Excerpt
Table of Contents
List of Figures
List of Tables
List of Abbreviations
Acknowledgements
Executive Summary
1 Introduction
1.1 Motivation and Problem Definition
1.2 Research Objectives and Contributions
1.3 Course of Investigation
2 The Concept of Private Equity
2.1 Asset Class - Private Equity
2.2 Private Equity Backed IPOs
3 Lite rature Review
3.1 Value Creation of Private Equity Firms
3.2 Characteristics of Private Equity Backed IPOs
3.3 Performance of Private Equity Backed IPOs
4 First Empirical Research
4.1 Study Objectives
4.2 Research Questions and Hypotheses
4.3 Relevance and Contributions
4.4 Research Methods
4.5 Identification of Private Equity Backed IPOs
4.6 Data Sample
4.7 Limitations
4.8 Descriptive Statistics
4.8.1 Distribution by Market Value, and Timing of IPO
4.8.2 Distribution by Industry Sector
4.9 Sample Analyses
4.9.1 Unadjusted Buy-and-Hold Returns
4.9.2 Buy-and-Hold Abnormal Returns
4.9.3 Cumulative Abnormal Returns
4.9.4 Wealth Relative
4.10 Summary and Conclusion of Findings
5 Second Empirical Research
5.1 Study Objectives
5.2 Research Questions and Hypotheses
5.3 Sourcing of Data Sample
5.4 Limitations
5.5 Descriptive Statistics
5.5.1 Distribution by Offer Size
5.5.2 Distribution by Country
5.5.3 Distribution by Industry Sector
5.5.4 Distribution by Time Period
5.6 Research Methods
5.7 Sample Analyses
5.7.1 Unadjusted Buy-and-Hold Returns
5.7.2 Buy-and-Hold Abnormal Returns
5.7.3 Cumulative Abnormal Returns
5.7.4 Wealth Relative
5.8 Summary and Conclusion of Findings
6 Summary and Conclusion
6.1 Key Take-Aways
6.2 Further Research
References
List of Figures
Figure 1. Structure of a Classical Private Equity Fund (Gilligan & Wright, 2014, p. 38)
Figure 2. Number of Private Equity Backed IPOs (Bloomberg, 2016)
Figure 3. Deal Value of Private Equity Backed IPOs between 2000 and 2010 per Country (Bloomberg, 2016)
Figure 4. Distribution of Industry Sector per Deal Amount - Private Equity Backed IPOs .47
Figure 5. Distribution of Industry Sector per Offer Size - Private Equity Backed IPOs
List of Tables
Table 1. Summary Statistics for Non-Financial Sponsor, Venture Capital and Private Equity Backed IPOs
Table 2. Summary Statistics for Non-Financial Sponsor, Venture Capital and Private Equity Backed IPOs
Table 3. BHAR of Private Equity Backed IPOs
Table 4. Overview of all IPOs in the Data Sample According to their Time Issue, Market Value and New Money Raised
Table 5. Overview of Private Equity Backed IPOs in the Data Sample According to their Time Issue, Market Value and New Money Raised
Table 6. Industry Sector Statistics of Data Sample UK
Table 7. Unadjusted Buy-and-Hold Returns for all IPOs
Table 8. Unadjusted Buy-and-Hold Returns for Private Equity Backed IPOs
Table 9. Unadjusted Buy-and-Hold Returns for Private Equity Backed IPOs per Issue Year
Table 10. Average BHR of each Benchmark
Table 11. BAHR - Private Equity Backed IPOs vs. FTSE
Table 12. BAHR - Private Equity Backed IPOs vs. FTSE
Table 13. BAHR - Private Equity Backed IPOs vs. FTSE
Table 14. Benchmark Average Cumulative Returns for each Year
Table 15. CAR - Private Equity Backed IPOs vs. FTSE
Table 16. CAR - Private Equity Backed IPOs vs. FTSE
Table 17. CAR - Private Equity Backed IPOs vs. FTSE
Table 18. WR - Private Equity Backed IPOs vs. FTSE
Table 19. WR - Private Equity Backed IPOs vs. FTSE
Table 20. WR - Private Equity Backed IPOs vs. FTSE
Table 21. Segmentation of Private Equity Backed IPOs using Offer Size
Table 22. Segmentation of all IPOs between 2000 and 2010 in Western Europe using Offer Size
Table 23. Segmentation of Private Equity Backed IPOs per Country
Table 24. Segmentation of Private Equity Backed IPOs per Country
Table 25. BHRs - Private Equity Backed IPOs
Table 26. BHRs - Private Equity Backed IPOs for different Time Period
Table 27. BHR of each Benchmark
Table 28. BAHRs - Private Equity Backed IPOs vs. FTSEurofirst 300 Index
Table 29. BAHRs - Private Equity Backed IPOs vs. FTSE Developed Europe All Cap Index
Table 30. BAHRs - Private Equity Backed IPOs vs. MSCI Europe Index
Table 31. Benchmark Returns for each Year
Table 32. CARs - Private Equity Backed IPOs vs. FTSEUROFIRST
Table 33. CARs - Private Equity Backed IPOs vs. FTSE Developed Europe All Cap Index
