Introducing the Green Economy

Investors have always looked at various elements for their investments in order to make the best choices and historically it was mainly a matter of returns. Responsible investments began in the 1960s as a social criterion, with investors excluding stocks involved in tobacco production or in the South African apartheid regime. For a long period of time, investors believed that ethical investments were reducing returns due to their nature. At the time, philanthropy was not known to be profitable. Furthermore, M. Friedman argued in the 70’s that the cost of behaving ethically would reduce returns.

However, due to the growing fears concerning climate change and new research (in particular Moskowitz’s in 1988) on the topic, Environmental, Social and Corporate Governance (ESG) factors became three leading criteria investors started looking at. ESG investing was given a shot in the arm when United Nations introduced the Principles on Responsible Investing (PRI) in 2006. The PRI has been signed by more than 2000 companies all over the world, including the main financial institutions such as Goldman Sachs, JP Morgan, Morgan Stanley or BlackRock and representing around $10.4 trillion out of the overall $89.6 trillion worldwide assets under management as of April 2018. The signatories have to commit to six voluntary principles such as, the incorporation of ESG issues into investment analysis and decision making and to increase disclosure about their environmental standards, their supply chains and their treatment of employees. ESG investing was even given a further push thanks to the Sustainable Development Goals (SDGs), a collection of 17 goals divided into 169 targets, set by United Nations in 2015 and to be achieved by 2030.

The same mainstream has been reached by Green Bonds, an investment solution that allows investors to generate profits while taking care of the planet’s health.

 

ESG investing

Nowadays many investors look at ESG factors to incorporate them into the investment process alongside with the traditional analysis. As you may have understood, now the approach to ESG investing is segmented into Environmental, Social and Governance factors. But those are only the three main criteria, whereas there are also subcategories for all of them. Regarding the Environment it could be divided into: climate change, natural resources, pollution & waste and environmental opportunities. The Social aspect mainly focuses on human capital, diversity, product liability, consumer protection and animal welfare. While Corporate Governance covers management structure, transparency, business ethics and employee relations.

Those factors can then be included in the investment process in two ways. Firstly, the “best in class” approach, focalizing into companies which within a sector have the best practices in term of sustainable development. Therefore, companies that are either polluting less or are having better social relations compared to companies in the same sector. Secondly, the “best in universe” approach, grouping companies that have the best sustainable development practices regardless of their sector of activity.

 

A growing trend

During the past years we saw heavy inflows into ESG investments and an increasing demand for those (Social Responsible Investments, SRI, rose by 33% between 2014-2016, up to $8.72 trillion). According to various studies, this is just the beginning and it can be explained by three main reasons.

Firstly, as mentioned above, the world is changing. Investors are getting more and more aware of climate change and its implications. According to a survey of Morgan Stanley, millennials are two times more likely to invest in companies targeting social or environmental goals compared to the overall population. Furthermore, global sustainability challenge is introducing new risk factors for investors and may force them to re-evaluate their traditional investment approach preferring an ESG one. Secondly, because investors are changing. Quoting a study made by Accenture, in the next decades there should be a wealth transfer of $30 trillion from baby boomers to 90 million millennials, which should likely be translated into roughly $20 trillion put into ESG investing. And lastly, thanks to the evolution of data and analytics on this topic available in the market. Better data and transparency from the companies will allow ESG investors to have accurate and precise information for their investment process.

 

A new approach for financial returns

As mentioned in the introduction, the main issue of ESG investing was the fear of lower returns, although some studies have proved the opposite. A recent MSCI study showed how companies with solid ESG practices have a lower cost of capital, lower volatility, and less bribery, corruption and fraud, in contrast to companies with poor ESG practices. The latter having higher cost of capital as well as higher volatility.

The graph above shows an analysis of the MSCI Emerging Market ESG Leader Index and the MSCI Emerging SRI Index returns compared to MSCI Emerging Markets Index. We can see that Companies with higher ESG ratings are usually associated with higher profitability, lower tail risk and lower systematic risk.

In order to invest in the right companies, asset managers are relying on more and more ESG rating agencies. Moreover, as the general demand is increasing, ESG indexes such as the Dow Jones Sustainability Index, the FTSE4Good Index, Bloomberg ESG data or the MSCI ESG Indices are rising in inflows.

 

Green Bond

A new initiative

Among the other market players, there is a non-profit organisation managing to mobilise a huge amount of money for climate change solutions. Its name is “Climate Bonds Initiative”, and the declared strategy is “to develop a large and liquid Green and Climate Bonds Market that will help drive down the cost of capital for climate projects in developed and emerging markets; to grow aggregation mechanisms for fragmented sectors; and to support governments seeking to tap debt capital markets”. By having a look its website, it is possible to figure out how its activities look like. Firstly, it manages the “Climate Bond Blog”, which is essentially a journal of record for relevant bond issuance including also some important industry updates, as well as drawing up a report concerning global outstanding bonds. The second workflow is related to developing trusted standards. The aim of these standards is to lead investors when making the right choice in order to tackle climate changes. Lastly, they provide policy proposals in the attempt to harmonise the work between governments, finance and industry.

