Some notes from a few weeks in Mid-Market PE
I just started as first-year (straight from undergrad) at a decently sized Mid-Market PE shop (somewhat well-known) and here are some observations:
-MOIC > IRR, for PE firms. There is a distinction and its important. Heh.
-Management projections exist in la-la land
-No-one can get financing. Anything more than 4.5x-5.5x EBITDA is close to impossible and terms are eye-watering.
-Basically, it's a buy-low-sell-high game. There is some other stuff in between, but it's the oldest game in town and it's not rocket science. Yeah, I am sure most of you already knew this, but it becomes crystal clear when you're actually doing it. Nothing will kill a deal faster than the stock price moving up.
-The difference in insight between the 'small-LBO-model' and the 'large-LBO-model' is small. And while banking analysts may think that building an LBO model is the easiest thing in the world, a 'real' one can be ridiculous and there is no room for error. Still, the conglomeration of snowballing assumptions that eventually have a ~50 bps impact on IRR can be kind of ridiculous. Eh.
-Everyone kind of expects your 'work' to be good. That is, no-one's going to give you props over doing things right or building the perfect model. Everything else you do -- assumptions, insight, strategy -- is what matters and what you're judged on. It's a subtle but important difference from the sell-side.
-There is way too much competition for deals in mid-market PE. There are a ton of shops and they're all chasing the same stuff. In a way, this credit crunch has been a boon for the megafunds. Basically, they have a whole space entirely to themselves. I expect a significant decrease in the number of active mid-market shops. You need to either focus on a sector or find some other expertise and stick with it. Otherwise, you're in danger of extinction. There is limited LP money for PE and the big boys have serious resources to go out and get it.
-Try to join a shop that does not have a sector focus or at least doesn't expect its analysts to work in a particular sector. I think you should try to be a generalist for as long as it's feasible. Don't try to be a generalist forever, but seeing different things can make all the difference and it's a good learning experience -- an entirely new industry every couple of weeks/months.
And that's it. I can answer questions from my (very) limited experience, but their usefulness is suspect.
Any tips/recommendations for a newbie from those with experience?
What is your education/intern. background? Usually pretty tough to get into PE straight from undergrad, so you must have some pretty good credentials.
Interesting take...funny how all MM shops are saying that the credit crunch is a boon for THEM because they traditionally use less leverage and are more flexible (ie even making some growth equity investments) where the mega-funds often depend on 6+X leverage and $2+billion deals to engineer a decent return.
I can see the argument you made, but you could also make the case that Mega funds are going to have to write bigger equity checks for their avg deal which is going to driving down returns, whereas the MM shops will be getting the same leverage they've always had (granted with worse terms)...
other thoughts? interesting to see both sides of the argument.
But as you know, the biggest driver of returns isn't leverage, it's purchase price. the premiums for MM deals are going higher as there always seem to be some other mom and pop PE shop around the corner who gets wind of the sale. At least that's my experience. The megas often can do extensive tie-ups with corporate (witness the recent Weather Channel deal) and have less competition for the same asset, at least when other financial players are concerned. Many get exclusive mandates more often. In addition, it's a big benefit to be able to scour for deals globally, especially when you have a brand-name that boards can get comfortable. I know this because we're expanding globally right now (Europe, Asia) and it's much harder than you think. Scale definitely helps. I feel like this downturn is going to kill a lot of MM firms.
Thanks for the notes. Was wondering if you could clarify something. You said:
"You need to either focus on a sector or find some other expertise and stick with it. Otherwise, you're in danger of extinction..."
But then you go on to say,
"Try to join a shop that does not have a sector focus or at least doesn't expect its analysts to work in a particular sector. I think you should try to be a generalist for as long as it's feasible."
Can you explain what you meant by these two statements? They seem contrasting to me.
Thanks
They're not contrasting. Generalist experience is great for the analyst: he gets to find out what he's like. But have you ever met a 'Generalist MD'? Nope. It's a luxury you should strive for but not something that works for the firm at all levels in the long-term. Do you see what I mean?
some good notes here - curious, when you have time, can you post a few of the things that helped you jump to PE straight from ug? was it straight networking or some cold calling also?
lucked into it really. networking and talking to alums basically. sorry i can't actually offer a process or anything. it was really a one-off thing and i think i am fortunate to have gotten the opportunity.
Top 10 non-Ivy undergrad Hard sciences major, graduated with honors - pbk, and honors in the major 3.8 790 on the GMAT Did a consulting internship at a top firm (non-MBB) Decent extracurriculars - leadership positions in several clubs, undergrad research etc.
Interesting notes, thanks for sharing, curiousmonkey.
Can you tell me what MOIC stands for?
multiple of invested capital
Thanks, iambateman.
Thanks for the notes. Was wondering if you could clarify something. You said:
"You need to either focus on a sector or find some other expertise and stick with it. Otherwise, you're in danger of extinction..."
But then you go on to say,
"Try to join a shop that does not have a sector focus or at least doesn't expect its analysts to work in a particular sector. I think you should try to be a generalist for as long as it's feasible."
