St. Petersburg State University
Graduate School of Management
Master in Corporate Finance
ANALYSIS OF THE RELATION BETWEEN
PRIVATE EQUITY INVESTMENT TENURE
AND PERFORMANCE OF EUROPEAN COMPANIES
Master’s Thesis by the 2nd year student
Concentration – Master in Corporate Finance
Aleksandr Burov
Research advisor:
Irina V. Berezinets, Associate Professor
St. Petersburg
2016
АННОТАЦИЯ
Автор
Буров Александр Николаевич
Анализ взаимосвязи между сроком private
equity инвестиций и результативностью
европейских компаний
Высшая Школа Менеджмента
Корпоративные Финансы
2016
Березинец Ирина Владимировна
Название магистерской диссертации
Факультет
Направление подготовки
Год
Научный руководитель
Цель:
Определить наличие взаимосвязи м е ж д у
с р о ко м p r i v a t e e q u i t y и н в е с т и ц и й и
результативностью европейских компаний.
Описание цели, задач и о сновных
результатов
Задачи:
Изучить деятельность private equity
фондов и их инвестиционные стратегии.
Проанализировать возможные причины
применения private equity фондами
различных инвестиционных стратегий,
включая сроки инвестиций.
Провести эмпирическое исследование с
целью выявления взаимосвязи между
сроком private equity инвестиций и
результативностью компаний.
Провести анализ полученных результатов,
сформулировать выводы и практические
р екомен д ац и и , о сн о ван н ы е н а
проведенном исследовании.
Основные результаты:
Была обнаружена положительная взаимосвязь
между между сроком private equity инвестиций
и результативностью компаний, измеряемой и
как темпами роста денежных потоков, и как
отношением чистого финансового долга к
операционной прибыли. Предложенные меры
результативности выше для компаний со
сроком private equity инвестиций менее 6 лет
по сравнению с остальными, включая те, в
которых не наблюдалось private equity
инвесторов; меры результативности не
отличаются от остальных компаний при сроков
инвестиций выше 6 лет.
Ключевые слова
Master student’s name
Частные инвестиции, срок инвестиций,
альтернативные инвестиции, частные
инвестиции в публичный капитал
ABSTRACT
Aleksandr Burov
2
Master thesis title
Faculty
Main field of study
Year
Academic advisor’s name
Analysis of the relation between private
equity investment tenure and performance of
European companies
Graduate School of Management
Master in Corporate Finance
2016
Irina V. Berezinets
Goal:
To determine whether the tenure of private equity
investments in European companies has relation
to their performance.
Description of the goal, objectives and main
results
Objectives:
To conduct a study of private equity funds’
activities and their investment strategies.
To analyze the causes of different investment
strategies used by private equity funds,
including different tenures.
To conduct an empirical study in order to
examine the relationship between private
equity investments’ tenure and companies’
performance.
To analyze the obtained results, formulate
conclusions and practical recommendations
based on the research.
Main results:
Positive relation of the investment tenure and
companies’ performance has been discovered,
both in terms of their cash flow growth and
solvency (as measured by net financial debt to
EBITDA ratio).
The suggested performance measures (either cash
flow growth rates or net financial debt to
EBITDA) are higher for companies with private
equity tenure below 6 years as compared to other
companies, including those with no private equity
investors at all.
There is no difference in the suggested
performance measures for companies with private
equity investment tenure above 6 years and other
companies, including those with no private equity
investors at all.
Keywords
Private equity, investment tenure, alternative
investments, private investments in public
equity
ЗАЯВЛЕНИЕ О САМОСТОЯТЕЛЬНОМ ХАРАКТЕРЕ ВЫПОЛНЕНИЯ
ВЫПУСКНОЙ КВАЛИФИКАЦИОННОЙ РАБОТЫ
Я, Буров Александр Николаевич, студент второго курса магистратуры направления
«Менеджмент», заявляю, что в моей магистерской диссертации на тему «Analysis of the
Relation Between Private Equity Investment Tenure and Performance of European Companies»,
представленной в службу обеспечения программ магистратуры для последующей
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передачи в государственную аттестационную комиссию для публичной защиты, не
содержится элементов плагиата.
Все прямые заимствования из печатных и электронных источников, а также из
защищенных ранее выпускных квалификационных работ, кандидатских и докторских
диссертаций имеют соответствующие ссылки.
Мне известно содержание п. 9.7.1 Правил обучения по основным образовательным
программам высшего и среднего профессионального образования в СПбГУ о том, что
«ВКР выполняется индивидуально каждым студентом под руководством назначенного ему
научного руководителя», и п. 51 Устава федерального государственного бюджетного
образовательного учреждения высшего профессионального образования «СанктПетербургский государственный университет» о том, что «студент подлежит отчислению
из Санкт-Петербургского университета за представление курсовой или выпускной
квалификационной работы, выполненной другим лицом (лицами)».
________________________________________________ (Подпись студента)
________________________________________________ (Дата)
STATEMENT ABOUT THE INDEPENDENT CHARACTER
OF THE MASTER THESIS
I, Aleksandr Burov, second year master student, program «Management», state that my
master thesis on the topic «Analysis of the Relation Between Private Equity Investment Tenure
and Performance of European Companies», which is presented to the Master Office to be
submitted to the Official Defense Committee for the public defense, does not contain any
elements of plagiarism.
All direct borrowings from printed and electronic sources, as well as from master theses,
PhD and doctorate theses which were defended earlier, have appropriate references.
I am aware that according to paragraph 9.7.1. of Guidelines for instruction in major
curriculum programs of higher and secondary professional education at St. Petersburg University
«A master thesis must be completed by each of the degree candidates individually under the
supervision of his or her advisor», and according to paragraph 51 of Charter of the Federal State
Institution of Higher Professional Education Saint-Petersburg State University «a student can be
expelled from St. Petersburg University for submitting of the course or graduation qualification
work developed by other person (persons)».
________________________________________________ (Student’s signature)
________________________________________________ (Date)
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Table of Contents
Introduction..................................................................................................................................... 6
Chapter 1. Private Equity Funds......................................................................................................8
1.1. Private Equity Fund Structures.............................................................................................9
1.1.1. Private Equity Fund Classifications.............................................................................. 9
1.1.2. Private Equity Legal Structures..................................................................................... 9
1.2. Private Equity Fund Life Cycle.......................................................................................... 10
1.3. Value Creation for Private Equity Portfolio Firms............................................................. 15
1.4. Private Equity Exit Routes and Risks.................................................................................17
1.4.1. Private Equity Exit Strategies......................................................................................17
1.4.2. Private Equity Risks.................................................................................................... 18
1.5. Private Investment in Public Equity................................................................................... 19
1.5.1. Strengths and Weaknesses of PIPEs............................................................................ 20
Summary....................................................................................................................................22
Chapter 2. Private Equity Investment Tenure................................................................................23
2.1. Private Equity Investment Holding Period......................................................................... 26
2.1.1. Private Equity Investment Tenure Impact on Portfolio Firm’s Performance..............26
2.1.2. Tenure of Leveraged Buyouts and Probability of Their Reversals..............................28
2.2. Private Equity Presence and Performance of Firms........................................................... 30
2.2.1. Private Equity Investment Impact on Industry Performance.......................................30
2.2.2. Impact of Private Equity Investments on Listed Equity..............................................31
2.2.3. Private Equity Financing Impact on Firm Activities................................................... 32
Summary....................................................................................................................................34
Chapter 3. Empirical Study of the Relation Between Private Equity Investment Tenure and
Performance of European Companies........................................................................................... 35
3.1. Research Hypotheses.......................................................................................................... 35
3.2. Research Methodology....................................................................................................... 38
3.2.1. Variables...................................................................................................................... 38
3.2.2. Sample Description......................................................................................................42
3.2.3. Descriptive Statistics................................................................................................... 46
3.3. Empirical Results and Discussion...................................................................................... 54
3.3.1. Determinants of Private Equity Investment.................................................................55
3.3.2. Investment Tenure Relation to the Performance of Target Companies.......................58
Conclusions................................................................................................................................... 64
List of References.......................................................................................................................... 66
Appendix 1. List of Companies Used............................................................................................70
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Introduction
Private equity (PE) has a significant role in the modern economy. Funds, which operate in
the industry, attract investable capital from, among many others, insurance companies, pension
funds, corporate investors, government agencies, and private individuals. Attracted resources are
invested in a wide range of portfolio companies: from start-ups and small companies that are
close to bankruptcy and require expertise in corporate recovery to large companies that lack
growth-oriented strategies. Apart from the plain provision of capital to such firms, private equity
funds bring managerial expertise and are actively involved in succession planning and postinvestment support. Funds’ management can also help with implementing distress measures,
which provide companies an opportunity to survive and to enhance productivity.
As a result, there is a number of positive outcomes of private equity investments. For
example, company performance increases as PE funds improve existing management practices
and supervise resources allocation. Greater innovation as private equity funds finance new
research and development projects as well as young and innovative firms. The positive impact of
PE on the performance of their investees in terms of their profitability and growth also translate
into improvements in overall competitiveness of particular companies and industries as a whole.
As a consequence, private equity essentially contributes to economic growth. At the same
time, PE funds are notorious for exceptional realized returns on their transactions. For instance,
Nordic Capital’s 3-year investment in Nycomed (pharmaceuticals company based in
Switzerland) granted the fund an unprecedented 74% gross return on investment. Another
example of a transaction involves Lux Med (health care services company based in Poland)
buyout. A landmark 1,000% gross return has been earned by Mid Europa Partners fund on this 6year long transaction.
The key question that raises is what factors drive private equity investment strategies that
make such outstanding returns possible? What approaches do they use to determine their
investee firms? Why would a PE fund choose to invest for 3 years in one company and twice as
much in another? What is the impact of such investments on a portfolio company? Is there any
relation between the investment tenure and the performance of investee?
Thus, the goal of this paper is to determine whether the tenure of private equity
investments in European companies has relation to their performance. In order to achieve the
specified goal, the paper will strive to provide new approaches in answering the abovementioned questions through a number of research goals:
To conduct a study of private equity funds’ activities and their investment strategies.
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To analyze the possible causes of different investment strategies used by private equity
funds, including different tenures.
To conduct an empirical study in order to examine the relationship between private equity
investments’ tenure and companies’ performance.
To analyze the obtained results, formulate conclusions and practical recommendations
based on the research.
The paper will particularly focus on private investment in public equity (PIPE)
transactions executed by PE funds. Within such transaction, a qualified investor buys a share in a
listed company that wishes to raise capital in a cost- and time-efficient manner, as compared to
seasonal equity offerings (SEOs). This effectiveness is achieved because PIPEs have a number of
benefits over other methods of equity financing: PIPEs do not require immediate regulatory
registration of the equity issue, do not need expensive roadshows while placement agents’ fees
are lower than such of underwriting banks. These features have made PIPE transactions
increasingly attractive in the recent years: in 2015, an increase of 38.7% in global capital raised
through PIPEs and total market size of $85.7 billion could be observed (PrivateRaise, 2016).
The paper structure is following: the first chapter is devoted to the study of private equity
activities and investment strategies. This chapter also focuses on peculiarities of PIPE
transactions. The second chapter analyzes the possible causes of different investment strategies
of PE funds. This chapter also addresses theoretical approaches, which describe the relationship
between PE investment tenure or presence in general and performance of the portfolio firms. The
third chapter is dedicated to the empirical study of the relationship between private equity
investment tenure and performance of the target companies. This chapter also covers all the steps
of the empirical research: its methodology, results of econometric and statistical analysis,
discussion of main findings, as well as practical recommendations.
The paper also applies several theoretical concepts covered in existing academic research.
For instance, research methodology draws particular ideas from “Determinants of Private Equity
Investment in European Companies” paper of Badunenko, Barasinska, Schäfer (2009) and
“Access to Private Equity and Real Firm Activity: Evidence from PIPEs” paper of Brown and
Floros (2012).
The empirical part of the paper is based on a sample of PIPE transactions that took place
in the years 2005 – 2014 and had European target companies. The sample is based on
transaction, financial, and shareholder structure information acquired from Thomson Reuters
Eikon and Datastream databases.
Main findings of the paper extend currently available research of both PIPE transactions
and private equity by introducing several approaches, which were not previously covered in
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academic papers. What is more, practical recommendations of the paper are useful for both the
firms, which consider PIPE financing, and for private equity investment decision-making.
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Chapter 1. Private Equity Funds
Private equity (PE) has become an important element of the modern financial system
from a niche activity. As opposed to public equity, private equity is generally an asset class that
is not listed on a stock exchange. However, over the years of the industry’s development, private
equity investments began to appear in a form of convertible debt, public equity taken private, or
even private investments into a listed company’s specific instruments, which are not available to
the broad public. Typically, such investments are made by private equity firms, financial
intermediaries for their investors, which in turn establish specialized private equity funds.
Globally, an increasing demand for such funds exists: PE fund-raising has increased by almost 5
times from an estimate of $105 billion in 2003 to $499 billion in 2014:
Figure 1. Global private equity capital raised by fund type (Bain & Company, 2015)
Each of the PE funds selects multiple companies (portfolio of companies), shares in
which can be sold after a few years, fulfilling the main goal of funds – generating a capital gain.
The capital gains are generated because the targets of PE funds are often underperforming
businesses so that the funds’ management can increase target’s profitability over the term, or
tenure, of investment. Increased profitability is reflected in higher valuation of the target
company, which is sold to other investors later at profit for a PE fund. Further on, the possible
variations in each of the steps of this business model are described in more detail.
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1.1. Private Equity Fund Structures
1.1.1. Private Equity Fund Classifications
Private equity is classified into 3 broad categories, depending on various factors
(European Private Equity & Venture Capital Association, 2016):
1. Venture capital. The category includes seed stage (business ideas without prototypes), startup stage (business and marketing plans are usually established), expansion stage (products
are already marketed, but funds for expansion are insufficient), and replacement capital
(financing to buy back shares from existing venture capital investors or to reduce debt
burden) funds, depending on the stage of financing of portfolio companies. Target businesses
for venture capital are usually non-mature and are limited in financing, thus, represent an
attractive investment due to new technologies, as opposed to stable revenue flows.
2.
Buyout. This category includes acquisition capital (debt and equity financing for a company
acquiring another firm), leveraged buyout (company buyout financed by excessive use of
debt capital – either junk bonds or loans – with company acquired serving as collateral) and
management buyout (management financed to acquire firm or its part), depending on type
and purpose of financing. Target businesses in this broad category are usually acquired
entirely, but the strategy of providing development capital may also be possible. As opposed
to venture capital investments, portfolio enterprises in this category are mature, while
technology considerations are rather irrelevant for investment decision-making. Most of the
times, if the target is listed on a stock exchange before the transaction, further delisting
process is expectable. This category historically has been the most popular in terms of
invested money (Fraser-Sampson, 2007, p. 8).
3. Special situations. This category includes mezzanine finance (financing in the form of
subordinated debt and equity), distressed securities (financing of distressed companies), onetime opportunities and others.
The first two categories, buyout and venture capital, are main categories of funds both in
terms of a number of funds and invested amounts (CFA Institute, 2015, p. 137). The categories
listed above, however, are not the only ways to classify private equity funds: very often funds are
also broken into smaller categories by geographical location and sector focus of target
companies.
1.1.2. Private Equity Legal Structures
The limited partnership – an agreement between general partner (GP, fund’s manager, a
private equity firm) and limited partners (LPs, fund’s investors) – has become the most
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widespread structure of private equity funds (Fraser-Sampson, 2007, p. 11). Due to private equity
funds often being highly leveraged entities (especially for LBO transactions), the GP of a fund
shares the risk and is liable for all the debts of a fund. On the contrary, LPs’ risk is limited to the
initial amount invested.
Another type of organizational structure for a PE fund is a company limited by shares,
which is similar to a limited partnership agreement, but sometimes provides better legal
protection to the GP as a receiver of operational fees charged by PE funds. Some other fund
structures may also provide more legal protection to the LPs, depending on fund’s jurisdiction.
1.2. Private Equity Fund Life Cycle
Terms of PE funds tend to be between 10 to 12 years (from initiation to termination),
usually extendable by up to 3 years (CFA Institute, 2015, p. 152). The life stages of a fund can be
generally described as follows:
Marketing
(Fundraising)
Investors'
commitments
Investments in
portfolio
companies
Exit from
companies
(?) Extension
Figure 2. Life stages of a private equity fund
1. The marketing stage is crucial for a PE fund as raising funds is the second most important
goal of a fund after generating capital gains. The intentions to create a new fund are
marketed to investors in advance to meet target fund size by the launch date. The target fund
size is fixed by the fund prospectus and indicates the fund manager’s ability to both manage
and raise corresponding amounts of money.
