Secondary Buyouts in Private Equity
Is the decision to perform a SBO influenced by market timing, holding
period and fund lifetime?
Rutger Go
10782923Msc Finance Thesis | Supervisor: J. Ligterink | 06-07-2015 Abstract:
This paper analyzes whether capital market conditions, holding period of the portfolio company and lifetime of the selling private equity fund have influence on the decision of secondary buyout (SBO) as exit route. According to the theory, favorable debt market conditions, a short holding period and a fund close to maturity should all increase the likelihood of a SBO exit. This thesis presents an empirical test of these parameters on a hand-collected dataset of 662 SBO, IPO and trade sale exit decisions between 1997 and 2015. The results show that these variables indeed cause for an increase in SBO likelihood and that excess returns at the equity market decreases the likelihood of a SBO due to the IPO preference of PE firms. Therefore, according to this thesis one could conclude that these criteria indeed have an influence on the exit and buying decision of PE firms.
Special thanks to Joop de Hoogh and Patrick Flaton of Berkeley Corporate Finance.
Table of Contents
1. INTRODUCTION ... 4
2. LITERATURE REVIEW & HYPOTHESES ... 7
2.1.PRIVATE EQUITY ... 7
2.2.INVESTMENT LIFECYCLE ... 9
2.2.1 The Acquisition Phase ... 10
2.2.2. Holding Period ... 11 2.3.SECONDARY BUYOUT ... 13 2.3.1. Market Conditions ... 14 2.3.2. Strategic ... 15 2.3.3. Fund Expiration ... 17 2.4.HYPOTHESES ... 17 2.4.1. Hypothesis I ... 18 2.4.2. Hypothesis II ... 18 2.4.2. Hypothesis III ... 18 2.4.3. Hypothesis IV ... 18
3. DATA & METHODOLOGY ... 20
3.1.DATA ... 20
3.2.VARIABLES AND REGRESSION MODEL ... 22
3.2.1. Dependent Variable ... 22
3.2.2. Independent Variables ... 22
3.2.3. Control Variables ... 25
3.3.REGRESSION MODEL ... 27
4. EMPIRICAL RESULTS ... 29
4.1.VARIABLES AND SUMMARY STATISTICS ... 29
4.2RESULTS ... 30 5. DISCUSSION ... 34 6. CONCLUSION ... 36 REFERENCE LIST ... 38 APPENDIX ... 41
Statement of Originality
This document is written by Student Rutger Go who declares to take full responsibility for the contents of this document. I declare that the text and the work presented in this document
is original and that no sources other than those mentioned in the text and its references have been used in creating it. The Faculty of Economics and Business is responsible solely for
1. Introduction
Private equity has the public opinion of investing in a company, increase the amount of leverage significantly in order to generate high returns and eventually resell this portfolio company full of excessive debt back to the public or a strategic seller. An example in the Dutch market is the acquisition of ‘Van Gansewinkel’ by KKR and CVC. They acquired this waste processor for 2.4 billion euro in 2007 from which 1.8 billion was debt. Almost 8 years later, the PE consortium made a deal with the creditors to drop 60% of the claim in order to avoid bankruptcy. One of the main reasons for the collapse of this 2.4 billion euro valued company was the unbearable amount of debt it was not able to repay1. For the public, this was a typical PE example, in which PE is seen as an economic destroyer for companies that were healthy and self-sustaining before the PE investment.
Kaplan & Stromberg (2009) formulated a three-step strategy applied by PE firms that suits this example as well, namely operational improvement, leverage and eventually multiple expansion. Although this strategy on itself is not per se considered as negative or controversial, PE firms have the reputation to apply this strategy within a timeframe that is solely based on their holding period, without any interest in the company’s performance after the exit. Cumming & MacIntosh (2003) state that a PE investor is commonly assumed to exit an investment once the marginal returns equals the marginal costs of its value creation efforts.
Both Kaplan & Stromberg’s three-step strategy and Cumming & MacIntosh’s marginal return-marginal costs balance underline the publics concern about PE and this derives the question from an economic viewpoint, how are these short-term oriented firms able to realize their profit, if their interest in the company’s performance is just limited for several years. Hence, what is the exit strategy and what drives these firms to perform which exit? Since profit realization happens during the exit, choosing the incorrect exit strategy can ruin an average of 5 to 7 years of hard work with the portfolio company, since the reward gained does not satisfy the effort. Furthermore, Kaplan & Schoar (2005) found a positive relationship between a general partner’s track record and his or her ability to attract capital in new funds. This implies that a good exit is not only profitable, but also highly important for future road shows.
Since the exit is of crucial importance for PE firms, it is interesting to look at the key drivers behind the exit decision. Schmidt, Steffen & Szabó (2010); Jelic & Wright (2011) found evidence that exit decisions are driven by market sentiments, which is a factor PE firms cannot influence. This is remarkable, since PE firms all have their own strategy to create as much value for their investment as possible, but once the investment is exited and profit is realized, they are dependent on external factors. This triggers the question how much this external factor is of influence on the exit decision.
The aim of this research is to study the preference of performing a secondary buyout by looking at market conditions, meaning by looking at the state of the equity and debt market at the time of the exit, the holding period of the portfolio company by the selling PE firm and the lifetime of the fund from which the portfolio company is sold at time of the exit. Lowry (2003) found evidence that IPO volume is highest when companies demand extra capital due to the favorable economic conditions. This suggests that during high stock market returns, SBOs would not be often-occurring phenomena, since there is a better alternative. Achleitner & Figge (2012) suggested in their paper that SBOs are mainly present when the acquiring private equity firm is able to take advantage of the attractive debt market condition.
My contribution is an extension to the literature available about SBOs, from which most of the papers analyzed some of the variables I used, but no paper combines them all. Mostly all included more portfolio company specific variables such as exit multiples and equity returns. My thesis solely focuses on market timing and time specific influences, which can be considered as the broader picture. Furthermore, there are some articles that take into account reputation when investigating exit strategies, but every paper has its own measurement technique. This thesis contributes to this literature by generating results with new reputation measurements. Table I shows a brief overview of these articles and their findings and thus my contribution to this list.
The literature review of this thesis provides a better understanding of SBOs as exit strategy, since it is a contradicting principle if you look at the overall opinion of private equity’s relatively short and self-interested investment strategy. Furthermore, since in a SBO both buyer and seller are generally assumed to rely on the same set of value creation tools, it is unclear how the second PE fund can continue to create value and generate attractive equity returns (Achleitner et al. 2012). Thus, this review answers the question why another PE firm would buy a company if all the value is already realized by its competitor. The empirical outcomes of this thesis have the
potential to provide an explanation of this contradicting exit route by taking into account the situation at the capital markets, the holding period of a portfolio company by the selling PE firm and the lifetime of the fund from the selling PE house during time of the exit.
