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2013 CFA Level II – Alternative Investments
Presented by: Arif Irfanullah
www.arifirfanullah.com
Private Equity Valuation
Contents
1. Introduction
2. Valuation Techniques
3. Private Equity Fund Structures and Valuation
4. Evaluating a Private Equity Fund
5. Case Study
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2.1 How Is Value Created in Private Equity
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Reengineer firm and make it more efficient
Obtain lower cost debt financing via access to cheap credit and few covenants
Align goals of management and private equity owners
Managers have long term focus
Effective structuring of investment terms (“term sheet”) results in a balance of rights and obligations between the private equity firm and the management team
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Exhibit 5. Stakeholder Payoff
5,000m investment 50% Debt; 50% Equity Equity: 2,400 PS owned by PE Fund 95 Equity owned by PE Fund 5 Equity owned by Management Assume the fund grows 1.6x to 8,000m by end of 2013
2.6 Exit Routes: Returning Cash to Investors
Initial Public Offering (IPO):
Highest exit value relative to other methods;
High liquidity, access to capital, and attracts good mgmt
Less flexible, more costly, and complex
Use when company has strong growth prospects, operating history, size
Timing of IPO is an important consideration
Secondary Market: sale to other financial investors or strategic investors
Second highest valuation
Management Buyout: firm sold to management
Significant use of leverage
Liquidation: Sale of firm’s assets
Lowest valuation, negative perception
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General Partner (GP) vs. Limited Partner (LP) Two core functions of a PE firm: 1) Raise Funds and 2) Manage Investments
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Deal by deal waterfalls Total return waterfalls
Alternative 1: GP gets CI only after committed capital has been returned Alternative 2: GP gets CI if exit value exceeds x% of invested capital
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Investors (LPs) evaluate funds based on IRR Gross IRR: relates cash flows between private equity fund and portfolio companies Net IRR: relates cash flows between private equity fund and LPs PIC DPI RVPI TVPI
Two ways of accounting for risk Use a very high discount rate Take a probability-weighted terminal value (did this in Level 1)
Terminal Value Example: Assume the possible terminal value are
$60 million, $40 million and $0 If each has an equal probability of occurring, then the expected
terminal value is:
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