private equity valuations: current themes, challenges, … · private equity valuations: current...

Private Equity valuations: current themes,challenges, and the Updated Guidelines

*connectedthinking

1 October 2009

Ashley Coups, Nick Rea, Attul Karir

PricewaterhouseCoopers LLP

October 2009

Contents and topics

• Introduction

• Key messages from today

• Current themes and challenges

• Principal changes within the Updated IPEVCG

• Option Value of Equity

• Conclusions

• Questions / Discussion


October 2009

Section one

Introduction


October 2009

Introduction

Nick ReaPartner, Financial Services ValuationPricewaterhouseCoopers LLP

Attul KarirAssistant Director, Financial Services ValuationPricewaterhouseCoopers LLP

Ashley CoupsUK Private Equity Assurance LeaderPricewaterhouseCoopers LLP


October 2009

UK Private Equity v Principal Comparators

-40

-30

-20

-10

0

10

20

30

2008 3 Years 5 Years 10 Years

UK Private Equity FTSE All-Share WM Pension Fund Assets

Private equity valuation performance in 2008%

ch

an

ge

inv

alu

e

Source: BVCA Performance Measurement Survey 2008


October 2009

UK Private Equity – Really That Good?

-40

-30

-20

-10

0

10

20

30

2008 3 Years 5 Years 10 Years

Total UK Private Equity Stable Currency

%ch

an

ge

inv

alu

e

Source: BVCA Performance Measurement Survey 2008

2008 performance adjusted for currency movements


October 2009

Section two

Key messages from today


October 2009

Key messages from today

1) Valuing investments remains difficult due to a lack of transactions and volatilemarkets

2) Valuation in 2008 was difficult – this year will not be any easier

3) The value of investments needs to be considered carefully given the rebound inequity markets in 2009 but challenging trading conditions (i.e. earnings will bescrutinised)

4) Potential covenant breaches can impact fair value and need to be considered

5) The Updated IPEVCG mean that the 12 month window for holding investments atcost no longer holds, and, in addition, the marketability discount needs to beconsidered in the multiple assessment

6) Valuations should not change as a result of the Updated Guidelines but compliancewith IFRS and US GAAP needs to be carefully reviewed (we understand that the USPE industry has asked for further clarification)

7) Investors are increasingly demanding in terms of regular and detailed information

8) DCF remains a valuation technique that is rarely used in this industry (and that isappropriate most of the time)

9) Cross-checks are critical and we, as auditors, need to use our judgement too

10)Decline in debt values do not automatically render equity worthless


October 2009

Section three

Current themes and challenges


October 2009

Valuation remains extremely challenging

Valuation is made difficult by:

- A lack of transactions

- Volatility in the price of securities

• Fair value is one of the hottest topicsfacing the alternatives sector today. Ever-increasing investor, regulatory andaccounting pressure for companies tofocus more attention on valuations hascoincided with the credit crunch.

• “There’s still some misconception thatthere is some magic number that’s theright one – and there isn’t,”

Nick Rea quote from FT article on 4 Dec08 “A magical mystery tour of privateequity valuations”


October 2009

Valuation is currently challenging

FTSE 100 - Share pricing

0

1000

2000

3000

4000

5000

6000

7000

31Dec

07

31Jan

08

29 Feb

08

31M ar

08

30 Apr

08

31M ay

08

30 Jun

08

31Jul

08

31Aug

08

30 Sep

08

31Oct

08

30

Nov

31Dec

08

31Jan

09

28 Feb

09

31M ar

09

30 Apr

09

31M ay

09

30 Jun

09

31Jul

09

31Aug

09

Change in Share price

Jan 08 - Dec 08


Jan 09 - Present

-31% 16%

Markets have rebounded…….


October 2009

Valuation is currently challenging

FTSE 250 - Share pricing

0

2000

4000

6000

8000

10000

12000

31Dec

07

31Jan

08

29 Feb

08

31M ar

08

30 Apr

08

31M ay

08

30 Jun

08

31Jul

08

31Aug

08

30 Sep

08

31Oct

08

30

Nov

31Dec

08

31Jan

09

28 Feb

09

31M ar

09

30 Apr

09

31M ay

09

30 Jun

09

31Jul

09

31Aug

09


Jan 08 - Dec 08


Jan 09 - Present

-40% 44%

Particularly, mid-caps


October 2009

The spotlight on valuations continues

• Communicate to investors where value is being added or lostover time in a Fund by reference to the fair value of portfoliocompanies;

• Make informed decisions on entry and exit by understandingupside and downside scenarios;

• Meet the requirements of the IPEVCG, IFRS and US GAAP andtherefore satisfy auditor review; and

• Produce regular valuations where investors trade on monthlynet asset value (NAV) in respect of open-ended funds.