This study is limited due to the small sample size, which can be interesting for academics to continue and update this thesis to adapt the outcomes to future economic circumstances. Furthermore, this thesis is relevant for PE fund managers at the buying and selling side, because these findings can support them in making the best exit or acquisition decision when taking into account the parameters in my thesis.
Based on the current literature, I expect that a favorable debt market will lead to an increase in the volume of SBOs, since I think that the cost of capital has a significant influence on PE investments as well as exit strategies, due to the importance of leverage in such transactions. Besides, I think that I will find significant evidence that an expiring fund lifetime will lead to SBOs as a more preferred exit route, since this exit is the least complicated, expensive and time consuming. Last, I think that there is a positive relationship between a short holding period and SBOs, since it is more likely for the buying PE firm to create additional value at the portfolio company in comparison to a company that is hold for a longer period by the selling PE firm. All the data used in this paper was hand-collected, mainly by using the Thomson One Database, Zephyr, FRED St. Louise, Yahoo Finance and data provided by Mr. J. Martin and Mr. J. Ligterink.
In order to draw a solid conclusion about the SBO decision and the influence of market timing, holding period and fund lifetime, I will use a probit model. The dependent binary variable will be either a SBO or IPO/trade sale. This model will consist of the proxies indicating excess equity returns, debt market favorability, monthly holding periods and lifetime of the selling PE fund in months. I will control the outcomes by country of registration of the portfolio company, industry the portfolio is active in and the reputation of the selling PE firm.
The thesis is structured as follows; first, I will give a brief explanation about private equity itself, the investment lifecycle and the holding period. I will than go into further detail about the SBO exit and 4 motivations to give a better understanding for the decision to perform this exit, concluding this section by providing three hypotheses. The third part will consist of an in-depth explanation about my data and methodology and its relevance. Section 4 provides the empirical results I found. Section 5 provides a discussion and a final conclusion is stated in section 6.
2. Literature Review & Hypotheses
In order to talk about SBOs, it is important to have a clear understanding of private equity itself. First, this literature review will introduce private equity and its working and history. Second, I will go in further detail about the investment lifecycle and looking specific at the acquisition and holding period. Third, I will give an in-depth explanation about SBOs as exit strategy and the factors that influence the decision to perform this exit above others.
2.1. Private Equity
The most basic definition of the Private Equity business is that these firms buy undervalued companies, increase profitability and after a period of time sell these acquired companies at a higher price. The most common techniques used to finance these acquisitions are through venture capital and through leveraged buyouts (Kaplan and Strömberg, 2008). Private equity funds generally raise their capital from a limited number of investors in a private placement and share the profits realized by the fund between the PE fund managers and the capital providers/investors (Levin 2009).
When acquiring a company through a leveraged buyout, a specialized investment firm uses a relatively small portion of expensive equity and a relatively large portion of outside relatively cheap debt financing, which banks generally provide. The reason for using a significant amount of leverage is that PE firms expect the future cash flow of the acquired company to be sufficient to repay this debt. Furthermore, the use of leverage will end up in maximizing the return on equity.
The lifetime of a private equity fund is fixed and generally ten years, with provisions to extend the partnership by one or two years up to a maximum of three years (Fenn, Liang & Prowse 1995). Former Bear Sterns employees Jerome Kohlberg, Henry Kravis and George Roberts are seen as the founding fathers of modern private equity and the volumes in which it is executed now. They started their company KKR in 1976 and in 1978 they were the first company that had a private equity fund with a specific mandate to finance public-to-private buyouts (Cheffins & Armour 2007).
Private equity became really noticeable to the public in the 1980s. During the 1970s, $1.4 billion was committed to private equity. This changed rapidly between 1980-1982, where in just
those two years $3.5 billion was committed to private equity partnerships (Fenn, Liang & Prowse 1995). This capital growth went through the roof the next three years after 1982, in which $4 billion was invested in private equity partnerships on an annual basis. Companies of interest during the 1980s were middle-market companies with revenues between $25 million and $500 million, with a not too complex business activity, for example retail manufacturing and distribution industries. These businesses were stable during that time and private equity was used in order to expand, through globalization and mergers & acquisition deals and to restructure the current capital structures.
Between 1980 and 1990, average Internal Rate of Return (IRR) for PE funds was 14,28%, which increased to 18.81% between 1990 and 1995 (Phalippou & Golttschalg 2009). This IRR outperformed the S&P500 returns during that timespan. S&P 500 returns adjusted for inflation and with dividends yielded an average of 12.64%. Between 1990 and 1995, this difference in outperformance increased even more, since PE’s IRR was 18.81% and S&P 500 returns adjusted for inflation with dividends were 10.5%.
Another indicator of an increase in PE popularity is by looking at exits realized, since a high deal flow shows liquidity and hence increased interest in PE deals. If we look at the exits performed between 1970-1984 and 1985-1989, a great difference is visible. Between 1970 and 1984, the total amount of IPOs, strategic sales and SBOs was 128. This increased tremendously between 1985 and 1989, with a total amount of the 3 exit strategies mentioned above of 452 (Strömberg 2008). In four years time, exits increased by 3.5 times in comparison to the previous 15 years. The timeframes are divided in these unequal year groups, to underline the increase in interest in private equity after 1980. Since a portfolio company is kept as an investment for an average of 5 or 6 years (Berger & Udell 1998), separating the group between 1984 and 1985 gives a clear indication of the difference between the PE boom starting in 1980 and the period where PE investments were less known.
This increase in PE activity remained until the dotcom crisis, when buyout funds rose up to $72 billion annually and double digit returns were generated, with 1999 as outstanding year yielding returns up to 30 percent (Cendrowski et al. 2012). When the dotcom crisis hit the market in March 2000, buyout funds capital raising declined to $21 billion per year, which is around a quarter of the amount raised during the economic and PE boom times. Besides the decreasing new capital committed by LPs, the debt market became highly illiquid during the dotcom crisis.
It took up until 2004 when PE firms recovered from this bust and the amount of capital raised by PE houses began to increase once again.
In 2005, PE buyout funds raised nearly $130 billion (Cendrowski et al. 2012). Furthermore, the debt market became liquid again which increased the number of deals performed by the buyout funds as well as the leverage volume included in the deals. These flourishing economic times drove PE to incredible heights, with 2007 as absolute maximum. During this year, PE firms bought 654 US companies, which was the largest PE market, for $375 billion representing 18 times the level of transactions closed in 2003 (Phalippou & Golttschalg 2009). Moreover, PE buyout fund’s IRRs exceeded almost 2.5 times the S&P 500 returns in 2007.
The 2008 crisis caused similar problems for PE firms as the dotcom crisis did, but since economy is still recovering from this recession, not much can yet be said due to the volatility in future prospects for the PE market.
