Private Equity

History of PE American Research and Development Corporation (1946) Investment in Digital Equipment Annualized return on capital of 101% $70,000 > $355 Million The first private equity company (Documented) was the American Research and Development Corporation which was founded in 1946 They began their portfolio with an early investment in Digital Equipment. This was their best investment and they turned 70,000$ initial investment into a 355Million dollar value. This related to an annualized return on capital of 101%

Panic of 1893 US relied heavily on high commodity prices Argentina – failure of wheat (1890) Run on gold Railroad overextension The story of PE starts with the panic of 1893 This was at a time when the US relied heavily on commodities and railroads (Shipping of commodities) for the economy The first kingpin to fall to spark the panic of 1893 was Argentina. Argentina relied heavily on the wheat crop for their economy, and the crop failed in Argentina. This brought all North and South American commodities into question and European investors began exiting these positions In addition to commodities going south, the railroads were all overextended, many times having no crates on them to ship.. As these started to have trouble in conjunction with commodities, European investors started to flee from US denominated assets. Given that the gold standard had already been created, this was eventually a run on gold

Union Pacific Badly run railroad Cheaply built with corrupt officials E.H. Harriman (with the help of Kuhn Loeb) Converted to cash cow Union Pacific was one of the railroads responsible for the panic of 1893. This was just “one of” the many cheaply built, poorly run, and corrupt railroads that existed during this time E.H. Harriman (with the help of Kuhn Loeb) a then prominent financial conglomerate helped to restructure this railroad and make it into a cash cow for the coming decades (This was one of the first examples of a PE-type deal)

First Leveraged Buyout 1901 JP Morgan & Co. Bought out Carnegie Steel for $480 Million (This would be equivalent to $15 Billion in today’s dollars) New company Capital = $1.4 Billion US Government Spending = $524 Million Fun Fact: Carnegie + Rockefeller + Vanderbilt = > $1Trillion in net worth The first example of a Leveraged Buyout was right after the panic of 93. In 1901, a prominent banker of the time JP Morgan bought out Carnegie Steel for a whopping 480 Million. This is equivalent to modern day 15 Billion dollars. This was one mans enterprise. Carnegie received most of these funds. He would be worth about 340 Billion today New company capital amounted to a whopping 1.4 Billion dollars while government spending for that same year was only around 524 Million

Glass Steagall Act 1933 – In the wake of Great Depression and bank failure Separated Investment and Commercial Banking Kept large banks out of PE space Only smaller deals

Kohlberg Kravis Roberts Known today as KKR Created in 1978 Partners from Bear Sterns Smaller/family deals

Gibson Greeting Producer of greeting cards $80 Million of which $1 Million was cash One investor (William E. Simmon) made $66 Million Caught attention of others

RJR Nabisco Culmination of 80’s boom KKR acquired RJR for $31.1 Billion Deal eventually went bust Trend arose of failed LBOs PE industry went quiet

Second Boom 1993-2003 New degree of respectability and legitimacy Companies focused on attractive deals

What is Private Equity? Equity capital not quoted on public exchange Two paths Directly into private companies Buyout of public company (delisting)

Raising Funds Retail and institutional investors Four uses for cash R&D in existing company Expand working capital Making acquisitions Strengthening balance sheet

Layout

Types of Funds LBO Venture Capital Growth Equity Fund of Funds Mezzanine Capital Distressed PE Secondaries

LBO – Leveraged Buyout Fund Investor + Borrowed Financial Leverage Majority Position Controls firm’s strategy

LBO Usually 90% debt to 10% equity Collateral Component Hostile Takeover Risk – who goes bankrupt?

Venture Capital Money provided to startup firms Significant long-term growth potential High risk Above average returns When does the money come?

Growth Equity Mature companies No future capital requirements Minority stake Company with little debt Invest at inflection point

Fund of Funds Fund doesn’t invest in companies directly Buys into portfolio of other PE firms Allows for greater diversification Fee charged (Professional portfolio management)

Mezzanine Capital Halfway between debt and equity Subordinated notes Preferred stock Hybrid financing Higher returns than debt, lower risk than equity

Mezzanine Financing

Distressed PE Serious financial difficulty Funds can buy shares cheaply Restructuring

Breakdown of Distressed PE

Secondaries Buy commitments from PE Turn a profit on positions Sometimes buy companies or assets from PE firms

Industry Analysis PE firms boom and bust (Cyclical) Debt Why? Debt Marco-economic trends Short on capital Fully Saturated Industry

Relative Size of PE

Deal Value & CAGR

Capital Raised by PE

Buyout-Backed Exits

Last year’s data

Exits by Investment Length

PE Life Cycle

Next Week Come in with an investment idea You will be pitching your stock to the group You can use a PPT to present We will be tracking these over the next quarter

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