Maintaining long lasting investor relationships is very important for success during
the marketing stage: not only can the private equity firm attract current or former funds’
investors, but convince them to co-invest in portfolio companies. Trust is fundamental in
private equity fundraising, especially after the financial crisis of 2007-2008, and only by
running consistently overperforming funds the private equity can succeed at this stage: PE
global fundraising in 2009 has been in trouble with total capital raised declining by more
than 50% as compared to 2008 (as can be seen in figure 1), however, 2011 has seen
considerable increase in positive cash flows generated by PE funds, increasing LPs’
willingness to become a party in new fundraising campaigns. Nevertheless, increased returns
in the private equity asset class alone cannot compensate for imbalance between the supply
of PE fund offers and aggregated capital, available LP for investments:
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Figure 3. Successful private equity fundraising in 2012 – 2014 (Bain & Company, 2015)
As we can see in the figure above, private equity market remains highly competitive,
with only less than 30% of the funds raising funds’ targets in less than 1 year. To further
enhance the trust and attract more investors, new models in the private equity investor
relations emerged lately (Bain & Company, 2013). For example, in 2012, CVC Capital
Partners, a UK-based PE firm founded in 1981, which manages numerous ten years or more
closed-end funds on behalf of over 300 institutional, government and private investors (CVC
Capital Partners, 2016), sold 10% stake in itself to sovereign wealth funds, like Government
of Singapore Investment Corporation and the Kuwait Investment Authority. Such nontraditional new fund marketing is beneficial both for the managing firm and its investors: the
GP receives a long lasting capital base, which can be split between new funds in the future,
while investing LPs will also receive increased cash flows from funds due to the share in
fees the PE firm receives from managing them.
Another example of new-coming investor relations strategies is running special
accounts – particularly used by one of the biggest private equity firms, Kohlberg Kravis
Roberts (KKR). KKR is US-based and was founded in 1976 while seeing first public
pension funds’ investments in its funds already in 1982 (Kohlberg Kravis Roberts & Co.,
2016). In 2012, KKR received $3 billion in commitments from Teacher Retirement System
of Texas, which would pay lower fees than a common LP of KKR’s fund, and would have an
opportunity to participate first on many of the KKR’s deals on preferred strategies. In its
turn, KKR demands capital commitments to be longer lasting than such of a typical LP.
One of the more traditional measures to increase investors’ trust even during a
marketing stage is key man clause, which is essentially a certain group of executives with
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diverse backgrounds that would manage the fund. This clause may restrict the GP from
making new investments in case a pre-defined part of the initial key group wasn’t
participating for the whole term of the fund. Such restrictions are put on a fund until new
key executives are negotiated with the fund’s investors. Another instrument is no-fault
divorce agreement, which may be implemented into the fund’s legal base, allowing the super
majority of investors’ to vote for removing fund’s manager throughout fund’s term without
providing any specific reason. On the contrary, removal for cause agreement allows
removing the fund’s GP or terminating the fund itself before its termination for a pre-defined
set of reasons like material flaw being found in fund’s prospectus.
2. The investors’ commitments (signing a legal agreement to provide a certain amount of
capital to the PE fund upon capital drawdowns, which are discussed below) stage is often
held parallel to the marketing campaign, and multiple “closings” are offered to potential
investors. This reflects the fact that most of the funds operate as “closed-end” funds, thus,
such legal agreements with PE funds can only be made at pre-defined by the GP periods and
subsequent investments cannot be redeemed over the lifetime of a fund. However, this
doesn’t mean that investors receive no cash flows until fund’s termination: such occur as
soon as the fund exits an investment, and cash is distributed among investors immediately.
Thus, the tenure of an investment in private equity is not equal to the term of the fund but is
rather unpredictable when the fund is started. This subject is discussed in more detail further.
Private equity funds usually raise funds from either from institutional investors
(pension funds, endowments, insurance companies) or from wealthy individual investors,
who invest through fund-of-funds or directly. Fund-of-funds intermediaries exist to provide
their investors more diversified solutions. From the committed capital management fees
(1.5% – 2.5%) are usually charged by a PE fund on an annual basis after the vintage year –
year the fund is launched (CFA Institute, 2015, p. 153). Less frequent fees are calculated
relatively either to invested capital or to the net asset value of fund’s current investments.
3. Before a fund makes any investments, screening of opportunities and preparing proposals
for the most attractive target companies’ investors is conducted. Valuation throughout the
whole expected investment horizon is also carried on this stage and exit routes are being
considered to apply stress tests to the appraisal in order to consider possible outcomes
depending on possible market conditions and financial forecasts. If a company is perceived
as a profitable investment by a PE fund, further structuring of the deal takes place before the
stake purchase takes place.
The LPs have no right to reject investments selected by the fund, as commitments are
legally defined and the drawdown notice just notices the purpose of the call for money.
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However, to limit fund’s investments activities, such usually have restrictions defined in the
fund’s prospectus like the minimum level of diversification or maximum levels of the fund’s
leverage. Another restriction on investments is co-investment agreement between fund’s GP
and LPs, allowing the latter to co-invest in a target company first (in case the fund doesn’t
execute a buyout solely), while the GP is restricted from such activities to avoid conflicts of
interest (like one arising from the GP investing in the same target with another fund).
The GP often benefits from transaction fees on this stage if the GP is involved in due
diligence or advising on mergers and acquisitions (or an IPO on the next stage). In case such
fees are shared with LPs, such are deducted from their future management fees.
It is important to notice that PE funds usually have highly unpredictable cash flows –
both in size and timing. Even though the committed capital of the fund has been legally set
on previous stages of the fund’s life, actual capital drawdowns – calls for investors’ money –
take place only upon identifying advantageous investment opportunities.
4. Even though exit opportunities are considered and planned in advance, even before any
investments are made, a lot can change in market conditions. This may cause inevitable
changes to the plan by either speeding up the exit not to lose current opportunity, or
postponing such and, for example, proceeding with more organizational changes to the
portfolio firm and waiting for better market conditions. This makes the actual timing of
selling a fund’s investment highly unpredictable, thus extending uncertainty of cash flows to
investors from amounts only to timing. Whenever a fund exits its investment by one of the
strategies discussed in a separate paragraph below and most likely realizes a capital gain on
the invested capital, a distribution notice is sent to investors, defining time and amount of
future cash flows to them.
Another possible distribution mechanism is the distribution in specie, which is
popular for US venture funds, but has met adverse reactions in EU and is barely used in the
region (Fraser-Sampson, 2007, p. 14). This form of distribution implies proportional transfer
of a target’s ownership to investors instead of exiting an investment. Because the shares are
often a restricted stock (which cannot be sold for a set amount of time, like 6 months), such
distributions often lead to massive sales on the first available day and, as a consequence, to
unsatisfactory prices for fund’s investors.
Even though that profits are most likely to be realized at this stage, it is not
obligatory for funds to report publicly their performance. Recent legislative acts require
public pension funds to report performance of the funds they invest in, however, the list of
PE funds’ target companies may still remain confidential. The lack of transparency in the
industry is largely motivated by limiting uninformed analysis and coverage of complicated
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returns analysis and desired privacy of venture capital funds on the matter of their target
investments (Fraser-Sampson, 2007, p. 94). However, this issue also complicates outsider
analysis of the industry, with very few percentage of the PE funds’ transactions covered even
in modern databases.
One of the most important features of private equity as an asset class is the j-curve
effect. An investment in a PE fund is characterized by a stream of cash flows, like bonds,
with an exception that both size and timing of cash flows are unpredictable. As mentioned
above, outflows occur after issuance of drawdown notices for each of PE fund’s investments
and depend on opportunities found by the fund, while inflows occur after PE fund generates
(perceived) maximum value per its investment in a portfolio company and exits the
investment. Obviously, investors tend to receive drawdown notices closer the vintage year of
a fund, while distributions of gains to investors tend to be concentrated around the
termination of a fund. This makes annual returns, as opposed to compound returns, an
invalid measure of a PE fund’s performance. At the same time, compound returns, depicted
by a fund’s IRR curve, take a J-shape because of negative returns in the early years, which
revert as a PE fund begins to carry out its exit strategies. Negative returns are driven by
value creation strategies, discussed in a separate paragraph below, which are restructuring
changes a fund enforces upon investing in a portfolio company. The steeper the curve is, the
faster cash is returned by a fund to its investors. As a consequence of annual returns being an
inadequate measure for PE funds, benchmarking of private equity returns against other asset
classes requires extra measures to be taken, while comparison of PE funds’ returns between
each other makes sense only between funds of the same vintage year.
Two other remarkable features of private equity returns are (Fraser-Sampson, 2007,
p. 30):
Persistence of returns over time: worst performing funds are likely to underperform
further on while best performing are likely to overperform in the future. As
investment opportunities for funds have already been identified during funds’ early
years, it is unlikely that less advantageous investments will perform better towards
fund’s termination.
Performance differences are very high across funds. This is also a consequence of
high competition of funds for extremely attractive investment targets: while certain
funds are successful at finding and investing in such, others are left with only decent
opportunities.
5. As simple as it implies, an extension is a mutual agreement between the GP and LPs to
extend the term of the fund. In case LPs did not enter the agreement to extend the term of the
15
fund, such fund is terminated. Upon fund’s termination, clawback provision is often due.
This provision requires fund’s manager to return capital (including fees and other expenses)
to investors in excess of the pre-agreed profit split between GPs and LPs. GP’s share of
profits generated by the fund (the carried interest) is usually around 20% of fund’s total
profits net of management fees (CFA Institute, 2015, p. 153). Allocations of carried interest
to the GP are only possible when fund’s IRR is above a pre-defined hurdle rate. The hurdle
rate is an additional incentive for fund’s manager to outperform a certain return benchmark
over the corresponding amount of time.
Two distribution waterfalls are possible for the fund’s profits:
a) Deal-by-deal: carried interest is distributed to the fund’s manager after each deal is
closed.
b) Total return: investors receive their distributions earlier in this case as carried interest
is calculated on the profits of entire portfolio and carried interest is distributed to the
fund’s manager after all the drown down capital is returned to LPs.
1.3. Value Creation for Private Equity Portfolio Firms
An essential part of private equity industry is the ability to create value for portfolio firms
and generate highly positive returns on selling fund’s stake. Exploiting the advantages of nonpublic terms of entering target companies is crucial for overall sustainability of the private equity
business and generally include:
Opportunity to take active control of a portfolio firm, granting:
o The ability to restructure its business model to increase the profitability . Improving
operational efficiency of portfolio companies has been claimed as the primary source
of increasing portfolio companies’ value (Koller, Goedhart and Wessels, 2010). Many
of the PE firms hire consulting companies to conclude, whether specific changes to
the company’s business model are feasible over the investment period. Some of the
largest private private equity firms even have dedicated positions for consultants with
diverse managerial backgrounds. One of them is Blackstone – a major US-based
private equity market player, founded in 1985 (Blackstone Group, 2016). Such
advisors are capable of providing the PE firm insights on local markets, industries
and assist firm funds’ ability to capture global opportunities and exploit such by, for
example, increasing target firm’s earnings growth, expanding operations or reducing
debt by the time of exit. However, business model restructuring alone would not be
able to generate abnormal returns for private equity funds, otherwise, superiority of
16
private equity firms in this field would mean that public companies are unable to
function efficiently without an intervention of PE funds.
o The ability to restructure target’s administrative model to increase incentives for the
firm’s management to perform better. Full or a great extent of control over a portfolio
company allows a PE fund to change existing compensation of management for it to
be in line with a fund’s exit price from the company (or total fund’s returns from the
transaction), or simply to replace positions with more motivated executives.
Investment terms, specified in the term sheet, pre-defines rights and obligations
between a PE fund and its portfolio companies. The most widespread provisions are
tag-along and drag-along rights, which are incorporated into investments’ legal
structure to protect minority shareholders’ rights. Tag-along right allows minority
shareholders to join majority shareholder and sell their stake at the same price and
terms while drag-along forces minority shareholders to do so. In both cases, such
rights prevent any future buyer of the company from gaining control over a company,
until the offer is extended to all shareholders, including executives. This legal
measure ensures that minority shareholders’ rights are taken into consideration by PE
funds and investments of the latter are not detrimental to existing owners of the
company. Among other instruments, aimed at balancing PE fund’s and management’s
interests are:
Availability of corporate board seats, which ensures PE fund’s control over a
portfolio company and ability to block major events like restructuring or
selling.
Preferred dividends and liquidation preference are rights for a PE fund to
receive distributions from a target company before other investors of such
company.
And even if a PE fund doesn’t achieve a controlling stake in its target firm,
reserved matters allow the fund to block major decisions like business model
changes or acquisitions.
Therefore, legal structuring of the deals alone can be a source of a PE fund’s
gains. Contractual terms of investments are especially important for a fund, willing to
gain major control over their venture capital portfolio firms, which are facing
particularly unclear prospects both financially and strategically.
Moreover, since shareholders’ and equity market players’ expectations are
pressuring public companies, incentives for meeting short-term goals, like increasing
sales or margins, exist. By exiting broad markets, executives of private companies are
17
more interested in approving longer-term projects, which eventually would bring
more value for a company under question, even at the cost of short-term effects,
which could possibly be perceived as negative by the market.
Access to debt markets at favorable terms, which were unavailable for the target firm alone .
Even though regulatory guidance for banks in the US states that it is not advised to finance
takeovers with Debt / EBITDA ratios of more than 6, in 2014, 40% of the LBOs were still
financed at higher ratios (The Wall Street Journal, 2014). Such high levels of leverage highly
exceed the comparable use of debt by public companies. This provides PE funds a unique
opportunity to exploit tax shields from their deals while such tax benefits still exceed
bankruptcy costs. Track record of a PE firm’s debt repayments, as well as ability to control
target firms’ management, is paramount to access the syndicated loan market or high-yield
bond markets. Most of the times, such syndicated loans are re-engineered later into either
collateralized loan obligations (CLOs), or collateralized debt obligations (CDOs), which
partially transfer credit risks from a PE firm to investors of such instruments.
Apart from favorable terms, leverage may also assist target firms at a better
distribution of its free cash flows. According to Jensen (1986), slow growth firms tend to
distribute their excess free cash flows to projects, which destroy company’s value. Utilization
of high debt burden by private equity funds re-allocate such cash flows to debtholders,
ultimately imposing discipline on target companies’ management and adding value to the
target company.
1.4. Private Equity Exit Routes and Risks
1.4.1. Private Equity Exit Strategies
Even though the previous part of the proves PE funds’ ability to create value, it is also
necessary to extract such value. A PE fund may attempt to increase its profitability by picking
out a strategy of exiting portfolio firm’s ownership that will increase the price of exit to the
greatest extent. Expected valuation of investment by the time of exit and deal’s IRR are closely
tied to the exit route, therefore, such strategies’ feasibility should be considered in advance. Four
possible options are:
1. IPO. Initial public offering results in higher valuation multiples due to the higher
liquidity of the stake a PE fund is selling, as well as access to a broader market of
investors. Even flexibility in gradually selling tranches of securities is possible if fund’s
termination time allows doing so. However, IPO is not always an optimal route for an
exit due to high costs and increased time needed to execute the exit. Moreover, there is
18
empirical evidence that timing of an IPO is essential for it to be successful (Lowry and
Schwert, 2002) while market conditions for the exit are barely predictable during fund’s
initiation of investment in a company.
2. Private sell. This option implies selling fund’s stake to another financial or strategic
investors, like ones willing to expand their operations geographically or integrate
upward / downward their value chain. Secondary buyouts to other private equity funds
are also possible, whether the latter expects such transaction to be profitable. This is
possible because of private equity market being highly segmented, thus, where one firm
may be specialized at restructuring, another firm may still earn high returns from
investing in the same portfolio company by merging such with other investments and
achieving synergies from this transaction. Overall, a nonpublic market sale will have a
discount for lack of liquidity, but will still yield highest valuation multiples, where an
IPO is not possible.
3. MBO. A management buyout with the use of high leverage is also possible. Nevertheless,
this option reduces the potential sell price due to management’s perfect understanding of
the business and excessive debt used in the transaction, thus this exit strategy is usually
considered where other options are unavailable.
4. Liquidation. Even though this exit route will result in the lowest price, it may still be
considered in the shortage of other options, for instance, when market conditions are
highly unsuitable for other ways of selling the stake. Even though a fund’s term is predetermined and all investments should be sold by the termination of the fund,
undertaking this option may have serious negative impact on PE firm’s reputation, for
instance, if many workers have been laid off as a result of the liquidation.
1.4.2. Private Equity Risks
Private equity investments’ increased returns come at the cost of increased risks,
associated with the asset class. Some of the risks, associated with this asset class are following
(CFA Institute, 2015, p. 156): lack of liquidity, unquoted investments (lack of frequent market
pricing, while valuation of investments using complex techniques like DCF, relative, real option,
and replacement cost valuation is subject to judgement), high competition for attractive target
firms, agency risk (of delegating investing decisions to the fund’s management), changes in
government regulations and / or tax treatment of capital gains (especially high due to long-term
nature of the asset class), lack of capital for target companies (if fund’s investment is insufficient
for reaching its goals), lack of diversification (due to how costly each investment in target
companies is), market risk (for interest rates, currency exchanges, etc.).
19
Because of high agency risks, there is also no guarantee that fund’s management will put
their best efforts in seeking lowest costs for any of the necessary fund’s activities, such as:
transaction fees (debt financing, legal fees, etc.), legal entity setup costs, administrative and audit
costs, dilution of ownership (in case stock options are granted for portfolio company’s
management), and others.
Due to such high risks, associated with private equity, such investments have certain
barriers to entry for individual investors. Even though fund of funds, which are reducing risks by
using expertise in selecting particular PE funds, may grant access to the asset class, many of such
funds are «invitation only». Moreover, in Europe, funds of funds usually have low allocations to
private equity itself (Fraser-Sampson, 2007, p. 3). Direct investments in PE funds are
complicated too: in most countries such investments are available only to accredited investors –
either financial institutions or wealthy individuals. The definition for individuals depends on
legislation system of the country under question (Wikipedia, 2016):
USA: a person with net worth of $1 million (excluding the value of primary residence), or
having an annual income of $200,000 ($300,000 combined income if married) over the last
two years.
