Philip Ashdown, Altima Partners LLP presented on "Private Equity: Is the bubble about to burst?" at Warwick Business School 22/10/2007

1. Private Equity - 'Is the bubble about to burst?'
Warwick Business School
Philip Ashdown
22nd October 2007
Views expressed are private ones of Philip Ashdown

2. Key Questions
• Where are we now?
• Where do we want to be?
• How are we going to get there?
• What ‘worldview’ do we consider?
• Systemic issue or a correction?
• What strategy do we adopt?
• What are the resource and capability gaps?
• (Anyway what is a (the) bubble? (in this context))

3. Model of the Elements of Strategic Management
M o d e l o f t h e E le m e n t s o f S t r a t e g ic M a n a g e m e n t
Must have consistentu ltu r e & high degree of congruency
C
and
S ta k e h o ld e r
E x p e c ta tio n s
External te rMarketoForces . Culture and Stakeholder Expectations I n te r n a l - R e Resources/Core Competences
E x – n a l - P r te r e tc
so u rce an d
C aInternal –C o r e C o m p .)
p a b ility (
M a r k e t B a s e d V ie w R e s o u r c e s B a s e d V ie w
E n v ir o n m e n t
A n a ly s is
I d e n tify
Identify
O p tio n s P la n n in g a n d
Planningnand Allocation
a llo c a tio o f
S tra teg y O r g a n is a t io n re so u rces
C h o ice I m p le m e n ta tio n
E v a lu a te
O p tio nEvaluate
s Culture a tio nArchitecture
O r g a n is and
s tr u c tu r e a n d
S e le c tin g d e s ig n
S tr a te g y M a n a g in g
Select Managing
C hange
Change

4. Road Map
• Helicopter ride
– Private Equity - some history and making superior returns
– World view
– Shocks and changes
• Helicopter landing – Overview of the European LBO Market
• Helicopter ride
– World View implications
– Private Equity implications
– Can Private Equity deliver superior returns?

5. Private Equity - History
• Culture as ‘master of the universe’ ?
• OR any fool could make money in the last 10 year bull run?
• Generally minimal understanding, ‘label’ or do not care……….but its ‘centre stage’ since 2006
• Background……
– Governments and entrepreneurialism
– Big Bang (1986) >hot boom > 1990-1993 recession
– ‘barbarians at the gate’
– Financial innovation and disintermediation
– Venture capital is way too risky thanks
• TMT and dot.com boom
• Economies of scale do not work in my business model
– Investors – ‘hey where do I put all my cash?’ (must have superior returns btw)
– Hedge Funds and ‘alternative asset/value managers’
– Bull market > 1997-2007 (BUT ‘shocks’)
– Reputation
– Secrecy, tax and non-doms
– Political and social impact

6. Private Equity – Segment and Asset Class
• Sector maturity, learning/experience curves
– Historical analysis and disclosure
– Barriers to entry rapidly rising
– Brands and the ‘Goldman Factor’
• Consolidation and/or natural removal of poor performers; swiftly
– Nature of fund raising and business model
– Emergence of ‘Alternative Fund Managers’ at meta level
– Prescriptive nature of pension fund investors
– Regulation etal.
• Performance vz Public equity markets (Mario Levis – Cass Business School)
– RoA, Ebit and cashflow persistently higher – factor of 50% (with PE ownership)
– Debt ‘appears’ to set a tight discipline on management
– PE investment cases - minimise bureaucracy and committees, lack constant public exposure
– Risk/reward profile is clearly set and monitored
• Performance vz Alternative Fund Managers/Assets
– Hedge funds - $2,000bn globally, expected $500bn withdrawal Q42007
– ABCP, CDO’s and other esoteric asset classes

7. The Credit/Equity Cycle – it’s always in the background!
Credit Equities
Phase 1
Repair BSheet
Leverage builds
Credit Equities Phase 4 Clock Face Phase 2 Credit Equities
Immature Bull
Emerging Bear
Technology Excess
Phase 3
Intervention period
Credit Equities
Mature Bull
Source : CitiGroup Investment Research