Table 34. CARs - Private Equity Backed IPOs vs. MSCI Europe Index
Table 35. WR - Private Equity Backed IPOs vs. FTSEurofirst 300 Index
Table 36. WR - Private Equity Backed IPOs vs. FTSE Developed Europe All Cap Index
Table 37. WR - Private Equity Backed IPOs vs. MSCI Europe Index
List of Abbreviations
BHAR Buy-and-Hold Abnormal Return
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Acknowledgements
First of all, I want to thank all of my professors from the finance department at the EBS University for Business and Law. They provided me with the necessary knowledge and technical skills to perform such a specific study. Moreover, without my bachelor and master studies, I would not have been able to conduct an academic research, as extensive as presented in this work. The last four years at the University contributed to my academic and personal development. My specific thanks go to my supervisor Professor Rasa Karapandza, who gave me the opportunity to work on such an interesting topic, as well as to Professor Christian Landau, who supported me in the process of my topic selection, by providing me with many insights in the field of private equity studies.
Furthermore, I would like to thank my entire family. They gave me a great support right from the beginning of my academic career in August 2012. Without their assistance, I would not be in the position where I am today. They gave me the opportunity to successfully complete my studies in such a short period of time. In addition, I would like to thank my grandmother, who is a role model for me in looking at things from a positive perspective. Last but not least, I want to thank all my friends for supporting and motivating me throughout the writing process.
Executive Summary
Private equity companies are seen as high risk investment funds, trying to gain high returns on their investments in a period of around three to seven years. Even if the private equity industry has played an important role in growth or as an external financing source of established companies as well as newly-established companies, private equity investors are not seen as sustainable value creators. In various occasions, private equity funds are even declared as a greedy instrument to earn fast money. In order to analyse whether private equity companies create value in a sustainable way, this study compares the performance of private equity backed initial public offerings (IPOs) with non-private equity backed IPOs. Moreover, it analyses whether private equity backed IPOs outperform the market. This study evaluates the performance of private equity backed IPOs by performing two separate empirical analyses: one focusing on the UK private equity market - the largest private equity market in Europe - and one focusing on the entire European market.
The research conducts a quantitative analysis of secondary data, more specifica ll y by using stock prices of private equity backed firms, non-private equity backed firms and applicable benchmark market indices. Such data was obtained from multiple sources, such as the London Stock Exchange, Bloomberg and Yahoo Finance. In general, the study compares the performance of private equity backed IPOs with non-sponsor IPOs with regard to their price development and abnormal returns. The analysis is based on mult ip le independent analyses of each IPO. In order to provide a general understanding of this issue and to be able to interpret the research results, the paper discusses the theoretica l framework and the findings of other authors. In recent decades, several authors have demonstrated their research on private equity based IPOs as well as the value creation of private equity firms. Based upon these, hypotheses are formulated, which are then subsequently tested using multiple research methods.
In general, the study indicates that the majority of private equity firms do not create sustainable value. More than 50% of the analysed private equity backed companies were not able to outperform the market benchmark indices. On average, private equity backed firms were able to significantly outperform the market in the UK. However, they were unable to perform equally well on a European level.
