Leveraged Buyout Market
-What Happened?
-Where Are We?
-Where Are We Going?
Presented by: Elias Sabo, Partner
Compass Group Management, LLC
April 2009 – FEI: 6th Annual Scholarship Awards Banquet
Table of Contents
Introductions
LBO Boom In Perspective
Growth & Collapse Of The Leverage Market
The Current Market
Equity Buyouts – Are They An Alternative?
What Should You Expect from Debt and Equity Sponsors?
Compass Group Management Overview
Compass Group Management LLC (“Compass”) is an external manager making investments in high
return assets on behalf of two primary investment pools:
– Compass Diversified Holdings (“CODI”): Publicly traded holding company with approximately
$1 billion of capitalization targeting middle market buyouts – currently over $400 million of
availability to consummate acquisitions.
– Kattegat Trust: Philanthropic organization which has provided over $350mm of equity capital to
invest opportunistically in high return assets.
CODI is the first U.S. listed, pure play private equity vehicle.
– Offering completed May 16, 2006 with four initial controlled companies (currently six).
– CODI provides 100% of the capital needed to consummate acquisitions allowing:
•
NO FINANCING CONTINGENCIES
•
Streamlined diligence process
•
Reduced time to close
•
Increased confidentiality
– Diversified portfolio and public structure reduces cost of capital.
– Permanent capital base removes need to exit around fund cycles.
End of the Party
After hours at the New York Stock Exchange, 1938. (BettmanCorbis)
The Boom Years
• Starting in 2002, the economy experienced a dramatic boom in growth.
– Nominal GDP grew 36% (5.3% CAGR) between 2002 and 2008.
– S&P 500 grew 67% (10.8% CAGR) between 2002 and 2007.
US Debt Outstandings as a % of GDP
( Nominal GDP in $Trillions)
380.0%
$1,600
$1,468
$1,418
360.0%
$1,248
$1,112
340.0%
$1,400
$1,200
$1,212
$1,000
$880
$903
$800
320.0%
$10.5
300.0%
2002
$10.9
2003
$11.7
2004
$12.4
2005
$13.2
2006
US Debt Outstandings as a % o f GDP
Source: Bureau of Economic Advisors and Yahoo Finance
$13.8
2007
$14.3
$600
$400
2008
S&P 500
Note: Nominal GDP in Red
Expansion Of Money Supply
Asset Class Expansion
US Leveraged Loans Outstanding:
– Grew from $13.6 billion in 1996 to $132.5 billion in 2002 (46% CAGR).
– Further grew from $132.5 billion in 2002 to $596.1 billion in 2008 (28% CAGR).
US Home Mortgage Debt Outstanding:
– Grew from $6.0 trillion in 2002 to $10.4 trillion in 2008 (9.6% CAGR).
US Consumer Household Debt:
– Grew from $2.0 trillion in 2002 to $2.6 trillion in 2008 (4.4% CARG).
US Financial Sector Debt Outstanding (excludes non regulated financial companies):
– Grew from $1.0 trillion in 2002 to $17.3 trillion in 2008 (60.8% CAGR).
According to a market survey report performed by the International Swaps and Derivatives
association, it is estimated that credit swaps on CDOs and other contracts not captured on
the DTCC’s Trade Information Warehouse may exceed $47 trillion, representing a 100 fold
increase over the past decade.
Growth of Middle Market Leveraged Loans
60
$25.0
50
$20.0
40
$15.0
30
$10.0
20
$5.0
10
$0.0
0
2001
2002
2003
MM Sponsor
Source: Standard and Poor's 4Q08 review and Middle Market Lenders
2004
2005
2006
MM Lead Agents
2007
2008
# of Agents
$ in billions
MM Sponsor Volume vs. # Lead Agents
$30.0
An Excess of Debt Issuances
• Leveraged buyout levels reached unprecedented levels in 2006 and 2007 vs. average 1998-2005 levels.