Can you explain what you meant by these two statements? They seem contrasting to me.
Thanks
The first quote when he says "You" , he is referring to the actual private equity shop. In the second quote he is referring to the analyst.
MOIC also known as COCR (cash on cash return)
some good notes here - curious, when you have time, can you post a few of the things that helped you jump to PE straight from ug? was it straight networking or some cold calling also?
curiousmonkey,
My firm interacts with hundreds of MM Private Equity shops and the vast majority of them are generalists. In fact, the vast majority of Partners at these firms are generalists as well. You have an amazing opportunity to work on the buyside as your very first job, but don't let it cloud your judgment into thinking that all firms are like yours. I've never seen such a wide variety of business styles lumped together in a single business model as I have in private equity and almost all of them are successful in one form or fashion.
Although my bank does not work with MMs, I'll try to offer some relevant comments.
Hahaha, interesting. :)
Completely agree. Management tends to fluff their company and, additionally, refuses to provide much information when we question a specific assumption. They don't realize that trying to dramatize their company's projections only hurts the entire process.
Where (region) do you work? 5.5x leverage has long dissapeared (those were 2006 levels). Senior at the present floats around 4.0x and total leverage is around 4.5x. 2007 levels were around 5.0x in total, although Q4 skewed the leverage down quite significantly. This also really depends on what level of financing you are referring to. Are you talking in terms of holdco or opco financing? Needs clarification because 5.5x multiple is very high if you look at any recently completed deals. Hell, I'm staring at some completed deals in front of me right now and there are some at 3.0x.
I agree with the terms. Term sheet conferences have been brutal, since nobody wants to give up grounds on even the most insignificant bullet points. I totally understand how our clients feel because, personally, I can tell that the financial covenants that we push for in term sheets are very stringent.
True. Even given a typically volatile industry like mining or an unpredictable cash flow business like those in the shipbuilding industry will attract significant sponsors attention if the price is low. Actually, this is the perfect time for PE entry because most valuations are so pessimistic that a long-term approach to investing seem to offer plenty of returns. Sucks for hedge funds (performance based on quarterly, if not monthly, basis), good for PE (performance based on >5 year returns).
I don't think any banking analysts who thinks lbo models are easy is very qualified to make that statement. Really, if you talk to any investment banker who knows modeling, they'll have a lot of respect for the leveraged finance bankers purely out of the fact that LBO models are the most difficult models to create. They may not be the most time consuming, but LBO models have numerous potentail to be the most challenging types of model.
You need to realize that most bankers do not and will not actually have experience building LBO models. Sector and M&A tends to do focus on merger models and spreading assumptions to connect the 3 statements, which will all be used as part of the LBO models by leveraged financiers.
This is practically the same in any area of high-finance. Depends on what area you are in within the sell-side.
Good deduction. Actually, I've just had a meeting with one of the megafunds that you speak of and they noted how much easier it's been to fundraise given the current conditions. With the shitty markets, the mega funds know that there are more opportunities to capitalize. Given the larger fund sizes and that many hedge funds are holding cash instead of investing for the sake of salvaging their performance records, large PE shops are swooping in quick.
You know, you're right. 5.5x is definitely very high. We were lucky enough to see a deal like that recently and I think I've been doing too much reading up on earlier models. The average breakdown nowadays is 3x Bank Debt and 1.5x High-Yield. Can do higher depending on target's business ans size of deal.
Not quite. There isn't that 'checking process' that there is with an analyst-associate-VP etc. You don't have your Associate checking your work 60 times to make sure he's right. Our Associates are operating more like principals or VPs and the Analysts are very close to the last line of defense when it comes to the model. I was in the sell-side and this is definitely very different. Often-times the MD will take my numbers wholesale, no checking, to a management meeting. That's a scary thought.
I'd say 'easy' is a relative term. Easier than MM firms for sure, but definitely not as easy as it was in 05-06-07. I'd say most megas are going to have 6-8 billion first closes, quietly inching up to 15-16 billion. That's why there is a proliferation of 'sector-focused' funds. We've noticed (and are acting upon) the impulse of LPs to be more comfortable with sector/geography allocations. Raising a 4B Tech Fund, a 3 B infra fund, and another 2B FIG fund is easier than raising a 9B general fund.
Also, LPs often have percentage allocations to alt-investments. With PE always outperforming the rest of their portfolio, our allocation increases organically compared to the rest simply due to better returns. But in the last year, the falling values of equities have increased our share in relative terms. LPs have mandates and they aren't comfortable with a 15% allocation to PE. Guess who's going to get cut when fundraising time comes around -- KKR/TPG/Carlyle/Blackstone or 'New PE shopwith superstar MD from megafund!'? Yeah.
5.5x+ leverage existed well into mid summer 2007.
curiousmonkey, I'll take your word on it. PWM people might be better suited to know the ins and outs of megafund fundraising, so this is not my focus area. The guys from the PE fund I met simply noted how it's easier to raise the funds, but relatively, like you said, that can mean a multitude of thing.