1 Introduction
Private equity firms are currently gaining increased importance in the global economy each year. In 2014, the worldwide private equity market exceeded the overall record in the value of buyout exits (Bain & Company, 2015, p.1). The business of private equity firms focuses on value creation during an investment. Without any value creation, these firms would not gain such high profits as they have delivered over recent decades (BVCA, 2014, p.4). Nevertheless, it is questionable whether this value creation only accounts for a short time or whether it is sustainable (Ernst & Young, 2014). This study attempts to answer this specific question. In the introduction section, the paper defines the scientific problem, explains the research objectives and outlines the course of investigation.
1.1 Motivation and Problem Definition
This study aims to provide evidence about the sustainability of value creation within private equity investments. Private equity firms have been often criticised for their methods (Baker, Filbeck, & Kiymaz, 2015). Researchers on the topic often argue that private equity firms have a negative impact on the society as they increase the systemat ic risk of the banking system due to highly leveraged deals as well as the squeeze out of their portfolio companies, which inevitably leaves their stakeholders empty handed (Burg & Rasmuss, 2007). Regardless of their individual arguments, the main statement of these criticism can be summarised in one sentence ‘the activities of private equity firms rather destroy value as they creating it’ (The Economist, 2007). Such criticism undoubtedly has a detrimental impact on the acquired companies of the private equity firms. In several European countries, there is an ongoing discussion concerning the impact of private equity firms (Strömberg, 2009). Some authors accuse financial investors for focusing their activities in a portfolio company only to obtain short-term returns rather than creating long-term value, which would be more beneficial as it would help all stakeholders. In addition, authors making such criticism only look at the short holding periods, which would also hurt the company rather than help them. Moreover, the critics also consider the high leverage as having a negative impact (Burg & Rasmuss, 2007). They claim that companies have to take on a high burden because they have to service their high debt obligations. Upon exit of any investment, these companies are inevitab l y forced to use their cash flows for debt repayment rather than investing it in their productivity. Overall, such and similar criticism is based upon a number of subjective accusations (Farzad, 2013; Campbell & Campbell, 2008; The Economist, 2007). Invest Europe, formerly known as European Private Equity & Venture Capital Association, attempts to prove the positive impact of private equity firms on the economy and society. They conduct in-depth analysis involving independent parties, hoping to convince the public of the positive nature of private equity firms. Moreover, they try to improve the transparency of the private equity market and show their benefits for their investors in order to gain the trust of the public (Invest Europe, 2016). This study seeks to contribute to this strand of knowledge by investigating the extend of value creation of private equity to determine whether there is a positive or negative effect in the long term.
The study compares private equity backed IPOs with non-private equity backed IPOs by using several benchmarks. In general, IPOs are issued by companies that plan to invest higher capital amounts, expand (i.e. internationally) or acquire another company. The IPO is classified as sale of equity in a public environment through a stock market (Brau & Fawcett, 2006). Private equity firms use this exit opportunity to gain returns after a process of value creation of a previously-acquired company (hvca, 2016). Most of the private equity firms acquire majority stakes in the capital of stock corporations, i.e. their targeted companies. Often they proceed through a leveraged buyout, abbreviated as LBO. In such cases, private equity firms resort to loans to acquire a company together with its existing management. After the acquisition, the private equity firms aim to increase the value of the acquired company by conducting operational and non-operationa l improvements. Within this process, they use internal and external expertise to increase the market value of a portfolio company. After the holding period of three to seven years, private equity firms seek to sell or divest - i.e. exit their investment - which can either happen through a direct sale to a financial investor, a strategic investor or through the public market with an IPO (Gilligan & Wright, 2014). At this point, the question thus emerges whether these companies would in the long-run be better off under a private equity ownership than without such an ownership. In order to answer this question, the study uses multiple abnormal return metrics to conduct its research.
In June 2015, 4.2 billion USD worth of private capital assets were managed by private equity firms, showing the relevance of this specific field of research (Preqin, 2016, p.7). The aggregated amount of buyout-backed exit was 422 billion USD in 2014, where the largest private equity market is located in the United States of America, followed by the United Kingdom (Bain & Company, 2016, pp. 20-21). The UK market together with the Irish market account for 27% of the buyout volume of the entire European region between 2013 and 2014 (PwC, 2015, p.15). These figures show the significance of the private equity segment in the economy. It is thus crucial to analyse the extent to which private equity firms create value over a sufficient time period. Therefore, this study analyses the UK market - as the second largest private equity backed IPO market worldwide - as well as the European market. More specifically, this research tries to find out whether the value creation is higher in companies in which a private equity firm has invested. This study is unique as to the applied time period and its individual selected data samples of the UK and European market. Therefore, the research adds a significa nt value to earlier research in the field of private equity backed IPOs.
