Module 3

Question 1

what are some driving characteristics that have shaped the high-multiple and high leverage environment we are in now?? (6)

Answer 1

readily available, inexpensive, and covenant lite capital options for quality assets

natural turn of PE investments from 05-07 (5 to 10 year periods)

low interest rates have led pension deficits in which further appetite for alternative investments

large institutional capital and sovereign wealth funds creating in-house management teams

bullish public equity markets are allowing certain corps to use their now higher valued shares for M&A

corps dependent on organic growth may be facing pressure to grow in a slow economic environment and may be looking to grow inorganically

Question 2

what are the 4 ways in which a private equity company can work with their investee company to increase top line growth? (GRIN)

Answer 2

entry into new market segments
geographic expansion
revitalization of an underperforming subsidiary
implementing a market strategy to increase volume or allow for real price increase

Question 3

What are the three ways in which a company can expand margin and operational improvements?

Answer 3

Cost cutting
Raising productivity
Improve working capital management

Question 4

What are the 5 ways in which a company can executing M&A or divestment activity?

Answer 4

Revenue synergies for cross-selling of complimentary products

cost synergies by allowing consolidation of manufacturing facilities

acquiring a competitor and increasing market share

opportunity to acquire a new business at an attractive price and capture accretive value

divestments on non-core assets

Question 5

what are four important considerations to take into account on pricing of M&A transactions ?

Answer 5

transformative or tuck-in?
does price include synergies or not?
how will synergies be realized?
multiples arbitrage?

Question 6

how can PE firms work with their investee companies to improve working capital?

Answer 6

tighten up A/R collections whilst extending their A/P to improve working capital in the business

Question 7

what is a tuck-in acquisition?

Answer 7

a small addition to an existing company, and this is driven by a small relative size to acquirer

Question 8

what is the primary advantage of tuck in acquisitions?

Answer 8

higher probability of the success of integration in comparison to larger acquisitions

Question 9

what impact on earnings and resultantly company value is usual from tuck in acquisitions?

Answer 9

since tuck in acquisitions are usually at smaller multiples than the acquiring co, tuck in acquisitions are usually immediately accretive to inherent value, as they then become subject to the parent multiple, with additional earnings

Question 10

what are follow-on acquisitions?

Answer 10

when additional equity is invested into an existing investment - additional capital usually comes from PE sponsor and results in additional ownership or pro-rata participation by existing shareholders

Question 11

what is the differentiator from tuck in and follow on acquisitions when evaluating a large transformative acquisition?

Answer 11

the size and degree of risk involved are much higher, and can either result in massive failure (AOL/Time Warner) or massive value creation (Kraft/Heinz)

Question 12

what is the primary use of leverage in PE M&A transactions?

Answer 12

to amplify returns to equity holders

Question 13

what common leverage ratio is used to earmark industry standards and appetite for financiers’ debt capacity?

Answer 13

debt to EBITDA ratio

Question 14

What are the two primary reasons for a leverage recapitalization?

Answer 14

dividend or repurchase a large portion of common stock in cash or in-exchange for other securities

Question 15

what are three important key points that need to be highlighted in the scenario of a dividend recap?

Answer 15

subject company can capture a tax benefit of having a leveraged balance sheet, properly debt-sizing the company

the post-cap capital structure may result in actually a higher valuation for the company, as equity relative to company valuation will decrease

additional leverage should amplify future returns to equity investors, subject to the company having the ability to handle the existing indebtedness

Question 16

what is also important to keep in mind when evaluating if a dividend recap is appropriate? from a risk perspective

Answer 16

projected future returns are going to be more highly sensitive to profit margins, tax rates, cost of debt, and market valuation - over-leveraging can quickly send a company downwards if not appropriately sized (ie. lack of liquidity, financial flexibility, etc)

Question 17

what is “multiple expansion”?

Answer 17

it is the increasing of the multiple realizable by the company, due to improved cash flows, improved outlook, lower risk, lower cost of capital, or various value creation strategies that have been successful (top line growth, cost cutting, etc)

Question 18

why do PE managers sometimes look for cyclical industries in a state of “multiple depression”?

