Disney PENN & ESPN Bet

Disney and PENN Entertainment Team Up to Launch ESPN Bet

Disney PENN & ESPN Bet
Disney Penn &Amp; Espn BetPenn Entertainment (Nasdaq: PENN) has rebranded its online sportsbook with a 10-year, $2 billion licensing deal with ESPN. The new look mobile app and website launches today, November 14th, and is available in 17 states including Arizona, Colorado, Illinois, Iowa, Indiana, Kansas, Kentucky, Louisiana, Maryland, Massachusetts, Michigan, New Jersey, Ohio, Pennsylvania, Tennessee, Virginia, and West Virginia. The state of Nevada is noticeably absent due to the state’s requirement for in person registration at a participating casino and ties to some of the biggest brands on the Las Vegas strip such as MGM, Caesars, and Wynn, each with their own sports betting apps. ESPN Bet is a bold endeavor for PENN to gain market share from industry leaders DraftKings (39%) and FanDuel (31%). PENN currently has only 2% of the legalized online betting in the U.S. but believes licensing the ESPN brand will allow it to reach its 20% market share target by 2027. It’s been a rough 2023 for PENN in the gambling space. Earlier this year, PENN acquired the remaining 64% stake in Barstool Sports for $405 million. PENN purchased a minority 36% stake in the Barstool in 2020 for $163 million. However, the acquisition of Barstool in February turned negative quickly as PENN was denied gaming licenses attributed to the controversial and polarizing content and personalities of Barstool Sports. As a result, PENN was compelled to sell Barstool back to founder Dave Portnoy for $1.00 in August, just months after the acquisition of the company. PENN reported a loss of disposal of Barstool in the amount of $923 million in its latest 10-Q, which included $715 million of goodwill and intangible write offs. The sale back to Portnoy included the right to 50% of any future sale of Barstool; although, Mr. Portnoy claims he will ‘never’ sell the company again. ESPN is diving deeper into the world of sports betting after strategically incorporating more betting odds and information into its broadcast content in recent years. The ‘worldwide leader in sports’ rebranded its Daily Wager show to ESPN Bet Live in September and moved its studio to ESPN headquarters in Bristol, Connecticut after three years at the LINQ Hotel on the Las Vegas strip. The LINQ residency was a partnership between Caesars Entertainment (owner of the LINQ) and ESPN. Now that ESPN has joined forces with PENN, it was time for a split and change of venue. Although there are concerns about ESPN’s sports broadcasting rights and its new venture into sports betting, the Disney owned company has placed wagering restrictions on select employees that could learn inside information as part of their coverage. The increasing commercial interest in U.S. sports betting is a result of the Supreme Court overturning the Professional and Amateur Sports Protection Act (PASPA) in 2018. The PASPA previously prohibited sports betting outside of the state of Nevada. Earlier this month, DraftKings reported revenue for the third quarter increased 57% to $790 million. Online sports betting revenue in the U.S. is expected to reach $7.6 billion in 2023 with projections to increase to $14.4 billion by 2027.

Middle Market Private Equity M&A Activity – Q3 2018

Middle Market Private Equity M&A Activity – Q3 2018

Executive Summary

Average Valuations are Slightly Down

The aggregate EV/EBITDA multiple of 7.3x for Q3 2018 is in line with the multiples observed over the last few quarters, but valuations have tapered off compared to the 7.5-8.0x seen in the latter half of 2017.

Leaning Towards Conservatism

It appears that private equity firms are preferring to use less debt in their acquisition efforts.  Despite plenty of capital available in the leveraged finance market, total debt/EBITDA has decreased, and the percentage of deals using less than the maximum amount of leverage allowed is rising.

Headwinds for Sectors Trying to Stay “In Favor”

Technology and health care were once again leaders in terms of highest average valuations, but their multiples in 2018 are lower compared to last year.

Also of note is the media & telecom sector.  This industry had an average EV/EBITDA multiple of 8.2x in 2017 (second highest among all sectors) but sharply fell to just 5.0x in 2018 (lowest among all sectors).

Based on our review of GF Data’s latest M&A Report, Q3 2018 was a mixed bag of indicators for the private equity transaction arena.  63 transactions were reported by more than 200 private equity firms in the quarter.  This is an increase over the 47 transactions reported last quarter and the 53 transactions reported in Q3 a year ago.  However, total transactions are slightly down from the 71 and 67 that were reported in Q4 2017 and Q1 2018, respectively.  Just 177 transactions have been reported for 2018 thus far, so we will need to see a slightly faster pace if we are to keep up with 249 transactions reported last year. Middle Market Private Equity.