GameTheory, did you understand what I wrote? It was specifically noted that 2007 levels were at 5.0x and that the 2007 Q4 conditions was a major influence in bringing it down to the final 5.0x level. Kindly re-read my post again and let me know if you have any questions re leverage.
Sure, I'll be sure to check with you next time I need any clarification on anything regarding leveraged transactions.
"5.5x leverage has long dissapeared (those were 2006 levels)" is what my comment was in reference to.
2006 was at 5.5x, 2007 at 5.0x, and ~4.0x for H1 2008. The 5.5x leverage appeared in early 2007, but was brought down significantly by the pressures of the later quarter 2007, as noted. Maybe I wasn't clear. Unless, of course, you were referring to what the definition of 'long' was. In that case, I can see where your perspective originates.
On another note, it's also interesting to note the different effects the subprime has had on PE and HF. Long considered the fraternal brothers in terms of high-finance prestige, the situation has changed, albeit not to an earth-shaking degree.
gnome, you are being a condescending toolbag when you say stuff like "let me know if you have any questions re leverage", especially to someone who already works in the PE industry. for some reason, your posts just come across as having this air of douchebaggery to them
"Long considered the fraternal brothers in terms of high-finance prestige, the situation has changed, albeit not to an earth-shaking degree." i hate to get into debates about prestige, because really, who cares... but how has this situation changed at all? furthermore, isn't fraternal a redundant description of brothers?
i'm sure your summer in banking has been extremely informative and educational, so please enlighten me
FreeCash, was just sharing thoughts on market conditions, not to start a fight. Preferred if people read through all message instead of taking stances on phrases. I have no problem with GameTheory, was just clarifying my earlier statement that he probably just skimmed and missed.
Thx for the grammar check though. Much appreciated.
Leverage for (senior) bank debt in the MM deals I've seen ranges from 2-4x (add 1 more turn for mezz for 3-5x avg. total leverage), price spreads have definitely increased by 200-400bps over LIBOR in the past 6 months (depending on the size of the deal), and I can't think of a single deal this year I've seen without a LIBOR floor (I've got a pile of term sheets sitting on my desk).
As a sidenote, if you're going to make an authoritative comment on the markets, please provide some disclosure on your current professional status (which is what the account page is for, yet no one seems to use it).
Curious: Congrats on nailing the job. Should be interesting to see how PE shakes out. We were having the same discussion back in '04 at my old job (AM) about how HF's were crowding out the market and chasing the same limited number of companies. Had a similar discussion two months ago about PE firms chasing the same companies (sitting on piles of cash but unable to get good terms for deals or even good first looks at companies outside of their markets). This is all MM of course. Can't comment on megafunds because I don't deal with them.
Interesting comments curiousmonkey. I am a little bit naive when it comes to PE, so I was wondering if you could perhaps explain further why purchase price is a bigger driver of returns compared to leverage? Is it because leverage is not as flexible to negotiate as purchase price? To me it seems an extra half-turn on leverage for a 200mm EBITDA company can have a reasonable impact on returns. And after all, how much can purchase price truly drive returns if we consider companies worth mm for example or even PE market currently is that of greater equity as a part of total consideration bringing down returns...doesn't this imply that leverage plays a key role in determining returns? Could you please clarify?
Also, could you clarify the difference between MOIC and IRR? They sound fairly similar to me.
RE: Purchase Price Once you've overpaid, you've overpaid. There's no changing that. You can always play with capital structure after you've made the initial purchase to improve your returns (dividend recaps, etc.)
IRR is effectively CAGR on your initial investment plus the returns from any cash distributions during the investment period.
MOIC is a multiple i.e. I invested $100 and I got $200 after 5 yrs. MOIC is 2x, IRR is ~15%.
Also, multiple arbitrage can have a huge impact on IRRs/MOICs... That's when the "but high/sell low" strategy mentionned earlier comes into play. As the PE market matured, you had basically a lot of firms which had been acquired in, say, 2003 at low multiples which were subsequently sold in 2006 in a market with a lot more buyers, at very high multiples which significantly improved the IRRs of the initial buyers. This impacted the IRRs much more than leverage or revenue growth on average. Now the market is seeing a limited number of assets for sales because these very guys who acquired companies at 12x EBITDA in 2006 are not ready to sell them at 8x today. Not to mention the credit crunch of course :)
-business is slow
-this was the best decision I ever made. My job is magnitudes more secure than the other opportunities I was considering.
-The LBO is the easiest part. The real thinking is in the Operating Model and the sensitivities. That's the party they don't really teach you in a bank. That's what you'll spend 95% of your time on.
"No-one can get financing. Anything more than 4.5x-5.5x EBITDA is close to impossible and terms are eye-watering."
Huh? The BDC market (GE/Ares, Golub, GSO, Sankaty, etc.) exists to bridge lending SIFIs can't provide. We've closed every single portco, including a recent one, at over 6x at around L+600-800bps usually with a nice DDTL thrown in. Where are you getting this?
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