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An Introduction to
Private Equity
Robert Burgess
Director
Montagu Private Equity
www.montaguequity.com
Who is Montagu?
What sort of deals do we do?
How are we different?
How are deals structured?
How do we deal with our portfolio?
How do we exit?
What is like to work for a PE firm?
Questions I will (try to) answer:
Degree in Business Administration at Bath (1990 – 1994)
Joined HSBC Investment Bank on graduation Two year graduate training programme,
including six months in private equity unit Placed in Project Finance in 1996
Moved across to PE in 1999 to work on UK deal origination
Became a director this year
My background
Currently investing a €2.3bn fund raised in 2005
Focussed on £100m - £750m+ buy-outs across the UK, France, Germany, Scandinavia
We are Britain’s biggest car auctioneer, the maker of 90% of F1 gearboxes, Germany’s biggest maker of sausage casings and France’s biggest publisher of racing newspapers
Profile of Montagu Private Equity
Formed in 1968 as a division of Midland Bank. Mainly growth capital.
Operating as HSBC Private Equity by the mid 1990s. Focus moved to £20m-£50m buy-outs.
81% stake sold to employees in 2003. HSBC retains 19% and remains a significant investor.
Business renamed Montagu Private Equity. Average deal size £250m.
35 executives plus support staff
What is the history of Montagu?
The Basics
Raise money from pension funds, endowment funds, etc
Leverage this money with bank debt and use it to finance management buy-outs of, in our case, mature industrial / service businesses
Buy around 4 businesses per year
Develop each business over 2-4 years
Sell the business and return the profits to our investors
What do we do ?
Private equity is NOT venture capital:
Substantially lower risk than start-ups or growth capital
Management buy-outs / ins, ‘take privates’ of PLCs, secondary buy-outs
Usually established and cash generative
Able to support heavy debt burden (usually 60% of the purchase price)
Venture Capital v Private Equity
Sub £100m deal size – ECI, Graphite, Gresham, Isis, Sovereign Capital, Exponent
Sub £750m – Montagu, Bridgepoint, Duke Street, Lloyds TSB, 3i
£750m+ - Apax, BC Partners, Cinven, CVC, Doughty Hanson, KKR, Permira, TPG
Who are the major players in PE?
The Montagu Way
In order of our enthusiasm:
PLCs selling assets to refocus on the core business or to reduce debt
Private companies with succession issues or where owner wants to move on
MBOs where the original backer wants to exit
Public companies looking to leave the market
Where do our deals come from ?
We only support incumbent management teams with a successful track record
Looking for “the man with the plan” ….
….. who works in a business that is No.1 or No.2 in its market, is stable and cash generative
We do not do turnarounds or MBI’s
Very low risk approach – until last year our loss rate was just 4% (then we had a problem …)
Why is Montagu different ?
Management executes its business plan
We sit on the board but have minimal active involvement as long as the plan is hit
Regular reporting to banks, with covenants to be met
Acquisitions / investments considered – we are happy to invest more money
The Montagu model day-to-day
Some PE firms change the CEO in 90% of the businesses they buy
Some PE firms are very “hands on” operationally
This can be hugely successful – i.e. Debenhams. It certainly leads to more volatile returns to investors – but this is OK for most of them!
Montagu deals tend to cluster at 2-2.5x equity return. Few massive wins, very few disasters.
PE firms are NOT all the same ….
Structuring a Deal
75
40
0
100
125
Failure Start Success
Equity
Montaguloanstock
Senior& juniordebt
Val
ue
%
How itworks
Typical price paid for a UK PE deal is 8-10 x EBITDA
Typically funded with: Senior debt to 4 x EBITDA Subordinated debt to 5.5 x EBITDA Montagu loan stock to 99% 1% pure equity
Management only invest in the pure equity. Usually £50k - £100k each for 10% - 15% in total.
Stability = Leverage
Senior debt: 3rd party - CIBC, JPM, Mizuho, HBOS etc 3 tranches, 7-9 years, 2%-2.75% margin Back-ended repayment
Subordinated debt: From bank or mezzanine / hedge fund 9 year maturity, bullet repayment 14%-16% coupon
Montagu loan stock: Coupon of 10%-12%, mostly rolled up
How the finance is sourced
On a £220m deal sold for £275m ….