Middle Market
Total Leveraged Market
$600.0
60.0%
$535.1
$25.0
25%
$22.5
$20.9
$480.1
$500.0
50.0%
40.0%
$246.1
$300.0
30.0%
$207.6
$200.0
$ in Billions
$ in Billions
20%
$16.7
$241.4
$400.0
$20.0
$15.0
15%
$10.0
10%
20.0%
$153.2
$234.0
$100.0
$5.0
$293.7
$130.6
$94.7
$77.0
0.0%
1998-2005
Average
Total Sponsor
2006
2007
Total Non-Sponsor
Source: Standard & Poor's 4Q08 Leveraged Buyout Review
5%
$-
0%
10.0%
$58.4
$0.0
$5.0
1998-2005
Average
2008
% Sponsor
MM Sponsor
2006
2007
2008
% of Total Sponsor Leverage
Credit Products Issued With Borrower Friendly Terms
Covenant Lite Loans By Volume and Number From 1997 - 1Q 2009
Volume
Number
$120
140
125
120
96.6
$100
100
In Billions
$80
80
$60
60
$40
37
40
23.6
$20
19
Source: Standard & Poor’s
1
0
2008
1Q09
4
2007
1
2006
3
2005
2001
1998
1997
0
NA
2004
1
2003
2
2002
2
2000
12
0.0
1Q09
2008
2007
2.5
2006
0.1
2004
2003
NA 0.5
2002
1999
1998
1997
$0
0.3 0.02
2001
0.3
2000
1.8
2.4
2005
3.1
1999
20
Loan Market Share: Banks vs. Non-Banks
Primary Market for Highly Leveraged Loans
100%
Non-banks
75%
50%
Banks
25%
20
06
20
07
Ja
nJu
l0
A
ug
7
-D
ec
20 07
08
(A
20
ll)
08
(N
ew
)
20
04
20
05
20
02
20
03
20
00
20
01
19
98
19
99
19
96
19
97
19
94
19
95
0%
Non-banks include: institutional investors, insurance companies, finance companies and securities firms
Excludes all left and right agent commitments (including administrative, syndication and documentation agent as well as arranger)
For 2Q08, All Deals includes block sales like TXU while New Deals include only deals launched and structured this year
New Funding Sources Emerge – Leveraged Buyouts
• New sources arose with the flood of money entering the system and funneled funds to private
equity and other users.
Leveraged Buyout Loans
2006 Agents
2009 Agents
 Long Term Funded Finance Co.’s
 Long Term Funded Finance Co.’s
 Commercial Banks
 Commercial Banks
 Short Term Funded, Securitized Finance
Co.’s / CLOs
 Short Term Funded, Securitized Finance Co.’s /
CLOs - INACTIVE
 BDCs
 BDCs - INACTIVE
 Low-Leveraged Hedge Funds
 Low-Leveraged Hedge Funds
 Public Finance Co.’s
 Public Finance Co.’s
 Investment Banks
 Investment Banks - INACTIVE
 Highly Leveraged Hedge Funds
 Highly Leveraged Hedge Funds - INACTIVE
New Funding Sources Emerge – Other Assets
• Other sectors of the economy also benefited from new funding sources.
• Funding Intermediaries created a variety of exotic instruments.
Other Asset Classes
Industry
• Mortgages
Financial Product Innovation:
• Home Equity Loans
• (Option) Adjustable Rate Mortgages
• Interest Only Mortgages
• Consumer
•
•
•
•
•
• Corporate
• Asset Backed Securities
• CLOs, CDOs, CBOs
• Credit Linked Notes
• Credit Default Swaps & Baskets
• Credit Enhancements
• Constant Proportion Debt Obligation
• Municipalities
• (Preferred) Auction Rate Securities
• Tender Option Bonds
Structured Investment Vehicles (SIV)
Variable Rate Demand Notes (VRDN)
Credit Cards
Student Loans
Auto Loans
Improved Credit Terms Resulted
Percent of Institutional Tranches Priced Inside of L+300 bp for deals rated BB- or higher
100%
98%
100%
94%
89%
75%
71%
69%
50%
46%
39%
33%
31%
24%
25%
0%
0%
1998 (70) 1999 (90) 2000 (91) 2001(88)
L+200 bp or Less
Source: Standard & Poor‘s
2002
(118)
2003
2004
2005
(104)
(148)
(118)
Period (Observations)
L+212.5 bp - L+237.5 bp
2006 (91) 2007 (62) 2008 (51) 1Q09 (0)
L+250 bp - L+287.5 bp
And Purchase Price Multiples Increased - LBOs
• Higher risk tolerance was a function of lower returns.
• Seeking higher yields, investors sought out riskier securities. Competition led to pricing at historical lows,
looser covenants, relaxed terms and support for higher leverage multiples.
• A fundamental flaw was that acquisitions were priced assuming continued economic growth or stability.