We also note that multiples, in terms of total enterprise value (EV) to EBITDA, were slightly down.  While two sectors reported higher multiples in Q3 than in Q2, most sectors declined.  In aggregate, EV/EBITDA multiples averaged 7.3x for Q3 2018.  This is down from 7.4x last quarter, 7.5x in the same quarter last year, and a high of 8.0x observed in Q4 2017.  Not surprisingly, targets with larger enterprise values were acquired at higher multiples.  In Q3, companies with enterprise values in the ranges of both $50-100M and $100-250M were acquired at 8.6x EBITDA, whereas companies in the $10-25M range were acquired at 5.8x EBITDA and $25-50M companies were acquired at 7.1x EBITDA.

Middle Market Private Equity

Industry Analysis

To get a better understanding of the mixed M&A trends, we took a deeper dive into the report and analyzed the various industry classifications of the acquisition targets. 

Middle Market Private Equity

Manufacturing

Manufacturing valuations have largely hovered in the low-to-mid 6x range since 2014, although they have trended upwards in the past two years.  Recent EV/EBITDA multiples observed include 6.8x in 2017 and 6.9x in 2018.  This is in comparison to an average of just 6.3x from 2014 to 2016.  However, there has been an apparent drop in recent deal volume.  Only 56 transactions have been reported in 2018 thus far, compared to an average of over 100 from 2014 to 2017.  Time will tell if Q4 activity will pick up and get manufacturing M&A volume back to historical levels. 

Mergers And Acquisitions

Business Services

While the average EV/EBITDA multiple of 7.0x for 2018 dipped slightly compared to the 7.3x in 2016 and 7.4x in 2017, EV/EBITDA multiples for the business services sector are still higher than their 2014 to 2017 average of 6.8x.  As another positive, volume is up for this sector in 2018 with 48 transactions already reported through just three quarters compared to only 44 and 41 in each of the previous two years.

Mergers And Acquisitions

Health Care Services

Both M&A multiples and volume are down for the health care sector.  EV/EBITDA multiples have averaged just 7.5x so far in 2018.  This is lower than the 7.8x, 7.6x, and 8.1x multiples observed in the last three years.  Volume is also down, with just 19 reported transactions in 2018 thus far compared to an average of 24 over the past three years.  However, if Q4 can keep the same pace as the first three quarters, 2018 could finish in line with average volume. 

Middle Market Private Equity M&Amp;A Activity - Q3 2018

Distribution

As of now, 2018 appears to be a lackluster year for M&A activity within the distribution industry.  The average EV/EBITDA multiple of 7.0x so far in 2018 is moderately lower than the 7.5x and 7.7x seen in 2016 and 2017, respectively.  Volume is also down thus far, with just 13 transactions reported in 2018 compared to twice as many (26) reported last year.  We still have one more quarter of data to digest, but with multiples and volume both appearing lower, we won’t be holding our breath for any magic in the distribution sector in 2018.

Middle Market Private Equity M&Amp;A Activity - Q3 2018

Retail

Retail showed signs of recovering with EV/EBITDA multiples of 7.0x and 7.6x in 2016 and 2017, respectively.  However, multiples have dropped to just 6.7x thus far in 2018.  On a positive note though, this is still higher than the EV/EBITDA multiples of 6.0x in 2015 and 5.5x in 2016.  Retail will be a key industry to watch regarding growth for the overall economy. 

Middle Market Private Equity M&Amp;A Activity - Q3 2018

Media & Telecom

At first glance, the media & telecom sector had a significant drop in its average EV/EBITDA multiple.  However, a closer look reveals that the average multiple of 8.2x for 2017 was largely inflated compared to the sector’s average EV/EBITDA multiple of 6.5x for 2015 and 2016.  This perhaps could have been influenced by numerous large mergers in the industry including Disney and Fox, AT&T and Time Warner, and others.

Middle Market Private Equity M&Amp;A Activity - Q3 2018

Technology

From 2014 to 2016, technology EV/EBITDA multiples averaged a respectable 7.7x.  Multiples then rocketed to an average of 10.2x in 2017.  It appears that this was not an anomaly as 2018 multiples have averaged 9.8x through Q3.  As “fin-tech”, cyber security, and data analytics continue to grow in popularity, we expect technology multiples to finish 2018 on a strong note and remain elevated into 2019.