At this point, someone could ask why there was the necessity to give birth to such a specific organisation. The answer lies in the overpowering rise of the abovementioned securities known as “Green Bonds”. These are issued by financial institutions, governments or companies allowing investors to receive their own returns but at the same time to contribute financing climate and environmental projects, and there is nothing else more right to do. In order to be labelled as Certified Green Bond, a security must undergo a strict process, at the end of which an Approved Verifier submit an assurance report to confirm that the bond meets the Climate Bonds Standard’s requirements. However, the Climate Bonds Standard Board has the final word. Certifications can be split in Pre-Issuance and Post-Issuance Certification, and they are available for asset related to specific sectors, currently including Solar Energy, Wind Energy, Geothermal Energy, Marine Renewable Energy, Water Infrastructure, Low Carbon Transport & Low Carbon Building. Nevertheless, other assets related to different sectors can be published after being approved by the Climate Bonds Standard Board. After the Post-Issuance verification, issuer’s duties are not over, since it is asked to provide the Climate Bonds Secretariat with annual reports with the purpose of keeping the compliance with the requirements.

 

2018 figures

Since their inception, Green Bonds have represented an unstoppable phenomenon that has seen the greatest global institutions as major players. The first socially-responsible fixed income security (€600m) has been issued in 2007 by the European Investment Bank, followed one year later by the World Bank, which issued the first Green Bond in history (€400m).

From 2008 on, a great work has been done in order to enhance the process, achieving relevant results. If we have a look again at a document from Climate Bonds Initiative, the 2018 Green Bond Market Summary, we can find some interesting figure that can help us understanding why last year has been exceptional concerning the green economy. Global green bond issuance reached $167.3bn in 2018, a figure that represents a 3% increase on 2017. Specifically, there have been 1,543 green bond issues from 320 issuers from 44 countries. The largest single green bond has been issued by Belgium with €4.5bn. USA has occupied the top spot in the bond issuance rankings for countries, followed by China and France. These three countries have already been ranked in the same positions in the previous years, and put together they have accounted to roughly $80bn issued in 2018. Consequently, it is easy to understand why the largest global issuer is an American company (Fannie Mae, $20.1bn), and the second one is Chinese (Industrial Bank Co, $9.6bn).

Source: Climate Bond Initiative – 2018 Green Bond Market Summary

Source: Climate Bond Initiative – 2018 Green Bond Market Summary

In addition, also Emerging Markets are playing a key role in the sector. With the contribution of Supranational Development Banks, EM accounted to the 31% of the total issuance. Obviously, China leads the group with 78% of EM’s issuance. Thanks to the introduction of the ASEAN Green Bond Standards, issuer from Thailand and Indonesia joined the market, with the latter becoming the first sovereign bond issuer from Asia in March 2018. On the European side instead, Poland, Iceland, Lithuania and Slovenia have been the major contributors.

Source: Climate Bond Initiative – 2018 Green Bond Market Summary

 

Outlook 2019

Fortunately, also the outlook for 2019 seems to be positive according to Moody’s Investors Service. Indeed, the rating company has forecast green bond issuance to increase up to $200bn globally, representing a year-on-year growth of c.20%. The driving factors will be the increased use of the United Nations’ Sustainable Development Goals (SDG), as well as the “heightened commitment to addressing climate change”. Moreover, not only just an overall increase is expected, but also a consistent diversification in terms of sector, region and use of proceeds. Lastly, the fact that it will be easier to qualify a project as green is going to be beneficial for the growth of the sector as well.

However, not only Green Bonds market is about to explode in 2019, but also Social and Sustainability Bonds are pushing to reach a recognised position. With the birth of the SDG frameworks in 2018, investors are now able to decide where to channel their money to bonds financing green projects or to those financing social ones. According to CBI, Sustainability Bonds issuance has risen up to $21bn, a figure representing a 114% growth over 2017. Considering these trends, it is reasonable to point out that 2019 will be the year of a great consecration.

 

It’s just the beginning

The investors’ change of mindset is shifting the world from a sole return-driven perspective to a more ethical and sustainable way of investing. This process is clearly helped by the implementation of new regulations by the United Nations and financial institutions. This is taking time and energy; and there is still a lot to do. As a study of PIMCO illustrates, although a lot of companies have a high level of awareness of the SDGs, only few are setting quantitative targets, letting us think that many are struggling to translate well-intentioned resolutions into action.