Large vs. Mid. Market LBO Purchase Multiples
(Mid. Market Multiple Displayed By Capitalization)
12.0x
10.2x
10.0x
9.3x
8.8x
xEBITDA
8.3x
8.1x
7.7x
8.0x
9.8x
7.1x
6.0x
59%
58%
5.4x
54%
3.6x
0.9x
0.4x
0.6x
0.8x
0.0x
62%
3.3x
4.0x
2.0x
4.1x
3.5x
3.3x
42%
3.0x
1998-2005
19982005
MM Equity Cap
Source: Standard & Poor's 4Q08 Leveraged Buyout Review
41%
2006
46%
38%
2006
MM Sub. Debt Cap
2007
3.8x
2007
MM Sr. Debt Cap
2008
Large LBO Multip
2008
Where Else Did Asset Prices Increase? - Housing
Where Else Did Asset Prices Increase? - Commodities
17 Components: Includes Livestock, Agriculture, Energy and Metals
The Reckoning Begins
The Bubble Bursts
Inflation Adjusted US House Price Index and Stock Prices, 2003-2009
Source: Case-Shiller; Dow Jones, Keefe, Bruyette & Woods. All indices inflation adjusted by the CPL
Rising Payment Default Rates Are Beginning
Percent of Outstanding Leveraged Loans in Payment Default or Bankruptcy
15.0%
9.9%
10.0%
10.0%
7.0%
5.0%
7.6%
7.4%
4.0%
3.7%
3.6%
2.6%
1.0%
1.9%
1.0%
0.6%
0.0%
As of
•Includes all loans including those not included in the LSTA/LPC mark-to-market service.
•Vast majority are institutional tranches.
Source: Standard & Poor’s LCD and S&P/LSTA Leveraged Loan Index
00
9
3/
27
/2
08
E2
0
Y
07
E2
0
Y
06
E2
0
Y
05
E2
0
Y
04
E2
0
Y
03
E2
0
Y
02
E2
0
Y
01
E2
0
Y
00
E2
0
Y
99
E1
9
Y
98
E1
9
Y
97
E1
9
Y
Y
E1
9
96
0.0%
Earnings Pressures Lead to Exercised PIKs
• Switching on a PIK toggle helps a company buy breathing room and preserve its cash until its financial
situation improves.
• PIK toggles — much like covenant-lite loans — still don’t address fundamental problems that a company
faces.
–While they buy breathing room, bankruptcy is still a possibility.
What Happens to Height of Market Valuations?
• If 2009 valuations drop to average levels from 1998-2005 (7.1x EBITDA), it translates to a destruction of
62% for Equity assuming constant debt levels.
–This drop in value is prior to any decline in EBITDA levels.
xEBITDA
Middle Market Capitalizations
Assuming a return to 1998-2005 average purchase price multiples
10.0x
9.0x
8.0x
7.0x
6.0x
5.0x
4.0x
3.0x
2.0x
1.0x
0.0x
9.3x
3.5x
62% decline in
equity value
7.1x
0.4x
1.3x
0.4x
5.4x
5.4x
2007
2009
Sr. Debt
Sub. Debt
Equity
Is There An End In Sight?
• Forced sales of defaulted ABS vehicles flooded the secondary market.
–Secondary prices dropped dramatically, with bids at the end of January at 70 for actively traded
names and 64 for leveraged middle market, lightly traded accounts.
• Secondary market trends create a challenge for new issue pricing due to relative value analysis.
Monthly Bid Prices by Market Size
105
100
95
Bid Price
90
85
80
75
70
65
Flow Names
Middle Market
Source: Standard and Poor's LoanStatsWeekly Supplemental and LSTA Weekly Secondary Spreads
9
20
0
15
/
1/
5/
20
08
8
11
/1
15
/
20
0
8
9/
15
/
20
0
8
Large Corporates
7/
15
/
20
0
8
5/
15
/
20
0
8
3/
20
0
15
/
1/
5/
20
07
7
11
/1
15
/
20
0
7
9/
15
/
20
0
7
7/
15
/
20
0
7
5/
20
0
15
/
3/
1/
15
/
20
0
7
60
A Glimmer of Hope?
What Strategies Are Equity Sponsors Employing?