1.2 Research Objectives and Contributions
This paper analyses the extent of value creation of private equity firms and whether it is sustainable, i.e. whether this value increase remains for a reasonable period of time after a private equity firm divests itself from a portfolio company. In order to perform this research, private equity backed IPOs are compared with non-private equity backed IPOs as well as with benchmark market indices in the UK and in the European market. The structure of this work is aligned to the analysis of the following research questions :
1. Does private equity backed IPOs have a better performance than non-private equity backed IPOs in the UK and in Europe over a long-term period of time?
2. Is the weighted average return on private equity backed firms higher than of non- private equity backed firms in the UK and in Europe?
In general, the objective of this study is a comparison of the performance, i.e. return of private equity backed IPOs to that of non-private equity backed IPOs and determine whether private equity firms have a positive sustainable impact on company success. The research assumes that financial success of a company is represented by its stock performance. The study should give a clear picture concerning whether private equity firms are only able to generate value during an investment period or whether their impact on the acquired companies’ business have a long-term lasting effect. In order to show such an effect, this study uses abnormal returns as an indicative parameter to measure value creation. Operational performance indicators cannot be considered in this work as such data is not usually published.
1.3 Course of Investigation
This master thesis follows a clear structure to provide an understanding of the specific research topic and extends the academic mind-set expressed in previous research studies by several authors. The main part of this study consists of an empirical analysis of the private equity value creation. Nevertheless, the definition and explanation of the private equity business model as well as the value creation part together with the review of previous studies on this topic is crucial for the overall concept of the study. Therefore, the study is structured in the following way.
The first chapter defines the problem and expresses the relevance of the research. Moreover, it explains why the research is conducted as well as how the study contributes an additional value to the existent academic research. The sub-chapter of the research objectives and contributions provides an overview of the targeted aims along with their corresponding research questions that need to be answered during this investigation. In the last part of the chapter, an outline of the investigation is offered. The investigation is established to answer three major questions: firstly, from where do the research questions come from, secondly, what is the basis for the study and, finally, what are the relevant findings?
The second chapter explains the concept of private equity firm. It defines their business model and their methods of value creation in a portfolio company. This part of the paper will demonstrate the stages of development during an investment period in an acquired company. Furthermore, this chapter describes the business of private equity firms and the reasons behind their need for divesture. One major type of divestment is the initial public offering. Basic knowledge about private equity backed IPOs is hence indispensable for this study. Therefore, this type of divestment is explained in detail in this particular chapter.
The third chapter reviews the reference literature on studies examining the performance of private equity backed IPOs. Multiple authors tried to analyse the topics at hand by using various approaches. Due the complexity of this topic, there are indeed a number of perspectives and analysis types. For the purpose of this study, only few relevant studies are selected and mentioned to show research results which are contrary to the findings in this work. Such reference papers are analysed in terms of their approaches. These analyses are expected not only to help to draw conclusions but also to create hypotheses for the two research samples. In the last decade, various authors have conducted studies exploring the value creation of private equity firms, as the private equity sector is seen as a mystery mainly due to lack of transparency. In this study, the data on the relation between IPOs and private equity firms is the determining factor for this work. The reviewed research papers have employed both primary and secondary research. Consequently, these authors provide several necessary inputs to the findings of this study. In this chapter, information is provided about the performance of private equity backed IPO as well as the fundamental figures of such companies. Moreover, this part gives a literature review on the most relevant findings on the topic to date.
