In February 2000. Louis Elson looked over the London skyline and reflected on the international private equity industry and the investing processes that would be necessary for success in this progressively competitory field. Elson. a pull offing spouse of the UK-based private equity house Palamon Capital Partners. was specifically sing an investing in TeamSystem S. p. A. . an Italian package company. Palamon was interested in TeamSystem for the growing chance that it represented in a fast-changing market. Palamon had an chance to buy a 51 % interest in TeamSystem for ( euros ) EUR25. 9 million. In fixing a recommendation to his co-workers at Palamon. Elson planned to measure TeamSystem’s scheme. value the house. place of import hazards. measure proposed footings of the investing. and see alternate issue schemes.
International Private Equity Industry
The international private equity industry was segmented into three sectors. Venture capital financess made bad early-stage investings in startup companies. Generalist private equity financess provided expansionary support or transitional support that allowed little companies to turn and finally travel public. And leveraged buyout financess financed the acquisitions ( frequently by direction ) of preexisting companies that had the capacity to take on debt and do extremist betterments in operations.
Private equity financess raised capital chiefly from single investors. pension financess. and gifts that were interested in more attractive risk/return investing propositions than the public capital markets offered. Fundss existed all over the universe. but. non surprisingly. North America had the largest figure of financess and largest dollar value of capital invested as of 1999.
This instance was prepared by Chad Rynbrandt from interviews. under the way of Robert F. Bruner. with the aid of Sean D. Carr. Some inside informations have been simplified for expositional lucidity. The cooperation of Palamon Capital Partners is appreciatively acknowledged. as is the fiscal support of the Batten Institute. Copyright ? 2001 by the University of Virginia Darden School Foundation. Charlottesville. VA. All rights reserved. To order transcripts. direct an electronic mail to [ electronic mail protected ]No portion of this publication may be reproduced. stored in a retrieval system. used in a spreadsheet. or transmitted in any signifier or by any means—electronic. mechanical. run offing. entering. or otherwise—without the permission of the Darden School Foundation.
This papers is authorized for usage merely by John McFadden at Temple University- Fox School of Business. Please do non copy or redistribute. Contact [ electronic mail protected ]for inquiries or extra permissions.
Europe and Asia had the following largest private equity industries. Exhibit 1 presents the figure and dollar values of private equity financess by planetary geographic part. Most private equity markets saw rapid growing in the 1990s. In Europe. the sum of new capital raised grew from EUR4. 4 billion in 1994 to EUR25. 4 billion in 1999. Correspondingly. the sum of capital invested by the financess more than quadrupled from EUR5. 5 billion to EUR25. 1 billion over the same period. Exhibit 2 summarizes the sum of new capital raised and the sum invested through the 1990s. Some cardinal participants in the midmarket sector in Europe included Duke Street Capital ( EUR650 million fund based in the United Kingdom ) . Mercapital ( EUR600 million fund based in Spain ) . and Nordic Capital ( EUR760 million fund based in Sweden ) . Large investing Bankss such as Dresdner. Deutsche Bank. and Banca de Roma besides had noteworthy private equity presences.
Louis Elson and Palamon Capital Partners
Louis Elson began working in private equity in 1990. when he joined E. M. Warburg. Pincus & A ; Co. Soon after fall ining the house. he began concentrating on European minutess and. in 1992. decided to relocate for good to Europe. Elson became a spouse of Warburg. Pincus in 1995 and was an built-in portion of a squad that built a ( U. S. dollars ) USD1. 3 billion portfolio of equity investings for the house. The portfolio contained more than 40 investings in seven different European states. In late 1998. Elson and another of his spouses. Michael Hoffman. saw a alone window of chance in the European private equity industry. They believed that the European economic landscape was altering in a manner that benefited smaller. middle-market companies. Therefore. Elson and Hoffman recruited two extra spouses and began puting the foundation for what would finally go Palamon Capital Partners. By August 1999. Elson and Hoffman had raised a fund of EUR440 million. They accomplished that despite macroeconomic obstructions like the Russian debt default by marketing their alone pan-European private equity experience.
