private equity case study

private equity case study

Private Equity: Maximizing Returns through Strategic Investments

1. Introduction

Private equity is a critical component in the financial industry that facilitates the movement of resources from those who hold them to those who are able to utilize them productively and efficiently. In this chapter, we begin by defining the nature of private equity and the various forms it can take. This leads to an analysis of the methods by which private equity creates value, focusing particularly on the financial engineering aspects involved. This is because, while private equity professionals often market themselves as active value creators, the bottom line is always whether the returns generated from value creation outweigh the money invested. We aim to show that in many cases, it is a rearrangement of the financial structures in the target company that provides the main source of value. Finally, we discuss the sustainability of value creation and the pitfalls in some methods of value creation that can lead to adverse effects in the long run.

2. Understanding Private Equity

Investment can range from providing seed capital for start-up businesses to financing a management buyout of an existing company. Venture capital (VC) is usually described as investment in early-stage, high-risk, and high-growth potential businesses. The objective is usually to obtain a substantial capital gain through the development and growth of the company, culminating in a realization event such as an initial public offering (IPO) or a takeover. Due to the high-risk nature of investing in unproven businesses, the cost of equity for the company will be high, and VC investors will look to obtain significant returns on their investment. Although investing in equity VC is a medium to long-term form of financing, it often takes several years before a company becomes profitable or the investment is liquidated. If the venture is not successful, there is a chance that the company can be liquidated, and VC is often provided in conjunction with secured loans on the assets of the company. An alternative for companies seeking VC funding is to obtain a listing on the Alternative Investment Market. This can provide the company with access to public funding and better access to future capital, although it is still a high-risk investment, and there are many examples of companies returning to private ownership.

Private equity investment encompasses all activity in the investment spectrum, from venture capital to mezzanine finance. Each of these investment classes provides funding for companies at different stages of their development and involves varying degrees of control.

An investor in a company with exchange-traded securities has the advantage of liquidity, although this comes at the cost of high agency fees due to the separation of ownership and control in the company from shareholders. This can lead to less efficiently run organizations, as managers may prioritize their own objectives and invest in low-risk, low-return projects. There are advantages to delisting, as private equity investment can often lead to added value through increased efficiency.

Understanding private equity (PE) is important for companies to be able to issue new shares and transfer existing shares in order to access new sources of capital. With new funding, a company can invest in new projects that will ultimately increase shareholder value. This is because the net present value (NPV) of the project will add value to the shareholders’ existing equity as it is invested in a project with positive returns. A company can issue various forms of equity, ranging from common stock to preferred shares. However, in PE situations, the investing company will usually obtain a controlling interest in the equity of the company.

3. Case Study: Successful Private Equity Investments

The private equity investment to be examined is the $100m investment made in United Cinemas International (UCI) in 1996. UCI was the leading operator of multiplex cinemas in the UK at the time and had significant growth potential. The investment was made during the buyout of UCI by its management team from its previous owners. The private equity backing allowed UCI to aggressively expand by building new cinemas and acquiring rival chains. This growth and consolidation strategy was a success and resulted in a doubling of UCI’s EBITDA over a four-year period. The investment was realized in late 2004 with the sale of UCI to its main rival Odeon cinemas. The total proceeds from the sale were $650m, of which $370m was the value of the equity. This resulted in a 3.7x return and an IRR of 53% (Kolb and Megginson, 2009).

Successful private equity investments are more profitable and rewarding than public equity investments due to access to better managerial practices, lower liquidity constraints, and better alignment of managerial incentives. This is a widely known and common proposition since private equity became an asset class in the early 1980s. There has not been, however, substantial evidence to support this claim due to the lack of detailed data on the characteristics of investments and the lack of a comparable public investment. This chapter aims to provide evidence to support the proposition by conducting a case study on a successful private equity investment and a comparable public market investment.

4. Key Strategies for Maximizing Returns

Changes to cash flow are usually at the center of a private equity value-creation strategy. This is based on the concept that changes to free cash flow, the cash that a company has left after all expenses, are highly correlated to changes in enterprise value. Enterprise value is often defined as net debt plus a multiple of market capitalization. Basically, it is the theoretical price at which the acquirer will buy the stock, and where the seller thinks twice before turning down the offer. The amount he will personally take home, the market capitalization, is squandered wealth if the seller’s stock goes to zero in a buyout. With little or no resources invested in acquisition, changes to EBITDA will affect enterprise value. But changes to free cash flow, which is vaguely operating income net of capital expenditures and tax adjusted, are much less volatile than changes to EBITDA. A dollar in missed savings or increased investment efficiency only turns up as fifty cents of lost free cash flow. Since free cash flow is net income plus depreciation and amortization sans changes to operating WC and CAPX, increasing free cash flow often involves changes to expense or revenue with negligible investment. This is ideal for a buyout company.

Once an investor selects an industry and an investment in a targeted company, the kinds of changes to be pursued fall into several categories. These include: – Changes to cash flow, both revenue and expense, with the expectation of increasing EBITDA in the short term. – Redefining the company’s business strategy. – Operating improvements that will increase the company’s earnings without requiring additional investment.

5. Conclusion

In answering this essay’s main question of how resources can be utilized and performance improved, private equity has been shown to be an effective tool when implemented correctly. An insider’s view of this industry has proven to be difficult to obtain, though it is becoming increasingly important to academic and corporate success. This essay has served to provide a guide of what to expect upon entry into private equity, either as a job-seeking individual, a manager, or a business owner seeking to enhance company performance. Understanding the implications of various investment activities and being able to clearly identify ways in which success will be measured are important tools for all involved in the modern investment process.

The research undertaken throughout this essay supports the idea that the level of activity in the private equity market has increased substantially over the past few years. Whether or not the public attention to private equity is reflective of its gradually increasing influence, it is clear that private equity is no longer a “niche” field but rather a powerful tool for maximizing returns in today’s business world. This idea is in coherence with the increasing level of attention on how shareholder wealth is being generated in both the academic literature and popular press.

Strategic investment, resource utilization, and performance maximization define the modern-day finance and business world. Today, in a highly competitive global economic environment, many companies, institutions, and even governments have realized the need to outperform and excel in a market which is defined by cut-throat competition, rapidly changing technology and laws, and ever-increasing customer choice. The need to perform better and outpace your rivals is greater than ever; growth and survival are no longer assured. “Private Equity: Maximizing Returns through Strategic Investments” discusses this very theme and aims to provide a guideline for maximizing returns in today’s business world.