The fourth chapter demonstrates and explains the first part of the study research. The research is divided into multiple parts. First, the study objective for this specific research is defined. In order to fulfil this objective, research questions and their associated hypothesis are further explained in a second sub-chapter. In order to clarify the concept of the research. Furthermore, this sub-chapter outlines the relevance of the study. In the fourth part within this section, the research methods are explained from a theoretical view point. Advantages and disadvantages are summarised to demonstrate the rationale for this study. In addition, the formulae of the three research methods BHAR, CAR and WR are shown to give the reader the opportunity to replicate this research. For this type of research study, the selection of an appropriate sample is of utmost importance for the success of the analysis. In order to demonstrate the complexity of this research, an entire sub-chapter is dedicated to the problems and challenges of identifying private equity backed IPOs. After the selection of the data, the next part explains the basic characterist ics and the source for the applied data sample. The seventh part within this chapter explains the limitations of this specific analysis. Due to the complexity of this type of analysis, it is necessary to clarify the possible interpretations of this research. The eighth part of this chapter demonstrates the descriptive statistics of the data sample. The focus in this part is mainly on the distribution of market value, the timing of the IPO, the market assignme nt and the industry sector. The next sub-chapter shows, explains and interprets the results of the research. This sub-chapter is divided into four parts, comprising Buy-and- Hold Returns, Buy-and-Hold Abnormal Returns, Cumulative Abnormal Returns and Wealth Relative. Each part is further divided to the respective three benchmarks, namely the FTSE 100, FTSE 250 and FTSE 350. The research results are analysed independent l y and summarised at the end of each sub-part. In the final section, the results of each analysis are considered as a whole. Such findings are used to draw conclusions as well as to answer the established research questions.
The fifth chapter shows the outcome of the second empirical research, in which the region of investigation is extended from the single focus on the UK to the entire Western European continent. Due to the complexity of the underlying research, it makes sense to further apply the same technical research methods on a larger number of IPOs. Such an approach is expected to improve the previously drawn conclusions. In addition, higher sample size is expected to give the findings a higher significance value. The structure of this investigation is similar to the first empirical research. The chapter begins with the definition of the study objective. Furthermore, research questions and their associated hypothesis, based upon the first research, are outlined and explained in the second sub-part. Subsequently, the process of data selection is demonstrated. The study explains at this point the challenges on the higher targeted level. In addition, such challenges not only occur in case of the sourcing of data but also in their interpretat io n. Therefore, the next chapter is dedicated to limitations to further discuss and explain such problems. In the fifth part of this chapter, this paper shows the descriptive statistics of the new data sample. It illustrates such findings in tables and graphs. After this sub-chapter, the research methods are briefly explained. Given that such methods are already explained in detail in the first research, it was found that there was no need to further elaborate on them in detail once more. The study outlines only the difference to the first research in case of the different benchmarks. This specific research uses the benchmarks : FTSEurofirst 300 Index, FTSE Developed Europe All Cap Index and MSCI Europe Index. In the eight section within this chapter, the outcomes of this analyses are summarised and interpreted. The structure is the same as for the first empirical research. It starts with the BHR, proceeds with the BHAR and CAR, before ending with the analysis of WR. Finally, the last part of this chapter elaborates upon existing research, summarising all findings and comparing them with those of the first empirical research.
The sixth chapter provides the conclusion of the entire study. It discusses the challenges and problems of this study to understand the drawn interpretations. Moreover, in this part all findings are summarized in a concise and understandable way. Using the information gathered throughout the process of the research, the final chapter delivers useful insights and valuable key takeaways. In addition to conclusion, further research recommendations are given, providing an additional value for future studies.
2 The Concept of Private Equity
In order to understand the present research work, it is necessary to understand, what private equity firms are and how they perform their business. Therefore, this chapter answers each questions independently. First, the asset class ‘private equity’ is defined by a description of the structure of a typical private equity firm. Moreover, the first chapter illustrates the process of a typical private equity fund circle from the stage of fund raising to investment and divestment of portfolio companies to the closure of a fund. The second part explains the initial public offering, as it is a specific type of divestment. As the research focuses on this divestment type, the understanding of this divestment is crucial to interpreting the final research results of private equity backed IPOs.