Middle Market Private Equity M&Amp;A Activity - Q3 2018

Information in this article is based on the GF Data November MA Report dated November 19, 2018.  GF Data provides private equity sponsored merger and acquisition information for middle market companies with enterprise values between $10M – $250M.

For more information, contact:

 

Leveraged Debt Outlook – Article #3

Can Leveraged Debt Retest Low Premiums?

This article continues the discussion started in Article #1, “Is It Time to Invest in Leveraged Debt?” and  Article #2, “Leveraged Debt Investment Alternatives.”  Article #3 addresses the question of whether or not the leveraged debt market has reached its cyclical peak and if credit risk premiums can narrow further from present levels

Can high yield bond credit risk premiums continue to narrow from present levels?

It’s a significant question.  Bonds provide returns to investors in two forms: 1) payment of the contractual rate of interest and 2) capital gains or losses.  Credit risk premiums seldom remain constant for any length of time; they continually trend up or down.  The chart below illustrate that cycles of decreasing credit risk premiums generally continue for a period of years and that cycles of increasing risk premiums can play out over a period of just a few months.

Leveraged Debt Outlook

Thus, the question of whether credit risk premiums can continue to decrease from present levels is very important.  If they can continue to decrease, high yield bonds are likely to provide attractive returns for several more quarters, perhaps even a year or two.

The chart above showed that credit risk premiums are nearing their all time lows.  The answer to the question of whether or not high yield credit risk premiums can return to their all time lows lies in part in the leveraged loan market. 

In Article #2 of this series, we explained that leveraged bank loans and high yield bonds are the two primary leveraged debt investment instruments.  Many leveraged debt investors will allocate money to the loan or bond markets depending on which asset class offers more attractive risk/reward relationship.  The chart below illustrates that the leveraged bank loan market is not presently retesting its all time lows from 2007.

Leveraged Debt Outlook - Article #3

Explaining the difference

The previous chart raises another important question – how can high yield bond credit risk premiums be approximately 1.0% from their all time lows when the credit risk premium on leveraged loans is almost 2.0% higher than its historic lows?  The table below illustrates the significance of this difference.

Leveraged Debt Outlook - Article #3

As we discussed in Article #2, bonds are riskier than senior secured loans.  As a result, the credit risk premium on “B” rated high yield bonds prior to and including the historic low was 171 basis points (1.71%) higher than the average on comparably rated loans (5.06% – 3.35%).  Today, the credit risk premium on “B” rated loans (4.03%) is higher than it is on “B” rated bonds (3.39%).  Credit risk premiums on bonds since 2009 have been very similar to what they were prior to the great recession but credit risk premiums on loans have been very  different.

The reason the high yield market has essentially returned to pre-2008 norms while loans have not reflects the fact that the market for leveraged bank loans is far more dependent on the securitization as a source of capital to fund loan investments than the bond market. Roughly half of all new leveraged bank loans are purchased into the investment portfolio’s held by Collateralized Loan Obligations (“CLOs”). 

Recall that mortgage loan securitizations (“CDOs”) were the epicenter of the financial crisis and recession that took place in 2008 and 2009. In response to the mortgage loan crisis, new rules were put in place to reduce the risks created in the securitization markets.  This affected not only the mortgage loan CDOs but also commercial loan CLOs.

The new rules increased the equity risk exposure CLO managers were required to retain and restricted many of the freedoms the CLO markets previously enjoyed despite the fact that CLO’s performed well during the this period.

Leveraged Debt Outlook - Article #3

The chart above shows that the blended credit risk premium on the average new CLO in 2017 was almost three times larger than the blended credit risk premium on new CLO’s in 2007.   The chart below shows that credit risk premiums on the AAA rated tranches of new CLOs have begun to decrease only recently, indicating that the CLOs which funded prior to 2017 had even higher funding costs.

Leveraged Debt Outlook - Article #3

The chart above shows that the average credit risk premium for AAA rated CLO obligations decreased 30 basis points (0.30%) in 2017.  This indicates that the credit risk premiums of CLO’s created prior to 2017 are generally 170 basis points (1.70%) or more.  This increase in CLO funding costs is a primary factor which has caused credit risk premiums on leveraged bank loans to remain stubbornly high relative to similarly rated high yield bonds.

