On Private Equity: Scott Schoen, THL

Scott Schoen started off by describing a simple structure for the fundamentals of PE.

The THL Perspective of Doing the Deal
Sourcing (involves valuations and generating deal flow for inside due diligence)
-> Financing (due diligence is key)
-> Operations (improvements are key)
-> Strategic Exits (options include secondary PE markets)

Inside due diligence consists of identifying the
level of control required of the target,
leverage for the deal,
operational value add opportunities.

Financing constructs considered include PIPE structures where the private equity firm can acquire control with about 30-% to 35% of equity without paying for control. Financing sources can be broken down into existing investors, the government, and Mergers & Acquisitions. Each of these requires various strategies to be in play.

Manifestations of the Current Economic Context
Scott Schoen’s key points about the manifestations of the current economic context:

Sizing the problem: The economic contraction is a function of leverage. It impacts US Financial Sector assets totaling $60 trillion on the US balance sheet, and also impacts the leverage ratio (40:1) of financial institutions. As an example, he pointed out that the total CLO transactions in Q4 2008 were $0.

Return to basics: The contraction will lead to companies looking for cost savings; however, one company’s cost savings are another company’s lost revenue. In terms of the private equity industry, this translates to a return to the basics- better covenants and refinancing of senior loans.

Restructuring: There are two ways to deal with distress scenarios. Either negotiate amendments when faced with defaults, or go into a court process as lenders are fragmented, with banks as senior lenders.

Rates and The PE Deal: New rates at LIBOR +2.5% to 8.5% are causing value to seep through the PE deal.

The Equity Overhang: The private equity industry equity overhang of $400 billion will likely go into mid market private equity transactions

LP Asset Allocation: Limited Partners have capital allocation challenges to deal with- these can be deduced from the equity overhang. A $10 billion fund that is allocating 5% in private equity needs $1 billion in investments as money comes back at a certain pace.

It would be interesting to evaluate the strategies that GPs, LPs and lenders are considering to find returns across the process. Given the willingness to consider PIPE transactions, would PE firms begin behaving like hedge funds to manage the huge equity overhang?


What do you think?


The Usual Disclaimer: This is purely a knowledge sharing resource and I have been careful to protect panelist/ speaker interests. Ethically, context is everything, and I will gladly retract anything that affects the parties mentioned. Call this my mini OpenCourseWare, if you will, where Open signifies life experiences.