EU: a person who worked in the financial sector for at least one year which requires
knowledge of services under question, and possessing financial instrument portfolio worth
more than €500,000.
1.5. Private Investment in Public Equity
Private Investments in Public Equity (PIPEs) are discussed separately in the paragraph
below as the main target of the study. PIPE is a transaction, in which a private equity fund, hedge
fund or another qualified investor purchases a privately issued share in a public company.
Similar to initial and secondary public offerings (IPOs and SPOs), the main purpose of a PIPE is
to raise additional capital for growth or to refinance. Typically, PIPEs involve issuing common or
convertible preferred equity, but structured issues of convertible instruments like debt are also
possible (Latham & Watkins, 2010). This source of financing has become increasingly
interesting for issuing companies with a total of $85.7 billion raised in 1,294 global PIPE
transactions during 2015. This is 39% higher in proceeds than in 2014.
As we can see from the figure below, the demand for PIPE placements has been growing
for 3 past consecutive years, showing recovery of the market. Huge amounts of capital raised
during the financial crisis mainly consist of large transactions: for instance, in 2007, plenty of
mega-PIPE issues by financial firms in response to crisis-related write-downs accounted for $40
20
billion in capital raised, 48% of the total market ( Sagient Research Systems, 2016). In 2008, 87
mega-PIPE transactions have already accounted for $165.1 billion raised, 93% of total market.
This abnormal use of PIPEs during years 2007 and 2008 indicates that, from issuer’s point of
view, such transactions are extremely attractive during times, when other sources of equity
financing become hardly achievable.
$140
2,500
$121
$120
2,000
$100
$86
$80
$72
$62
$60
$39
$40
$22
$20
$0
1,500
$17
$18
$19
$42
$49
$39
$40
$47
$23
500
2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016
Capital raised, billion
1,000
0
Number of placements
Figure 4. Global historical PIPE transactions and capital raised (PrivateRaise, 2016)
For the non-crisis periods, biotech companies, real estate investment trusts, and
technology companies have been historically dominating in the numbers of PIPE transactions,
representing industries, which are also attractive for private equity funds (Morrison & Foerster,
2016). In more recent years, mature companies in more established industries, apart from
financial services, have also shown interest in PIPE transactions, seeking an alternative source of
capital: the average U.S. PIPE proceeds were $56.5 million with 9 deals having proceeds of
more than $1 billion with only a few of such attributed to the financial services industry, while
more traditional IPO capital-raising proceeds averaged at $176.5 million throughout 2015 (Zacks
Equity Research, 2016).
1.5.1. Strengths and Weaknesses of PIPEs
Under certain circumstances, a PIPE, even during non-crisis times, may be more
attractive for an issuing company than an SPO for the following reasons:
1. Delayed registration of the issue with regulatory agencies. A PIPE involves the placement of
unregistered securities, thus, there is no immediate burden, including fees, from registering
the issue with the U.S. Securities and Exchange Commission (SEC) or its counterparts in
European countries. Usually, the registration is deferred to a later date – 60 to 90 days from
21
the initial sale, to provide PIPE investors ability to freely sell the securities on the public
markets later (Taft Slettinius & Hollister, 2009).
2. No expensive roadshows held by underwriting investment banks. Private investments in
public equity are marketed by placement agents, which are similar to underwriting
investment banks in IPOs, but among a relatively small group of investors, thus making
overall transaction expenses lower than such for an SPO. Moreover, the marketing stage may
remain confidential, thus reducing the possible negative impact of market reactions to the
deal’s announcement, which is impossible under SPOs.
3. Increased time efficiency of the issue. Due to the reasons given above, a PIPE can also be
completed more quickly than an SPO, which can be especially attractive for fund-raising
during volatile markets.
For the above-mentioned reasons, and especially because PIPEs provide a relatively costeffective alternative source of financing, such transactions became attractive for enterprises with
substantial capital requirements. Nevertheless, such efficiency of PIPEs comes at cost of specific
disadvantages for the issuer, such as:
1. Unfavorable pricing of equity shares. The transaction implies selling initially unregistered
securities, which are, like in IPOs, are subject to black-out periods, during which the share
purchased cannot be resold. Because of this, application of a discount for lack of liquidity,
compensating initial restrictions for investors, should be expected during the valuation of the
stake offered.
2. The discount from a PIPE may cause an adverse market reaction. Upon the announcement of
the sale later, traded equity may negatively reflect the discount, which is applied to the
investors of a PIPE.
3. Restrictions on investors for PIPE transactions. The PIPE can only be marketed to accredited
investors, limiting the issuer’s flexibility (Morrison & Foerster, 2016). Moreover, the pool of
investors for a PIPE transaction is limited to such, willing purchase no more than 20% of the
company’s ownership in total, which represents an upper limit of an offering not requiring
prior shareholder approval.
From the investor’s point of view, PIPE transactions are attractive for a number of reasons:
1. Investments are made at a discount. As mentioned above, the initial lack of liquidity of
PIPEs causes such to be discounted for selected investors. The strongest point of the
transaction is when the securities become registered or converted to common equity
instruments, enabling the investor to sell his share freely. Using equity markets for exiting
investments is much more convenient for private equity funds, as compared to other
22
investments, like buyouts, where additional substantial costs are incurred at this stage (as
expressed by either IPO or M&A advisory fees). However, this discount may be instantly
reflected in the downward movement of market prices upon the public disclosure of the deal
by issuing company, making this investment riskier over the short-term horizon.
2. Expansion of investment opportunities for funds. In a heavily competitive environment of
seeking more traditional private equity investments, PIPEs offer new opportunities for funds,
willing to invest in companies without gaining control. Even though the target company is
public, due to the timing of capital infusion for the company, the investment may still offer
private equity-type return (Fraser-Sampson, 2007, p. 49).
3. Fixed sale price for the share in PIPE transaction, which means that it is not adjusted for
market price or to fluctuating ratios. This is a major advantage for investors of PIPEs, as
compared to investors of IPOs and SPOs, because upon discovering potentially underpriced
investment opportunities, a fund may fix its invested capital immediately by signing the
purchase agreement. Under certain circumstances, investor of a PIPE may negotiate a
downside protection of their investment’s value in the event of stock’s price decline on the
markets by issuing additional shares. On the other hand, public companies may also negotiate
caps and floors, which limit the number of issued shares as a result of price changes. Overall,
the investor (not the issuer) of a PIPE will still bear the market risk to a certain extent.
4. Instrument’s structure flexibility. As noted above, most of the PIPEs involve the purchase of
common or convertible preferred stock, as well as less popular convertible debt instruments.
Any of the convertible securities is ultimately converted to common stock for easy market
access of traded securities: either through a mandatory conversion (upon the appearance of a
triggering event, like reaching a certain price per share) or through investor’s or issuer’s
option. The structure of cash flows before the conversion is also highly negotiable. Apart
from cash dividends at a pre-defined rate, a pay-in-kind dividend with compounding effect is
also possible, obliging the company to issue additional securities for holders of such
instrument at an increasing rate. Investors protection may also be embedded into the
instrument, like a springing board appointment right, which entitles the investor to introduce
additional directors to the company’s board in case it hadn’t paid dividends for a pre-defined
number of periods.
Summary
In this chapter, a wide range of private equity peculiarities has been reviewed, including
strategies of private equity funds to enter and exit their investments in companies, sources of
23
value creation for their portfolio firms, and industry-specific risks. Moreover, the potential of
growth in PIPE transactions segment has been highlighted, as well as strengths and weaknesses
of such financing both for the target company and investing private equity fund. Over the course
of the next chapter, a considerable variation in private equity investment holding periods will be
shown and explained through the study of market and existing papers.
24
Chapter 2. Private Equity Investment Tenure
Holding periods (from initial investment to complete exit) of shares in portfolio
companies vary between private equity firms, funds, investing and exit strategies, and industries
of target companies. For example, buyouts, which have historically represented the largest
portion of total private equity fundraising, have also seen their average holding periods varying
across years:
Average Holding Period (Years)
7
6
5
4.5
4.4
2006
2007
4.1
5.1
5.3
2010
2011
5.5
5.8
5.9
2013
2014
5.5
4.3
4
3
2
1
0
2008
2009
2012
2015 YTD
Year of Exit
Figure 5. Global Average Buyout Holding Period by Year of Exit, 2006 - November 2015 YTD (Preqin, 2015)
The differences between holding periods are illustrated best with real-life examples,
having their own similarities. There are 2 transactions with targets with absolutely unfamiliar
industries, but with quite similar value creation route taken by investing private equity firms.
What is more interesting, those transactions have different investment periods, while a longer
investing period is not accompanied with increased returns: Nordic Capital (founded in 1989 in
Sweden, currently – Jersey) has invested in Nycomed (a pharma company founded in 1874 in
Norway, currently – Switzerland) 2 times: for 3 years with an approximate gross return of 74%
and for 6 years with approximate gross return of 34% (Nordic Capital, 2016). Apax Partners
(founded in 1969 in the UK), on the other hand, invested in Tommy Hilfiger (a fashion company
founded in 1985 in the US) only once for 4 years with approximate gross return of 44% (Apax
Partners, 2016). As we can see from these 3 buyout examples alone, gross returns are lower as
investment tenure increases. A short summary of the transactions is given in a table below:
25
Table 1
Nycomed and Tommy Hilfiger Transactions Summary
Target companies
Target industries
Investing PE firms
Transaction
Exit route
Pharmaceuticals
Nordic Capital
Buyout
Trade sale
1999 – 2002 (3 years),
Investment period(s)
Investments in R&D and
marketing
Through
Complementary businesses
acquisition
Value Created
New products sourced through
in-licensing
Deleveraging
New CEO, Håkan Björklund,
who led Nycomed from 1999 to
2006 – 2010 (4 years)
2005 – 2011 (6 years)
Expansion in new European
markets
Fashion
Apax Partners
Buyout
Trade sale
Stores expansion
Investments in growth, including
e-commerce platform relaunch
Consolidation of suppliers
Distribution agreement with a
major retailer
Deleveraging (Net Debt reduced
by 50%)
New CEO, Fred Gehring
$1.6 billion
$2.3 billion
2011
Approx. €512 million (1999) +
€176 million (2001)
Purchase price
Approx. €1.4 billion (2005) +
€7.2 billion (related acquisition,
2006)
Approx. €1.2 billion (2002)
(74% gross return)
Sale price
Approx. €9.6 billion (2011) +
€1.9 billion (related spin-off,
(44% gross return)
2012)
(34% gross return)
Even though investment tenures and gross returns differ significantly for the 3
transactions, private equity funds, the exit routes were the same. What is more, we can see clear
similarities between the strategies of the 2 companies during investment periods of
corresponding private equity firms:
26
Both companies expanded geographically: Nycomed was entering developing markets in
Western Europe while Tommy Hilfiger was developing its retail stores globally.
Both companies made investments with a substantial part of such allocated to marketing:
Nycomed invested heavily in research & development of new products and marketing for
new markets while Tommy Hilfiger required investments for new stores and re-development
of its e-commerce platform to sell products online.
Both companies deleveraged heavily and introduced new management teams, including
CEOs, for the whole period of private equity presence in their ownership structures.
It would be easier to say that different holding periods for Nycomed and Tommy Hilfiger
are attributed to industry specifics, but can also be proven not to be the only reason. As we can
see from the figure below, average holding periods between consumer and healthcare industries
5.2
5.2
5.1
5.0
5.0
4.9
4.7
4.6
4.4
4.3
Food & Agriculture
Materials
Information _x000d_Technology
Business Services
Healthcare
Infrastructure
Real Estate
Clean Technology
Energy & Utilities
5.3
Telecoms & Media
5.3
Consumer & Retail
6
5
4
3
2
1
0
Industrials
Average Holding Period (Years)
differ by less than half a year:
Figure 6. Global Average Holding Period by Industry for All Exits, 2006 - April 2015 YTD (Preqin, 2015)
Another example of transactions with similarities includes comparably smaller businesses
– buyouts of Magellan and Lux Med, both established in Poland and operating in the healthcare
industry (Invest Europe, 2016). Brief information on the transactions can be found below:
27
Table 2
Magellan and Lux Med Transactions Summary
Target companies
Target industries
Investing PE firms
Transaction
Exit route
Magellan
Healthcare
Enterprise Investors
Development capital into buyout
IPO, SPOs
2003 – 2007 (4 years)
Investment period
2007 – 2013 (6 years)
Minority until 2013 (10 years)
Investments in new clinics,
equipment and IT systems
Value Created
Through
Lux Med
Healthcare
Mid Europa Partners
Buyout
Trade sale
Integrated several businesses
New management
Investments in customer service
improvements
Expanded operations to Slovakia
and Czech Republic
New management
These 2 cases prove that longer investments are not always detrimental from private
equity firm’s point of view, as it might seem from Tommy Hilfiger and Nycomed cases: Mid
Europa Partners has managed to earn about 2.5x gross return upon selling their stake in Lux Med
6 years later (The Alternative Assets Network, 2013); Enterprise Investors have reached
landmark 10x gross return on initial investment made 10 years before by selling 34% share in
Magellan on the Warsaw Stock Exchange (MergerMarket, 2013). Moreover, the 2 buyouts prove
industry specifics not to drive differences in holding periods solely.
Throughout the next chapter, different academic papers will be reviewed in order to find
possible explanations behind the differences in private equity investment periods, and how such
investments might be reflected in company’s performance.
2.1. Private Equity Investment Holding Period
2.1.1. Private Equity Investment Tenure Impact on Portfolio Firm’s Performance
Few papers examine the relation between private equity holding period and performance
of portfolio companies. In one of such articles Badunenko, Baum and Schäfer (2010) examine,
how the presence of private equity investments influences the performance of European
companies, and how it changes over the holding period. To test the hypothesis of significantly
increased performance for firms with PE investments, the authors have chosen to compare firms
with private equity presence and without. Another possible suggested method is to compare
firms that attract PE investors’ entry and exit with those which don’t. Authors have also assumed
that effects of private equity-forced restructuring decisions would not be reflected in company’s
performance immediately, suggesting that superior performance of PE-backed companies would
28
only be appreciable after some time. In other words, the second hypothesis of the paper is that
the longer PE investors are in the company, the larger impact from their presence would be on
the performance of a company.
For the analysis, a sample of 159,425 firm-years has been collected, containing firm-level
and macroeconomic data from 2002 to 2007 in 22 European countries. Such large-scale sample
is driven by both private and public enterprises being included by the authors, as well as minimal
annual revenue requirements for the company to be included set at only 5,000 Euros, justified by
a higher cutoff being unnecessary as small companies might be important. Nevertheless, the
observations across the sample are not persistent, and the panel is claimed to be highly
unbalanced. For the given years, around 2.69% of observations conforming for inclusion in the
study are related to presence of at least one private equity the investor in ownership structure,
with the highest portion of 5.30% attributed to the year 2007. The countries with largest portions
of observations with at least one PE investor are: Ireland (14.87%), Luxembourg (5.85%),
United Kingdom (5.36%), Netherlands (4.04%), France (2.95%), Belgium (2.80%), and Finland
(2.32%) with the rest 15 countries having less than 2% of observations.
As a measure of company’s performance, return on assets has been used, with top and
bottom 1% of observations dropped from further analysis as perceived to be outliers, resulting in
a total average of 5.81% between all years. In the same manner, companies with 1% highest
logarithm of revenues, debt ratios, and cash flows were omitted from the sample. It is unclear,
however, why authors have only used return on assets, not accounting for the case where interest
expenses on outstanding debt could represent a major part of operating incomes, which makes
return on equity a more adequate measure of performance for company’s stakeholders.
The tenure of private equity in a company’s ownership structure is controlled by a
separate variable, which is equal to 1 for the first year of PE investment, and increased by 1 for
each additional year during which the company had at least one PE investor. It is worth noting
that authors do not differentiate between investments of specific private equity funds, thus, the
variable will still increase by 1 if PE investor “A” exits a company and investor “B” enters in the
following year. Nevertheless, only 0.30% of companies have seen PE investments lasting for 6
years, or the total interval of the sample. To control for other possible sources of changes in
company’s performance, a wide range of variables has been used – both internal and external,
some of them having noteworthy features:
Instead of Altman Z-Score authors used Bureau van Dijk database estimate of the default
probability.
In case any share of a company is held by a legal title owner and beneficial owner is
identifiable, a specific dummy variable is attributed value of 1 to control for
29
environmental differences in which firms operate – with not further clarifications on how
this variable could be a proxy for such.
Debt variable is expressed as a ratio of current liabilities to total assets instead of total
debt, which doesn’t control for overall financial leverage of a company.
Any balance sheet items were preliminarily divided by firm’s country harmonized CPI to
control for macroeconomic differences.
Local stockmarket-to-GDP ratio was used as a proxy for country’s financial development.
Possible variations in global economic business cycles are accounted for by
implementing 6-month LIBOR rate as a separate variable.