2.2. Investment Lifecycle
Once a PE firm finds an attractive investment opportunity, a certain investment lifecycle occurs, which is applicable for almost every PE investment. The lifecycle starts at the moment the PE firm starts with converting their interest in actually acquiring the company of interest and ends when the exit is realized. The time in between these boundaries is the holding period, in which value is created through several channels.
I will divide the investment lifecycle literature review in two subparagraphs. First is the acquisition, which provides an in-depth explanation of the three main financing structures in PE, namely the leveraged buyout (LBO), high-yield debt and mezzanine financing.
Second section is the holding period, where I will look at the most used value creation methods performed by the PE firms. During the holding period, PE firms create value by improving operational performance, which is the key value creation driver in a PE transaction (Guo et al. 2011). This value creation consists of increase in revenues, operating margins improvements (Acharya et al. 2013), divestments, acquisitions (Nikoskelainen & Wright 2007) and governance engineering (Kaplan & Stromberg 2008).
Reviewing the literature concerning the investment lifecycle could help give an insight in how the portfolio company is financed and what changes are made in the holding period, which is of great interest for the buying PE house in a SBO deal.
2.2.1 The Acquisition Phase
The first and main acquisition strategy is a LBO, which is the acquisition by a specialized investment firm using a relatively small portion of equity and a relatively large portion of outside debt financing (Kaplan & Stromberg 2008). Potential investment opportunities can be public or privately held companies and to illustrate the volume of LBO deals, Chung (2014) found that over the last two decades, the number of LBO transactions involving privately held targets totaled over more than 10,000 with deal value of around $850 billion, accounting for 46% of the worldwide overall LBO market.
The small portion of equity in the LBO acquisition is provided by the PE fund, which is a closed-ended limited partnership (LP), from which the LPs provide most of the capital and led by a general partner (GP) that represents the PE firm that controls the fund. These GPs are compensated by a percentage of the capital committed and employed paid as an annual management fee and a carried interest payment, which is a percentage over the profit made by the fund almost always around 20% (Ljungqvist & Richardson 2003). Both management fee and carried interest secures LPs that GPs keep the money active and seek for the highest returns.
The large portion of debt mostly consists of a loan that is senior and secured provided by (investment) banks and a junior unsecured amount of debt, mezzanine and high-yield bonds, which is provided by institutional investors, endowment funds and hedge funds (Kaplan & Stromberg 2008). The interest payments on this debt loans serve as a tax shield for the portfolio company. The tax shield is the principle where companies can deduct their interest payments from their taxable income. This means that by looking purely at net income, a portfolio company can be interpreted as not very valuable, however this is due to the high interest payments.
Mezzanine financing is debt that is subordinate to debt owed by traditional lenders, which makes them second in line to receive assets as compared to traditional loans (Bean 2014). However, they have a first claim (senior) in receiving equity in case of default, since the borrowing company pledges this mostly as collateral in a mezzanine financing. The main advantages of mezzanine financing is that it is treated like equity on the company’s balance sheet, which makes it easier to obtain standard bank financing (debt loan) and it is relatively cheaper to use than equity financing (Bean 2014).
High-yield debt is also (unkindly) known as junk bonds (Gertler & Lown 1999) and these bonds are placed in the market with relatively high interest rates. This method is used as an extra
leverage kicker, to go beyond the senior loan acquired in the first stage. An important measure for the conditions of this specific debt market is the spread between these high-yield bonds, which ranges from BB+ until CCC (Helwege & Kleiman 1996), and safe or risk-free interest rates. Higher spreads mean a more volatile macroeconomic time, since credit raters imply that lower rated firms are more likely to default than in more favorable times and thus require a higher cost of capital.
2.2.2. Holding Period
Once a company is acquired, the holding period starts, which is the period the portfolio company stays in the fund of the PE firm. As described above, the PE house will start to create value and generate cash in order to repay the debt obligations and work towards a profitable exit that produces a high internal rate of return. PE firms tend to avoid long holding periods, because this could have a significant effect on the IRR (Phalippou 2008). By keeping the acquired company too long in the PE’s portfolio, the IRR will decrease and this will eventually have a negative effect on their reputation and track record. The reason IRR can decrease is because the longer the holding period, the less likely PE firms are to realize high profits. One explanation is the expiration of fund maturity, which I will explain in section 2.3.3. Furthermore, most value is realized in the first years of the holding period as stated in the introduction, which makes it less favorable for PE firms to keep a company too long in their portfolio. This decreasing IRR will make it harder for PE firms to set up new funds, which they do every three to five years on average. The capital that is provided by LPs is invested during the first three to five years and thereafter; the investments are gradually liquidated (Fenn et al. 1995).
Operational performance improvements through governance engineering is achieved through improved reporting procedures and the active monitoring of operations by PE professionals (Acharya et al. 2011). Besides, PE firms build specific operational expertise and industry-specific capabilities to actively support their portfolio companies in improving their operations. Due to this expertise, significant efficiency gains are achieved within the first three years of the acquisition (Alperovych et al. 2013). Meuleman et al. (2009) supports this statement, since they found a significant increase in efficiency and growth during the first three years measured in sales per employee and by employee growth.
A sufficient cash flow to fulfill the interest obligations is generated through growth in sales and expansion of margins, realized due to the expertise and money invested by the PE investor.
Furthermore, the PE investor can generate extra cash by streamlining or divesting capital expenditure (CAPEX) and optimizing working capital (Achleitner & Figge 2014).
Last main value creation tool is to expand business in order to foster growth opportunities and create or sustain economic advantage (Meuleman et al. 2009). Furthermore, economics of scale and scope can be gained by performing M&A deals with the money invested in the portfolio company (Acharya et al 2012, Nikoskelainen & Wright 2007).
PE managers typically raise a new partnership fund at about the time the investment phase for an existing partnership has been completed. Thus, the managers are raising new partnership funds approximately every three to five years and at any one time may be managing several funds, each in a different phase of its life (Fenn et al. 1995).
Profit is realized during the exit; hence the exit strategy used is a crucial factor in the investment period PE firms. Furthermore, profit maximization is not only beneficial for the fund managers themselves; it also supports the reputation and track record of the private equity firm positively. A good reputation and a positive track record are very important for the firms when they are creating a new fund (Sousa 2010).There are several exit strategies, with IPO, trade sale and SBO as main exit strategies. For the relevance of this thesis, I will now briefly explain IPOs and trade sales and in the next sub section extensively review SBOs.