A key challenge is to develop an agreed set of performance indicators that shows a company’s target and progress. This would be extremely important for investors, in order to compare the SDG contribution of companies. We encourage financial institutions and private investors to do so and to keep on making investments in a more responsible way (obviously with the objective of delivering returns).

Is all this going to lead to a permanent change in investors’ mentality or are we just witnessing a fancy, but temporary, trend?

 

Authors: Federico Giorgi, Thomas Bauzon

 

Supervisor: Carmen Alvarez

1. PE funds produced another impressive surge in investment value in 2018, capping the strongest five-year stretch in the industry’s history. Fierce competition and rising asset prices continued to constrain deal count (i.e. the number of transactions fell by -13%, to 2,936 worldwide) with total buyout value jumped +10% to $582bn supported by a strong growth of public-to-private transactions which globally reached their highest value since the previous take-private boom in 2006–07.

2. Despite the steady pace of investment, PE dry powder has been on the rise since 2012 and hit a record high of $2tr at year-end 2018 across all fund types and $695bn for buyouts alone. The build-up of excess capital is putting pressure on PE firms to find deals, but the good news is that buyout firms hold 67% of their dry powder in funds raised over the last two years, meaning the recent deal cycle is clearing out the older capital and replacing it with new.

3. The stiff competition and high multiples (i.e. 10.9x was the average EV multiple for North American buyouts in 2018) that made it challenging to find deals in 2018 also made it a great time to exit. With 1,146 transactions valued at $378bn, exit activity came in a smidgen lower than in 2017, but the total was still a strong contributor to a historic five-year stretch that has produced unprecedented distributions for investors. There was clearly some urgency on the part of GPs to sell assets, as signs of economic weakness pile up. The median holding period for buyouts fell last year to 4.5 years, after edging down slowly from a peak of 5.9 years in 2014. PE funds continued to attract an impressive amount of capital in 2018, although the pace fell off from 2017’s record-breaking performance. GPs raised $714bn from investors during the year (i.e. the third-largest amount ever) bringing the total since 2014 to $3.7tr. LPs remain committed to what has been their best-performing asset class (i.e. 90% of all institutional investors say they intend to maintain or increase their PE allocations).

4. After several years of heavy stock market volatility around the world, buyout funds continued to outperform public equity markets in all major regions, over both short and long time horizons. At the same time, buyout returns in the current cycle have not been as robust as they were in the previous cycle. As the overall PE industry has matured and become more competitive, the outsize returns that GPs could once earn on a large pool of undervalued assets are harder to find. Yet, top-performing funds still exceed the industry average by a relatively wide margin.

SOURCES

• Global PE report 2019 – Bain & Company https://www.bain.com/contentassets/2792a2cbcdcf4e94acfddc077a85c5ea/bain_report_private_equity_report_2019.pdf

From Quantitative Easing to Tightening Policies

On Tuesday 16^th December 2008, following the recession, the Federal Reserve lowered its benchmark interest rate to a range of 0 – 0.25%. The central bank also implemented the Quantitative Easing, which consists in purchasing US Treasuries and mortgage-backed securities to increase liquidity and stimulate the economy with new printed money.

In December 2015, based upon a better economic backdrop, Janet Yellen as Chair of the Fed, began a tightening policy. Since then, the Fed has raised the interest rates by 25 basis points 9 times, rising from 0 – 0.25% to a range of 2.5 – 2.75% in only 3 years. Since Jerome Powell succeeded to Yellen as Chairman of the Fed, his increasing confidence in the US economy, based upon accelerating inflation and a solid economic backdrop, allowed the Fed to raise the interest rates 4 times in 2018. While the Fed had signaled it would probably raise rates twice in 2019 and twice in 2020 to finally reach 3.5-3.75% in 2020, a dovish January Fed meeting changed expectations as it seemed the central bank would be more patient than expected regarding a future rate increase.

Figure 1: Federal Reserve’s funds rates increasing over time

   Source: Macro Trends

Borrowers taking cautious stances

Since the tightening policy began in December 2015, signs of rising inflation, pushed the central bank into a more hawkish direction, raising the rates by 2.25% in 3 years. A moderate rising inflation is indeed an indicator that the economy is doing well, and it paves the way for salary increases but also interest hikes. Higher rates allow a better yield for savers, but it also means consumers and business will face higher costs when they want to access credit. Even more worrying, with US incomes still relatively flat, higher interest rates mean many homeowners with flexible-rate mortgages may be unable to repay their loans. This was one of the causes for the subprime crises: people took on mortgage debt at a very low interest rate thinking they would be able to reimburse it, but when the rates increased, they found themselves with not enough liquidity to pay back their interests on debt and lost a major part of their savings. And not only…

Bond holders see their prices fall…

A tightening monetary policy is a negative news for investors who see the price of their bonds fall. Interest rates and bond prices have an inverse relationship; meaning if one goes up, the other goes down. Therefore, if the interest rates increase, the value of a bond will decrease. The reason for this is that new bonds can now be issued at a higher yield and will therefore give a higher return than the bonds which are already on the secondary market pushing the demand for the existing bonds down together with their price.