The conclusions of the analysis state that private equity ownership alone has no
significant influence on the firm’s performance in a given year. Nevertheless, when the impact of
the fact of ownership is analyzed together with its tenure, both have statistically significant
relationship to the company’s performance. Authors claim that this might imply dependence of
the PE effect on how long private equity funds have been investing in the particular firm. By
further analyzing the marginal effect of the private equity’s tenure, the authors have also found
that statistically significant increase in company’s performance is only achieved after 6 years –
the longest tenure possible in the sample. Thereby, the initial hypothesis of increased
performance among firms experiencing private equity ownership is proved to be true only for the
PE tenure of 6 years, while hypothesis of increasing performance for longer tenures of PE
investments couldn’t be proved to be true for the sample.
2.1.2. Tenure of Leveraged Buyouts and Probability of Their Reversals
Leveraged buyout transactions – backed by private equity funds or not – most of the
times end up with either firm going for an IPO, or with a secondary market sale. In case the
initial company has already been public, IPO or a sale to a public enterprise, which force the
company to become public again, would cause the so-called “reverse LBO” (RLBO). The
probability of reversal of LBO transactions and, what is more important, factors that influence
the timing of the reversal if it occurs, have been studied by Van de Gucht and Moore (1998) in
their research paper. The idea of the research emerged from controversy in current academic
research of LBOs: some authors believe LBOs to be superior to public equity as ownership
concentration reduces agency conflicts between management and shareholders (Jensen, 1986),
while others believe that LBOs result in net disadvantage for enterprises due to increased risks
and vulnerability to financial crisis, thus should be reversed at some point (Rappaport, 1990). To
provide further empirical insights on the issue, the authors have made the following hypotheses:
30
There is a non-linear relation between firm size and reversal probability and timing as
both large and small enterprises are claimed to have their own incentives to reverse
LBOs.
Divisional management buyouts (MBOs) are expected to have a lower probability of the
reversal and have longer tenures because management teams possess asymmetric
information and are able to capitalize on increased control over investment target.
LBOs related to growing industries with favorable public market conditions, as expressed
by relatively higher Tobin’s q-values (market-to-book value ratios), are more likely to
become public again.
Shorter LBO tenures are expected in early stage industries, which are experiencing high
ratios of research & development expenses to revenue. This is hypothesis is based on an
assumption that non-mature industries exhibit increased needs in external financing for
further growth.
The analysis is conducted on a sample of 343 global LBOs in years 1980 – 1992 with the
transaction size of no less than $100 million. 26.8% of LBOs in the sample have been reversed
with an IPO after 43 months on average, 9% were acquired by public enterprises in 46 months
on average, while the remaining either 48.4% remained private (48.4%), filed for bankruptcy
(12.2%), or had been acquired by another private firm (3.5%). Entire company LBOs accounted
for 54.5% of the observations while that related to management buyouts – 54.8%. What is more
interesting, LBO reversal tenures ranged from 4 months to more than 12 years.
The authors have found that probabilities of LBO reversal increase steadily after the
transaction up to seventh and eighth years, and decline thereafter. Highest probabilities of
reversal and earliest public sales occur for medium-sized LBOs, proving the initial hypothesis of
a non-linear relation of LBO size to such true, yet the other way round: the authors initially
expected the result to be corresponding to small- and large-sized transactions. For the LBOs with
management participation, which eventually reversed, the decision of going public is delayed, as
compared to other transactions, which also proves the corresponding hypothesis to be true. In the
same manner, LBOs within high growth industries tended to be more likely to reverse and to
reverse faster, which also confirms the author’s hypothesis. Nevertheless, LBOs within nonmature industries, as expressed by relatively high R&D expenses, didn’t prove to reverse neither
more likely nor faster.
31
2.2. Private Equity Presence and Performance of Firms
2.2.1. Private Equity Investment Impact on Industry Performance
Jensen’s (1986) paper on agency costs of free cash flow has frequently been cited as a
basis for a widespread opinion that private equity investments are able to improve company’s
performance. Bernstein et al. (2010) have decided to take a look at the issue from the perspective
of industry-wide performance. The authors hypothesize that industry performance might improve
if private equity activities are common to such. By analyzing the PE impact on industry level
authors hope to capture “contagion” effects: that is if improvements in bought-out firms tend to
force their industry competitors to improve. The authors also pay special attention to economic
cycles as a major determinant of the impact of private equity activities: they suppose that private
equity investments during economic booms have comparably minor impact on industry-wide
performance, as many sources of financing for growth is widely accessible. On the other hand,
the concentration of ownership, associated with PE investments, during economic downturns
may help companies raise additional financing on terms, which are unavailable to enterprises not
backed by PE investments.
To put the suggested hypotheses under test, the authors used a sample of 14,300
transactions announced between years 1986 and 2007 with 13,100 different firms from
Organization for Economic Co-operation and Development (OECD) countries, each involved in
any of the following PE-related transactions: management buyout, leveraged buyout, or going
private. The large-scale sample is possible because authors used fitted values of deals sizes
instead of omitting about 50% of announced transactions from the analysis. They acquired such
values by regressing deal size on fixed effects for the economy, investment year and target
industry, without providing any reference to a possible misstatement of the results. Industryrelated data, consisting of 11,135 country-industry-year observations for the same period,
includes:
Gross output of industry in current prices. This measure includes both sold and stocked
goods and services, but authors didn’t clarify if a major portion of stocked items in gross
output would signify inefficiency within the industry in a given year.
Value added (output net of materials purchased) as a proxy of industry’s contribution to
national GDP. The authors have mentioned possible differences in calculating the value
across countries but stated that the main interest is differences across time for a given
nation.
Total labor costs, including wages, salaries and other distributions like pension
contributions and health insurance.
32
Number of paid employees within the industry, excluding self-employed.
Gross capital formation as the closest proxy for aggregate capital expenditures, calculated
as assets acquisitions (including intangibles like IT-technologies) less disposals.
Consumption of fixed capital as fixed assets value reduction per year due to use or
deterioration of such.
By combining the industry- and private equity-related data, a total of 8,596 country-
industry-year observations for the period from 1991 to 2007 were obtained, as private equity
activity is expressed as volume of PE deals that took place over the previous five years in the
given country and industry. The authors were able to observe that private equity activities were
especially present among “traditional” industries like textiles, machinery, paper products, electric
equipment, and chemicals while the countries with greatest levels of PE activities were the US,
the UK, Netherlands, and Sweden.
By conducting an empirical study, authors have found that industries, which received PE
investments over the past five years, were growing more quickly as reflected by several of the
suggested measures increasing. This finding proposes initial hypothesis to be true, including the
inference that industry peers without PE-backing are also forced to perform better to maintain
their competitive positions. By examining industry performance during different economic
cycles, authors concluded that PE-backed industries are less exposed to industry shocks, while
performance during more stable times doesn’t significantly differ among industries that are
receiving PE investments and those that do not. This also proves both related hypotheses to be
true. Among other interesting findings of the paper, is the fact that for the studied sample there is
no statistically significant difference in private equity investment impact on industries’
performance between Europe, USA, and the United Kingdom, even though the level of PE
activities is reported to be higher for the latter countries.
2.2.2. Impact of Private Equity Investments on Listed Equity
In order to understand possible motives behind choosing specific investment holding
periods of private investments in public equity, peculiarities of capital gains generation for openmarket share acquisitions should also be reviewed. In their paper, Stotz, Wanzenried and Döhnert
(2010) have analyzed general effects of open-market investments by private equity funds, as well
as provided a more detailed look at size and home-bias effects. Authors have also analyzed
whether private equity investments increased the value of target firms – both in the short- (upon
deal announcement) and long-term. The key hypothesis of the research is that success of private
equity investments is related to possession of non-public information, which can later influence
portfolio companies’ corporate decisions. As a proxy for this non-trivial factor, authors used
33
indicators, which support better information flow: home bias and the size of the target company.
I.e. authors believe that companies, which belong to the same country as investing funds, will
experience increased open-market acquisition returns because it’s easier for local investors to
communicate their business ideas to firm’s management. At the same time, small companies,
which have less public and analyst coverage, are believed to be more likely to obtain private
information from its investors.
Authors have used a sample of 689 global open-market deals, related to 100 largest
private equity companies, during the period from 1999 to 2007. The median size of the
transactions globally was $50 million with a very high heterogeneity of the deal size across
countries (for instance, an especially high median of $390 million is attributed to France while
transactions related to targets in Germany had a median size of $27 million). UK and US have
accounted for the largest amounts of deals for the period. Globally, the number of deals has
increased steadily with each year, but in size the largest median deals size have occurred in 2001
and 2007, which authors attribute to economic downturns during the years.
By further conducting analysis using Fama and French model to reveal short-term and
long-term effects of private equity investments, authors have discovered both to be accompanied
by abnormal market returns of the stocks. Moreover, investments in small capitalization and
local companies have experienced higher excess returns on average, proving the initial
hypothesis of the research to be true. What is more important, of authors have made a side
discovery that such effects are also extended to the long-term perspective, with investment target
values increasing during a period of up to 3 years after the announcement of the deal with a
subsequent reversal of the effect.
2.2.3. Private Equity Financing Impact on Firm Activities
Another study of the private equity’s investments in public equities relates specifically to
PIPE transactions. In their paper, Brown and Floros (2012) have studied how external equity
from private placements affects real firm activities, i.e. how the capital raised is allocated inside
the company. The authors implicitly hypothesize that proceeds from private investments are
mainly used for research & development activities.
To find empirical evidence for their hypothesis, authors have collected data on U.S. PIPE
and secondary offerings (SEOs) of 1,532 firms from 1995 to 2008. The sample has shown that
PIPE financing has been used more frequently than SEOs: on average, there were 290 PIPE
issues and only 34 SEOs per year. Authors have also identified tendency of firms to use PIPE
financing repeatedly with those having more than 3 PIPE transactions (2,634 observations, 34%
34
of total) for the period having substantial differences to those which had only 1 transaction
(2,566 observations, 34% of total), which is expressed by:
25% higher PIPE proceeds ratios (relative to total assets);
Negative cash flow ratios (relative to total assets);
21% higher cash ratios (relative to total assets);
17% higher R&D ratios (relative to total assets);
54% lower sales ratios (relative to total assets);
10% lower tangibility ratios (net property, plant and equipment minus inventories);
$67 million (79%) lower net assets.
These statistics reflect the profile of a typical PIPE issuer, a small high-tech firm with
limited internal resources, volatile earnings, and significant R&D expenditures. The authors try
to explain theoretical reasons why PIPE financing applies to companies with great intangible
investment opportunities better than other sources of external financing in the following way:
Debt contracts are poorly suited for financing risky investments with volatile returns.
Intangible investments lack collateral value, thus costs of external debt financing raises
dramatically.
Due to high-tech nature of the firm, information asymmetry between it and potential
equity investors may also increase the cost of external equity financing.
Transaction costs for raising external debt or equity may be too high for small firms.
private equity investors, on the other hand, are more concerned about possible upside of
their investments, while collateral value represents a relatively minor interest. Moreover, many
PE firms have industry expertise, which allows them to reduce information asymmetry.
The authors proceeded further by specifically analyzing R&D levels between firms based
on their PIPE proceeds and other possible sources of financing (internal, debt and SEOs). As a
result, they have found that indeed, PIPE financing had a significant impact on levels of R&D
spending, as well as increased cash levels, which authors believe are to be used for further R&D
expenditures, proving their hypothesis to be true. The authors have also developed side
conclusions based on their analysis: on average, R&D expenses were increasing more if a private
equity fund was the investor of a PIPE (as opposed to hedge funds and corporations). This effect
is claimed to reflect that PIPE capital supplied from non-private equity funds is mainly used for
immediate operational needs rather than strategic intangible investments. What is more, a switch
of PIPE capital suppliers from one to another is, on average, accompanied with increased capital
allocation to R&D, which implies that the real impact of PIPE financing has also depended on
relationships between PIPE suppliers and issuers, with latter taking less risks as expressed by
relatively lower R&D investments.
35
Summary
Few research papers on private equity investment tenure exist with more academic focus
shifted on the problem of PE impact on companies. Nevertheless, empirical evidence supports
the following:
Private equity presence may not be reflected in a company’s performance immediately,
as corresponding organizational changes need “time to build”.
The size of the transaction influences the tenure of investments to a great extent, and the
relationship may not be linear.
Buyout deals with management participation have seen longer tenures, which implies
that industry expertise also affects investment tenure.
Private equity investments have proved to have a positive impact on industries’ overall
performance in countries where present, with comparatively minor impact during
economic growth periods. This finding implies that private equity investment holding
periods should be analyzed together with global economic environment.
Private equity investments in listed companies have proved to have short- and long-term
positive impact on stock returns. The influence lasts up to 3 years, thus in the context of
private investments in public equity, a major focus should be on smaller time intervals.
For the PIPE transactions a predominant group of issuers has been identified – high-tech
companies with comparably small capitalization and complicated access to other sources
of capital. Research and development expenditures were a major allocation of the
proceeds from PIPE transactions, which needs special attention when evaluating
intercompany risks and investment holding period.
36
Chapter 3. Empirical Study of the Relation Between Private Equity
Investment Tenure and Performance of European Companies
3.1. Research Hypotheses
The empirical study is divided into two major stages: firstly, determinants of private
investments in public equity will be analyzed. Secondly, the analysis of the relation between
private equity investment tenure and performance of European companies will be conducted. In
the following section of the paper, the hypotheses regarding the two stages are carried out.
Hypotheses 1a – 1c relate to the first stage of the research concerning determinants of PIPE
investments while hypotheses 2 and 3 relate to the study of the relation between investment
tenure and performance of portfolio companies.
Risky companies are likely not to be able to raise external capital neither from debt
capital markets nor through banking system: margin of safety for risky companies is heavily
reduced. At the same time, risky companies are often unable to adhere to imposed debt
covenants, especially maintenance covenants of banks that relate to running the business under
certain ratios (for example, Debt / EBITDA). Thus, obtaining external financing from
institutional investors might remain the only vital alternative (CFA Institute, 2013, pp. 650-653).
Especially this is the case for small- and medium-sized enterprises, which have historically been
the most attractive targets for PIPE transactions (Särve, 2013, p. 31): smaller-sized companies
generally have less access to bank loans (The Economist Newspaper, 2009). Badunenko,
Barasinska and Schäfer (2009) state that banks would not grant financing to companies that cross
certain probability of default threshold (i.e. risk). The authors have also found an empirical
evidence that private equity investors, in general, could be such type of investors. The research,
however, is based on buyout transactions, which grant the control over a portfolio company. This
also allows a private equity fund to shape the target company’s strategy and operations and
reduce both financial and overall business risks.
On the contrary, most of PIPE transactions involve minority investments (FraserSampson, 2007, p. 49; Särve, 2013, p. 32). Thus, due to the limited control over PIPE portfolio
firms, private equity funds are hypothesized to be risk-averse to a certain extent. This means that
funds would seek to invest in such targets, which are subject to lower levels of risk, and avoiding
investment targets, which are approaching, for instance, a bankruptcy state.
37
Hypothesis 1a. Companies’ risk is negatively related to the likelihood of attracting a private
equity investor.
In the same manner as risk, low profitability might constrain a firm’s access to debt
markets as credit analysts typically assess company’s ability to service the debt by analyzing
profitability ratios among others (CFA Institute, 2013, pp. 628-631). Would the company choose
an alternative source financing its activities through equity markets (for instance, through an
SPO), financial statistics with poor profitability ratios would hamper finding new investors for
the issue, thus, would increase the discount needed to market the stock (CFA Institute, 2013, pp.
227-232). Särve (2013, p. 29) also emphasizes that PIPE as a category of distressed investing
targets companies that both have often been making pre-mature public offerings and are
experiencing poor financial performance. Unlike risk, company’s performance in relation to its
profitability is more likely be boosted with an infusion of external financing. Thus, it may be
anticipated that companies with lower profitability levels are more likely to become targets for
private equity investors.
Hypothesis 1b. Companies’ profitability is negatively related to the likelihood of attracting a
private equity investor.
According to Jensen (1986), slow growth firms tend to distribute their excess free cash
flows to projects, which destroy company’s value. By increasing the leverage of portfolio
companies, private equity funds re-allocate such cash flows to debtholders. Kaplan and
Strömberg (2009) define such actions as financial value creation for private equity funds in
relation to buyout activities. Nevertheless, most of PIPE transactions usually involve an
acquisition of minority shares (Fraser-Sampson, 2007, p. 49; Särve, 2013, p. 32) and due to the
limited control over PIPE portfolio firms, private equity funds could be unable to increase the
company’s leverage. What is more, buyout transactions are often financed with debt in order to
increase their return on invested capital (The Wall Street Journal, 2014). This is, however, not the
case for PIPE transactions: Särve (2013, p. 47) has found that PIPE transactions are hardly
financed by debt. In order to compensate for the lack of leverage from the fund’s side, it may be
anticipated that instead companies with higher leverage are more likely to become targets for
private equity investors. This fact also would explain why firms seek private equity backing
instead of raising capital on debt markets: higher debt burden comparatively limits access to such
(CFA Institute, 2013, pp. 628-631).
38
Hypothesis 1c. Companies’ financial leverage positively related to the likelihood of attracting a
private equity investor.