IPO is short for Initial Public Offering and is the sale of stock by a private company to the public (Lowry 2003). Due to the high excess returns that could be generated during this exit, Schwienbacher (2002) and Schmidt et al. (2010) describe IPOs as an exit channel for highly profitable portfolio companies. The companies that offer their shares to the public are mainly characterized by a convincing equity story and high growth prospects. Positive equity market conditions are the most important factor in the decision to go public (Ritter & Welsch 2002). Although IPOs are costly, time consuming and have regulatory issues for PE firms (Jenkinson & Sousa 2010), if performed well and in a hot equity market, (significant) excess return can be generated (Jelic & Wright 2011). Overall, SBOs are less like to yield such excess returns as IPOs (Schmidt et al. 2010), which is why IPO remains the most favorable exit strategy for PE firms. However, due to the external factors and high costs that influence the results of an IPO, this favorability does not necessarily mean that this is the most used exit strategy.
The most used PE exit route is when a portfolio company is sold to a strategic investor, called a trade sale or strategic sale (Schmidt et al. 2010). According to Strömberg (2007), trade sales are
the most common exit route for PE, accounting for 38% of all exits in his dataset, which covered 21.000 transactions between 1970 and June 2007. Most acquiring and thus strategic companies use the portfolio company as expansion or synergy tool for their own business (Cumming & MacIntosh 2003). Furthermore, Sousa (2010) found evidence that trade sales occur mostly for smaller companies that have experienced stronger growth. One of the reasons is that the portfolio company has proven to be successful and is thus a valuable asset for a large umbrella company operating within the same business.
2.3. Secondary Buyout
A secondary buyout is a leveraged buyout where the private equity house, who had previously taken control of a target through an LBO, sells the portfolio company to another private equity firm instead of selling it back to the public market (Wang 2011) and covered in 2013 40% of all PE exits (Degeorge et al. 2013). Achleitner & Figge (2012) investigated the operational performance and equity returns of portfolio companies after the SBOs were realized and concluded that they still display equity returns and operational performance improvements comparable to those of primary buyouts. Furthermore, Jenkinson & Sousa (2012) even found evidence that after the second and third year of the exit, firms that were exited through a SBO manage to increase their net cash flow more than IPO firms during the same period. According to their investigation, this was mainly the case due to the smaller increase in CAPEX by secondary firms and a huge increase in CAPEX by IPO firms. By looking more specific at the buyer’s incentive to engage in a SBO, for them it can be an attractive opportunity to quickly draw down capital to provide LPs with a positive signal on the quality of the investment pipeline, thus building reputation (Gomper 1996).
However, PE firms are known for squeezing out the majority of a companies value between the actual leveraged buy out and the exit, which makes the ultimate value of the company very uncertain and no or only small additional value creating opportunities can be achieved (Jenksinson & Sousa 2014, Wang 2012). Hence, some skepticism can be placed at this SBO principle. I will discuss this exit strategy on the basis of several theoretical viewpoints, consisting of ‘market liquidity’, ‘strategic’ and ‘fund expiration’.
In the market liquidity section, I will review the literature discussing that conditions at the capital markets have influence on the exit decision of PE firms, meaning a cold equity market and a hot debt market should lead to an increase in SBOs.
The strategic principle will focus on the holding period of the portfolio during the exit, the different levels of expertise and amount of uncalled capital, hence different motivations/strategies by PE firms. In this part of the literature review, I investigate whether there is evidence that the realization of a SBO is positively associated with a shorter holding period than the average 5 or 6 years and whether there are strategic motives involved as well.
The fund expiration part covers a review whether theoretical evidence exists about the relation between SBO as an exit and lifetime of the selling fund. SBOs are considered to be less time consuming and less capital intensive than IPOs. This could implicate that approaching fund expiration would increase the likelihood of SBOs.
2.3.1. Market Conditions
As described above, profit optimization created during the exit is crucial due to several factors. The three main exits are dependent on different capital market situations. First IPOs, from which the profitability of this exit is heavily influenced by the equity market conditions. This due to the simple fact that the portfolio company is sold in this market. The debt market conditions are a benchmark for the SBO decision, since this exit strategy has a significant amount of debt involved. Last is the trade sale, which a combination of both markets. Strategic buyers are most of the time large companies that make acquisitions if the overall economy is positive (widely used benchmark for a positive economy is the equity market) and if they are able to borrow at a favorable interest rate (debt market conditions).
As already extensively explained at the acquisition phase section 2.2.1, debt plays a key role in PE deals. PE companies typically acquire companies with 60-80% debt and 40-20% equity financing (Kaplan & Stromberg 2008), which underlines the importance of the debt market. Achleitner & Figge 2012 suggested that SBOs present an attractive deal option if the second financial sponsor is able to take advantage of attractive debt market, because they found evidence that during SBOs, 28-30% more leverage was used in comparison to other exit strategies. Ljungqvist et al. 2007 even found evidence that the overall investment pace of PE funds accelerates when interest rates are low. There are two ways to measure the cost of debt for PE firms, being the USD LIBOR rate and high-yield spreads.
First, the interest rate spreads that PE houses can borrow at fluctuate between 250 and 500 basis points over USD LIBOR (Kaplan & Stromberg 2008), dependent on the reputation and borrowing history between the PE firm and the lender. LIBOR stands for London Inter Banking
Offer Rate and is set daily by the worlds leading banks. This rate indicates the interest rate banks charge each other for short-term lending and is most widely used as a benchmark for lending activities.
Another way to measure debt market conditions relevant for PE is by looking at the high-yield spread. This is the spread between the index of bonds that are below investment grade (BB or lower) and the US spot treasury rate. By adding the spread to the treasury rate, a suitable benchmark for PE borrowing is generated. Since PE can place high-yield bonds in order to back their investments, the movement of this spread gives a suitable indication of the conditions at the debt market for PE firms.
2.3.2. Strategic
The second motivation for a SBO is the strategic decision, which mainly consists of three different elements namely, the holding period, level of expertise and the amount of uncalled capital. These strategic drivers are suitable and important indicators for both the selling and buying PE firm.
First the ‘low-hanging fruit’ principle, which implicates that if the holding period of the selling PE firm was (significantly) lower than the average holding period, the seller was simply not able to realize all the value and only took the ‘low-hanging fruit’ (Capizzi et al 2008), meaning that it was only able to realize the most easy and quickest value within the portfolio company. For example, an easy way for PE firms to realize quick value is by selling the ‘silver ware’. This is a strategy mostly used for large retailers, who often are in the possession of a lot of real estate in triple-A locations. Selling and leasing it back generate a significant amount of cash, however no value was realized in for example operating efficiency. If the company is than sold to another PE firm, only the ‘low-hanging fruit’ was realized. Cumming and MacIntosh (2012) suggested that the longer the holding period, the higher the probability of IPOs, because an IPO is regarded as an exit channel for high flyers, followed by secondary sales and eventually SBOs. The reason for SBOs to be the least likely exit route is that short term multiple expansion is hard to acquire since the previous PE owner streamlined the portfolio company during the longer holding period and is more likely to have stripped off most value.
