October 2009

Light at the end of the tunnel

PE opportunities emerge amid improving sentiment and stability
– by Simon Boughey

Global markets have come a long way in six months, and although the private equity sector lags the rest it
appears that new investment opportunities are emerging. After a long period in the desert, general partners
are seeing the odd oasis.

The sort of investments made and the circumstances in which GPs commit capital will be radically
different from a couple of years ago, but seeing investment opportunities of any kind is a development to be
cheered lustily.

“The climate is getting better. We’ve been getting positive feedback. LPs are beginning to plan ahead,”
says a private equity banker at a fund of funds in London.

The return of a measure of confidence in the fundamental stability of the financial system and much higher
equity prices than three or four months ago have stirred the private equity market from its paralysis. As
another partner of a London-based sponsor says, “Business is picking up because there is more certainty
about the economic outlook. People were very reluctant to pull the trigger when it looked like things would
bounce along the bottom.”

Private equity bankers say that investment opportunities have also increased because vendors have become
more realistic about the prices they are likely to get. Even though equity prices have rebounded from the
lows, they are still far from the peaks of the market. The Dow Jones Industrial Average, for example,
currently trades around 10,000 points. While this is much higher than the levels of 6,500 seen in March, it
is still a long way off the highs of over 14,000 recorded exactly two years ago. Finally, it seems, sellers are
beginning to adjust aspirations to the new realities.

“Vendors are getting more realistic and are willing to embrace valuations. If they need to sell then they
have to put a plan in place,” says a senior professional at a GP in London.

But there are several significant caveats regarding the return of optimism and deal flow. Although vendors
are becoming more realistic, there is frequently a gap between their price expectations and those of the
buyers.

Moreover, most vendors are under no pressure to act. With interest rates likely to remain at historic lows
for the foreseeable future as central bankers fear strangling any nascent recovery at birth, would-be vendors
can survive without being forced to raise capital.

“A lot of vendors are just bumbling along. Lloyds, for example, will need to sell things but at the moment
there is no pressure. They have been holding out,” comments another senior partner at a GP in London.

The financial sector as a whole is seen as a rich source of business over the next few years as banks seeking
to return to basics divest their non-core businesses, but at the moment there is little action on this front.

Neither has bank lending revived to anything near the degree required to support a large-scale return to
private equity investment. Bank financing conditions are beginning to ease, but, as GPs point out, they
couldn’t have got any worse.
Standard & Poor’s LCD Private Equity Report, October 2009 Page 2 of 4

One of the most recent and well-publicised takeovers, that of Just Retirement by Permira, was a controlled
buyout with no leverage involved. The deal was completed at the end of September for ₤230 million, and
Permira pledged to inject a further ₤25 million of fresh capital.

The firm, which sells enhanced retirement annuities to those whose life expectancy is below average, was
floated at 148p per share in 2006, which is almost twice the price of 76p a share Permira offered. But
Permira’s offer also represents a 57% premium above the closing price of 48.5p a share at which Just
Retirement traded on Nov. 7 2008, its last full day of trading before the firm announced it had received bid
interest.

In general, private equity professionals believe that although the climate is better than it was a few months
ago, real business flow will not be seen until near the latter stages of the first quarter of 2010.

“In 2009, we’ve been drifting along like it is the end of the world, but 2010 will see things start to happen,”
predicts a partner at a sponsor in London.

That said, a few deals are coming together. In the U.S., Blackstone has agreed to buy ten theme parks from
brewer Anheuser Busch InBev for between $2.5-3 billion. It would have been a paltry deal in the heyday of
the market, but in these chastened times it is set to be the largest private equity deal of the year.

BC Partners has made a few ripples lately as well. In June, it bought $350 million of convertible perpetual
preferred shares in Office Depot, the U.S. office supply firm, and three BC Partners staff joined the board.
Upon conversion, the purchase represents a 20% stake in the firm.

BC Partners also announced the planned merger of two European heating firms in its portfolio – De
Dietrich Remeha and Baxi Group – to form a combined business with revenues of €1.8 billion.

At the beginning of September, the company took a 40% stake in Synlab, a German medical laboratory,
and it also took over FutureLAB, an Austrian laboratory. Both deals will close at the end of the year, at
which point BC Partners plans to merge these firms as well.

Other GPs in London and New York say that investment opportunities can be found, but that sponsors may
have to look further afield and into different businesses than they did in the past to find them.

It’s easier in CEE

One fund that specializes in central and eastern Europe says opportunities in these regions are better than
they are in western Europe. A senior partner for the firm says that it is still relatively easy to raise Є150
million of debt for investment in central and eastern Europe, so the acquisition of firms worth €300 million
or so is possible.

“All I see in western Europe is a tremendous degree of uncertainty and unhappiness in private equity. The
amount of disruption in well known houses is really very disconcerting. But we’re one third invested in our
most recent fund. So central and eastern Europe are probably more buoyant than anywhere else. The deal
flow is less dynamic that two or three years ago but it is nonetheless interesting,” he says.

One reason for the relative attractiveness of assets outside western Europe is that the recession has had less
of an impact there. Growth rates were far higher than in western Europe before the crisis struck, and they
remain flat or at minus 1% versus 4-6% in 2005-2007. Indeed, Poland is the only country in Europe to
retain positive growth.