By realizing different strategies of value creation – either financial, governance, or
operational improvements, private equity funds increase the target company’s value, thus, are
able to sell the company at a gain (Kaplan and Strömberg, 2009). Badunenko, Baum and Schäfer
(2010) have found an empirical evidence of increases in companies’ performance over longer
tenures of private equity investors in general. This study, however, focuses on particular PIPE
transactions and particular private equity investors, as opposed to the presence of such in
general. PIPE transactions tend to be related to minority shares in companies while PIPE
investor’s control over target companies is rather limited (Dai, 2011). Nevertheless, granting
capital that is crucial for the survival and development of small and financially distressed
business alone might provide opportunities for growth, which is reflected by analyzing the
relation of tenure to the growth of cash flow. What is more, Gompers, Kaplan and
Mukharlyamov (2015) have conducted a survey, which revealed that private equity funds often
initially estimate their exit value based on discounted cash flow (DCF) based growing perpetuity.
This approach is used in order to estimate the intrinsic value of an investment and to avoid future
equity market uncertainties, associated with other multiple-based methods of valuation –
comparable companies and transactions. Under DCF valuation, terminal (exit) value is most
sensitive to changes in growth rates of cash flows (CFA Institute, 2015, p. 249-250). In this
manner, it might be anticipated that private equity funds tend to choose targets with the potential
of an increase in performance measures that affect intrinsic value of a company. This is also in
line with the main goals of a private equity fund emphasized by current practitioners: to improve
the performance of a target firm, achieve higher cash flows, and upgrade the target’s valuation
even further (Gatti et al., 2015). What is more, corresponding changes in the organization might
require “time to build” effect, similar to the one described by Badunenko, Baum and Schäfer
(2010), i.e. changes in a performance measure would gradually show up over time. Thus, a
positive relation of private equity investment tenure to cash flow growth might be anticipated.
Hypothesis 2. Private equity investment tenure is positively related to the performance of target
companies in terms of their cash flow growth.
As it has been mentioned above, PIPE targets are usually small and financially distressed
enterprises (Särve, 2013, p. 29; Dai, 2011). Such enterprises might have little external financing
alternatives – both from the debt markets and banking system (Badunenko, Barasinska and
Schäfer, 2009; The Economist Newspaper, 2009). This category of companies faces such
39
difficulties because of their frequent inability to meet the imposed debt covenants. For instance,
banks often require the business to meet maintenance covenants (such as Debt / EBITDA) for the
whole term of the loan, otherwise, an early repayment of debt might be required (CFA Institute,
2013, pp. 650-653). Similar solvency measures are applied by rating agencies in order to
determine the credit rating of a debt issue (Standard & Poor’s Financial Services, 2013), thus,
directly affect the pricing of a bond issue. By raising capital through PIPE transactions,
companies might address the issue of inaccessible debt markets by internal restructuring to
improve their solvency over the investment tenure of a private equity fund. Thus, a positive
relation between the investment tenure and companies’ solvency might be anticipated.
Hypothesis 3. Private equity investment tenure is positively related to the performance of target
companies in terms of their solvency.
3.2. Research Methodology
In order to test the suggested hypotheses on empirical data, the following econometric
models have been chosen:
Prob ( PIPEentry =1| Risk , Profitability , Debt ¿=
exp ( z )
1+exp ( z )
,
where
(1)
z ¿ β0 + β1 Risk + β2 Profitability+ β 3 Debt
CF growth ¿ β0 + β1 Tenure+β 2 ¿ β ¿3 Risk + β 4 Profitability+ β 5 Debt +u
(2)
NFD EBITDA ¿ β0 + β1 Tenure+ β 2 ¿ β ¿ 3 Risk +β 4 Profitability + β5 CF+u
(3)
3.2.1. Variables
In the following section, descriptions of the variables used in both models are given. All
financial data for corresponding calculations, as well as ownership data, has been sourced from
Thomson Reuters Eikon database. Market data – capitalization of a given company in a given
year – is acquired from Thomson Reuters Datastream database. In relation to model (1), the
following variables have been used:
1.
PIPE entry : a dummy variable, which is equal to 1 if the company has been subject to
PIPE investment in the following year, and equal to 0 otherwise. The fact that the
40
following year is used is an alternative approach to shifting financial-related data 1 year
backward, as to capture which financial statements were available to the fund prior to
investment.
2.
Risk : the company’s overall risk as measured by Altman’s Z-Score. According to
Damodaran (2016, pp. 66-67), using proxies for measuring company’s risk based on
ratios alone would result in a risk of missing information. Thus, the author suggests using
Altman’s Z-Score, which is based on multiple ratios. The variable is calculated in
following way:
'
Risk= Altma n s Z - score=1.2 A+1.4 B+3.3 C +0.6 D +1.0 E , where:
Table 3
Altman’s Z-Score components
Ratio
WorkingCapital
A=
Total Assets
B=
Retained Earnings
Total Assets
Comments
The ratio measures company’s liquid assets portion of
total assets.
Measures company’s earning power and indirectly
indicates firm’s age, as higher shares of Retained
Earnings in Total Assets are usually achieved for firms
that have been present for a relatively longer period.
C=
EBIT
Total Assets
Measures company’s operating efficiency.
The ratio indicates whether share price fluctuations are
Market Value of Equity
D=
relatively risky as compared to company’s balance sheet
Total Liabilities
items.
Represents company’s asset turnover, indicating firm’s
Revenue
E=
Total Assets
efficiency in utilizing its assets.
3.
Profitability : measures company’s overall profitability, as measured by net profit
margin. The net margin indicates what percentage of firm’s revenues are turned into
profits, and is calculated in the following way:
Profitability=Net Profit Margin=
4.
Net Income After Taxes
Revenue
Debt : is the variable measuring the company’s financial leverage in the given year.
Calculated by dividing company’s total debt by total assets, as presented on the firm’s
balance sheet.
41
In relation to model (2), the following variables have been used:
1.
CF growth : company’s free cash flow growth rate in the given year, which represents
changes in company’s core performance. Calculated by dividing given year’s free cash
flow by previous year’s free cash flow of the firm. Free cash flow is determined as:
FCF =EBIT ( 1−T ) + NCC−FCInv−WCInv , where:
EBIT
income statement.
T – company’s effective tax rate for the given year, which is calculated as:
(
– company’s earnings before interest and taxes, as presented in the
)
T = 1−
Pretax Income
Net Income After Taxes
NCC
– company’s noncash charges for the period, equal to depreciation and
amortization, as presented in the income statement.
FCInv – company’s fixed capital investment in the given year, which is equal
to the change in gross property, plant and equipment (PP&E):
FCInv t =Gross PP∧ E t−Gross PP∧E t −1
WCInv
– company’s working capital investment during the period, which is
equal to the change in noncash working capital, as compared to the previous
period. It should also be noted that for working capital investment calculation,
unreported inventories were assumed to be zero for companies working in
information technology and financial services industries. Working capital
investment is calculated in the following way:
WCInv t =∆ t Accounts receivable+∆t Inventories−∆t Accounts payable
If the company was not listed on a stock exchange in prior years, no free cash
flow growth rate is calculated for the first year the stock is traded in order to only include
data for companies of similar legal organizational form.
2. Tenure : the tenure of a PIPE investor. Calculated as a cumulative number of months,
for which the private equity investor has been present in the firm’s ownership structure,
divided by 12. The data for this variable has been obtained from Thomson Reuters Eikon
42
database by monitoring ownership structure history of the selected companies for the
3.
tenure of such investors.
¿ ¿ : natural logarithm of the company’s revenue in the given year. Choice of such
proxy for firm size is motivated by the research conducted by Dang and Li (2015), who
have concluded that such measure is more related to firms’ products rather than financial
markets like capitalization. Since the market is outside the scope of this research, revenue
is the preferred measure. What is more, authors have proposed another alternative to
measuring firm size – with total assets. Nevertheless, this option is not viable since the
sample of the research includes many technology-intensive and service companies, which
would certainly have comparatively lower levels of assets, thus making such size
measure less representative.
4. The rest of variables ( Risk ,
Profitability ,
Debt ) are used with no alteration to
model (1) methodology.
In relation to model (3), the following variables have been used:
1.
NFD EBITDA : a measure of company’s solvency, often used by rating agencies as one of
two core payback ratios for assessing firm’s credit rating (Standard & Poor’s Financial
Services, 2013; Moody’s Investors Service, 2016). Another core ratio is funds from
operations to debt (FFO / Debt), which is more complicated to calculate than the selected
ratio: Standard & Poor’s defines funds from operations as net income from continuing
operations plus depreciation, where determining the continuing operations basis is rather
complicated on a large scale. The selected measure of solvency is calculated by dividing
net financial debt (NFD, interest bearing liabilities minus cash and cash equivalents) by
earnings before interest, taxes, depreciation, and amortization (EBITDA):
NFD EBITDA =
2.
Interest Bearing Liabilities−Cash
EBITDA
CF : is the measure of company’s cash flow, calculated in the same manner as for
CF growth variable (described above), and normalized by company’s total assets in order
to prevent size effects.
3. The rest of variables ( Tenure ,
¿¿ ,
Risk ,
Profitability ) are used with no
alteration to model (1) and model (2) methodology.
3.2.2. Sample Description
For the purposes of empirical analysis, companies, for which PIPE transactions took
place were acquired from Thomson Eikon deals database. During the period from the year 2005
43
to 2014 (total of 10 years), 827 such transactions are identifiable in the database for European
target countries. The following limitations have been applied:
As the purpose of the analysis is to identify the relation between the private equity
investment tenure and the company’s performance, only initial PIPE investments were
included in the sample, thus, transactions, where a private equity fund increases its share
in a company, were omitted from the research. This results in the decrease of suitable
transactions number to 229 in the given period.
Transactions, for which target companies were located in Western Europe, Turkey,
Cyprus, and several other countries, financial markets of which are comparably less
stable and due to other legislation differences as compared to other European countries
(S&P Dow Jones Indices, 2016), were omitted from further research. This results in a
further decrease of suitable transactions number to 199.
Even though the companies under study are public, due to data availability, especially for
the share of a private equity fund in a given company, the number of transactions has
been reduced to 99.
Due to differences in the analysis techniques used for financial services industry and the
reset of industries present in the initial sample, all financial institutions have been
removed from the sample. For instance, neither cash flow growth nor net financial debt
are adequate measures of changes in a financial company’s performance. Thus, the
number of transactions has slightly decreased to 91, out of which 79 are attributed to
unique companies.
By applying the above-mentioned criteria for building the sample, a diverse range of
companies has been obtained. For instance, targets for PIPE deals have occurred in a wide range
of economic sectors (using The Global Industry Classification Standard, GICS). Targets for PIPE
deals were most frequently operating either in Information Technology sector (25%) or Health
Care (19%). This finding – the relative attractiveness of companies, which operate in
technology-intensive sectors – is similar to such of Brown and Floros (2012), who have also
found that PIPE transactions frequently have target companies that use the investment proceeds
for strategic intangible investments (like increasing research & development expenses), as
opposed to immediate operating needs, i.e. target companies that operate in technology-intensive
industries. The following figure presents sectoral distribution of PIPE target companies, which
match the sample forming criteria:
44
Materials; 8.79%
Telecommunication
Services; 2.20%
Consumer Discretionary;
18.68% Staples;
Consumer
Information
Technology;
25.27%
12.09%
Health Care;
18.68%
Industrials;
14.29%
Figure 7. PIPE target companies’ distribution by sectors
The diversity of target companies is also present from the country point of view, as can be
seen in the following figure, on which the distribution (on transaction basis) of PIPE target
companies by country of domicile is presented:
United Kingdom;
10.11%
Sweden; 4.49%
Spain; 11.24%
Netherlands;
2.25%
Belgium; 3.37%
France; 50.56%
Italy; 3.37%
Germany; 11.24%
Ireland; 2.25%
Austria; 1.12%
Figure 8. PIPE target companies’ distribution by countries of domicile
Such overbalance for France is not only due to increased PIPE activity in the country.
Only 29.1% of total initial PIPE investments took place for French targets. The corresponding
portions of targets for Germany and the United Kingdom were 14.1% and 29.6%
correspondingly. The latter, however, suffered the most from dropping observations due to data
availability. This finding differs from such of Badunenko, Baum and Schäfer (2010), who have
seen the greatest amount of companies with the presence of a private equity investor to be
45
domiciled in Ireland (14.9%) and rather a low amount of such domiciled in France (6.0%). Yet,
only 2.5% of PIPE targets were domiciled in Ireland. This may be attributed both to the
transaction specifics and differences in its relative prelevance in various countries and shift in the
observation period to more recent years (from 2002 – 2007 to 2005 – 2014).
Särve (2013, p. 31) also notes that targets for PIPE investments are usually small- and
medium-sized enterprises. This is also true for the selected companies: the vast majority (75%)
of such have annual revenue less than 100 million EUR while only 16% of companies were
comparatively large-sized with annual revenue more than 500 million EUR. The distribution of
PIPE target companies by their annual revenue is presented in the figure below:
More than 500 m
EUR; 16.03%
Less than 2 m
EUR; 5.64%
100 - 500 m EUR;
9.59%
2 - 10 m EUR;
10.72%
10 - 50 m EUR;
23.36%
50 - 100 m EUR;
34.65%
Figure 9. PIPE target companies’ distribution by annual revenue
In order to mark out private equity funds’ presence in a company’s ownership structure
relation to the performance of such company, for each transaction in the sample, a comparable
company (peer) has been added as identified by Thomson Eikon database. Thomson Reuters
proprietary algorithm for choosing peers, as described in the database, includes taking into
consideration the following information:
Competitor lists provided in filings;
Analyst cross coverage;
Business classification;
Revenue proximity.
Such comparable companies have been manually chosen in such a way that ultimate
peers would have been listed on a stock exchange during the whole observation period from
2005 to 2014 and were not a subject to private equity investments during any of the given years.
46
A full list of selected companies, their peers and respective countries of domicile, sectors and
industries are presented in appendix 1. The peer selection for the sample has resulted in the
following distributions of matches and mismatches between PIPE target company and its
comparable company’s industry, sector, or country of domicile:
Industries (and
sectors) match
Only sectors
match
Peer from
another sector
10.99%
14.29%
42.86%
57.14%
74.73%
Countries
match
Peer from
another
country
Figure 10. Industry and / or sector match
Figure 11. Country match
between the target company and its peer
between the target company and its peer
As it can be seen from the figures above, a number of mismatches have occurred. In
respect of industry matches, Thomson Reuters peer selection algorithm has been able to offer
closely related comparable companies. For 14% of transactions target company’s industry did
not match comparable company’s industry, although the fit is quite decent (for instance,
Transportation Infrastructure – Construction; Electronic Equipment, Instruments & Components
– Semiconductors & Semiconductor Equipment; etc.). In 11% of the cases, sectors were not
matching between the target and comparable company. Such issues were controlled on an
individual basis, and the peer’s fit was ensured to be adequate (for example, this mismatch was
the case for companies involved in Building Products industry in Industrials sector and
Construction Materials in Materials sector). In 58% of the cases, Thomson Reuters peer selection
algorithm was unable to offer a comparable company from the same country (at least, such,
which wasn’t a subject for private equity investments during the period from 2005 to 2014).
Especially this was the case for a number of French target companies. Nevertheless, the issue
was also controlled on an individual basis, where in most cases the peer was selected to be
geographically domiciled in a country, close to the target company’s domicile (for instance,
United Kingdom and France, France and Belgium or Netherlands), thus the suggested by
Thomson Reuters database target markets for products and services of such companies were
quite similar. Thus, the resulting pairing between PIPE target companies and their peers is
assumed to be suitable for further analysis.
47
In case the company, which was a target for a PIPE transaction, was listed or delisted
(most probably, because of a buyout) during the period, data for its comparable company has
also been cut. For instance:
A company was listed in 2007 and has been subject to PIPE investment in 2008.
Available data for both the company and its comparable company are taken from 2007 to
2014, regardless of the private equity fund exit.
A company has been delisted in 2012 and has been subject to PIPE investment in 2007
with private equity fund exit in 2010. Available data for both the company and its
comparable company are taken from 2005 to 2011 as financial statements are no longer
available to public for the year 2012.
For the company listed prior to 2005 and not delisted until 2014, available data for both
the company and its comparable company are taken for the whole period of observation –
from 2005 to 2014.
This approach prevents the sample from exhibiting survivorship bias by including
transactions for companies, which are no longer traded. Thus, 79 companies with 91 transactions
and 91 unique comparables for each transaction were used in the sample with a total of 1,722
company-year observations for the period. Such size of the sample is more than sufficient for the
suggested models.