This brings us back to our original question.  Can the high yield bond market retest the all-time low credit risk premiums it experienced in 2007?

In our view, the answer to this question is probably not.  Leveraged bank loans are a good substitute asset for high yield bonds.  Thus, if bond yields get too low, investors are well advised to move their investments to loans so that they can get higher yields for similar risk.

Conclusion

In January, credit risk premiums on high yield bonds were significantly lower than their long term averages and they were nearing the all time lows experienced in 2007. 

If the funding cost of CLOs continues to tighten as it did in 2017, bank loan credit risk premiums could decrease further – this would enable additional decreases in bond credit risk premiums.    The magnitude of the decrease in CLO funding costs in recent months suggests that bonds could appreciate further before reaching their next cyclical peak.

The structural changes in the market for leveraged bank loans which occurred after the financial crisis of 2008 and 2009 make it unlikely that credit risk premiums on high yield bonds will return to their 2007 lows in the foreseeable future.  The significance of this is that we anticipate high yield credit risk premiums are unlikely to decrease more than an additional 100 basis points from January 2018 levels.

Past Articles

Article #1:  Is It Time to Invest in Leveraged Debt?

Article #2: Leveraged Debt Investment Alternatives

Coming Articles

Article #3:  Can Leveraged Debt Retest Low Premiums?

Article #4:  Signs That It’s Time to Sell Leveraged Debt

Article #5:  Signs That It’s Time to Buy Leveraged Debt

Article #6:    The Appeal of Investing in Distressed Debt

Article #7:   Investment in Leveraged Debt through the Business Cycle

Thereafter:  Updates regarding important market statistics with current commentary

Data Sources for the Article

The data presented in this article was obtained from the Federal Reserve Bank of St. Louis (ICE Benchmark Administration Limited (IBA), ICE BofAML US High Yield B Option-Adjusted Spread [BAMLH0A2HYB], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/BAMLH0A2HYB, January 8, 2018) and from the Leveraged Commentary and Data news service provided by Standard and Poors Corporation.

For more information, contact:

Christopher C. Lucas, CFA, CPA

PRINCIPAL
clucas@valuescopeinc.com
Full Bio →

If you liked this blog you may enjoy reading some of our other blogs here.

Leveraged Debt Outlook – Article #2

Leveraged Debt Investment Alternatives

Leveraged Debt Outlook Vol 2

This article continues the discussion started in Article #1, “Is It Time to Invest in Leveraged Debt?” and  describes the primary debt types that trade in the leveraged debt markets

What is leveraged debt?

Leveraged debt is the financial obligations of large businesses and certain governments whose credit ratings do not qualify as “investment grade.”  These obligations take the form of both leveraged bank loans and high yield bonds.  Because they are large obligations of large issuers, they are syndicated to investors and may be purchased or sold in secondary markets, much like those for stocks and investment grade bonds.  Common characteristics of leveraged bank loans and high yield bonds are described below.

Characteristics of leveraged bank loans

  • Floating rate coupon (contractual interest rate)
  • Commonly senior secured
  • Some benefit from financial covenants
  • Retail investors can gain exposure through mutual funds and ETFs
  • Experience significant price volatility over the course of the business cycle
  • Meaningful risk of bankruptcy and principal loss but less principal risk than for high yield bonds

Characteristics of high yield bonds

  • Fixed rate coupons
  • Commonly unsecured
  • Limited benefits from financial covenants
  • Retail investors can gain exposure through mutual funds and ETFs and through direct ownership (not recommended due to high trading costs)
  • Significant cyclical price volatility
  • Meaningful risk of bankruptcy and principal loss

Leveraged debt background

Leveraged bank loans and high yield bonds are most commonly created to finance acquisitions of large businesses or other transactions by private equity firms.  These acquisitions are frequently financed with a combination of bank loans and bonds; as a result there is a large overlap of corporate issuers in the leveraged loan and high yield bond markets.  Loans and bonds offer different advantages to borrowers.  By investing in the secured claims of the issuer, loan investors take less principal risk than high yield bond investors.  As a result, nominal high yield bond coupons tend to be larger than nominal bank loan coupons.  Because they take more principal risk, high yield bond prices in the secondary market tend to be more volatile than loans’.