Equity Buyout Example
Leveraged Buyout
Equity Buyout
$100 Million
$100 Million
EBITDA
$860 Million
Purchase
8.6x EBITDA
$550
Million
5.5x EBITDA
Initial EBITDA:
Purchase Price:
Purchase Multiple:
Debt Invested:
Equity Invested:
EBITDA Growth/Year:
EBITDA in Year 4:
Special Dividend (4x):
EBITDA Year 5:
Sale Price at 7x:
Profit:
Key Facts
LBO
EBO
$100
$100
$860
$550
8.6x
5.5x
$645
$0
$215
$550
10%
10%
$146
$146
$0
$586
$161
$161
$1,127
$1,127
$267
$577
•Less Debt
$645 Million
Debt
$0
$215
Million
Equity
$550
Million
IRR Return:
17.5%
•Includes Dividend
•Less Debt
17.5%
Equity Buyout Example
Leveraged Buyout
Equity Buyout
$100 Million
$100 Million
EBITDA
10%
Annually
EBITDA
Growth
Year 4: Special 1-Time Dividend
(4x EBITDA, paid via debt-issuance)
$161 Million
Key Facts
LBO
EBO
$100
$100
$860
$550
8.6x
5.5x
$645
$0
$215
$550
10%
10%
$146
$146
$0
$586
$161
$161
$1,127
$1,127
$267
$577
Year 5
10%
Annually
$586
Million
Initial EBITDA:
Purchase Price:
Purchase Multiple:
Debt Invested:
Equity Invested:
EBITDA Growth/Year:
EBITDA in Year 4:
Special Dividend (4x):
EBITDA Year 5:
Sale Price at 7x:
Profit:
•Less Debt
$161 Million
EBITDA
IRR Return:
•Includes Dividend
•Less Debt
17.5%
Leveraged Buyout
17.5%
Equity Buyout
Year 5
$1.1 Billion
Sale
$1.1 Billion
$267
Million
Profit
$577
Million
7x EBITDA
~17.5% IRR
~17.5% IRR
Predicting The Future – Intermediate Term
Deal Flow:
– Deal flow will return to historical returns, but remain low given economic uncertainty.
– Funds that depended on financial engineering to drive returns will be distracted by tripped
covenants, liquidity challenges and potential brand damage for future fund raises.
Holding Period:
– Given the lackluster IPO market, Strategics’ focus on current operations and most Sponsors
frozen given the credit markets, exit opportunities will be minimal.
– Quick flips will fade as historical hold periods of 5+ years return.
Sponsor Returns:
– Funds that fully invested 2006-2008 may not be able to return capital to investors.
– Funds not fully invested may be able to average down their portfolio’s average purchase price
and improve returns going forward
What Is The New Normal For Lendors?
Multiples:
– 2.5x EBITDA is the norm for senior multiples (maybe 3x for pristine operating profiles).
– 3.5-4.0x for total leverage (mezzanine, subordinated debt) vs. 2007’s 6x
– In 2009, leverage multiples for a stable, recession-resistant, cash flow transaction are
expected to be no greater than 2.50x senior and up to 3.75x total (+/- 0.25x).
Debt Pricing:
– Senior debt is more expensive at L+650 to L+700
– Including Libor floors of 2-3% and upfront fees of 3%, all-in pricing approaches 11.5-13%.
Impact on Transaction Pricing?
– 40% equity translates to 5.8-6.6x EBITDA purchase multiples vs. 8.3-9.3x for 2008 & 2007.
What Is The New Normal For Equity Sponsors?
Pre-Transaction
Company Differentiation (Pre-LOI):
– What is the company’s reason to exist?
– Unique product lines, customer relationships, etc.
Heightened Due Diligence:
– More information requested and in greater granularity
– Deeper understanding of company attributes
– Longer periods to close post-LOI.
 Has EBITDA stabilized?
 Was that new customer account signed?
Impact on Transaction
Pricing?
More Expensive Debt
+ Higher Equity Contributions
+ Heightened Economic Uncertainty
Lower Purchase Multiples
What Is The New Normal For Equity Sponsors?
Post-Transaction
OPERATIONAL IMPROVEMENTS
More Intense Focus on Portfolio Companies:
– Expect greater involvement by equity sponsors on a weekly (if not daily) basis.
– Be ready to defend proposed investments.
• What is the ROI on the investment? Is it possible to accelerate the payback of the
investment? Is the investment nice to have or a must have?
– More accountability of senior management teams
– Are current investments in HR and Capital appropriate given current business levels?
Strategic Initiatives
– Does it make sense to acquire / merge?
– Divestitures of non-core operations
– Heightened scrutiny of non-income producing investments
Questions?
Compass Group Management