3.2.3. Descriptive Statistics
The following section of the paper will be structured in the same manner as research
hypotheses statement: firstly, it will address the sample regarding the research of private equity
investment determinants. Secondly, the section will focus on the sample regarding the research
of private equity investment tenure relation to the performance of European companies. Note
that all the data in the following section is analyzed to exclude outliers by applying the method
of Hadi. In the following table descriptive statistics for the variables used in model (1) are
presented:
Table 4
Descriptive statistics of the supplementary sample: investment determinants
Variable
PIPE entry
Risk
Profitability
Debt
Observations
Mean
182
163
148
179
0.500
2.550
0.043
0.186
Standard
Minimum
Maximum
deviation
–
1.856
0.087
0.165
value
0
-2.263
-0.235
0
value
1
8.227
0.334
0.641
48
In order to analyze the determinants of private equity investments, the initial sample has
been modified in order to include information on companies and their peers only for those years,
during which those companies have been subjects to PIPE investments. In other words, in case
the company has been listed prior to the year 2005 and was not delisted until 2014, only 1 out of
10 years is included as an observation in the sample. For the same year, this company has raised
capital through a PIPE transaction, data for the company’s peer is included in order to compare
the interfirm determinants of the investment. Thus, 50% of observations relate to companies that
have been subjects to PIPE investments, and 50% relate to their peers. It should also be
mentioned that the sample does not capture all exits from observed PIPE investments. The
following figure presents PIPE entries and exits distribution across years:
25
20
20
15
10
10
9
7
5
0
9
8
2006
0
2007
0
2008
9
6
6
2012
2013
4
3
2005
0
9
2
2009
Number of PIPE entries
5
1
2010
2011
Number of PIPE exits
Figure 12. Dynamics of PIPE investment entries and exits
The variability in the number of observations for different variables is due to the fact that
Thomson databases in some cases did not provide the financial data necessary for the calculation
of some variables. Only observations with all data available may be used in the logistic
regression analysis. Heavily negative minimum values of both risk and profitability measures
support the findings of Särve (2013, p. 29) and Dai (2011), who have concluded that targets of
PIPE investments are often financially distressed enterprises: such companies with the Z-Score
below 1.1 account for 18.4% of total observations, while 19.6% of companies were unprofitable.
Many of the companies were both distressed and unprofitable simultaneously. At the same time,
less risky companies with Z-Scores in the “safe zone” above 2.4 account for 47.2% of total
observations. At the same time, only 22.3% of observations were related companies experiencing
profitability either more than 10% or below -10%, which, most of the times, were technologyintensive companies (Health Care and Information Technology). As expected, the sample also
49
includes companies with high levels of leverage, with debt reaching up to 64.1% in total assets.
Nevertheless, on average, the companies in the sample have a capital structure primarily
financed through equity. Mean profitability and leverage differ among the companies that were
5%
5%
4%
4%
3%
3%
2%
2%
1%
1%
0%
4.8%
3.8%
25%
Companies that
were subjects to
private equity
PIPE investments
Companies that
were subjects to
private equity
PIPE investments
Comparable
companies with
no private equity investors
Comparable
companies with
no private equity investors
Total Debt / Total Assets
Net Proft Margin
subjects to PIPE investments and their peers, as it can be seen from the figures below:
1
20%
20%
17%
15%
10%
5%
0%
1
Figure 13. Differences in mean profitability
Figure 14. Differences in mean leverage
between two groups of companies
between two groups of companies
However, the conducted mean-comparison tests have shown that the observed visual
differences in both profitability (p-value of 0.705) and leverage (p-value of 0.297) do not have
statistical confirmation. Most likely, such differences are random.
A major concern for the analysis would be the presence of a strong linear relationship
between the chosen variables. Particularly, from the financial point of view, a strong relationship
between companies’ risk and debt levels might exist.
Table 5
Correlation matrix of the sample: investment determinants
Risk
Profitability
Debt
Risk
Profitability
Debt
1
0.407***
-0.470***
–
1
-0.164**
–
–
1
Note: symbols *, **, and *** represent significance at
α=10
,
α=5
, and
α=1
respectively
However, as it can be seen from the table above, the relationship is moderate for the two
variables and is rather weak between risk and profitability. Thus, the data can be proceeded with
for further steps of econometric analysis.
The following part of the section is appurtenant to the main sample regarding the research
of private equity investment tenure relation to the performance of European companies. In the
following table, descriptive statistics for variables used in the model (2) and model (3) are
50
presented. It should be mentioned that variability in the number of observations for different
variables is due to the fact that Thomson databases in some cases did not provide the financial
data necessary for the calculation of some variables. Unlike the logistic regression analysis, all
observations, even those including missing data, may be used within panel data regression
analysis, which refers to an “unbalanced” panel.
Table 6
Descriptive statistics of the main sample: investment tenure
Variable
CF growth
NFD EBITDA
Tenure
¿¿
Risk
Profitability
Debt
CF
Observations
Mean
1,454
1,0931
1,722
1,699
1,585
1,486
1,687
1,379
-0.076
2.811
0.702
18.572
2.559
0.032
0.199
0.031
Standard
Minimum
Maximum
deviation
0.473
2.741
1.548
2.615
2.327
0.115
0.169
0.158
value
-2.018
0
0
8.261
-6.938
-0.442
0
-0.614
value
1.771
15.519
8.917
25.203
11.929
0.502
0.895
0.682
Proceeding with the discussion of PIPE investment characteristics, it should be
mentioned that the majority of transactions involved the purchase of a minority stake, which is
also presented in the figure below. This result is conforming to findings of Fraser-Sampson
(2007, p. 49), Särve (2013, p. 32), Dai (2011) and Brown and Floros (2012). The mean tenure of
approximately 8 months (0.7 years) as presented in the table above has little practical implication
as the data is presented for the whole sample. Instead, examining tenure for deals that have
already seen investor exits would be more appropriate. A figure corresponding to the distribution
of committed exits by cumulative investment tenure is presented below for 32 exits observable in
the sample:
1 Comparatively, a low number of NFD / EBITDA observations is related to the limitations of
the ratio. Decreases in the ratio caused by either net debt reductions or EBITDA increases are
both positive signs of increasing solvency. In case company’s profit is negative, however, the
ratio becomes meaningless. 31.3% of total observations were related to companies with negative
EBITDA. Thus, such observations were omitted from related analysis.
51
Below 20%
investment
17.58%
12.50%
15.63%
3.30%
Below 2 years
2 - 4 years
20% - 50%
investment
4 - 6 years
28.13%
Above 75%
investment
43.75%
Above 6 years
79.12%
Figure 15. Distribution of company shares purchased
Figure 16. Distribution of committed exits
within PIPE transactions
by investment tenure
As we can see, 84% of PIPE investments were exited with cumulative tenure below 6
years, which corresponds to general findings of Badunenko, Baum and Schäfer (2010) and
general practice regarding the term of a private equity fund (CFA Institute, 2015, p. 152). For the
part of the sample, which corresponds only to the companies that have been subjects to private
equity PIPE investments, an almost linear growth of mean investment tenure may be observed,
as can be seen in the figure below. This peculiarity corresponds to the accumulation of
observations with longer tenures over time, but has no side effects within regression analysis, as
variability of investments with different tenures for each year is still high.
4
3
2
1
0
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Mean tenure, years
Figure 17. Dynamics of the mean tenure for companies with the presence of a PIPE investor
At the same time, only 19.4% of companies were experiencing cash flow growth either
more than 50% or below -50% (which is, still, volatile), 32.4% with profitability more than 10%
or below -10%, and 15.4% with normalized cash flow more than 20% or below -20%, which,
52
most of the times, were technology-intensive companies (Health Care and Information
Technology).
From this point analysis of descriptive statistics will be conducted by separating
observations that relate to companies, which have been subjects to private equity investments,
and observations that relate to comparable companies with no private equity investors for the
whole period of observation. In the following two tables separate descriptive statistics for two
groups of companies are presented:
Table 7
Descriptive statistics for companies that were subjects to PIPE investments
Variable
CF growth
NFD EBITDA
Tenure
¿¿
Risk
Profitability
Debt
CF
Observations
Mean
720
592
890
872
789
726
867
691
-0.088
3.107
1.358
18.347
2.593
0.020
0.218
0.010
Standard
Minimum
Maximum
deviation
0.498
2.902
1.935
2.690
2.393
0.116
0.181
0.167
value
-1.970
.007
0
8.261
-6.938
-0.442
0
-0.614
value
1.771
15.519
8.917
25.203
11.929
0.459
0.842
0.682
Table 8
Descriptive statistics for comparable companies with no private equity investors
Variable
CF growth
NFD EBITDA
Tenure
¿¿
Risk
Profitability
Debt
CF
Observations
Mean
734
501
832
827
796
760
820
688
-0.064
2.462
0
18.810
2.527
0.044
0.179
0.052
Standard
Minimum
Maximum
deviation
0.447
2.496
0
2.513
2.262
0.114
0.154
0.146
value
-2.018
0
0
8.485
-6.287
-0.433
0
-0.603
value
1.491
15.128
0
24.749
11.342
0.502
0.895
0.621
As it has been mentioned above, targets for PIPE transactions might often be described as
small and distressed enterprises (Särve, 2013, p. 29; Dai, 2011). Thus, highly negative values for
cash flow growth rate, cash flow normalized by total assets, and profitability, as well as high
leverage, make sense. General presence of such values for both groups of companies corresponds
to Thomson Reuters proprietary algorithm for choosing peers, which seem to also be financially
distressed in many cases. From the two tables above certain differences between two groups of
53
companies can be seen. For instance, the following figures below present differences in cash
flow related variables.
4%
2%
1.0%
0%
0%
5.2%
Companies that
were subjects to
private equity
PIPE investments
Companies that
were subjects to
private equity
PIPE investments
Comparable
companies with
no private equity investors
Comparable
companies with
no private equity investors
1
Cash Flow growth
Cash Flow / Total Assets
6%
1
-2%
-4%
-6%
-6.4%
-8%
-10%
-8.8%
Figure 18. Differences in mean cash flow ratio
Figure 19. Differences in mean cash flow growth
between two groups of companies
between two groups of companies
The visual differences in the cash flow ratio have been tested with the mean-comparison
test (p-value of 0.000). At the same time, similar test for cash flow growth (p-value of 0.335) has
shown that the observed visual differences in the means do not have statistical confirmation.
Most likely, such differences are random. As we can see, cash flow to total assets ratio (often
referred to as free cash return on assets (ROA) is dramatically lower for companies that have
been private equity backed for a certain term during the whole period of observation. This may
be thought of as that companies which were targets for PIPE investments were more financially
constraint on average. This difference is similar to findings of Brown and Floros (2012), though
they have discovered even a negative free cash ROA for PIPE targets. Moreover, both groups of
companies had relatively low earning power as measured by free cash ROA. This is in line with
high maximum values for both of the variables: pre-mature companies that became listed have
experienced high volatility in their earnings. For instance, many observations relate to companies
that have been listed after the year 2005 (20 companies in total). Thus, infusion of equity capital
could have probably resulted in a rapid growth of such companies, which has eventually changed
for a steady decline.
From the perspective of solvency, certain differences between two groups of companies
may also be observed. The following figure also presents dynamics of such differences:
54
Mean NFD / EBITDA ratio
4
3.5
3
3.3
3.3
3.2
3.3
3.0
3.0
2.6
2.3
2.5
2.4
2.6
2.8
3.0
2.7 2.6
2.3
2.1
2.1
2.8
2
1
0
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
Companies that were subjects to PIPE investments
Comparable companies with no private equity investors
Figure 20. Dynamics of the mean NFD / EBITDA ratio for two groups of companies
The visual differences in NFD / EBITDA have also been tested with the meancomparison test for all years simultaneously (p-value of 0.000). As it can be seen, the dependent
variable of the model (3), on average, has been higher for the companies that were targets for
PIPE investments. Since net financial debt is in the ratio’s numerator, this implies that such
companies were less financially stable than their comparable companies. Indirectly this is related
to the background for hypothesis 3: at least, on average, companies with the presence of a PIPE
investor had comparatively more potential to improve their solvency over the tenure of a private
equity investor, thus, increasing access to debt capital markets. One unexpected finding of the
NFD / EBITDA dynamics concerns the lack of relative decrease in both groups of companies’
solvency during the crisis period, as compared to previous periods. This effect might be
appurtenant to the lack of reduction in companies’ interest bearing liabilities with the lack of
increase in cash reserves to cover possible shortages of liquidity, rather than increases in mean
operating profit during the crisis. Thus, such companies did not take additional measures to
reduce their financial risks during the crisis. Overall, mean NFD / EBITDA ratios are below
values (around 6.4), which usually correspond to the default state of a company (Moody's
Investors Service, 2016).
The mean size of the companies, as measured by revenue, did not have major differences
between the groups. The same applies to their risks measured by Altman’s Z-Score. However,
slight distinctions in their mean profitability and leverage has been found:
55
25%
4.4%
2.0%
Companies that
were subjects to
private equity
PIPE investments
Companies that
were subjects to
private equity
PIPE investments
Comparable
companies with
no private equity investors
Comparable
companies with
no private equity investors
Total Debt / Total Assets
Net Proft Margin
5%
5%
4%
4%
3%
3%
2%
2%
1%
1%
0%
22%
20%
18%
15%
10%
5%
0%
1
1
Figure 21. Differences in mean profitability
Figure 22. Differences in mean leverage
between two groups of companies
between two groups of companies
The visual differences have been tested with the mean-comparison test for profitability
(p-value of 0.000) and leverage (p-value of 0.000). As it can be seen, companies that were targets
of PIPE investments, on average, have dramatically lower profitability and slightly higher
leverage ratios. This finding is similar to the one for the sample containing only the years of
PIPE investments, and most likely represents greater financial stability for comparable
companies in terms of their earning power, as well as comparatively less reliance on debt
financing.
The concern regarding the presence of a strong linear relationship between the chosen
variables has also been addressed. As it can be seen from the table below, only a moderate
relationship exists between Debt and NFD / EBITDA, which are not used simultaneously:
Table 9
Correlation matrix of the sample: investment tenure
Variable
CF growth
NFD EBITDA
Tenure
¿¿
Risk
Profitability
CF growth
1
NFD EBITDA
Tenure
¿¿
Risk
Profitability Debt
CF
–
–
–
–
–
–
–
-0.075**
1
–
–
–
–
–
–
0.042
0.144***
0.165***
-0.033
0.031
-0.136***
1
0.000
-0.015
–
1
0.012
–
–
1
–
–
–
–
–
–
–
–
–
0.226***
-0.221***
-0.050*
0.335***
1
–
–
Debt
-0.045*
0.415***
0.072**
0.147
0.352**
-0.390***
-0.118***
1
–
CF
0.222***
-0.056*
-0.028
0.078***
0.233***
Note: symbols *, **, and *** represent significance at
α=10
*
0.326**
*
,
α=5
, and
α=1
0.090**
*
1
respectively
3.3. Empirical Results and Discussion
56
The following section of the paper will follow the same logic as research hypotheses
statement and descriptive statistics sections: firstly, the results regarding the supplementary
research of private equity investment determinants will be addressed. Secondly, the focus will
shift towards the results regarding the main research of private equity investment tenure relation
to the performance of European companies.
3.3.1. Determinants of Private Equity Investment
The main aim of the supplementary study is to determine, whether a company’s risk,
profitability, and debt affect private equity funds’ decision to choose such company as a target
for their investments. In order to test corresponding hypotheses 1a – 1c, a basic binary choice
model has been chosen. The result of a logistic regression, marginal effects of a variable, would
show how values of a given variable affect the probability that the dependent variable would
equal to “1”. In this case, “1” is attributed to observations, where a private equity fund has
invested in the company through a PIPE transaction, while “0” is attributed to the rest.
Financial data for the logistic regression is lagged backward for 1 year in order to capture
only such financial information, which was available on the investment date. In other words, for
PIPE transactions that took place in the year 2005, financial results for the year 2004 are
considered, which prevents the forward running problem in econometric analysis. In the
following table descriptive statistics for variables used in model (1) are presented:
Table 10
Regression results: investment determinants
Variable
Model (1) coefficients
Risk
Profitability
Debt
Constant
2
Pseudo R
p - value
Note: symbols *, **, and *** represent significance at
Model (1) marginal effects
PIPE investment
0.261*
-1.075
4.683***
-1.834
0.065*
-0.266
1.159***
–
0.063
0.006
α=10
,
α=5
, and
The suggested binary choice model is significant even at
α=1
respectively
α=1 , thus, we can proceed
with making further conclusions. The model has classified 58.9% of observations correctly, i.e.
the fact of a private equity entry or non-entry was estimated correctly for 58.9% of observations.
Even though such results are barely usable for making forecasts of a private equity entry,
interpretation of results and making conclusions on the suggested hypotheses is still possible.
57
Interpretation of the coefficients acquired from a logistic regression does not bear any
economic sense and the estimates are presented for informational purposes only. Instead,
marginal effects of such coefficients should be analyzed:
An additional point in Altman’s Z-Score, on average, increased the probability of a
private equity investment by 6.5% (ceteris paribus). Since the measure of risk is complex
and involves the weighing of various ratios, little further conclusions can be made.
The estimated coefficient for profitability variable is not statistically significant even at
α=10 , thus, no interpretation is possible.
An additional percent of the financial leverage (as measured by total debt to total assets
ratio), on average, increased the probability of a private equity investment by 1.2%
(ceteris paribus).
In relation to the suggested hypotheses 1a – 1c, the following conclusions can be made:
the initial hypothesis 1a of a negative relation between companies’ risk and the likelihood of
attracting a PIPE investor is accepted. The estimated coefficient is statistically significant while
the marginal effects experience a positive sign. The result may seem misleading as the estimated
coefficient is positive, however, Altman’s Z-Score interpretation is inverse: higher values
correspond to lower levels of risk (Altman, 2000). As it has been discussed previously, risky
companies might face difficulties with raising external capital either from debt capital markets or
through the banking system. The question of the survival of such companies, especially in the
case of small and medium-sized businesses, remains open, as their margin of safety is heavily
reduced and often they are unable to follow the debt contract terms, particularly, its covenants.