Advantages of investing in leveraged bank loans

  • They offer large, current, floating-rate coupons (more than LIBOR + 1.75%)
  • The floating rate coupon shields investors from losses in the event inflation and interest rates begin to rise and thereby simplifies portfolio management
  • Senior secured status means that bank loan investors will get the best recovery of all investors in the event of the obligor’s bankruptcy. It is common for bank loan investors to recover 100% of their investment despite significant impairment losses at junior levels of the issuer’s capital structure (secured obligations obtain a recovery prior to unsecured obligations)
  • Second-lien loans provide investment opportunities with more risk and larger coupons
  • Leveraged bank loans trade in a secondary market which is normally reasonably liquid
  • Some leveraged bank loans benefit from financial covenants which enable lenders to reprice loans if the borrower fails to meet agreed minimum financial performance targets
  • Broad downturns in the market can be reasonably anticipated enabling alert investors to take steps to hedge or reduce their risk
  • Loan market corrections and recoveries tend to precede the equity market’s
  • Moments of market illiquidity are moments of market inefficiency – finance theory teaches us that inefficient markets create economic opportunity for the astute

Disadvantages of investing in leveraged bank loans

  • Institutional investors use extensive leverage to finance their investments in leveraged bank loans – this has a twofold impact:
  • Significant selling pressure can arise when investors who have borrowed money to purchase leveraged bank loans receive margin calls
  • The secondary market can become very illiquid during broad market corrections
  • Aggressive lending, especially in the latter stages of a long period of strong demand, can lead to principal losses, even on first-lien secured bank loans
  • Limited cost to call loans results in frequent demand for interest rate reductions from corporate issuers when economic conditions are favorable
  • Significant price volatility over the course of a business cycle relative to other classes of fixed income investments can give investors a sense of motion sickness
  • Cannot be directly acquired by retail investors but there are many ways for retail investors to gain exposure to the asset class – specifically through mutual funds and ETF’s

Advantages of investing in high yield bonds

  • They offer large, current, fixed-rate coupons
  • High yield bonds are much more expensive to refinance than loans; as a result investors experience much lower demand for interest rate reductions from corporate issuers than loan investors
  • High yield bonds trade in a secondary market which is normally reasonably liquid
  • Broad downturns in the market can be reasonably anticipated enabling alert investors to take steps to hedge or reduce their risk
  • Investors focused on high yield bonds tend to use less leverage than loan investors; this helped to mute bond volatility somewhat relative to loans in the bear market of 2008 and 2009
  • Bond market corrections and recoveries tend to precede the equity market’s
  • Moments of market illiquidity are moments of market inefficiency – finance theory teaches us that inefficient markets create economic opportunity for the astute
  • High yield bonds may be purchased by retail investors but transaction costs associated with purchasing odd-lots (less than $100,000 of a specific issue) of bonds make this option unattractive for many; there are other ways for retail investors to gain exposure to the asset class – specifically through mutual funds and ETF’s
  • High yield bond exposure can be hedged by shorting bonds but the cost of carry on short positions is not insignificant

Disadvantages of investing in high yield bonds

  • High yield bonds absorb a disproportionate share of principal losses relative to leveraged bank loans in the event of the issuer’s default.
  • Aggressive lending, especially in the latter stages of a long period of strong demand, can lead to principal losses when the business cycle turns
  • Significant price volatility over the course of a business cycle relative to other classes of fixed income investments can give investors a sense of motion sickness
  • Absence of collateral increases risk of principal loss on default
  • Absence of financial covenants creates no opportunity to reprice the bonds during periods of poor business performance

Conclusion

Both leveraged bank loans and high yield bonds offer meaningful compensation to investors but they also offer significant amounts of investment risk.  Investors who understand the risks inherent in these investments can take steps to manage the risk they underwrite.  Investors who cautiously underwrite their investments in leveraged debt preserve their ability to take advantage of the market in its moments of illiquidity.  This creates the opportunity to earn significant economic profits through the credit cycle.

Past Articles

Article #1:  Is It Time to Invest in Leveraged Debt?

Coming Articles

Article #3:  Can Leveraged Debt Retest Low Premiums?

Article #4:  Signs That It’s Time to Sell Leveraged Debt

Article #5:  Signs That It’s Time to Buy Leveraged Debt

Article #6:    The Appeal of Investing in Distressed Debt

Article #7:   Investment in Leveraged Debt through the Business Cycle

Thereafter:  Updates regarding important market statistics with current commentary

For more information, contact:

Christopher C. Lucas, CFA, CPA

PRINCIPAL
clucas@valuescopeinc.com
Full Bio →

 

If you liked this blog you may enjoy reading some of our other blogs here.