Investors require regular and robust information and are increasingly demanding interms of analysis of investments. There are clear benefits from a rigorous valuationprocess, including the ability for investment managers to:


October 2009

Common issues in 2008

• Can recent transactions be utilized as appropriatebenchmarks for portfolio company investments?

- consider the timing / nature of the transaction- transactions can be distressed, not entire markets!

Market ApproachComparableTransaction

• To what extent should recent stock market declinesimpact portfolio company valuations?

- the market cannot be ignored- consider use of averages (within reason!)- document adjustments to multiples

Market ApproachComparableCompany Multiple

MarketQuestions

ValuationMethodology


October 2009

Anticipated challenges

Key Question: Are earnings maintainable?

• Focus in prior year was on updating multiples to reflect thedownturn in markets

• This year, emphasis may be on earnings estimates andwhether they have been updated to reflect recentperformance

• However multiples are also important now that control andmarketability can be reflected within the multiple


October 2009

Anticipated challenges

• The different approach to marketability discounts should not impact valuations

• Has a control premium been factored in?

+V

alu

e

Discounts

• Lack ofmarketability

• Keymanagement ?

Premiums

• Control premium

Control Premium Minority Discount

Marketability Discount

Controlling Interest

Marketable Minority Interest

Non-Marketable Minority Interest


October 2009

Section four

Principal changes within the Updated IPEVCG


October 2009

Updated IPEVC Guidelines

Updated Guidelines should not result in achange in valuations

Fair value of portfoliocompanies

on8 Sept 09

Fair value of portfoliocompanies

on9 Sept 09


October 2009

Updated IPEVC GuidelinesReleased in September 2009 and contains updated guidance such as:

1) Marketability discount has evolved from a standalone adjustment tobeing incorporated into determining appropriate multiple (plus noillustrative 10%, 20%, 30% examples)

2) Some recognition of control premium

3) There is no longer a reference to a 12 month ‘window’ for holdinginvestments at cost

4) No 25% impairment rule-of-thumb

5) Milestone analysis given more recognition

6) Guidance is included on valuing fund interests and secondarytransactions

7) DCF is appropriate for standalone mezzanine interests

8) A view that the whole market cannot be distressed

9) Absence of guidance on whether equity can have value even if debt isunderwater


October 2009

Marketability discountsThe level at which the discount is applied should not impact fair value

Potential impact of updated approach to marketability discount

Previous IPEVCG Updated IPEVCG Updated IPEVCG

£m £m £m

EBITDA 1,248 1,248 1,248

EBITDA multiple 9.5x 7.6x 9.0x

Enterprise Value 11,856 9,485 11,290

Net Debt (9,213) (9,213) (9,213)

Gross Attributable EV 2,643 272 2,077

Marketability discount of 20% (529)

Equity Value 2,114 272 2,077

Fair Value of 1% equity stake 21 3 21

Cost 50 50 50

Write down implied £m (29) (47) (29)Write down implied % -58% -95% -58%

20% marketabilitydiscount applieddirectly to multiple(9.5x * 0.8 = 7.6x)

Marketability discountshould now be 5%not 20% applieddirectly to multiple(9.5x * 0.95 = 9.0x)


October 2009

The US perspective

The U.S. Private Equity Valuation Guidelines were updated in March 2007 inresponse to FAS 157

• In September, 2006, the Financial Accounting Standards Board releasedStatement of Financial Accounting Standards No. 157, Fair ValueMeasurements

• The Updated U.S. Private Equity Valuation Guidelines were intended to assistmanagers in their estimation of fair value and were intended to be consistentwith FAS 157 and the AICPA Audit and Accounting Guide - Audits ofInvestment Companies

• The AICPA Guide’s definition of Investment Companies includes PrivateEquity Investors and requires investments to be reported at fair value

• Private Equity CFOs in the US have found the IPEVCG to be conceptualrather than prescriptive

• The U.S. Private Equity Valuation Guidelines already suggest thatmarketability discounts can be built into the multiple

• The U.S. Private Equity Valuation Guidelines are a less prominent referenceguide compared to the IPEVCG


October 2009

Compliance with IFRS and US GAAP

The IPEVCG claim compliance “can be” achieved with IFRS and US GAAP

Compliance cannot be assumed,

particularly with respect to debt

investments (settlement versus

exchange)

Updated IPEVCG are more consistentwith IFRS approach to fair value

Compliance with US GAAPCompliance with IFRS


October 2009

Section five

Option Value of Equity


October 2009

Option Value of Equity / Fair Value of Debt

Is deduction of the face value of debt acceptable in the waterfall if there areindications that the fair value is lower?

