2013 CFA Level II Alternative Investments

Private Equity Valuation

Presented by: Arif Irfanullah www.arifirfanullah.com

Contents
1. 2. 3. 4. 5. Introduction Valuation Techniques Private Equity Fund Structures and Valuation Evaluating a Private Equity Fund Case Study

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1. Introduction

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2.1 How Is Value Created in Private Equity

Reengineer firm and make it more efficient Obtain lower cost debt financing via access to cheap credit and few covenants Align goals of management and private equity owners Managers have long term focus Effective structuring of investment terms (term sheet) results in a balance of rights and obligations between the private equity firm and the management team

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Term sheet might contain the following

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EBITDA multiples are frequently used

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Exhibit 3

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Exhibit 5. Stakeholder Payoff 5,000m investment 50% Debt; 50% Equity Equity: 2,400 PS owned by PE Fund 95 Equity owned by PE Fund 5 Equity owned by Management Assume the fund grows 1.6x to 8,000m by end of 2013

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2.6 Exit Routes: Returning Cash to Investors

Initial Public Offering (IPO): Highest exit value relative to other methods; High liquidity, access to capital, and attracts good mgmt Less flexible, more costly, and complex Use when company has strong growth prospects, operating history, size Timing of IPO is an important consideration Secondary Market: sale to other financial investors or strategic investors Second highest valuation Management Buyout: firm sold to management Significant use of leverage Liquidation: Sale of firms assets Lowest valuation, negative perception
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General Partner (GP) vs. Limited Partner (LP)

Two core functions of a PE firm: 1) Raise Funds and 2) Manage Investments

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Example 2. Calculation of Carried Interest

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Deal by deal waterfalls

Total return waterfalls

Alternative 1: GP gets CI only after committed capital has been returned

Alternative 2: GP gets CI if exit value exceeds x% of invested capital

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Example 3. Distribution Waterfalls

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More corporate governance terms

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Investors (LPs) evaluate funds based on IRR Gross IRR: relates cash flows between private equity fund and portfolio companies

Net IRR: relates cash flows between private equity fund and LPs

PIC

DPI

RVPI

TVPI
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Example 4. Calculating and Interpreting a Private Equity Fund Performance

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 Two ways of accounting for risk

Use a very high discount rate Take a probability-weighted terminal value (did this in Level 1)

Terminal Value Example: Assume the possible terminal value are $60 million, $40 million and $0 If each has an equal probability of occurring, then the expected terminal value is:

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Conclusion

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