Value Drivers - example
 Entry:
 EBITDA $110m
 Negotiated EV = $990m (9x EBITDA)
 Debt = 55.6% = $550m (5x EBITDA)
 Next 4 years:
 EBITDA grows at 8% annualized to $150m
 Target generates surplus FCF of $250m (during 4 years) to repay debt
 PE fund sells the company at 10x EBITDA
 Calculate:
 Multiple on Invested Capital (MOIC)
 Created value (for equity investors) and impact of EBITDA, Multiple, Net Debt as value drivers
 IRR
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LBO in different avatars
Management Types of BO
Teams in BOs Transactions

Management
Public to
Buyout
Private
(MBO)

Management
Carve-out
Buy-in (MBI)

Institutional Family
BO (IBO) Business

Secondary BO

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Hony, CIFA and Zoomlion

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Investment in Zoomlion
 Why did it make sense for Hony to invest in Zoomlion?
 Operational inefficiencies to be improved
 Why couldn’t Zhan, an enthusiastic backer of reforms, do it earlier?
 Dynamics of governance and management
 Excellent fit with Hony’s focus
 No ‘quick flips’
 SOE – a spealist
 Fabulous bargain
 Bought at less than 4x EBITDA (state price based on valuation consultant)
 Made 3x MOIC on day 1 of investment!
 Risks?
 Success of the deal depends on fundamental restructuring
 State will continue to hold a significant stake

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CIFA Deal – Pros and Cons
 Rationale
 Synergies and strategic benefits
 Deep industry knowledge with Zoomlion and Hony
 GS and Italian PE group to add strategic value
 A few missing points (vis-à-vis original investment)
 Hony, Zoomlion – no experience in cross-border transactions (integration!)
 Uncertainty of financial markets (50% debt could become a liability)
 What if the markets crash? Can the deal be passed or renegotiated?
 Valuation by bidding – higher end of the range of PE transactions
 Zoomlion was a play on China’s booming construction sector. CIFA?
 Sany’s presence – winner’s curse?
 Hony’s LPs may have invested for Chinese regional investments + Problems with JV structure

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What happened?
 Deal closed with purchase price of €490 million (plus €20 million in fees):
 €270 million equity and €240 million debt
 Debt/Trailing EBITDA=5x
 EV/Trailing EBITDA=10.3x
 Global recession battered CIFA’s EU sales; Italy allowed moving production to China
 CIFA European production largely shut down; R&D continued
 CIFA’s production moved largely to China (factory-within-factory + numerous synergies)
 Zoomlion experienced remarkable growth in sales and profits, in part due to acquisition
 Sales –RMB 20.8 billion in 2009 and RMB 32.2 billion in 2010
 Stock price grew to 350% at the end of 2010 from Sep 2008

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