Poland supplies 30% of the GDP of the entire region, but growth prospects are also good in the Czech
Republic, Slovakia and Slovenia. The Ukraine, Rumania and Bulgaria, in contrast, offer less enticing
opportunities.

© 2009 Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved.
Standard & Poor’s and S&P are registered trademarks of The McGraw-Hill Companies, Inc.
Standard & Poor’s LCD Private Equity Report, October 2009 Page 3 of 4

The defensive sectors, such as health care and telecommunications, are still the best places to be in what
were once very fast growing economies, according to the eastern Europe experts. There is less interest in
investment in cyclical firms and in those catering to the consumer.

EQT recently launched a public tender offer to acquire 100% of Poland’s HTL-Strefa, a manufacturer of
safety and personal lancets for capillary blood sampling. The acquisition will be financed by 100% equity,
according to a company press release, although the sponsor may look to leverage up the business with debt
financing further down the line.

But investment in eastern and central Europe is not something into which private equity firms should
blithely sail and hope to reap rich rewards. Sponsors established in these areas may thrive, but those
without a reputation in central and eastern Europe will find the going very tough.

Infrastructure opportunities
Another private equity firm has had success raising capital for investment not in pure private equity but in
infrastructure, such as telecommunications services, utilities, road building and airport construction. It has
raised over €150 million for its infrastructure fund so far and believes it can raise another €150 million.

“The big thing about infrastructure is that it generally shows robust and predictable returns, based on a
transparent cash flow profile. Often services like the provision of water and electricity are tightly regulated,
and pricing is often index linked to inflation,” says a partner with the firm.

This relative stability and transparency are desirable qualities after the worst financial crisis in living
memory. In general, returns from this sector are not as good as classical private equity investment. The data
is often inadequate, but it seems that returns of 8-10% per annum are common, versus returns of 15% or
more from LBO investments. Nonetheless, these figures are compelling enough at the moment.

It should be noted, however, that not all infrastructure investment is immune from recession. Some, like
road building to an airport, is inextricably linked to a nation’s GDP.

One power plant, although it might be privatized, could have 25-year inflation linked contracts for the
supply of power. It might also have predictable fuel costs tied to tariffs.

Another power plant might have no such agreements in place. It may be forced to sell electricity to a
national grid at the current spot price and at the same time have no fuel supply agreement in place. In the
one case, returns are clear and predictable, and in the other less so.

Secondary generates buzz

The visibility of secondary investment in private equity is also helping to create interest in this sector at the
moment. An LP may wish to sell its stake in another private equity fund owned by a GP, or it might wish to
sell a direct stake in a company. In both cases, another private equity firm will take over its stake and then
sell to another LP.

This offers various attractions. The visibility means both out-performers and under-performers can be
easily identified. Stakes are also thereby more easily priced. Fees and expenses are often absorbed by the
original LP.

Sellers are often under some pressure to shed their investments, so stakes can be priced at a discount to
NAV. There is great diversification, by style, sector, even by manager. Finally, because the new LP joins
the investment later in the investment cycle, the J curve can be reduced.

Supply of secondary investment opportunities is increasing for a number of reasons. This is partly a
function of the massive growth of the private equity market as a whole in the several years before 2008.
Some $1.7 trillion was raised in the years 2005-2008 inclusive, compared, for example, to around $800
billion from 1997-2000.

© 2009 Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved.
Standard & Poor’s and S&P are registered trademarks of The McGraw-Hill Companies, Inc.
Standard & Poor’s LCD Private Equity Report, October 2009 Page 4 of 4

Non-traditional sellers, like pension plans and insurance companies, have entered the secondary market
latterly to reallocate exposure. The crisis has meant that many LPs are overweight private equity and need
to divest.

The general turmoil has also meant LPs need to sell secondary stakes just to raise capital.

All this means that there should be plenty of business in the secondary space. Unfortunately, as private
equity firms active in this sector ruefully concede, this hasn’t happened yet. Bid/offer spreads are still wide
and NAVs have not dropped sufficiently. Neither are sellers yet keen to do deals at a discount.

Specialists are confident that the pace of business will pick up next year. They say that bid/offer spreads
will narrow as NAVs are written down, and the pressure on sellers will increase as capital calls pick up.
But, at the moment, as in so many areas of the private equity world, the message seems to be “wait for
2010.”

The announcement of the bid for Cadbury by Kraft in September gave many in the private equity world –
and in the wider markets in general – the impression that the wheel was beginning to turn. At the end of
September, the U.K.’s Takeover Panel gave the U.S. food group until Nov. 9 to make a formal offer or
walk away.

This news certainly indicates that the mood has shifted from the overwhelming fear and gloom that
persisted in the first six months of the year. But deals like that remain the exception. Although novel
opportunities for investment certainly exist, and the tone of the market has doubtless lifted, it would be a
mistake to expect many GPs to put large slabs of capital to work until 2010.

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© 2009 Standard & Poor’s, a division of The McGraw-Hill Companies, Inc. All rights reserved.
Standard & Poor’s and S&P are registered trademarks of The McGraw-Hill Companies, Inc.