Badunenko, Barasinska and Schäfer (2009) believe that banks would not take part in financing
companies that are above a certain threshold for the probability of default. What is more,
smaller-sized enterprises, which have historically been the most attractive targets for PIPE
transactions (Särve, 2013, p. 31), in general, have less capability of borrowing from banks (The
Economist Newspaper, 2009). Thus, the only alternative to raising capital from institutional
investors might remain (CFA Institute, 2013, pp. 650-653). Badunenko, Barasinska and Schäfer
(2009) that private equity investors, in general, could serve as such type of investors and back
the businesses ran at higher risks. The research, however, is concentrated around buyout
transactions, which grant the control over portfolio companies, thus, a potential to influence
target company’s business strategy exists, including minimizing operational and financial risks
over the term of the investment.
Nevertheless, most of PIPE transactions involve minority investments (Fraser-Sampson,
2007, p. 49; Särve, 2013, p. 32). Thus, due to the limited control over PIPE portfolio firms,
58
private equity funds were hypothesized to be risk-averse to a certain extent, thus, such funds
would seek targets, which operate at lower levels of risk, and avoid investing in targets, which
are approaching a bankruptcy state. By discovering the negative relation between the companies’
risk and the likelihood of attracting a PIPE investor and failing to reject the corresponding
hypothesis, a conclusion can be made: private equity funds, indeed, select portfolio companies,
which are less risky as compared to their peers with similar businesses in identical industries. By
infusing external capital into such firms, which lack opportunities to finance elsewhere, private
equity funds, without taking excessive risks, might intend to recover the businesses from the
distressed state, which would be the subject for further analysis. In practice, the finding would
imply that private equity funds with PIPE investments do not tend to serve as investors of last
resort for those enterprises, which have seen severe decreases in their financial stability. An
extreme case for lack of financing sources for higher-risk companies would be either going
bankrupt or becoming a target of a buyout.
In respect of the hypothesis 1b regarding the negative relation between companies’
profitability and the likelihood of attracting a PIPE investor, no conclusions can be made. Even
though the discovered marginal effect has a negative sign, the coefficient estimate is not
statistically significant.
The initial research hypothesis 1c regarding positive relation between the companies’
financial leverage and the likelihood of attracting a PIPE investor is accepted. The estimated
coefficient is statistically significant while the marginal effects experience a positive sign.
Kaplan and Strömberg (2009) have previously defined such actions as financial value creation
for private equity funds in relation to buyout activities. By increasing the debt of portfolio
companies, private equity funds re-allocate excessive cash flows, which are otherwise allocated
to projects destroying company’s value (Jensen, 1986). Instead, firms are obliged to repay debt,
which disciplines the management in terms of their internal investment decisions. Badunenko,
Barasinska and Schäfer (2009) have also found that higher equity levels in firms’ capital
structures (i.e. lower leverage) increase the likelihood of a buyout.
As it has already been mentioned above, PIPE transactions involve an acquisition of
minority shares (Fraser-Sampson, 2007, p. 49; Särve, 2013, p. 32), thus, do not grant a similar
extent of control over portfolio companies, as compared to buyouts. In this manner, private
equity funds could seek such PIPE targets, which already have higher financial leverage. By
experiencing comparatively limited access to external debt financing because of higher current
debt burden (CFA Institute, 2013, pp. 628-631), such firms would also be more willing to raise
capital through PIPEs. By obtaining a positive relation between the financial leverage and the
likelihood of a PIPE investment, it has been found that more leveraged companies are, indeed,
59
more likely to become targets of such investments. This is also identical to findings of Brown
and Floros (2012): the authors describe a typical PIPE target as a more leveraged company, as
compared to those, which raised capital through seasoned equity offerings (SEOs) or capital
increases. In practice, this finding would imply that companies that have already proved the
capability of maintaining higher financial leverage are preferred by private equity funds as the
targets for their PIPE investments. Considering that the mean portion of debt financing is rather
low for the group of companies backed by private equity funds (20% of total assets), we can
conclude that track record of repaying comparatively higher debt plays a certain role during the
consideration of investment opportunities. In this manner, hypothesis 3 on the relation between
private equity investment tenure and solvency performance of target companies would extend
this finding by analyzing, whether actual improvements in companies’ solvency occurs over the
investment period. If it truly does, a conclusion could be made that private equity funds seek
firms with a decent track record of debt repayment with the further potential to increase their
solvency and, consequently, access to a broader market of debt capital.
3.3.2. Investment Tenure Relation to the Performance of Target Companies
The following part is devoted to the results regarding the main research of private equity
investment tenure relation to the performance of European companies. In order to test the
suggested hypotheses 2 and 3, an initial choice of model has been made. The pooled regression,
using data for both model (2) and model (3) across all companies and all years without
identifying such, has shown that overall choice of variables is adequate. The following tests have
been conducted to determine which model specifications are adequate:
Breusch and Pagan Lagrangian multiplier test for random effects to determine, whether
the pooled regression or random effects regression is adequate (p-values of 0.440 and
0.000 for models (2) and (3) correspondingly).
Hausman test to determine, whether fixed or random effects model is adequate (p-values
of 0.000 and 0.000 correspondingly).
Wald test to determine, whether pooled regression or fixed effects regression is adequate
(p-values of 0.000 and 0.000 correspondingly).
For both models fixed effects regression is adequate. Thus, further analysis will be
conducted using fixed effects specification. The regression results for model (2) and model (3)
are presented in the following table:
60
Table 11
Regression results: investment tenure
Variable
Tenure
¿¿
Risk
Profitability
Debt
CF
Constant
2
R
p - value
Note: symbols *, **, and *** represent significance at
Model (2)
Model (3)
CF growth
NFD EBITDA
0.024**
0.102**
0.063***
0.868***
-0.300
–
-2.171***
0.049
0.000
-0.106*
-0.227
-0.246**
-5.648***
–
-0.859
8.187
0.058
0.000
α=10
,
α=5
, and
α=1
respectively
Both models were significant even at α=1 . Interpretation of the obtained coefficients
is as follows:
An additional year of PIPE investor’s tenure increased the cash flow growth, on average,
by 2.4% (ceteris paribus).
An additional year of PIPE investor’s tenure reduced the NFD / EBITDA ratio, on
average, by 0.106 (ceteris paribus).
Before focusing on analyzing the implications of the results, an additional research has
been conducted in order to determine a kind of marginal effects for different tenures. This would
allow to expand the managerial implications of the obtained results. Within the modified models,
t h e Tenure
variable has been substituted by a set of dummy variables, which represent
different intervals of investment tenure: zero (omitted), below 2 years, 2 to 4 years, 4 to 6 years,
and above 6 years. Division by broader intervals of 2 years or more is conducted to ensure
sufficient observations are present for each of the intervals. The regression results for the
modified models (2) and (3) are presented in the following table 1:
Table 12
Regression results: investment tenure marginal effects
Variable
Tenure : below 2 years
Tenure :2−4 years
Model (2)
Model (3)
CF growth
NFD EBITDA
0.109**
0.128***
-0.507*
-0.289
1 All specification tests have been also conducted upon the substitution of
Tenure
variable
with a set of dummy variables. Tests had the following p-values for modified model (2) and (3)
correspondingly: Breusch and Pagan test – 0.4559 and 0.000; Hausman test – 0.000 and 0.000;
Wald test – 0.000 and 0.000. Thus, in both cases, fixed effects models remain adequate.
61
Tenure : 4−6 years
Tenure :above 6 years
¿¿
Risk
Profitability
Debt
CF
Constant
2
R
p - value
Note: symbols *, **, and *** represent significance at
0.175***
0.116
0.101**
0.064***
0.861***
-0.297
–
-2.160***
0.052
0.000
α=10
Again, both models are significant even at
,
-0.777**
-0.588
-0.227
-0.248**
-5.592***
–
-0.831
8.245
0.057
0.000
α=5
, and
α=1
respectively
α=1 , thus, we can proceed with making
further conclusions. As it can be seen from the table above, there is statistically significant
relation between investment tenure and cash flow growth rates for all tenure intervals below 6
years. In the same manner, tenure intervals from 2 to 4 years and above 6 years have also
statistically significant relation to the companies’ solvency as measured by NFD / EBITDA ratio.
Since the rest of tenure variables are insignificant and are dummy, we can make a set of
conclusions:
There is no difference in cash flow growth rates for companies with private equity
investment tenure above 6 years and other companies, including those with no private
equity investors at all (ceteris paribus).
There is no difference in NFD / EBITDA ratios for companies with private equity
investment tenure below 2 years and above 6 years and other companies, including those
with no private equity investors at all (ceteris paribus).
The statistically significant coefficients tend to increase towards longer tenures for both
models. These findings are especially important to form managerial implications of the paper,
which are provided in the discussion part below.
As Kaplan and Strömberg (2009) have previously defined, private equity funds increase
the target company’s value by realizing different strategies of value creation. Badunenko, Baum
and Schäfer (2010) have found an empirical evidence of increases in companies’ performance
over longer tenures of private equity investors in general. The authors have identified that for the
tenure of 6 years, the presence of private equity investors in a company’s shareholders structure
was positively related to such company’s performance. However, lower tenures had a negative
relation to the performance, which has been addressed as the time needed for internal
restructuring. Nevertheless, the analysis had a number of limitations regarding: lack of
identification of particular private equity fund’s tenure; rather short observation period as the
62
sample is constructed for 6 years. Similar positive relation over the course of PIPE tenure was
expected and achieved, though was observed during earlier tenures. Moreover, the research
extends both the observation period and identifies particular transactions for the purposes of the
analysis.
The suggested hypothesis 2 regarding the positive relation of private equity investment
tenure to the performance of target companies in terms of their cash flow growth is accepted.
The estimated coefficient is both statistically significant and positive. By granting capital that is
crucial for the development of small and financially distressed businesses provides opportunities
for growth, which is reflected by the positive relation of tenure to the growth of cash flow. This
result is similar to the main goals of a private equity fund emphasized by current practitioners: to
improve the performance of a target firm, achieve higher cash flows, and upgrade the target’s
valuation even further (Gatti et al., 2015). As Gompers, Kaplan and Mukharlyamov (2015) have
identified in their survey, private equity funds often rely on intrinsic valuation and estimate their
exit value based on the DCF based growing perpetuity to avoid market uncertainties. Such
valuation is extremely sensitive to the changes in growth rates of cash flows (CFA Institute,
2015, p. 249-250).
The obtained positive relation indicates that private equity funds do, indeed, choose
targets, for which the PIPE funding would potentially grant new growth opportunities for the
company. The research also identifies “time to build” effects, similar to the ones described by
Badunenko, Baum and Schäfer (2010). As it can be seen from the marginal effects of tenure,
coefficients gradually increase for longer tenures. Nevertheless, on the contrary to the authors’
research, PIPE investments do differ in a number of ways. Apart from the minority shares being
purchased within a PIPE transaction, and, consequently, lack of control over target firms, the
increases in the performance measure are achieved even for tenures lower than 6 years. This may
be attributed to the fact that PIPE timing is essential, as described by Särve (2013, p. 18) and
Fraser-Sampson (2007, p. 49). By infusing external capital into companies, which have shown to
operate at comparatively lower risks than their peers, private equity funds exploit an opportunity
of increasing the target company’s growth rates. What is more importantly, no statistically
significant relation between the tenure and cash flow growth is present for longer tenure over 6
years. In practice, these findings imply that immediate effects of a capital infusion through a
PIPE is achieved and is spread over the medium-term investment horizon. However, longer
tenures lack such effects. This means that capital sourced from private equity has already
exhausted its potential to provoke company’s growth. At the same time, companies might be
willing to seek new opportunities for financing their activities. The findings regarding
63
companies’ solvency (as described below) reveal that such opportunities might be also related
not only to new PIPE investments but also to debt financing.
The suggested hypothesis 3 regarding the positive relation of the investment tenure to the
performance of target companies in terms of their solvency is also accepted. The estimated
coefficient is both statistically significant and positive. In the same manner as conclusions on
hypothesis 1a, the result may seem misleading as the estimated coefficient is negative. Note that
solvency is measured by NFD / EBITDA ratio (net financial debt to earnings before interest,
taxes, depreciation, and amortization), thus, decreasing ratio would imply improvements in a
company’s solvency. This measure for solvency reflects two out of three main considerations in
credit analysis: its leverage and debt coverage (CFA Institute, 2013, pp. 628-631). Another
consideration would be company’s profitability and cash flow, which has already been covered.
Improvements in solvency as measured by the ratio can be achieved either through increasing
operational earnings (i.e. EBITDA), through debt reductions (i.e. reducing interest bearing
liabilities, which are a part of NFD), or through creating cash reserves for possible shortages of
liquidity (i.e. increasing cash, which is subtracted from interest bearing liabilities in NFD
calculation). The measure is also known to be widely used by credit agencies as one of the core
ratios for determining credit ratings of companies within bond issues (Standard & Poor’s
Financial Services, 2013), as well as banks as a basis for loan maintenance covenants (CFA
Institute, 2013, pp. 650-653).
A common PIPE target, a small and financially distressed enterprise (Särve, 2013, p. 29;
Dai, 2011), has been thought of as being unable to borrow neither from debt capital markets nor
from banks. This assumption has also been backed both by academic research and market news
coverage (Badunenko, Barasinska and Schäfer, 2009; The Economist Newspaper, 2009). This
assumption seems to be even more realistic since it has been found that leverage is rather low
across all companies that have been subjects to PIPE investments (22% as measured by total debt
to total assets). Thus, such companies, which are used to running the business under
comparatively higher financial leverage, tend to fund their operations and investments through
PIPE transactions. More importantly, private equity investments have shown the potential to
increase companies’ solvency over time, thus, expanding such companies’ opportunities to raise
debt capital in the future. In practice, these findings imply that there are almost immediate
increases in companies’ solvency from the capital achieved from private equity investors. Thus,
over the tenure, solvency does improve, but no evidence of a positive effect exists for tenures
above 6 years. This implies that private equity investments for a period over 6 years have
questionable benefits in terms of solvency improvements. From the company’s perspective, it
would be essential to seek alternative sources of financing 6 years after the initial investment.
64
Were the company’s solvency improvements not sufficient to receive access to debt markets,
additional PIPE capital might be used. The practice of recurring funding with PIPE proceeds is
common and observable in both the presented sample and other papers (Brown and Floros,
2012).
Managerial implications have been defined over the course of the results discussion. The
following table summarizes the results for the suggested research hypotheses:
Table 13
Obtained results in respect of research hypotheses
Research hypothesis
1a
1
b
1c
2
3
Companies’ risk is negatively related to the likelihood of attracting a
private equity investor.
Companies’ profitability is negatively related to the likelihood of
attracting a private equity investor.
Companies’ financial leverage positively related to the likelihood of
attracting a private equity investor.
Private equity investment tenure is positively related to the
performance of target companies in terms of their cash flow growth.
Private equity investment tenure is positively related to the
performance of target companies in terms of their solvency.
Expected
Discovere
relation
d relation
–
–
–
X
+
+
+
+
+
+
Note: symbols +, –, and X represent positive, negative, and the relation without conclusions respectively
65
Conclusions
The paper addressed the issue of the relationship between private equity investment
tenure and companies’ performance by the successive achievement of the research goals. First of
all, a study of private equity funds’ activities and their investment strategies has been conducted.
Over the course of the study, a wide range of private equity peculiarities has been reviewed, such
as strategies for entry and exit, sources of value creation, and industry-specific risks. Moreover,
the concept of PIPE transactions has been reviewed, highlighting strengths and weaknesses of
such, as compared to other sources of financing.
Second, possible causes of different investment strategies used by private equity funds,
including different tenures, have been analyzed. In respect of investment tenures, type of
transaction and target investee characteristics might matter the most. For PIPE transactions, a
predominant group of issuers has been identified as high-tech companies that are comparably
small in size and that experience difficulties with access to other sources of capital, such as debt
(Brown and Floros, 2012; Särve, 2013, p. 31). The failure to raise capital elsewhere could also be
attributed to inability to meet the imposed bank loan maintenance covenants, such as Debt /
EBITDA, which is also used by rating agencies as one of core ratios to determine the credit
rating of a bond issue on debt capital markets (Standard & Poor’s Financial Services, 2013).
Most of PIPE transactions have also been discovered to involve minority investments with lack
of control over investees (Fraser-Sampson, 2007, p. 49; Särve, 2013, p. 32) and that targets of
such investments are frequently financially distressed enterprises (Dai, 2011). The abovementioned findings imply that private equity tenure, on average, might be equal to the time
needed for companies to exit the distressed state and improve their financial performance to be
able to raise capital from other sources. In case such improvements are not likely to take place, a
fund might choose to exit immediately.
Third, an empirical study has been conducted in order to examine the relationship
between private equity investments’ tenure and companies’ performance . The sample of 91 PIPE
transactions corresponding to 79 European target companies that occurred from the year 2005 to
2014 has been used. The sample has revealed findings, similar to those discussed before:
prevailing targets of PIPEs are small- and medium-sized enterprises, many of which are
financially distressed. Also, a supplementary study associated with the determinants of private
equity investments has been conducted.