With the fund closed. Elson and Hoffman grew the Palamon squad to nine professionals. They hired people with experience in private equity. investing banking. corporate finance. and direction consulting. Consistent with Elson and Hoffman’s original vision. the Palamon squad used their comprehensiveness of experience to construct a portfolio of investings that would supply investors with a alone hazard profile and significant long-run returns. Basically. Palamon was a generalist private equity fund that served the section of investor that was interested in less hazard than venture capital. but more hazard than the leveraged buyout financess. Consequently. Palamon targeted a 35 % return on a individual portfolio investing. and 20 % to 25 % blended net return on a portfolio. with an investing skyline of about six old ages. Louis Elson said:
Our investors include big American populace sector pension financess. corporate pension financess. major fiscal establishments. and big gift financess. They look for us to crush the return on the S & A ; P Index by 500 footing points per twelvemonth on norm. We have the best opportunity of acquiring funded once more if we can crush this mark. adjusting of class for hazard. We look to pick up good concerns at attractive monetary values. and so add value through active engagement with them. Like other Renaissance man financess. Palamon’s investing scheme was to do “bridge” investings in companies that wanted to travel from little. private ownership to the public capital markets. Unlike many private equity financess. nevertheless. Palamon did non curtail itself to one specific European state. nor did it restrict its range to one industry. Alternatively. Palamon focused more
loosely on small-to-midsize European companies in which it could get a commanding interest for between EUR10 million and EUR50 million. For companies that fit Palamon’s profile. the passage from private to public ownership required both support and direction ability. Palamon. therefore. complemented its fiscal investings with consultative services to increase the chance that the portfolio companies would successfully do it to the public markets. Elson was optimistic about Palamon’s investing scheme. As Elson sat in his office. Palamon was finalising its first investing. a Spanish Internet content company. Lanetro. S. A. . and had three other investings ( including TeamSystem ) in the grapevine.
Palamon’s investing procedure began with the development of an investing thesis that would typically affect a market undergoing important alteration. which might be driven by deregulating. trade liberalisation. new engineering. demographic displacements. and so on. Within the chosen market. Palamon looked for attractive investing chances. utilizing investing Bankss. industry resources. and personal contacts. The hunt procedure was time-consuming. with merely 1 % of the chances doing it through to the following stage. due diligence. which involved thorough research into the history. public presentation. and competitory advantages of the investing campaigner. Typically. merely one company made it through that concluding screen to supply Palamon with a feasible investing option.
Palamon brought its deal-making experience to bear in determining the specific footings of investing. Carefully trim understandings could increase the likeliness of a successful result. both by making the right inducements for operating directors to accomplish marks. and by clocking the bringing of hard currency returns to investors in ways consistent with the operating scheme of the mark. Deal dialogues covered many issues including monetary value. executive leading. and board composing. Once a trade had been completed. Palamon so offered value-added support to direction.
To shut the procedure. Palamon searched for the best issue option. one that would assist them to the full recognize a return on the fund’s investing.
Authoritative issue options included sale of the house through an initial public offering in a stock market. and sale of the house to a strategic purchaser. Exhibit 3 provides more item about Palamon’s procedure and the firm’s investing testing standards.
TeamSystem. S. p. A.
Palamon’s theme-based hunt generated the chance to put in TeamSystem. S. p. A. In early 1999. even before Palamon’s fund had been closed. Elson had concluded that the paysheet serving industry in Italy could supply a good investing chance because of the industry’s utmost atomization and invariably altering ordinances. History had shown that authoritiess in Italy adjusted their policies every bit frequently as four times a twelvemonth. For Palamon. the infinite represented a mature chance to put in a company that would capitalise on the demand of little companies to react to this legislative volatility. With the aid of a dress shop investing bank and industry contacts. Palamon approached two taking participants in the market. Neither company was suited to Palamon. but both identified their most well-thought-of rival as TeamSystem. Palamon approached TeamSystem straight and found a good tantrum. Due diligence was done and. by the terminal of the twelvemonth. a specific investing proposal had taken form. It was the one Elson now considered.
TeamSystem was founded in 1979 in Pesaro. Italy. Since its initiation. the company had grown to go one of Italy’s taking suppliers of accounting. revenue enhancement. and payroll direction package for small-to-medium-size endeavors ( SMEs ) . Led by cofounder and CEO Giovanni Ranocchi. TeamSystem had built up a client base of 28. 000 houses. stand foring a 14 % portion of the Italian market.
TeamSystem offered its clients a compelling value proposition. The company’s package integrated a business’s fiscal information and automated boring and complex administrative maps. The package besides enabled SMEs and their fiscal advisers to remain on top of the often altering regulative environment. To that terminal. TeamSystem continually invested in development to maintain its package current. Customers were given entree to merchandise ascents in exchange for a annual care fee that the company collected ( in add-on to the initial purchase monetary value of the package ) . TeamSystem had excelled in client service and developed loyal clients. About 95 % of its clients renewed their care contracts every twelvemonth.
In 1999. TeamSystem generated gross revenues of ( Italian lira ) ITL60. 5 billion ( EUR31. 3 million ) and EBIT ( net incomes before involvement and revenue enhancements ) of ITL18. 5 billion ( EUR9. 5 million ) . Those consequences continued a strong form of growing for TeamSystem. Since 1996. gross revenues had grown at an annualized rate of 15 % and operating borders improved. As a consequence. EBIT had grown at an annualized rate of 31. 6 % over the same period. Exhibit 4 provides extra item on TeamSystem’s historical gross revenues and profitableness from 1996 through 1999. Exhibit 5 contains equilibrate sheet information for the same period.