• IPEVCG’s application of waterfall analysis considers settlement rather thantransfer of liability). This may not be consistent with US GAAP which follows atransfer notion for debt.

• This impacts the exit route: If a minority position is held, it may not belegitimate to assume a sale of a company and therefore the repayment of debtat face value.

• When debt is a relatively small portion of capital structure, face / book value ofdebt may represent a reasonable proxy.

100

1,000

1,100

200

5.5x

BV of Debt

FV of Equity

BEV

EBITDA

Implied Multiple

For example:

In this example, if the fair value of debt is 50%below its book value, the multiple onlydecreases to 5.3x


October 2009

Fair Value of Debt

In the current market, many bonds issued by highly leveraged companies are tradingfor less than 50 cents on the dollar

“Since Nov 2008, atleast seven companiesowned by private-equityfirms, includingBlackstone’s Freescaleand Apollo’s Harrah’sEntertainment Inc, havesought to pare morethan $50 billion ofborrowings by offeringlenders the chance toexchange debt at adiscount for cash ornew securities.”

Source: 11 March 2009 Bloombergarticle: “Private Equity IndigestionComes with Bain Bloomin’ OnionDebts”


October 2009

Does equity have value when debt is underwater?

If leverage / gearing is significant, fair value of debt may need to be considered

The example below illustrates a distressed portfolio company with an enterprisevalue

(£300m) that is lower than the face value of its debt (£400m)Enterprise Value Allocation Summary Enterprise Value Allocation Summary

ExpectedLow

Scenario (1)

High

Scenario (1)Cash Flow

Return

BusinessEnterprise Value

300£ 100£ 500£ 300£

Debt 300£ (2) 100£ 400£ £ 250

Equity -£ -£ 100£ 50£

(1)50% Probability

(2)Face value of debt is 400

Estimated Value

Multiple Outcome ApproachTraditional Waterfall

Fair

value

of debt

Option

value of

equity


October 2009

Section six

Conclusions


October 2009

Conclusions

1) Valuing investments remains difficult due to a lack of transactions and volatilemarkets

2) Valuation in 2008 was difficult – this year will not be any easier

3) The value of investments needs to be considered carefully given the rebound inequity markets in 2009 but challenging trading conditions (i.e. earnings will bescrutinised)

4) Potential covenant breaches can impact fair value and need to be considered

5) The Updated IPEVCG mean that the 12 month window for holding investments atcost no longer holds, and, in addition, the marketability discount needs to beconsidered in the multiple assessment

6) Valuations should not change as a result of the Updated Guidelines butcompliance with IFRS and US GAAP needs to be carefully reviewed (weunderstand that the US PE industry has asked for further clarification)

7) Investors are increasingly demanding in terms of regular and detailed information

8) DCF remains a valuation technique that is rarely used in this industry (and that isappropriate most of the time)

9) Cross-checks are critical and we, as auditors, need to use our judgement too

10)Decline in debt values do not automatically render equity worthless


October 2009

Contact details

Nick ReaPartner, Financial Services ValuationPricewaterhouseCoopers LLPEmail: [email protected]: +44(0) 20 7212 3711

Attul KarirAssistant Director, Financial Services ValuationPricewaterhouseCoopers LLPEmail: [email protected]: +44(0) 20 7213 4952

Ashley CoupsUK Private Equity Assurance LeaderPricewaterhouseCoopers LLPEmail: [email protected]: +44(0) 20 7804 9609

This publication has been prepared for general guidance on matters of interest only, and does not constituteprofessional advice. You should not act upon the information contained in this publication without obtaining specificprofessional advice. No representation or warranty (express or implied) is given as to the accuracy or completenessof the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP,its members, employees and agents do not accept or assume any liability, responsibility or duty of care for anyconsequences of you or anyone else acting, or refraining to act, in reliance on the information contained in thispublication or for any decision based on it.

© 2009 PricewaterhouseCoopers LLP. All rights reserved. ‘PricewaterhouseCoopers’ refers toPricewaterhouseCoopers LLP (a limited liability partnership in the United Kingdom) or, as the context requires, thePricewaterhouseCoopers global network or other member firms of the network, each of which is a separate andindependent legal entity.

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