Fourth, the obtained results have been analyzed and conclusions have been formulated
based on the research. The study regarding the determinants of private equity investments
revealed that less risky companies with comparatively higher financial leverage are more likely
66
to attract private equity investors (ceteris paribus). No conclusions on the relation between the
companies’ profitability and the likelihood of becoming a target of PIPE investment could have
been made. In respect of the investment tenure, positive relation to the companies’ performance
has been discovered, both in terms of their cash flow growth and solvency (as measured by net
financial debt to EBITDA ratio).
The fact that companies with comparatively higher financial leverage are more likely to
attract PIPE investors implies that targets with a greater track record of debt repayments are
chosen for the transaction. Thus, improvements in their solvency might be desirable.
Nevertheless, such companies, still, are mostly equity-financed, which is also in line with the
assumption that those are unable to attract other sources of capital. Over the private equity
tenure, however, either debt or other forms of equity markets should become more reachable for
the companies as the solvency improves.
What is more, the paper provides practical recommendations based on the research. Even
though there are almost immediate increases in companies’ capability to repay debt and growth
rates of their cash flows, such are not observable for the tenures beyond 6 years. The exhausted
potential to improve solvency and cash flow growth implies that private equity funds, on
average, should consider either providing additional capital to the company or sell its share.
From the company’s perspective, the recommendations are similar: were the solvency
improvements not sufficient to increase access to debt markets, raising additional capital through
a PIPE should be considered. This recommendation is in line with current practice of recurring
PIPE investments in the same target companies.
Thus, the goal of the paper has been achieved: the relationship between the tenure of
private equity investments and the performance European companies has been determined. The
research, however, might be expanded in certain ways. First, the investment tenure relation to
other practice-oriented characteristics might be considered. Especially, this is the case for various
multiples used in the comparable company and transaction valuation, which are also applied by
private equity funds to estimate their exit price. Second, the research might be extended for other
types of private equity transactions as long as the tenures of specific investors are analyzed.
67
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Accessed February 19, 2016. http://www.nasdaq.com/article/us-ipos-lacked-in-2015-will2016-turn-the-tables-cm563445.
71
Appendix 1. List of Companies Used
Industry (GICS)
Peer
Peer
Country
Peer
Sector (GICS)
Transportation
Infrastructure
Hotels, Restaurants
& Leisure
Machinery
Obrascon Huarte Lain
SA
Spain
Industrials
Sodexo SA
France
Firefly AB
Sweden
IT Services
Alten SA
France
IT Services
Sopra Steria Group SA
France
IT Services
Dassault Systemes SA
France
IT Services
Neurones SA
France
Information
Technology
IT Services
Tecnocom
Telecomunicaciones y
Energia SA
Spain
Information
Technology
IT Services
France
Consumer
Discretionary
Household
Durables
Guy Degrenne SA
France
Consumer
Discretionary
Household
Durables
Britvic PLC
United
Kingdom
Consumer Staples
Beverages
Remy Cointreau SA
France
Consumer Staples
Beverages
Camaieu SA
France
Consumer
Discretionary
Specialty Retail
Netherlands
Consumer
Discretionary
Specialty Retail
Carrefour SA
France
Consumer Staples
France
Consumer Staples
Club Mediterranee SA
France
Consumer
Discretionary
Food & Staples
Retailing
Hotels, Restaurants
& Leisure
Pierre et Vacances SA
France
Consumer
Discretionary
Compagnie de Saint
Gobain SA
France
Industrials
Building Products
Lafargeholcim Ltd
Switzerland
Materials
Corep Lighting SA
France
France
France
Household
Durables
Leisure Equipment
& Products
MG International SA
Cybergun SA
Consumer
Discretionary
Consumer
Discretionary
Catana Group SA
France
Company
Country
Sector (GICS)
Industry (GICS)
Peer
Peer
Country
#
Company
Country
Sector (GICS)
1
Abertis
Infraestructuras SA
Spain
Industrials
2
Accor SA
France
3
Alexanderwerk AG
Altran Technologies
SA
Altran Technologies
SA
Germany
6
Atos SE
France
7
Ausy SA
France
8
Ausy SA
France
9
Baccarat SA
1
0
11
4
5
1
2
1
3
1
4
1
5
1
6
#
France
France
Consumer
Discretionary
Industrials
Information
Technology
Information
Technology
Information
Technology
Information
Technology
Macintosh Retail
Group NV
Casino Guichard
Perrachon SA
Consumer
Discretionary
Industrials
Information
Technology
Information
Technology
Information
Technology
Information
Technology
Consumer
Discretionary
Consumer
Discretionary
Peer
Sector (GICS)
Peer
Industry (GICS)
Construction &
Engineering
Hotels, Restaurants
& Leisure
Machinery
IT Services
IT Services
Software
IT Services
Food & Staples
Retailing
Hotels, Restaurants
& Leisure
Construction
Materials
Household
Durables
Leisure Equipment
& Products
Peer
Industry (GICS)
1
7
1
8
1
9
2
0
Cybergun SA
France
Consumer
Discretionary
Leisure Equipment
& Products
C Bechstein
Pianofortefabrik AG
Germany
Consumer
Discretionary
Cybernetix SASU
France
Industrials
Machinery
Saipem SpA
Italy
Energy
Delfingen Industry SA
France
Consumer
Discretionary
Auto Components
Paragon AG
Germany
Consumer
Discretionary
Delta Plus Group SA
France
Industrials
Commercial
Services & Supplies
Fiducial Office
Solutions SA
France
Industrials
2
1
Demos SA
France
Industrials
Professional
Services
DRS Data and
Research Services PLC
United
Kingdom
Information
Technology
2
2
Deoleo SA
Spain
Consumer Staples
Food Products
Baron de Ley SA
Spain
Consumer Staples
Beverages
2
3
DGC One AB
Sweden
Telecommunication
Services
Diversified
Telecommunication
Services
Bredband2 i
Skandinavien AB
Sweden
Telecommunication
Services
Diversified
Telecommunication
Services
2
4
2
5
Ducati Motor Holding
SpA
Italy
Consumer
Discretionary
Motorcycles
Bayerische Motoren
Werke AG
Germany
Consumer
Discretionary
Automobiles
Ebro Foods SA
Spain
Consumer Staples
Food Products
Unibel SA
France
Consumer Staples
Food Products
2
6
Ecotel Communication
ag
Germany
Telecommunication
Services
3U Holding AG
Germany
Telecommunication
Services
2
7
Eiffage SA
France
Industrials
Imerys SA
France
Materials
2
8
Fagron NV
Belgium
Health Care
PCB SA
Belgium
Health Care
Firestone Diamonds
PLC
United
Kingdom
Materials
Metals & Mining
Lonmin PLC
United
Kingdom
Materials
Metals & Mining
Floridienne SA
Belgium
Materials
Chemicals
Gurit Holding AG
Switzerland
Materials
Chemicals
General de Alquiler de
Maquinaria SA
Spain
Industrials
Trading Companies
& Distributors
Elton SA
Spain
Industrials
Trading Companies
& Distributors
Greenyard Foods NV
Belgium
Consumer Staples
Food Products
Cranswick PLC
Consumer Staples
Food Products
Company
Country
Sector (GICS)
Industry (GICS)
Peer
Peer
Sector (GICS)
Peer
Industry (GICS)
2
9
3
0
3
1
3
2
#
Diversified
Telecommunication
Services
Construction &
Engineering
Health Care
Providers &
Services
United
Kingdom
Peer
Country
Leisure Equipment
& Products
Energy Equipment
& Services
Auto Components
Commercial
Services & Supplies
Electronic
Equipment,
Instruments &
Components
Diversified
Telecommunication
Services
Construction
Materials
Health Care
Providers &
Services
3
3
3
4
3
5
3
6
3
7
3
8
3
9
GW Pharmaceuticals
PLC
Highfield Resources
Ltd
Highfield Resources
Ltd
HTI High Tech
Industries AG
IMA Industria
Macchine Automatiche
SpA
United
Kingdom
Health Care
Pharmaceuticals
Sanochemia
Pharmazeutika AG
Austria
Health Care
Pharmaceuticals
Spain
Materials
Chemicals
Ercros SA
Spain
Materials
Chemicals
Spain
Materials
Chemicals
Suedwestdeutsche
Salzwerke AG
Spain
Materials
Chemicals
Austria
Industrials
Machinery
Molins PLC
United
Kingdom
Industrials
Machinery
Italy
Industrials
Machinery
Recordati Industria
Chimica e
Farmaceutica SpA
Italy
Health Care
Pharmaceuticals
Innate Pharma SA
France
Health Care
Biotechnology
Cellectis SA
France
Health Care
Biotechnology
Jazz Pharmaceuticals
PLC
Ireland
Health Care
Pharmaceuticals
AstraZeneca PLC
United
Kingdom
Health Care
Pharmaceuticals
Elmos Semiconductor
AG
Germany
Information
Technology
Semiconductors &
Semiconductor
Equipment
Redrow PLC
United
Kingdom
Consumer
Discretionary
Aixtron SE
Germany
Information
Technology
Aixtron SE
Germany
Information
Technology
Electronic
Equipment,
Instruments &
Components
Household
Durables
Semiconductors &
Semiconductor
Equipment
Semiconductors &
Semiconductor
Equipment
4
0
Jenoptik AG
Germany
Information
Technology
4
1
Kaufman & Broad SA
France
Consumer
Discretionary
4
2
Kontron AG
Germany
Information
Technology
4
3
Kontron AG
Germany
Information
Technology
4
4
4
5
4
6
4
7
Laboratorio Reig Jofre
SA
Spain
Consumer Staples
Personal Goods
Ulric de Varens SA
France
Consumer Staples
Personal Goods
Lanson BCC SA
France
Consumer Staples
Beverages
Vranken Pommery
Monopole SA
France
Consumer Staples
Beverages
Lexibook Linguistic
Electronic System SA
France
Household
Durables
Dantax A/S
Denmark
France
Software
PSI Produkte und
Systeme der IT AG
Germany
Consumer
Discretionary
Information
Technology
Household
Durables
Linedata Services SA
Consumer
Discretionary
Information
Technology
#
Company
Country
Sector (GICS)
Industry (GICS)
Peer
Peer
Country
Peer
Sector (GICS)
Peer
Industry (GICS)
Household
Durables
Semiconductors &
Semiconductor
Equipment
Semiconductors &
Semiconductor
Equipment
Software
4
8
Logic Instrument SA
France
Information
Technology
4
9
Logic Instrument SA
France
Information
Technology
5
0
Lombard Medical
Technologies Ltd
United
Kingdom
Health Care
5
1
Lombard Medical
Technologies Ltd
United
Kingdom
Health Care
Makheia Group SA
France
Consumer
Discretionary
Medasys SA
France
Mediacontech SpA
Technology
Hardware, Storage
& Peripherals
Technology
Hardware, Storage
& Peripherals
Health Care
Equipment &
Supplies
Health Care
Equipment &
Supplies
Technology
Hardware, Storage
& Peripherals
Technology
Hardware, Storage
& Peripherals
Health Care
Equipment &
Supplies
JLT Mobile Computers
publ AB
Sweden
Information
Technology
Cibox Inter@ctive SA
France
Information
Technology
Aortech International
PLC
United
Kingdom
Health Care
Agfa Gevaert NV
Belgium
Health Care
Health Care
Technology
Media
Infas Holding
Aktiengesellschaft
Germany
Consumer
Discretionary
Media
Health Care
Health Care
Technology
ifa systems AG
Germany
Health Care
Health Care
Technology
Italy
Consumer
Discretionary
Media
Immaliance SA
France
Consumer
Discretionary
Media
Mersen SA
France
Industrials
Electrical
Equipment
Exel Industries SA
France
Industrials
Machinery
Metabolic Explorer SA
France
Materials
Chemicals
Sniace SA
Spain
Materials
Chemicals
Mood and Motion AG
Germany
Consumer
Discretionary
Media
Vela Technologies PLC
United
Kingdom
Consumer
Discretionary
Media
Northbridge Industrial
Services PLC
United
Kingdom
Industrials
Machinery
Lewag Holding AG
Germany
Industrials
Machinery
Octo Technology SA
France
Information
Technology
IT Services
Triad Group PLC
Information
Technology
IT Services
OctoPlus
Netherlands
Health Care
Biotechnology
Proteome Sciences
PLC
United
Kingdom
United
Kingdom
Health Care
Biotechnology
Onxeo SA
France
Health Care
Biotechnology
Biosearch SA
Spain
Health Care
Biotechnology
Orexo AB
Sweden
Health Care
Pharmaceuticals
Boiron SA
France
Health Care
Pharmaceuticals
6
3
Orpea SA
France
Health Care
Health Care
Providers &
Services
Eurofins Scientific SE
Luxembourg
Health Care
#
Company
Country
Sector (GICS)
Industry (GICS)
Peer
Peer
Country
Peer
Sector (GICS)
5
2
5
3
5
4
5
5
5
6
5
7
5
8
5
9
6
0
6
1
6
2
Health Care
Providers &
Services
Peer
Industry (GICS)
6
4
6
5
6
6
6
7
6
8
Pescanova SA
Spain
Consumer Staples
Food Products
Anglo-Eastern
Plantations PLC
United
Kingdom
Consumer Staples
Food Products
Pharming Group NV
Netherlands
Health Care
Biotechnology
Probi AB
Sweden
Health Care
Biotechnology
Premier Foods PLC
United
Kingdom
Consumer Staples
Food Products
Greencore Group PLC
Ireland
Consumer Staples
Food Products
Proservia SA
France
Information
Technology
IT Services
Quotium Technologies
SA
France
Information
Technology
Software
Provexis PLC
United
Kingdom
Consumer Staples
Personal Goods
Midsona AB
Sweden
Consumer Staples
Personal Goods
Switzerland
Health Care
Biotechnology
Bioporto A/S
Denmark
Health Care
Biotechnology
Switzerland
Health Care
Biotechnology
IDL Biotech AB
Sweden
Health Care
Biotechnology
SFC Energy AG
Germany
Industrials
Electrical
Equipment
Phoenix Solar AG
Germany
Information
Technology
Semiconductors &
Semiconductor
Equipment
Sidetrade SA
France
Software
Crimson Tide PLC
United
Kingdom
Sidetrade SA
France
Software
Solteq Plc
Finland
Sidetrade SA
France
Sidetrade SA
France
7
6
Soitec SA
France
Information
Technology
7
7
Store Electronic
Systems SA
France
Information
Technology
6
9
7
0
7
1
7
2
7
3
7
4
7
5
Santhera
Pharmaceuticals
Holding AG
Santhera
Pharmaceuticals
Holding AG
Information
Technology
Information
Technology
Information
Technology
Information
Technology
Software
Software
Semiconductors &
Semiconductor
Equipment
Electronic
Equipment,
Instruments &
Components
AND International
Publishers NV
Keyware Technologies
NV
Netherlands
Belgium
Information
Technology
Information
Technology
Information
Technology
Information
Technology
STMicroelectronics
NV
Switzerland
Information
Technology
Basler AG
Germany
Information
Technology
Software
Software
Internet Software &
Services
IT Services
Semiconductors &
Semiconductor
Equipment
Electronic
Equipment,
Instruments &
Components
Country
Sector (GICS)
Industry (GICS)
Peer
Peer
Country
Peer
Sector (GICS)
Store Electronic
Systems SA
France
Information
Technology
Electronic
Equipment,
Instruments &
Components
TT electronics PLC
United
Kingdom
Information
Technology
Swedish Orphan
Biovitrum publ AB
Sweden
Health Care
Biotechnology
Meda AB
Sweden
Health Care
Pharmaceuticals
ThyssenKrupp AG
Germany
Materials
Metals & Mining
Salzgitter AG
Germany
Materials
Metals & Mining
TradeDoubler AB
Sweden
Information
Technology
Internet Software &
Services
MCH Group AG
Switzerland
Consumer
Discretionary
Media
Trans-Siberian Gold
PLC
United
Kingdom
Materials
Metals & Mining
Auriant Mining AB
Sweden
Materials
Metals & Mining
United Internet AG
Germany
Information
Technology
Internet Software &
Services
Drillisch AG
Germany
Telecommunication
Services
Wireless
Telecommunication
Services
Valneva SE
France
Health Care
Biotechnology
Ipsen SA
France
Health Care
Pharmaceuticals
Vet’Affaires SA
France
Consumer
Discretionary
Specialty Retail
Basic Net SpA
Italy
Consumer
Discretionary
Specialty Retail
8
6
Vexim SA
France
Health Care
Geratherm Medical
AG
Germany
Health Care
Health Care
Equipment &
Supplies
8
7
Vidrala SA
Spain
Materials
Zardoya Otis SA
Spain
Industrials
Machinery
8
8
Viscofan SA
Spain
Consumer Staples
Food Products
Prosegur Compania de
Seguridad SA
Spain
Industrials
Commercial &
Professional
Services
Wireless Group PLC
(UTV Media PLC)
Ireland
Media
Constantin Medien AG
Germany
Xilam Animation SA
France
Media
Mondo TV SpA
Italy
Xing AG
Germany
Internet Software &
Services
Wirecard AG
Germany
#
Company
7
8
7
9
8
0
8
1
8
2
8
3
8
4
8
5
8
9
9
0
9
1
Consumer
Discretionary
Consumer
Discretionary
Information
Technology
Health Care
Equipment &
Supplies
Containers &
Packaging
Consumer
Discretionary
Consumer
Discretionary
Information
Technology
Peer
Industry (GICS)
Electronic
Equipment,
Instruments &
Components
Media
Media
IT Services
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