Leveraged Debt Outlook

Is it Time to Invest in Leveraged Debt?

In the week ended January 11, 2018, retail investors poured $2.65 billion into the high yield bond market.  Was this a good idea?

The chart below describes the historical yield experience investors have enjoyed (sometimes endured)  through their investments in leveraged debt.

Leveraged Debt Outlook

Leveraged debt includes all below investment grade (“junk”) debt obligations of large issuers including corporations and certain governments. They are called below investment grade because the issuers have issued large quantities of debt, face significant operational problems or both.  Rating agencies assess the likelihood these issuers will default and assign credit ratings ranging from “BB” (good junk) to “B” (questionable junk) to “CCC” (risky junk).

The chart above shows that credit risk premiums were close to historic lows in early January. 

The chart above presents credit risk premiums by rating category over a period of more than 20 years.  The credit risk premium is the compensation in excess of treasury yields received by investors for investing in corporate debt.  To create a simple example, an investor in a the Merrill Lynch BB rated bond index on January 5, 2018 would expect to earn:

  Credit Risk Premium + Treasury Bond Yield = Expected Return

                  1.99%           +      2.40%           =   4.39%

The yield on 7 year US Treasury bonds on January 5 was 2.40% (we assumed the average term to maturity on bonds in the index approximates 7 years).  When we add the credit risk premium on “BB” rated bonds of 1.99%, we obtain an expected return of 4.39%.  In the case of an individual bond, the expected return might also be described as the yield to maturity.

The chart above shows that credit risk premiums on below investment grade debt vary widely during the course of the business cycle.  During good times, investors are calm and do not require large credit risk premiums.  During tough times, investors are fearful and expect much larger returns for putting cash to work in risky investments.  Since the contractual rate of interest on a bond is fixed, an increase in the required return is reflected in the price at which the bond trades in the secondary market. 

In an extreme case, if the required return (treasury yield + credit risk premium) on a bond with a 5.0% contractual interest rate increases to 20.0%, the bond’s price changes as follows:

  5.0% coupon / 20.0% required return = 25

In this example, the bond’s price would fall by 75% to 25 cents on the dollar.

The low points of the graph above represent moments when bonds are expensive (unattractive) relative to their long term average prices and the high points on the graph represent moments when bonds are inexpensive (attractive).

The chart below converts the credit risk premiums described in the first chart into approximate historical prices.  For simplicity, we calculated prices assuming the average high yield bond in each index had a remaining term to maturity of seven years and paid an annual cash coupon of 7.0%. 

Leveraged Debt Outlook

This chart reflects the fact that leveraged debt investment prices are subject to significant changes in value over time.  Because these investments are subject to high degree of risk, investors should exercise caution when investing in them.

The next six articles in this series provide important background information regarding the leveraged debt markets (Article #2) and guidance regarding when to invest and how to structure investments in leveraged debt (Articles #3 through #7).

Outlook and Conclusions

The last broad correction in leveraged debt began in the third quarter of 2007, more than 40 quarters ago.  Credit risk premiums are nearing their all time lows and structural market changes could make it difficult to every reach previous lows (see Article #3).

We do not anticipate a significant correction in the leveraged debt markets in 2018 but we believe that, as of early January 2018, leveraged debt investments presented modest return potential with significant risk of future loss.  Timing is important to successful investment in leveraged debt. 

Active investors who vigilantly monitor economic and market conditions will likely be able to wring further gains from this increasingly dry market.  Passive investors may find that the risks presently outweigh the rewards.

Coming Articles

Article #2:  Leveraged Debt Investment Alternatives

Article #3:  Can Leveraged Debt Retest Low Premiums?

Article #4:  Signs That It’s Time to Sell Leveraged Debt

Article #5:  Signs That It’s Time to Buy Leveraged Debt

Article #6:    The Appeal of Investing in Distressed Debt

Article #7:   Investment in Leveraged Debt through the Business Cycle

Thereafter:  Updates regarding important market statistics with current commentary

Data Sources for the Article

The data presented in this article was obtained from the Federal Reserve Bank of St. Louis (ICE Benchmark Administration Limited (IBA), ICE BofAML US High Yield B Option-Adjusted Spread [BAMLH0A2HYB], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/BAMLH0A2HYB, January 8, 2018) and from the Leveraged Commentary and Data news service provided by Standard and Poors Corporation.