8. Let’s get in a helicopter
World View
Industry structures/change
China Asia Crisis
Petro-Dollars Internet bubble
Russia LTCM
India Virtual Circles ROCE (Basle 11)
New Paradigms Cash Multiples not IRRs
Financial Models and Statistics
ASSETS LIABILITIES
Innovation
Regulation and Deregulation
Liquidity
Tax
IT USA deficit
Dollar liabilities
Sovereign wealth funds Emergence of Euro
Relative sophistication Fall of iron curtain
Real Liquidity Economic reform/stability
Fed/Central Bank creds’
Labour mobility
Globalisation

9. ………………..but they crash
Perception
Dollars/Euro/ Industry structures/change
VAR
breaks
China Gold??? Shocks Asia Crisis down
Petro-Dollars Internet bubble
Russia VAR LTCM
breaks
India Virtual Circles
down ROCE (Basle 11)
New Paradigms Cash Multiples not IRRs
ASSETS Financial Models and Statistics
complexity
LIABILITIES
Innovation
Regulation and DeregulationAsset Values
Liquidity Inflate
Tax + IT USA deficit
System Momentum Dollar liabilities
Sovereign wealth funds Speed Emergence of Euro
Relative sophistication Reaction time
Media Power Fall of iron curtain
Real Liquidity Economic reform/stability
Rabbits + Fed/Central Bank creds’
Perception headlights
Labour mobility
Dollars/Euro/ Globalisation
Gold???

10. OMG what is my
cap’ structure?
…..correction +/or systemic +/or another paradigm?
What is Financial
my risk? Structures Industry structures/change
China Leverage + Asia Crisis
Petro-Dollars Trading ? Internet bubble SD is 8x!
Russia LTCM Leverage is
India Virtual Circles INVERSE ROCE (Basle 11)4*4*!
New Paradigms ‘ITS OLD AGAIN’ Cash Multiples not IRRs
Financial Models and Statistics MISTRUST
ASSETS Innovation EXCESS LIABILITIES
Regulation and Deregulation CONFUSION
Liquidity REAL + FALSE
‘banana republic’
Tax TAKER
IT SPEED EXPONENTIAL USA deficit
System BREAKDOWN Dollar liabilities
Sovereign wealth funds Emergence of Euro
Relative sophistication STRENGTH BY DEFAULT
Trade deficit
Real Liquidity Interest rates Fall of iron curtain
Perception
DILEMNA Economic reform/stability
Where is In/Out Fed/Central Bank creds’
my risk? fast Labour mobility
Globalisation

11. …….can this helicopter fly again?
Industry structures/change
China Asia Crisis
Petro-Dollars Internet bubble
Russia LTCM
India ROCE (Basle 11)
Virtual Circles Cash Multiples not IRRs
New Paradigms
ASSETS Financial Models and Statistics LIABILITIES
Innovation
Regulation and Deregulation USA deficit
Liquidity Dollar liabilities
Tax + IT Emergence of Euro
Fall of iron curtain
Sovereign wealth funds
Economic reform/stability
Relative sophistication
Fed/Central Bank creds’
Real Liquidity
Labour mobility
Globalisation
…..time and process to get control; feedback to real world

12. Flying the helicopter…not a problem
• System Momentum = mass * velocity (* powerful internal cultural factors)
• Even when we think we understand/see the problem we do not get
behaviour change (why?)
‘When liquidity runs out it will be very complex, however, the music is still
playing and we are still dancing…..(this is a great time to make superior
returns)’ Head of CitiGroup early July 2007 when talking about LBO’s
(Private Equity)
$5.9bn losses announced 2nd October ($20bn+ losses Q3 across the market)
PS Volatility/Shock – Citi losses increased by $600m by 15th October

13. Private Equity Economics
• Buy an asset at the right • Where are we in the
price helicopter today?
• Optimise the capital • Reflective of where we are
structure
• Optimise industry position • Am I deep enough in the
and operational efficiency woods? Its very tough in
(…competitive advantage) here
• Sell an asset at the right • Where is my helicopter
price going and do I have enough
fuel?

