Level2 Alt Private Equity Valuation

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

www.arifirfanullah.com 2

1. Introduction





2.1 How Is Value Created in Private Equity


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


Term sheet might contain the following…


EBITDA multiples are frequently used


Exhibit 3





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

16


General Partner (GP) vs. Limited Partner (LP) Two core functions of a PE firm: 1) Raise Funds and 2) Manage Investments




Example 2. Calculation of Carried Interest



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


Example 3. Distribution Waterfalls


More corporate governance terms…






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


Example 4. Calculating and Interpreting a Private Equity Fund Performance








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:

38

Conclusion


Documents

Level2 Alt Private Equity Valuation