For more information, contact:

Christopher C. Lucas, CFA, CPA

PRINCIPAL
clucas@valuescopeinc.com
Full Bio →

If you liked this blog you may enjoy reading some of our other blogs here.

Simple Analysis is Never a Solution in Valuing Complex Derivative Securities

Valuing Complex Derivative SecuritiesValuing Complex Derivative Securities

Even though private equity fund managers are in the business of sourcing and investing daunting amounts of money into a variety of private companies, their mindset often resembles that of the businesses in which they invest. In their 2015 Annual US PE Fund breakdown, Pitchbook identified the average size of a PE firm in 2015 was $177,000,000. Assuming a pretty standard annual management fee of 2%, the fund manager of an average PE fund in 2015 “earned” $3,540,000 of revenue from management fees…and probably close to $0 in free cash flow. This is because they spend their revenue like most small businesses; on human resources, rent, travel & entertainment, infrastructure, capital formation with potential investors, and marketing to potential portfolio companies.

PE Fund managers typically don’t achieve “free cash flow” until they begin to harvest their portfolio company investments 5-10 years into their fund’s lifespan. On top of that, unlike most business owners, they typically don’t get to participate in the profits of their labor until their investors first recover a preferred annual return somewhere in the neighborhood of 8%. Said differently, on a $177,000,000 fund, they have to return $14,160,000 per year before they can participate in the incremental profits of the fund! For a $177,000,000 fund, that’s about $70 million over 5 years!

While the image of a “vulture” private equity firm descending upon the salt-of-the-earth family-run enterprise has become ingrained in pop culture and the political discourse, the fact is that the vast majority of private equity firms are run just like small businesses too. Entrepreneurs should keep this in mind the next time a Private Equity fund contacts them about a prospective growth investment or buy-out.


Tags: Valuing Complex Derivative Securities

Dr. Scott Hakala has extensive practical knowledge of finance, economics, statistics, and business valuation theory. His expertise includes: corporate finance, restructuring and cost of capital; the valuation of securities and business interests (transactions, mergers, acquisitions, fairness opinions); the valuation of intangible assets (patents, trademarks); analysis of publicly traded securities (insider trading studies, trading analyses, event analyses, materiality, damages in securities litigation); expert testimony and economic loss analyses (commercial litigation); wage and compensation determination (reasonable compensation studies, lost personal income, wrongful termination); transfer pricing; derivative securities (options pricing and valuation); and antitrust and industry structure, strategic pricing, marketing and cost allocation analyses.

If you liked this blog you may enjoy reading some of our other blogs here.

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Are most Private Equity fund managers small business owners too?

Private Equity Fund Managers Small Business OwnersPrivate Equity Fund Managers Small Business Owners?

Even though private equity fund managers are in the business of sourcing and investing daunting amounts of money into a variety of private companies, their mindset often resembles that of the businesses in which they invest. In their 2015 Annual US PE Fund breakdown, Pitchbook identified the average size of a PE firm in 2015 was $177,000,000. Assuming a pretty standard annual management fee of 2%, the fund manager of an average PE fund in 2015 “earned” $3,540,000 of revenue from management fees…and probably close to $0 in free cash flow. This is because they spend their revenue like most small businesses; on human resources, rent, travel & entertainment, infrastructure, capital formation with potential investors, and marketing to potential portfolio companies.

PE Fund managers typically don’t achieve “free cash flow” until they begin to harvest their portfolio company investments 5-10 years into their fund’s lifespan. On top of that, unlike most business owners, they typically don’t get to participate in the profits of their labor until their investors first recover a preferred annual return somewhere in the neighborhood of 8%. Said differently, on a $177,000,000 fund, they have to return $14,160,000 per year before they can participate in the incremental profits of the fund! For a $177,000,000 fund, that’s about $70 million over 5 years!

While the image of a “vulture” private equity firm descending upon the salt-of-the-earth family-run enterprise has become ingrained in pop culture and the political discourse, the fact is that the vast majority of private equity firms are run just like small businesses too. Entrepreneurs should keep this in mind the next time a Private Equity fund contacts them about a prospective growth investment or buy-out.

Christopher C. Lucas, CFA, CPA

PRINCIPAL
clucas@valuescopeinc.com
Full Bio →