2.1 Asset Class - Private Equity
Private equity is defined as an asset class, in which investors use private capital for equity investments (Jegadeesha, Kräussl, & Polleta, 2009). Such capital is mainly committed by institutional investors to invest in non-publicly listed companies and divest such companies after a holding period of usually three to seven years. Investors of private equity funds are pension funds, fund of funds, insurance companies, banks, investme nt companies, asset managers, government agencies, family offices, wealth managers and high net worth individuals (Gilligan & Wright, 2014, p.39). The structure of a private equity firm can be easily defined by providing the business circle of a fund. In detail, private equity firms, known as general partners, allow individual and institutio na l investors to invest into their funds. These funds are established during the capital raising period, where external investors commit to provide capital resources for later investments. As they are only liable to their committed capital, such investors are defined as limited partners. All investment terms are comprised in the limited partnership agreement between limited partner and general partner. The general partner, e.g. private equity firm, advises as consultant to the fund and decides together with an investme nt committee or board on the investments in portfolio companies. In this paper, the term private equity firm always refers to the general partner. Private equity firms earn a management fee covering all business expenses, as well as a carried interest, which is earned if the fund reaches a previously defined performance hurdle rate. The carried interest has a typical rate of 20% (Baldwin, 2015; Gilligan & Wright, 2014; Loos, 2005).
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Figure 1. Structure of a Classical Private Equity Fund (Gilligan & Wright, 2014, p. 38)
The business model of a private equity firm is simple and straight- forward. In detail, private equity firms usually provide capital to companies that want to start a new business, launch a new product, build a new division, restructure their business, want to expand globally, acquire a company or are in need of capital for any other purposes. Different to debt lender, they invest capital as equity into the companies. An investme nt of such a financial investor can be classified as an active strategic execution aiming to generate high returns. In this active process, the private equity firm acquires the companies as well as their future supervisors, who are expected to support the company with their managerial expertise (evca, 2007). All actions during an investment process are aimed to generate value, and to increase the equity value of the acquired companies. Higher equity values lead to higher selling prices, which in turn result in higher returns. Financial investors are pressured to deliver high returns to their limited partners. Therefore, they provide monetary and non-monetary support like a network of business partners and consultants. The established management in the acquired company is usually forced to invest in their own company, as private equity firms want to see their commitment to the entire investment project. In order to find accurate targets, private equity firms screen various industries or connect with M&A advisers. As soon as a potential target company is identified, financial investors initiate an analysis the company regarding its potential value and whether an investment is in the interest of both parties.
More specifically, private equity investors aim to acquire companies with high potential to generate high returns (Baldwin, 2015; Gilligan & Wright, 2014; Loos, 2005).
2.2 Private Equity Backed IPOs
Private equity backed IPOs are a special type of a divestment for portfolio companies. In such a stage, the previous private company is taken public by giving out shares to the stock market (Povaly, 2006). Even though private equity backed IPOs are becoming increasingly popular, the term as such is not scientifically and practically defined. Most authors, who analysed this specific research segment, used ‘buyout-backed IPOs’ for their data sample selection. This term means that the public going companies experienced a buyout investment from a financial sponsor prior to their IPO. For this specific study, however, buyout-backed IPOs are considered as being a part of private equity backed IPOs, as the data sample also includes private equity investments, which were not always buyout-backed IPOs. The sample includes all private equity backed IPOs that had a major stake of a private equity company at the time of the IPO. Nevertheless, most of the private equity backed IPO were buyout-backed IPO. Therefore, it is necessary to clarify the term ‘buyout’.
A buyout is defined as a transaction in which an individual or group acquires a majority controlling stock of a company entity. The management of the acquired company remains the same. Furthermore, private equity firms often use a specific buyout, namely a leveraged buyout (LBO). In such a buyout transaction, investors acquire their stake with a high amount of debt (leverage) (Olsen, 2002). The typical LBO target company can be described as mature, it has high amounts of tangible assets as well as predictable and stable cash flow streams (Loos, 2005).
Certain authors like Cao & Lerner (2006) who focus their research on private equity backed IPOs only include IPOs in their research that were publicly traded before they were taken private in a LBO. Such transactions are called ‘reverse leveraged buyouts’. Other researchers like Muscarella and Vetsuypens (1989) defined them as ‘second IPOs’ or like Mohan (1990) as ‘LBO-IPOs’. Later research such as Ang and Brau (2002) extended the research by including IPOs that were previously privately owned. In this paper, the term ‘private equity backed IPOs’ refers to all IPOs that were previous ly acquired by private equity firms and in which the private equity firms are the largest shareholders.
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