14. …….let’s land the helicopter in……..
The European Leveraged Buy-Out Market
Source : Standard & Poors LCD Debtwire Statistics as at March & June 2007

15. European LBO Market Volume
Exponential market growth : private equity raised globally in past 5 years $551bn #
€140B Deal 320 €40B
Annual Senior Loan Volume Monthly Senior Loan Volume (Last Twelve Months)
Count:
214
280 €35B
€120B
240 €30B
€100B
200 €25B
€80B
160 €20B
€60B
120 €15B
€40B
80 €10B
€20B
40 €5B
€0B 0 €0B
1999 2000 2001 2002 2003 2004 2005 2006 2007
6
07
07
07
7
6
6
6
6
7
7
6
-0
-0
-0
-0
l-0
-0
-0
-0
-0
n-
n-
b-
ov
ar
ec
ug
ep
ay
pr
ct
Ju
Ja
Ju
Fe
M
O
A
N
1Q 2Q 3Q 4Q Deal Count*
M
D
A
S
* Deal Count counts First and Second Lien portions of a single transaction
as one event; Deal Count also excludes any amendments.
# Source : Sunday Times 29th April 2007

16. Avg. LBO Purchase Price as Multiple of Pro Forma Trailing EBITDA
Excess supply of funds and liquidity is chasing higher enterprise valuations
rationalised against increasingly aggressive strategic business plans
10.00
9.00 0.40
0.38
0.38
0.38
8.00 0.35
0.41
0.39
+34%
0.33 0.38
7.00 0.34
0.35 8.57 8.72
0.33 8.42
7.81 7.93
7.27 7.17
6.00 6.97 6.93
6.72 6.64
6.48
5.00
1997 1998 (35) 1999 (33) 2000 (40) 2001 (37) 2002 (52) 2003 (66) 2004 (77) 2005 (87) 2006 (120) LTM 31/3/07 1Q07 (30)
(Observations: (126)
14)
Purchase Price Fees/Expenses
Excluding Platform Acquisitions and Other Sponsor Driven Transactions.

17. Average Total Debt Leverage Ratio for LBO’s:
Europe vs. US with EBITDA of €/$50M or More
7.0x
Debt multiples have risen c.a. 40% since 2001
6.1
6.0x 5.8 5.8
5.5 5.5
5.4
4.9 4.9
5.0x 4.7 4.8
4.7
4.4 4.5
4.3 4.3 4.4
4.1 4.1
4.0x
3.0x
2.0x
1.0x
0.0x
1999 2000 2001 2002 2003 2004 2005 2006 1Q07
Europe US

18. Key Ratios (Europe) – 1999-2007(Q1)
6.0x
c.a. 40% increase in leverage
c.a. 40% negative shift of
Interest cover and
Core investment coverage
4.0x
2.0x
0.0x
Debt/EBITDA Senior EBITDA/Sr Interest EBITDA/Cash EBITDA - Mainten. EBITDA -
Debt/EBITDA Interest Capex/Cash Capex/Cash
Interest Interest
1999 (53) 2000 (80) 2001 (75) 2002 (101) 2003 (115) 2004 (149) 2005 (210) 2006 (236) 1Q 2007 (62)

19. Who finances this growth?

20. Primary European LBO Market by Broad Investor Type
Clear growth evident in institutional market away from banks,
will drive complex outcomes as market deteriorates
100%
10%
75%
50% 55%
25%
0%
1999 2000 2001 2002 2003 2004 2005 2006 LTM
31/3/07
European Banks Non-European Banks Institutional Investors Securities Firms

21. Institutional Investor Group and Vehicle Count
European LBO Market
350
303
300
Exponential growth in
250 CDO/CLO funds 241
200
150
126
112
99
100
70
53
50 43 33
33
21 18 22
8 14
3 3 7
0
1999 2000 2001 2002 2003 2004 2005 2006 1H07
Manager Groups Active Loan Investment Vehicles
Excludes U.S. Dollar Tranches Syndicated in the US
Note: Investor group and vehicles include CDOs that are in late stages of warehousing and exclude Finance companies