Second is the lack of expertise in the portfolio company’s market, which is also considered as a reason for PE firms not being able to realize all the values of the portfolio company, despite holding period. Kitzmann & Schiereck (2009) found that different financial investors engage in
different lifecycle phases of a company. Thus, the acquiring investor may still be able to use his different expertise in order to maximize firm value. An example of this expertise difference is the LBO of United Dutch Breweries by Nimbus. According to Jonno Beugels (Investment Manager at Nimbus), they bought UDB as a divested company by InBev. After restructuring and building a solid framework, Nimbus performed an SBO with Egeria as acquirer, who used the ‘framework’ to start operating successfully within several European countries (Floris Muijser, Partner Egeria). After several years, they exited UDB as a SBO to GIMV who are currently expanding the business to Africa and Asia (Floris van Oranje, Head of GIMV Netherlands). This example shows three very different stages UDB went through, all performed by different PE companies2.
The third strategic motivation for SBOs is a more recent development and includes the large amount of uncalled capital by PE funds. Before the 2009 financial crisis, a period of economic boom existed, which lead to enormous committed capital to PE funds between 2005 and 2008. When the crisis hit the market, PE firms had to minimize their investments leading to a tremendous amount of uncalled capital. The three main reasons why PE avoid uncalled capital can be explained according to management fees and PE funds performance.
First, management fees are calculated over the cost price of the investments, which means that if not all capital is invested, maximum management fees are not received by GPs. Since these fee percentages are calculated over funds with hundreds of millions or even billion(s) dollars committed, a small percentage of uncalled capital can lead to a huge cash miss out for GPs.
Second, due to the crisis, PE firms used a lot of the (uncalled) money in their funds to save their portfolio companies, which lead to PE backed companies being less damaged by the crisis than public companies. Due to the crisis and thus the decreasing surviving opportunities for public companies, public-to-private deals became a less attractive investment opportunity for PE firms. This lead to PE firms focusing more on comparable PE firms’ portfolio and they eventually started buying from each other increasingly since this was the best option for them in economic recession. This combination of uncalled capital and PE firms being able to rescue their portfolio companies increased the volume of SBOs during the crisis (Achleitner et al 2012).
Last, since PE firms aim to raise a new fund every 3-5 year their reputation and track record are crucial for their ability to do so (Kaplan & Schoar 2005). Track record is not only determined
2 The UDB case was explained by the persons quoted during the M&A Community Alex van Groningen private equity summit at
by historical returns, but also by the investment track record and activities at their current funds during the time the money for new funds is raised. If the most recent fund still has a substantial amount of uncalled capital near the end of its investment period, the LPs are unlikely to commit capital to a new fund. This puts further pressure on PE funds to invest their dry powder in order to boost their investment record (Arcot et al. 2014).
2.3.3. Fund Expiration
A third sub-category for PE firms to choose a SBO is the influence of fund lifetime limitations. The fund typically has a fixed life, usually ten years, but can be extended for up to three additional years. The private equity firm typically has up to five years to invest the capital committed to the fund into companies, and then has an additional five to eight years to return the capital to its investors (Kaplan & Stromberg 2008). Due to this limited fund lifetime, it is very important for PE firms to exit their investments in time, because a forced sale in case of fund maturity can lead to decreasing selling prices hence lower profit.
Axelson et al. (2009) found evidence that SBOs indeed can be seen as an exit strategy due to fund life constraints. They stated that when the end of the investment period approaches, investors might be pressured to expedite the disposal of the company to return the capital to the limited partners. In such a case SBOs might be a quicker way out than a trade sale or an IPO that can be either too lengthy, face unfavorable market conditions or both.
This implicates that performing an SBO can in some cases be less of a free of choice decision, but an adjustment to the approaching expiration date, which would suggest that this pressure could lead to discounts. Arcot et al. (2014) found supporting evidence that pressured sellers move the transaction multiples significantly lower if fund life is expiring.
2.4. Hypotheses
Below are the hypotheses I will use for my empirical analysis according to the literature review. These hypotheses are formed in order to draw a conclusion on the question whether SBOs as exit strategy depend on capital market conditions, holding period and fund lifetime. Chapter three describes the variables concerning every hypothesis and the regression model that suits every hypothesis best. I will also give a brief explanation for every hypothesis, showing the relevance it has on the conclusion.
2.4.1. Hypothesis I
Hypothesis I: If the equity market is favorable, PE firms are less likely to perform a SBO as exit strategy.
As explained in section 2.3.1, IPO is the most preferred exit strategy for PE firms. This automatically leads to the hypothesis that favorable equity market conditions will make it less likely for PE firms to choose SBO as exit strategy.
2.4.2. Hypothesis II
Hypothesis II: If the debt market is unfavorable, PE firms are less likely to perform a SBO as exit strategy.
The idea behind this hypothesis is that if debt market is unfavorable, hence access to money for PE firms is relatively more expensive; they are less likely to find a counterparty to exit their portfolio company. Hence, this makes it less likely for PE firms to perform a SBO.
2.4.2. Hypothesis III
Hypothesis III: If the holding period of the portfolio company exceeds or falls significantly below the average holding period, the less or more likely that the exit strategy will be a SBO.
According to the sub paragraph in the SBO strategic theory, PE firms have a limited investment period for their portfolio companies. In line with the reasoning of Achleitner & Figge (2012), who came up with the ‘low hanging fruit’ principle, if PE companies have had a company for a relative short period in their portfolio, other PE firms are more willing to be a counterparty in the deal. This because the PE firm that holds the company was not able to realize all the profits in such a short time horizon, hence a positive correlation. Second, is the opposite of the ‘low-hanging fruit’ principle, meaning that the longer the HP of the portfolio company, the less likely there is any value to be realized and thus a decreasing likelihood that the exit route will be a SBO.
2.4.3. Hypothesis IV
Hypothesis IV: If the lifetime of the fund is expiring, PE firms are more likely to perform SBO as an exit strategy.
As mentioned in previous sections of this thesis, PE funds have a fixed maturity time, as well as an average investment period per portfolio company. This requires PE houses to exit their investments after a certain time period. The closer to the deadline, the more likely they will
perform a SBO, since for example IPOs are more time consuming and more costly in comparison to a SBO. The selling party can move quicker if they approach a similar PE firm and eventually close the deal in a shorter time span in comparison to other exit strategies.
3. Data & Methodology
This section will cover what different sources were used to gather my data and a motivation for every source why this was of best interest for my thesis and its outcomes. Besides the data formation, I will also give an in-depth explanation about the variables used in the regression model I formed according to the data I found. I conclude this section by showing the complete regression model, including all variables needed to generate the best outcome for this thesis. 3.1. Data
In order to study the exit strategies, I used the Thomson One and Zephyr database to analyze the volume of SBOs, IPOs and trade sales as exit strategies. Also, I paid special attention to PE holding periods of the sold companies. PE firms rarely hold their portfolio companies longer than 5 or 6 years, which could maybe lead to indifferences in exit strategies. However, the research might show us that if PE firms holding periods and or fund lifetime are expiring, they will prefer SBOs, even though the equity market is more favorable, since this is a less time consuming strategy (no roadshows etc.). Furthermore, the holding period of the divested portfolio company can also provide an answer to my third hypothesis. I also made distinctions between the portfolio company’s different industries, countries of registration and PE firms’ reputation, which is the best measurement for PE firms’ experience.
