FINspeak

While the Private Equity buyout firms made their mark unlocking value from carving out underperforming corporate assets, many had shifted in recent years to simply buying the corporation outright thanks to larger fund sizes and relaxed debt structures. This move towards whole company acquisitions started shifting back around the 2003 timeframe and accelerated until the recent financial collapse (using data from Dealogic). With liquidity tight again, we should see that trend reverse as more PE firms look for more affordable business unit-level acquisitions, but executing a successful carve-out has its challenges.

The obvious benefit of purchasing an entire company is that you get the entire support infrastructure so you can focus more simply at trimming the excess while operations continue to function. With a carve-out, the acquirer has to look at which staff will move over, mandatory Day 1 functions that need to be separated, how to set up a Transition Services Agreement (TSA) with the parent for technology or infrastructure support, etc. While this transition period is much more complicated, in my opinion, it offers a greater chance to realize value of the acquisition. My reasons are that are allowed to immediately cut non-core activities or have those activities performed by a third party with a lower cost basis since they simply don’t have to exist in their old form. It is much easier to remove operational costs from a newly designed firm than an existing entity. The trick is to balance the desire for a functional transition against keeping enough subject matter expertise with more “virtual” or variable cost resources (in addition to any specific expertise you may have paid for in the acquisition). This model creates a more rapid time to value and better returns for the acquirer.

At Infosys, we have looked very closely at this unique scenario for supporting carve-outs and have developed specific approaches to ensure we are reducing as much risk as possible for the acquiring firm. It is just another way we try to add value by combining our skills in new ways from an operational and technical perspective to best benefit our customers. M&A activity can be a healthy contributor to well functioning markets and should be supported.
What are some of your carve-out experiences?

Posted by Jeremy Kloubec at 06:34 PM | Permalink | Comments (0) | TrackBacks (0)

In the current market conditions, it becomes harder to find a safe haven for any investment. One particular investment segment that has come under scrutiny is placements into Private Equity buyout firms. As a diversification strategy for large portfolios, some money managers have chased outsized returns with Private Equity to balance other less risky (less rewarding) investments. Acting as a Limited Partner (LP) for a Private Equity Buyout fund has historically been one way to aggressively put your money to work and generate returns that significantly outpace the overall market.

However, being a Limited Partner, just as the name implies, makes you are a true partner of the buyout firm. LPs often times invest in multiple fund vintages from the same Private Equity firm with the assumption that some disbursements from previous funds would roll forward to fund future obligations in addition to providing liquidity back to the money manager. This riskier partnership and the Private Equity investment class in general has rewarded those investors with outsized returns in the past, but has flat lined in this current market. Regardless of the fund return, LPs are still legally bound to fulfill their full capital funding obligations (often putting 20% or more upfront) during the life of the fund with capital being drawn down to make acquisitions or buyouts (sometimes those obligations can be sold to a secondary buyer at a discount, just like any other asset). Unfortunately for LPs, many are experiencing interrupted disbursement cycles due to fund losses or an inability to divest fund holdings. This puts significant stress on the LP as they will continually be required to place money into these funds without planned payback.

This may sound like a bad deal as there has been an uptick in the number of articles written about the stress that these Private Equity relationships have put on LPs from this capital call arrangement. I have even seen quotes to saying that they [LPs] would rather not see any new buyouts so those capital calls would not have to be funded. While it may be an interesting human angle and generate some sympathy for LPs, I am a bit confused as to the problem. Risk is rewarded by higher returns. An indefinite higher return is free money and nothing is for free so I don’t understand the worry about these LPs since they should have modeled downsides into their investment strategy. If they have not, then we may see a period of underfunding for buyout firms (in addition to LP portfolio strategy changing) which could limit buyouts in a 1-3 year window if a number of LPs take a haircut via forced liquidation to secondary firms which reduces their appetite during future fund raising. Interestingly enough, I really feel this is much ado about nothing and don’t believe it will have a drastic impact on most buyout firms. I am basing my assumption on the fact that there is still a significant amount of uncommitted capital or “dry powder” and deal sizes will be smaller since banks will not be backing mega-buyouts so that capital will go farther. While I can’t appreciate these LP concerns over losses, my bigger worry is that some LPs are also state retirement funds which becomes a completely different story…

Posted by Jeremy Kloubec at 02:31 AM | Permalink | Comments (0) | TrackBacks (0)

I previously posted on the slowing VC investment cycle and potential effect on innovation (http://www.infosysblogs.com/finspeak/2009/03/from_where_will_the_innovation.html#more). I wanted to provide an update on the subject, thanks to recent information released from the National Venture Capital Association (NVCA).  

MoneyTree has the Q1 numbers that reflect a 61% drop YOY and 47% drop in investments from Q4. With this sort of slow down, it is not surprising that the NVCA is proposing new solutions to get their sector moving again. My only concern is that they are benchmarking statistics to the late nineties boom which was a massive outlier in regards to any other time period in the last 30 years (NVCA posts this data in their presentation http://www.slideshare.net/NVCA/nvca-4pillar-plan-to-restore-liquidity-in-the-us-venture-capital-industry-1360905?type=presentation ).  Yes, IPO volume is down, those IPOs are requiring more funding and the timelines to harvest are growing when compared to 1998, however, I am not really we will get back there any time soon. It is sort of like asking for 2006-07 back for Private Equity buyouts, it may be a while.
 

With that said, I do appreciate the points they have put forth, namely

• Enhancing the Ecosystem- Encourage new buyers and better accounting support by changing their relationship with investment banks and accounting firms
• Increase Liquidity- Support new market platforms and boutique bank participation
• Pro-Growth Tax Incentives- Promote investment for certain technologies
• Optimize Regulation for VC- Better coordinate regulation to support VC
   

Really, you have two systemic changes to their process and two macro changes that have created a drag on VC through attempts to fix other financial industry issues. I can sympathize with their current situation of being hurt by regulations not intended to harm VC, but have to assume trying to enact regulatory exceptions will be a much harder task than fixing their own inefficiencies.
 

There is a contrarian view to this argument that contraction is needed by the sector as a whole and that the NVCA is solving the wrong problem. The blog www.avc.com has put together a compelling argument on VC Math showing that there should be less funding in the sector since it cannot support the expected returns. Assumedly, this would be a self-correcting problem if true as investors would move to other asset classes.

Posted by Jeremy Kloubec at 04:32 PM | Permalink | Comments (0) | TrackBacks (0)