22. Institutional Investors’ Share of the Primary Market
European market structure has evolved to USA model; what’s over there is coming here
100%
80%
60%
40%
20%
0%
1999 2000 2001 2002 2003 2004 2005 2006 LTM LTM
30/6/07 30/9/07
Europe US

23. …..back for a helicopter ride

24. Financial Product Segments affected – August 2007 - Globally
$6,900bn
into
$1,500bn $2,670bn $3,000bn $5,700bn $2,400bn
Subprime CDOs LBOs Xover ABCP FIs Economy
Extreme Sensitivity Limited Supply Liquid hedge Unwinding Liquidity BackStops Tighter credit
House Prices Leverage PB lines
Haircuts Slower GDP
Ratings Uncertainty Inability to refi
ACBP
Memo – June 2007 REPOs
Equities $23,500bn Capital scarcity
TBill $4,300bn
Muni $2,500bn
Agency $2,700bn Genuine Liquidity Crunch – not isolated to subprime
MoneyMarket $4,300bn
US Capital Markets data only
Source : CitiGroup Global Markets

25. Implications for the system
World View Industry structures/change
China Asia Crisis
Petro-Dollars Huge Complexity Internet bubble
Russia LTCM
India ROCE (Basle 11)
Virtual Circles Cash Multiples not IRRs
New Paradigms
ASSETS Financial Models and Statistics LIABILITIES
Innovation
Regulation and Deregulation
Liquidity
Tax + IT USA deficit
Dollar liabilities
Sovereign wealth funds Emergence of Euro
Relative sophistication Fall of iron curtain
Real Liquidity Economic reform/stability
Momentum = (Mass*Velocity)*Culture Fed/Central Bank creds’
Labour mobility
Globalisation

26. Implications for the system
China Can China keep growing at 12%p.a.+?
Petro-Dollars What happens to oil prices, liquidity flows and investment?
Russia Political influences, war mongering, terrorism
India Social unrest
Powerful exogenous factors impacting interest, FX rates
ASSETS and asset prices
Investment is being increasingly driven directly
Sovereign wealth funds •In house wealth funds ($8trillion+ >reserves of central banks globally by 2011)
Relative sophistication Industry sectors
Real Liquidity Globally – ‘strategic assets’
Hot money (+/or)…..
Sustainable ‘locked’ flows

27. Implications for the system
Industry structures/change
• Ongoing change (hetro>homogenous) but cultures
Asia Crisis
• Core driver to investment activity and superior returns
Internet bubble
• Lessons will be learnt; add the 2007 credit crunch
LTCM
• Financial sector equity, leverage, returns re-assessed
ROCE (Basle 11)
• Risk free rates, core risk skills, asset values tested
Cash Multiples not IRRs
• Time period will lengthen (hold periods)
• Safety margin broadens LIABILITIES
• USA not able to manage interest rates, ultimately
USA deficit
• Equals yield curve volatility; FX volatility; asset volatility
Dollar liabilities
• Europe has same problem but for different reason
Emergence of Euro
• Economic stability will likely revert to variable
Fall of iron curtain
• Cycles, inflation and/or Japan
Economic reform/stability
• Reduced credibility, intervention, monetarism returns
Fed/Central Bank creds’
• Consideration to controls (indirect/direct)
Labour mobility
• Core liquidity is ‘global’ and will move swiftly
Globalisation
• Huge liquidity imbalances; funding structures are key

28. Implications for the system
What was old is new (paradigm)
Recession (risk of) and cycles
Virtual Circles Volatility everywhere
New Paradigms Inflation
Financial Models and Statistics Japan experience
Innovation Innovation - excess controlled (self and external)
Regulation and Deregulation Tight(er) regulation
Liquidity Liquidity – deep understanding/controls needed
Tax + IT Tax abuse (tend to eradicate)
IT control and development of better
risk models and feedback mechanisms
Media management reviewed
Protection for ‘man in street’
The brakes are slammed on; there is no ABS and its very icey
I am sure we will not overreact………….much anyway!