My data cover the period of January 1997 until April 2015, since this time horizon covers several financial crises, which is beneficial for my analysis. Beneficial in the sense that de capital markets experienced serious fluctuations, which widens my benchmark and secures that the exit decision could be clearly linked to different economic circumstances and market conditions. In the Thomson One Database I hand-collected 442 SBO deals out of over thousands PE deals, by ranking the deal output of the Thomson One database in number of total estimated equity invested by firm to date. In order to keep the data randomly selected, I did not use more than 6 exits performed by 1 PE firm. Selecting exits from a small number of firms only could lead to biased results, since some PE firms use their own specific (exit) strategies and by including those firms too much, the outcomes can be adjusted to these (exit) strategies.
Some deals were performed (buying or selling side) by small funds, so in order to maintain a lower boundary, I excluded deals performed by funds with a size of less than 100 million dollar.
Furthermore, I excluded deals labeled by Thomson One as SBOs if they were performed within the same PE house, but between different funds. Although in theory this is a SBO, in practice it is just a strategic decision by a PE firm to extend the holding period or use a different financing structure without taking the equity or debt market into account.
Last, for some useful SBOs the first fund raising month was unknown, but the year was known. To generate as much deals as possible, I used January of the year the fund was raised as starting date of the fund. It is of importance to understand and take into account in the result and conclusion section that this is a potential bias. However, since it was difficult to collect enough data to perform an analysis, I decided to include several deals under these conditions.
The deals covered 378 different portfolio companies, which deviates from the 442 SBO deals because some portfolio companies were exited through a SBO several times. The difference between the lifetimes and holding period and number of SBO deals, is that some companies were in possession of multiple funds at different PE houses. Figure 1 shows how the SBO deals are divided over the 5 industries and figure 2 shows the 4 geographical allocations of the SBO deals.
I used the same criteria when searching for IPO exits in order to maintain the same boundaries as in my search for SBOs. In the Thomson One and Zephyr database, I hand-collected 190 portfolio companies that were exited through an IPO between 1997 and 2015. Figure 3 provides an overview of the hand-collected IPO exits and its corresponding years.
Trade sales were very difficult to find in the databases available, however I managed to find 20 useful trade sales with the help of Mr. J. Martin and Mr. J. Ligterink. These trade sales were found by combining their input, the Thomson One Database and Zephyr and these trade sales occur between 1997 and 2015. Figure 3 shows an overview of all the hand-collected exits divided over the timespan used for generating the empirical results. The difference in exit volumes between different strategies can be a potential bias.
In order to investigate equity returns, I used the monthly S&P 500 returns from yahoo finance in the period between January 1996 and April 2015. To generate a monthly average, I took the mean of the opening and closing price adjusted for dividends and stock splits every month. In the methodology part, I will describe how I generated excess returns. The monthly S&P500 excess returns are shown in figure 4.
For the situation at the debt market I used two measurement techniques. First by looking at the BofA Merrill Lynch High Yield Master II Option Adjusted Spread, which is a widely known
benchmark for junk bond rates. These spread numbers were measured as monthly averages and were found at the Federal Reserve Economics Data (FRED) St. Louise Fed, ranging from January 1997 until April 2015.
Second debt market indicator is by including the 6-month monthly average USD LIBOR rate, provided by FRED St. Louis Fed with January 1997 as starting date and April 2015 as ending date. As stated in the theory, PE borrows at LIBOR plus a premium, which makes the LIBOR rate a solid benchmark for PE debt market conditions. In figure 5 both the 6-month USD LIBOR rate and high-yield spread rates are shown.
3.2. Variables and Regression Model
This section will provide a better understanding and explanation for the decision of my variables and regression model. In my probit model, I used a binary dependent variable, which made my regression a probit model, 7 independent variables and 26 control variables. Besides, I also included an error term to correct for errors. Table VI provides an overview of the summary statistics of every variable.
3.2.1. Dependent Variable
The dependent variable y = Exit Strategy, indicated by a 1 if the corresponding exit was a SBO and labeled as 0 if the exit was through an IPO or trade sale. This dependent variable approach is according to the probit model, since the dependent variable can only have the value 1 or 0.
3.2.2. Independent Variables 𝛃𝟏𝐝𝐄𝐑 – Equity market conditions:
Since I will take the state of the equity market into account as well, I need to define how to measure a favorable equity market and what a proper definition is of a ‘favorable’ equity market. A suitable measurement for a favorable equity market is by looking at excess returns. I will use the S&P500 as a benchmark. Even though not all the companies exited were US companies, the buying and selling PE firms were almost all US companies, or firms with their headquarters based in the US.
Excess returns are measured by looking at the average of the 12 monthly dividends adjusted returns before the month of exit. Table II shows the formula I used to calculate the excess returns. That outcome is used as benchmark for the return of the month when exit is performed. One
could say that the decision to IPO the portfolio company is not directly linked to the actual IPO date, which means that a better benchmark would be by looking at the equity market conditions during the IPO decision, for example 6 months before the IPO date. However, since experienced parties perform these IPOs, it is safe to assume that they made their own predictions about the state of the equity market during the actual IPO moment. This formula provided me of all the monthly excess returns, which was than linked to the month of the exit for every portfolio company. I created a dummy variable for favorable exit strategy that indicates favorable with a ‘1’ if excess return is greater than 0.5% for that month. Although this seems not very excessive as return, PE firms prefer IPO as exit strategy since it is more likely to realize higher returns during an IPO in comparison to SBO, which is extensively explained in section 2.2.2. That is why I kept the barrier for favorable equity market low.
𝛃𝟐𝐝𝐋𝐁𝐑 𝐚𝐧𝐝 𝛃𝟑𝐝𝐇𝐘𝐒 - Conditions at the debt market:
The conditions at the debt market can be measured best by looking at the LIBOR rate and the high-yield spread. The reason for including this variable is that SBOs are highly levered transactions and due to the risk profile of PE’s investments, these rates suits the PE debt market conditions best. In order to get more precise outcomes, I used 2 different PE borrowing dummies.
First, according to the literature review PE borrows at the LIBOR rate plus premium. In order to decide whether the debt market was favorable during the exit month, the basis LIBOR rate is thus a suitable benchmark.
Second, is by looking at the high-yield spread, which indicates the cost of capital for PE firms when leveraging their investment in the same way the LIBOR rate does. Since no clear distinction or preferred rate is found in the literature review, I will include both parameters.