Montagu receives loan stock + 85% of equity gain = £122m
3 year IRR of 25% on our investment of £62m
Management share £7.5m (15% of equity gain)
Exit in 3 years @ £275m£ 000,000
Debt outstanding 145Montagu loan stock 80Equity 50
275
Entry£ 000,000
Third-party debt 158 Montagu loan stock 60 Equity 2
220
Banks have right to take control if interest payments or covenants are not met
Some flexibility but ultimately we have little choice but to replace management and restructure the debt
Our equity value can be wiped out relatively easily
If it all goes wrong …..
Case Study
Dignity Caring Funeral Services
UK’s leading undertaker (500 sites) and crematorium operator (20 sites)
£20m+ operating profit when we bought it in 2002
The story of a deal
1994 – US funeral group SCI enters UK and acquires the two main quoted players, Great Southern Group and Plantsbrook Group
1998 – SCI encounters problems in US due to high debts and in UK over well-publicised customer service failings
1998+ - Peter Hindley, well respected UK funeral industry executive, brought in to fix UK operations
2000 – Montagu approaches Hindley for first time
2002 – Business acquired for £235m inc costs
History pre-deal
Funeral directors provide services to bereaved including collection of deceased, viewing of the deceased, arranging funeral, disbursements and arranging memorials
Co-Op has 18% share, Dignity 12%, independents 70%
The UK funeral services industry
Market is highly stable – death rate is steady and predictable
70% of sales from referrals from family, friend, hospital, priest, etc. This makes it hard for new entrants to make an impact.
Minimal price comparison or competition – 92% approach only one person
Unusual market dynamics (1)
Heavy operational gearing – low marginal cost per funeral but need to cover fixed cost of premises, staff, cars etc. Each additional funeral is therefore highly profitable.
Major benefits from owning multiple sites in one area, given that the average undertaker only does two funerals per week
Only Dignity and Co-Op can offer pre-paid, pre-arranged funerals since people move home, requiring national coverage
Unusual market dynamics (2)
Dignity had predictable and resilient earnings Death rate x market share x average
revenue per funeral = turnover
Dignity is growing revenues and profits 5% pa historic EBITDA growth
Dignity was a highly leverageable asset Pre-completion indications that a £250m
refinancing was possible
Why Montagu liked Dignity
Low risk investment Resilient, predictable, not affected by
economic sentiment
Biggest issue was no obvious exit However, refinancing was a possibility
Under the refinancing case we expected a five year IRR of between 23% and 29%
Why it was right for our fund
MBO @ £235m (inc. costs) in February 2002 7.8x historic EBITDA
Refinanced in December 2002 @ £250m Returned 92% of our original investment
Exited through an IPO in April 2004 @ £394m IRR of 91% Money multiple 2.8x 9.9x historic EBITDA
Shares doubled since we sold out ….
Outcome
Working for a PE firm
7 execution Directors (3 in London) each with 1-2 Investment Directors / Investment Managers in support
At four deals per year each team will complete one deal every two years on average
Dedicated origination, portfolio support and investor relations units in London
How are we structured ?
All firms have different cultures – finding a match is key
Firms can be banker-driven, strategy consultant-driven, industrialist-driven
Smaller than you think – we have only 35 executive staff
Older than you think – unlike investment banks, entry age (for us, anyway) is 28-30
What sort of people are we ?
Typically, an undergraduate would join KPMG, qualify, move internally to tax or PE advisory, work on a Montagu deal, impress us, get hired
In the last three years we have moved to hiring top flight MBAs (Harvard, Insead) with pre-MBA experience at an investment bank or consultancy
Why change? Are we getting better people?
The way we hire has changed ….
Some run an analyst pool – a two year contract post Uni with a view to moving on to an MBA. Some will return, others will join another firm or change career.
Smaller funds still pick up accountants, bankers, etc. Little undergraduate recruitment into execution. (perecruit.com is a good site)
Core skill is administration, marshalling 100 lawyers, accountants, pension consultants, environmental consultants, etc to pull together feedback for an investment case
Other firms have different models
Main driver is ‘carried interest’ – a 20% profit share paid fund by fund
Montagu’s current fund (3-4 years of investment) is €2.3bn. If we double our money, the ‘carry’ will be €460m. Tax rate is 10%.
Bulk of profit share retained on deals done during your tenure even if you leave
However …. requires a long-term horizon. Our 2005 fund is unlikely to pay anything until 2010. New joiners will rely on basis / bonus until then.
Is it good money ?
An Introduction to
Private Equity
Robert Burgess
Director
Montagu Private Equity
www.montaguequity.com