As Elson looked through the Numberss. he noted the current deficiency of debt on TeamSystem’s balance sheet. In his sentiment. that represented an chance to convey TeamSystem to a more effectual capital construction that might take down the company’s cost of capital. Elson besides noted the “pro forma” label on both fiscal statements. TeamSystem. given its private ownership and multicompany construction. did non hold audited amalgamate fiscal information for the old five old ages.
The Italian accounting. revenue enhancement. and payroll direction package industry in which TeamSystem operated was extremely disconnected. More than 30 package suppliers vied for the concern of 200. 000 SMEs with the largest holding a 15 % portion of the market ( TeamSystem ranked figure two with its 14 % share. ) All of the important participants in the industry were family-owned companies that did non hold entree to international capital markets. Exhibit 6 shows 1998 grosss for the nine largest participants.
Analysts predicted that two things would qualify the hereafter of the industry— consolidation and growing. Consolidation would happen because few of the smaller companies would be able to maintain up with the research and development demands of a altering industry. Analysts pointed to three acquisitions in 1998–99 as the start of that tendency. As for growing. experts predicted 9 % one-year growing over the period 1999–2002. That growing would come chiefly from increased Personal computer incursion among SMEs. greater end-user edification. and continued cybernation of administrative maps.
After reexamining TeamSystem’s past public presentation and the province of the industry. Elson returned his attending to the particulars of the TeamSystem investing. The most recent proposal had offered EUR25. 9 million for 51 % of the common ( or ordinary ) portions in a multipart construction that besides included a recapitalization to set debt on the balance sheet:
Palamon would put ITL50. 235 billion ( EUR25. 9 million ) in the ordinary portions ( i. e. . common equity ) of TeamSystem S. p. A. Those portions would be purchased from bing stockholders of TeamSystem. Giovanni Rannochi would keep a 20 % shareholding. while noncore employees would be diluted from retentions runing from 3 % to 8 % to merely 1 % each after completion.
More than half of TeamSystem’s ITL28. 5 billion of hard currency was to be distributed to bing stockholders via two dividend payments before Palamon’s investing: an ITL8. 5 billion dividend to bing TeamSystem stockholders in April 2000. and an ITL6. 5 billion dividend to be paid at clip of shutting. A hard currency balance of ITL13. 5 billion would stay.
With Palamon’s aid. TeamSystem would borrow ITL46 billion from Deutsche Bank. in a seven-year loan. offering a three-year chief refund vacation and an initial cost of 1. 0 % over base rates ( Italian authorities bonds ) . Stockholders would have the returns of the debt at clip of shutting in another particular dividend.
Excess existent estate would be sold by TeamSystem. therefore taking the distraction of unrelated belongings investings. A group of bing stockholders had made an offer to buy ITL2. 1 billion of existent estate at book value if the dealing closed.
The beginnings and utilizations of financess in the dealing are summarized in Exhibit 7. An income statement and balance sheet for TeamSystem. pro forma the dealing. are given in Exhibits 8 and 9. Palamon. as a bulk stockholder. would hold full effectual control of TeamSystem. although the bing stockholders would hold a figure of minority protection rights. For illustration. Palamon would be unable to disregard Ranocchi for a biennial period. But Palamon would hold the ability to present 100 % of the portions of the company to a trade purchaser should that be the appropriate issue. Furthermore. more than 40 % of the hard currency to be paid to the going stockholders would be held in escrow for a period of at least two old ages. under Palamon’s control.
To decently measure the trade. Elson had to develop a position about the value of TeamSystem. He faced some challenges in that undertaking. nevertheless. First. TeamSystem had no strategic program or future prognosis of profitableness. Elson merely had four old ages of historical information. If Elson were to make a proper rating. he would necessitate to gauge the hereafter hard currency flows that TeamSystem would bring forth given market tendencies and the value that Palamon could add. His best conjecture was that TeamSystem could turn grosss at 15 % per twelvemonth for the following few old ages. a gait above the expected market growing rate of 9 % . followed by a 6 % growing rate in sempiternity. 1 He besides thought that Palamon’s professionals could assist Ranocchi better operating borders somewhat. Last. Elson believed that a 14 % price reduction rate would suitably capture the hazard of the hard currency flows.
That rate reflected three package companies’ trading on the Milan stock exchange. whose betas averaged 1. 44 and unlevered betas averaged 1. 00. The 2nd challenge Elson faced was the deficiency of comparable ratings in the Italian market. Because most rivals were family-owned. there was really small market transparence. The nearest lucifers he could happen were other European and U. S. endeavor resource planning ( ERP ) 2 companies and accounting package companies. The fiscal profiles of those comparable houses are contained in Exhibits 10 and 11. Looking through the informations. Elson noticed the high growing outlooks ( greater than 20 % ) for the package houses and correspondingly high rating multiples.