Table VI shows the summary statistics for the variables used in the regression model. The findings in this table indicate that by looking at the debt market, the average LIBOR rate throughout the years in the dataset was 2.1% and an average high-yield spread of 5.1%. These outputs lead to the decision to set the dummies at a LIBOR rate below 2% as favorable and a high-yield spread below 5% favorable as well for PE. Both dummies are included in the probit model as debt market parameters.
𝛃𝟒𝐝𝐇𝐏𝟏, 𝛃𝟓𝐝𝐇𝐏𝟑 𝐚𝐧𝐝 𝛃𝟔𝐇𝐏𝐦 - Holding period of portfolio company in months:
As discussed in the theory, PE houses tend to hold their portfolio companies on average for not more than 5 to 6 years (60 - 72 months). After this period, the company is sold and preferably a profit is generated, which contributes to the IRR of the fund. The theory states that the holding period lays somewhere between 5 and 6 years, so I will take the average and use a holding period of 5.5 year as basis for this holding period beta, hence 66 months.
I will use censoring to keep all my data, as they were hard to acquire and contain 378 different portfolio companies. My lower boundary will be 12 months, since they cannot have an actual influence on their investment if the holding period is lower than one year. So every company with a holding period lower than 12 months will be adjusted to this boundary hence rounded to 12 months. The upper boundary will be 120 months, since PE funds will pay out their investors after 10 years on average.
To generate a dummy indicating whether the holding period exceeded or felt below an average timespan, I divided the 12-120 months time horizon into three groups. The dummy variable for the first group indicates a 1 if the holding period is between 12-48 months. This gave me dHP1, which is the dummy that shows empirical results for the ‘low-hanging fruit’ principle. Thus according to my theory, a more likely chance the exit route will be through a SBO. The average and thus middle group consists of portfolio companies with a holding period between 48 and 84 month. dHP3 indicates whether the longer the holding period and hence most of the value is already realized, the less likely the exit will be a SBO. This last group dummy variable receives a ‘1’ if the holding period is between 84-120 months.
Last, I will also look at the holding period in months, to correct for omitted variable bias, since table VII shows there is correlation between the variables.
Table II shows how I calculated the corresponding holding period value for every exit. 𝛃𝟕𝐋𝐅𝐄 - Lifetime of the fund in months at time of exit:
As discussed in the theory, PE firms’ funds have a limited maturity, mostly no longer than 10 years, with a 3-year extension possibility. For my data, this means that a fund matures after 120 months, with a maximum after extension of 156 months. If funds had a value of more than 156 as LFE, this maximum was used for censoring. The lowest value for the lifetime at time of exit will
be 12 months, since everything below that amount of months could be considered as asset flipping.
3.2.3. Control Variables
In order to control for events that can influence the outcome of my empirical tests, I included 3 different control variables based on previous literature regarding SBOs. These previous literature and a short background stories can be found in table I.
𝛃𝟖𝐈𝐧𝐝𝐮𝐬𝐭𝐫𝐲 – Dummy variables for industry specific input
As I gathered my data, I divided the portfolio companies according to the industry sectors used by Thomson One, in order to correct for industry specific fixed effects. This correction is based on the empirical methods used in investigating SBOs by Kitzmann & Schiereck (2009), Degeorge et al (2013), Bonini (2014) and Wang (2012).
Although there are several industries in which SBOs occurred in my data, I separated them in 5 different categories, namely Consumer Related, Industrial/Energy, Medical/Health, IT and Other. Of these 5 dummies, I will exclude ‘Other’ in my model. Figure 1 shows the volume of the different industries used as dummy in which the SBOs of my dataset took place.
𝛃𝟗𝐂𝐨𝐮𝐧𝐭𝐫𝐲 – Country or region of registration portfolio company
Since my data cover worldwide SBO deals, I included the countries or region were the portfolio companies were registered at the time of the deal. By doing so, I corrected my model for geographical specific effects. Correcting for these effects was also included in the papers of Achleitner & Figge (2012), Degeorge et al. (2013) and Bonini (2014), all investigating SBOs.
This gave 4 main geographical categories that are listed in figure 2. From these 4 categories, I will include 3 dummies in my regression, namely US, Europe and Other. Small side note, there were 10 IPOs of portfolio companies that were registered in Bermuda. Since this country is known for its enormous number of shelter holdings, see for example the Alibaba IPO, I included Bermuda in the US country dummy. The last variable is ‘Other’ and consists of companies mainly throughout the continents Asia and Australia.
𝛃𝟏𝟎𝐑𝐞𝐩𝐮𝐭𝐚𝐭𝐢𝐨𝐧𝒕 - Reputation of the selling PE firm
Since reputation is key for PE firms, I will make a distinction between ‘good’ and ‘normal’ PE houses. ‘Good’ PE firms have a proven track record, which enables them to borrow at a less high premium. As Ivashina & Korver (2011) state, since PE is frequent lender, low asymmetry between lender and borrower and the bank may gather such soft information on the LBO firm’s willingness or ability to contribute additional capital to the company if trouble arises. As long as this information can be reused, each additional loan has a lower marginal cost of monitoring or screening. In a competitive market for bank loans, these lower costs will result in lower interest rates. Another way in which repeated interactions between banks and LBO firms might reduce the costs of asymmetric information is through reputation building. In the absence of repeated interactions with the lender, equity holders may take actions that endanger the lender’s capital, such as investing in excessively risky projects.
The reputation of the PE firm is interesting to include, since it can indicate if the selling PE firm is familiar with SBO as exit. The better the reputation, the more experienced the PE firm is and thus able to choose the best exit route under the conditions during the time of the exit. This reputation variable was also included in the papers of Bonini (2014), Wang (2012) and Demiroglu & James (2010), however these papers all had different criteria for a ‘good’ or normal reputation. The fact that previous papers that checked for reputation as control all had different criteria to label a PE firm as ‘good’, underlines the fact that there is not one measurement technique. The boundaries I use to analyze the reputation of a PE firm were formed during the search for data and by discussing the topic with experts. The data search gave me a better feeling with the volumes and numbers of funds sizes & fund numbers and overall equity invested. Although PE professionals all have their own standards, no one rejected these boundaries or classified them as impossible.
The dummy variable Reputation is indicated be a 1 if the firm has a good reputation and 0 if not. A good reputation is measured by three principles, from which at least 2 out of 3 will be sufficient to call the firm experienced and good.
First, I will look at the total known equity invested by the selling PE firm to date at the time of the exit. If this amount of equity equals or exceeds 3 billion dollars, the firm can be considered as experienced and good. This measurement is applicable since, as described in the theory, PE firms are heavily dependent on their track record in order to raise money for their funds. By setting this
standard at 3 billion, the PE firmed shows that it was not only capable of raising a large sum of money, but was also able to find investment opportunities.