Answer 18

it may potentially leave future upside on industry-wide bounceback to be accretive to exit value (ie. think O&G industry and market-wide movement of multiples)

Question 19

what are the larger 5 reasons for a PE manager to refinance the capital structure?

Answer 19

match duration of debt to expected hold

achieve lower cost of capital than existing indebtedness

reduce financial covenants

dividend recapitalization

poor performance may lead to a new amended structure with existing creditors with achievable covenant package

Question 20

what are three primary questions for investors to ask in regards to a refinancing situation?

Answer 20

what are the sources and uses?

how is interest rate on new debt being calculated? (variable, fixed, LIBOR)

what were the refinancing costs? this is important in determining net returns

Question 21

what are the three overarching types of considerations for PE managers when timing an exit?

Answer 21

company specific
industry specific
market specific

Question 22

what are company specific timing considerations for exit?

Answer 22

time taken to implement certain strategies, such as a new operational platform and realizing synergies

Question 23

what are industry specific timing considerations for exit?

Answer 23

the potential for lack of investor appetite for certain types of investments (based on industry)

Question 24

what are market specific timing considerations for exit?

Answer 24

factors such as compressed equity value when looking to IPO, or markets depressed in a global financial crisis, resulting in a liquidity crunch

Question 25

What are the four main methods of facilitating an exit?

Answer 25

trade sales
IPO
Secondary Sales
liquidation

Question 26

what are trade sales ?

Answer 26

general M&A, where buyers are in the same industry as the investee company

Question 27

what are the key advantages of trade sales? (3) think in comparison to IPO process

Answer 27

special purchaser synergies
expedited process
control

Question 28

what are the disadvantages of trade sales? (4) in comparison to IPO

Answer 28

management resistance - management may be replaced

discounts embedded in consideration - liquidity and marketability discounts may apply

safeguard of information - competitive process discloses target private info in which otherwise would not be released

regulatory approvals in cross border transactions - certain transactions by non-canadian entities must go through the investment act and disclosed to the Commissioner of Competition

Question 29

what are the advantages of an IPO in a exit strategy? (2)

Answer 29

post-IPO appreciation - potential upside from increase in implied value following the IPO

management support - management teams are typically incentivized to take public due to increased liquidity and further upside

Question 30

what are the disadvantages of an IPO in an exit strategy? (5)

Answer 30

valuations vis-a-vis a trade sale - potential discount to a valuation on sale to a strategic purchaser

public market volatility - potential risk of post-IPO price deadline

time and costs - IPO process is both costly (advisory, printing, listing fees) and time consuming

reporting requirements necessary

public markets focus on short term results which may impede a long term strategy if the PE investor is still involved

Question 31

what are secondary sales in the context of exiting PE investments?

Answer 31

full or partial sales to another private equity investor

Question 32

what are the key advantages to secondary sales? (2)

Answer 32

quick realization - liquidity in a shorter amount of time

relationship building - may lead to future deal flow on both sides of both the buy and sell side of the businesses

Question 33

what is the key disadvantage to secondary sales?

Answer 33

proceeds of intrinsic value - financial buyers may not be able to pay for synergies that would otherwise be realized by a strategic purchaser and as such, total consideration may be less

Question 34

what is the result in liquidation for a PE firm exit? what would form priority on claim of assets?

Answer 34

company is strategically wrapped up - shreholder loans (or debt-like securities) would have precedent on asset proceeds on liquidation to make themselves whole

Question 35

what is a “break case” analysis for PE managers?

Answer 35

downside assessment that is used to assess the floor to potential future returns

Question 36

what would break case analysis usually entail changing in the forecast? (4)

Answer 36

adverse regulation
failure to realize synergies
negative revenue growth
increased competition

Question 37

what are the main 5 areas of due diligence?

Answer 37

Economic
Industry 
Operational 
Financial 
Management

Question 38

What are the 5 common downfalls of Private Equity?

Answer 38

Entry price too high 
Insufficient due diligence 
improper deal structure 
miscalculation of synergies
lack of strategy

Question 39

why is it important in structuring “rolled equity” from prior ownership?

Answer 39

to ensure that management is incentivized properly to keep the company performing, even with the PE investment