29. Implications for the system
…..time and process to get control; feedback to real world
• We have an acute balance between control and chaos
The chances of a USA recession in 2008 have risen from 3-1 to 2-1 (Greenspan, October 1st); most
see it as 50/50 to likely
If investors fund less $ liabilities….global liquidity flows and imbalances
Interest rates and/or asset values will shift swiftly
Euro is too strong (driven by alternative investment home) equals inflation ultimately……..
Japan has had zero interest rates and no asset growth for >13 years
System has landmines everywhere – shock and volatility to come
o Late cycle sub-prime is estimated at $700bn; $100bn found; losses could be $300bn???
o LBO debt is c.a.$500bn ‘hung bridges’ plus excess growth since 2005
o Corporate debt has had limited diligence for 3 years
o Property prices and leverage (residential and commercial) excessive
o Inherently unsustainable financing, liquidity and capital structure issues (innovation excess)
o Will somebody explain liquidity to me!!!
Does Fed intervention get control?
Is the ECB a credible central bank or a political and naïve player?
The UK is left in the backwash?
What happens when equity markets ‘get this’? (Asymmetry between credit and equity markets)

30. Private Equity
External
• Correction and back to normal………
• Or correction into chaos then…? What time period?
• Sustainable industry/investor group or not?
Internal
• What strategy to adopt ?
– Providers of liquidity
– Fund managers
– Long/short asset holders
– Existing portfolio
– New investments

31. The Credit/Equity Cycle – it’s always in the background!
Credit Equities
Phase 1
Repair BSheet
Leverage builds
Credit Equities Phase 4 Phase 2 Credit Equities
Cre
Equ
Immature Bull
dit
Emerging Bear ity
Technology Excess
Phase 3
Intervention period
Credit Equities
Mature Bull
Source : CitiGroup Investment Research

32. 1
Cost of (<) BBB over Credit/Equity Cycle
4 2
CEq
re uity
dit
3 Mature Bull Emerging Bear Immature Bull Mature Bull
Phase 3 Phase 4 Phase 1 Phase 2 Phase 3
1700
Fed ease Fed tighter US High Yield
1500 European High Yield
Shocks
1300
1100
Reduce leverage Use leverage
900 Shocks
700
High Volatility Low volatility
Fed ease
500
300
100
98
98
01
02
03
04
04
06
06
9
0
0
2
5
7
99
00
00
00
00
00
19
19
20
20
20
20
20
20
20
/1
/2
/2
/2
/2
/2
2/
9/
8/
8/
8/
2/
8/
7/
4/
18
21
29
20
29
24
/0
/0
/0
/2
/0
/1
/1
/0
/1
5/
1/
9/
2/
7/
8/
01
09
06
10
07
03
11
04
12
LTCM Nasdaq/TMT ABCP
Source : Merrill Lynch data; Citi Investment Research
Bubbles ‘innovation’

33. Can Private Equity deliver superior returns?
• Buy an asset at Where are we in the helicopter today? Validate the environment
the right price
• Optimise the Reflective of where we are EV off 2x minimum
capital structure
• Optimise SCA Am I deep enough in the woods? Probably not, so……..
• Sell an asset at
the right price Where is my helicopter going? Get in it for the long term;
choppy ride ahead P3/P4
Firm and Resource competences vary materially across the sector
Control mechanisms break down; political influences drive behaviour
Given the environment what resources and capability gaps do I have?
Re-evaluate past process and procedures – formal and INFORMAL
Examine existing portfolio deeply
Examine and change funding structure and investor type/diversify
Seek consolidation opportunities +/or stretch business model
Create sustainable funding structures - remove M2M/NAV dynamics
Socially aware/change
Overtly communicate and manage PR
Main stream not ‘secret, off-shore, barbarians at the gate’
Apply double-loop learning consistently – remove culture from macro strategy

34. Meaning of life…….
• Always seek to understand the macro drivers in the financial system
globally and its feedback into ‘your (industry/sector) worldview’
• Change or die …….(+ use a helicopter and seek to be informed yet
intuitive for big bets)
• Remove ‘culture’ from ‘big bet’ decision process (monitor always)
• Get lucky, cash out at the top and go to the beach…….
• Stay on the beach, re-invest at the bottom but get private equity
(alternative asset) fund managers to do the work for you……..(for
above average index returns)
• Q&A………………