Second, a suitable measurement is the number of funds raised at time of the exit. As stated in the theory, PE managers typically raise a new partnership fund at about the time the investment phase for an existing partnership has been completed. Thus, the managers are raising new partnership funds approximately every three to five years, which means that the more funds they were able to raise, the better their track record was and eventually their reputation. I will set my boundary at more than 15 funds raised and closed, which clearly underlines the capabilities and track record of the PE firm.
My third and last criteria for PE firms to be considered as having a good reputation is by looking at average fund size at time of the exit, since PE firms with good reputations are able to fill larger funds. An annual average fund size of more than $500 million separates the small PE firms from the big PE firms hence, firms with good reputations from firms with normal reputations.
Since my dataset covers the period from 1997 to 2015, I had to hand-collect the data for these three criteria and look at this per year, which generated a dummy for every selling PE firm for every year, hence the large number of control variables.
3.3. Regression Model
In the previous (sub) sections, I described all my hypotheses, the way I hand-collected all my data and an explanation for all my variables. To conclude, this sub section shows the regression model applicable for every hypothesis and the complete regression model that suits this thesis best in order to find an answer to my research question.
Hypothesis I: If the equity market is favorable, PE firms are less likely to perform a SBO as exit strategy. This hypothesis solely focuses on the equity proxy, indicating whether there are excess returns or not during the exit.
Hypothesis II: If the debt market is unfavorable, PE firms are less likely to perform a SBO as exit strategy. The two debt market proxies are of interest in this hypothesis, showing the cost of borrowing at time of the exit.
Hypothesis III: If the holding period of the portfolio company differs from the average holding period, the more/less likely that the exit strategy will be a SBO. The variables concerning this hypothesis are holding period in months and the two dummy holding period areas, one between 12-48 months (more likely a SBO) and one between 84-120 months (less likely a SBO).
Hypothesis IV: If the lifetime of the fund is expiring, PE firms are more likely to perform a SBO as exit strategy. Last hypothesis only focuses on the lifetime of the selling PE fund, using the proxy lifetime of selling fund in months.
Since I consider all hypotheses to be significant, I will run the complete model with all the variables. The model that will provide me with the empirical results looks as follows:
𝐲 = 𝛂 + 𝛃𝟏𝐝𝐄𝐑 + 𝛃𝟐𝐝𝐋𝐁𝐑 + 𝛃𝟑𝐝𝐇𝐘𝐒 + 𝛃𝟒𝐝𝐇𝐏𝟏 + 𝛃𝟓𝐝𝐇𝐏𝟑 + 𝛃𝟔𝐇𝐏𝐦 + 𝛃𝟕𝐋𝐅𝐄 + 𝐂𝐨𝐧𝐭𝐫𝐨𝐥 𝐕𝐚𝐫𝐢𝐚𝐛𝐥𝐞𝐬 + 𝛆𝐢
4. Empirical Results
In this section, I will provide the empirical results generated by running the probit model in Stata. The regression table is divided into 5 columns, dividing the outcomes in a column without control variables, 3 columns for every control variable included separately and the last column showing the output of the complete model, including all the control variables and corrected for robustness.
4.1. Variables and Summary Statistics
Table III shows all the industries in which the exits took place. Most of the exits took place in the ‘other’ sector as Thomson One and Zephyr labeled it, which makes sense since it is a broad term for several markets. Interesting is the fact that the volume in the consumer related market is close to ‘other’ category and exceeds the third biggest market, IT, significantly. This shows that the consumer related market is a popular PE target. This is in line with the findings of Acharya et al. (2013), Nikoskelainen & Wright (2007) and Kaplan & Stromberg (2009), who together stated that PE preferably creates value through improving revenues & operating margins, divestments of CAPEX or unnecessary divisions and acquisitions for expansion. Especially the first two value creation tools are most applicable for the consumer related market; in which PE usually increases value by restructuring the balance sheet’s asset side and increased operational efficiency.
Table IV shows all the countries and geographical areas in which the exits took place in my dataset. The US is by far the largest PE market with more than twice as much exits in comparison to runner up UK. France and Germany are the two most active PE markets in Europe, which makes sense since they are the two largest and most important European economies. The group ‘other’ consists mostly of Australia and Asian countries.
Table V provides an overview of the exit deviation over the years in the dataset. The most recent economic crisis is shown in the different exit routes, with SBOs exceeding the IPO volume significantly when the crisis started. This output is in line with Ritter & Welsch (2002) who found evidence that positive equity market conditions are the most important factor in the decision to go public. However as already mentioned, there is a potential bias in the fact that my dataset contains more SBOs than IPOs and trade sales, so this output should be placed in perspective.
Table VI shows the summary statistics for the variables in the regression model. The LIBOR rate averaged 2.1% throughout the years and de high-yield spread 5.1%. The average holding period in months is 57, which comes down to 4.75 years. Columns 2 to 5 show these holding periods per exit. This is a little shorter than the findings by Kaplan & Stromberg (2008), who investigated the mean holding period between 1970 and 2007 and found an average holding period between 5.5 and 6 years. However, they also mentioned that this varied strongly over time. Last is the mean lifetime of the fund during time of the exit, which is 89 months and thus close to 7.5 years.
Table VII provides the correlation between the variables and hence the relevance to include them separately. Logically, there is a high correlation between the holding period in months variable and the two dummies that provide output for the likelihood of SBO exits for the short and long holding period timespan as explained in the previous chapter. Furthermore, there is a noticeable correlation between the three holding period proxies and the fund lifetime proxy, which can be declared by the fact that for example a very long holding period of the portfolio company is accompanied by a fund that is reaching maturity
4.2 Results
Table VIII shows the empirical results divided in the 5 columns as mentioned in the introduction of this chapter, all regressions are done using heteroscedasticity robust standard errors. The first column without control variables looks at excess returns at the equity market and the likelihood of SBOs, there is a negative relation between excess returns and SBOs. This is in line with the theoretical findings of Jelic & Wright (2011) and Schmidt et al. (2010) who stated that if an IPO is performed in a hot equity market, excess returns could be generated, which is the main reason why IPOs remain the most favorable exit strategy for PE firms. This is confirmed with -0.210 at a 5% significance level; hence if there is excess return at the equity market, the likelihood of a SBO decreases with 0.210. Second is the debt market conditions consisting of the LIBOR and Spread dummies. Both should generate negative coefficients, since an increase in both costs of capitals should lead to a decrease in the SBO route. This is not shown in the first column, since the LIBOR proxy is positive with 0.096, indicating that an increase in the LIBOR rate should lead to an increase in SBOs. However, this evidence is weak due to the lack of significance. On the other hand, the spread proxy shows overlapping results with the theory provided by Achleitner & Figge (2012) who suggested that SBOs are mainly present when the