“If the Fed is buying Treasuries, investors have to go further out the risk spectrum in search of returns,” said Subadra Rajappa, head of US interest rate strategy at Société Générale. “So, if the Fed is unwinding QE then the reverse should be happening. It should be negative for credit spreads and equities”.

…and so do equity holders

It seems the market wasn’t prepared to switch to quantitative tightening as US stocks had their worst December since 1931. The S&P 500 Index fell 15.7% between December 3^rd and December 24^th, when it reached its lowest point of the month. The Dow Jones Industrial Average fell 15.6% entering the correction zone.

Equities usually underperform during tight monetary policy periods. The higher the interest rates, the easier for investors to find low risks investment with high yields, such as bonds. As risk appetite is restricted, equities sell-off drives stock markets prices lower. On the other hand, higher interest rates environment impacts investor confidence that the economy is growing strongly enough for the corporations to offset the impact of higher borrowing costs.

Figure 2: S&P 500 (blue) and Dow Jones (red) Indexes falling for the month of December

The impact on the Yield Curve

The Yield Curve is a graphic representation of the interest rates at different maturities for a given credit quality. The most common yield curve compares different maturities of the U.S. Treasuries. The tightening policy of the Fed controls short-term interest rates but has very little impact on the long-term. Therefore, the Fed monetary policy has a crucial impact on the Yield Curve. As shown on the graph below, as short-term interest rates rise, the spread between the short-term and long-term maturities diminishes, which causes a flattening of the yield curve over the years. Concerns rose around the flattening of the yield curve as it means investors do not expect to get a higher yield for long-term investments than for short-term investments even though long-term ones are riskier. In other words, it means investors expect an economic slowdown in the future.

Figure 3: US Treasury Yield Curve

Source : Guru Focus

The flattening Treasury yield curve has also raised concerns as it paves the way for a future inversion. An inverted yield curve is an interest rate environment in which long-term debt securities have a lower yield than short-term debt securities. It means that investors expect their return to slow down in the future, hence, an inverted yield curve has often been seen as an anticipator of a recession, as it has been historically observed twice and both times it was the case. The Fed takes into account inflation, economic growth and unemployment when voting for a rate hike, however it may also take into account the yield curve and pause hikes if it were to flatten further or possibly inverts.

Figure 4: The visual representation on the inverted and the normal yield curves

Source : Forbes

The impact on Emerging markets

Fed’s U-turn from Quantitative Easing (QE) to Quantitative Tightening (QT) is pretty significant for emerging markets (EMs).

As already said above, following the financial crisis, the Fed injected liquidity into the market aiming to ease financial conditions and borrowing costs by increasing demand for relatively safe assets. As a consequence, prices rose, and interest rates fell (this is the supposed effect of a QE).

Central banks across EMs followed suit, to allow non-financial corporations to get cheaper debt, consequently, private credit across EMs ballooned. Now that central banks are holding their current portfolios of bonds until maturity and selling the assets on their balance sheets to the market (QT), that private credit has started to shrink (Figure 5). Given that “credit creation has been the most important driver of asset prices for decades” as credit creation has pulled back, economies have tumbled.

Figure 5: Private sector credit creation started falling

Source : National Central Banks

EMs have strongly been affected by this unwinding for two main reasons:

1. They binged the most on the giant pool of cheap money in the years since the crisis
2. As the Fed started shrinking its balance sheet, as observable on the appendix 1, the supply of global dollars will also shrink making it more expensive. The dollar rally in 2018 worsened currency crises in the economies with large dollar-denominated debt (Appendix 2).
3. Higher interest rates in US means higher returns for dollar-denominated banking accounts that increase investors’ demand for dollars consequently making the USD more expensive vs other currencies (Appendix 3). 

Appendix 1: Fed’s balance sheet, showing a steep increase after the 2008 crisis and now starting to decrease

Source : Bloomberg

Appendix 2: the huge evolution of the Chinese debt in US dollars value, representative on the EMs debt trend

Source : IMF data, Tradingview representation

Appendix 3:  Balance sheet roll off is supportive for the Dollar

Source : CitiFX, Bloomberg

Authors: Noa Lachkar, Greta Pontiglio

Supervisor: Lorenzo Bracco

By Ascanio Rossini

The race to become Europe’s first $100bn private-equity firm is accelerating as the recent fundraising boom shows. Europe’s largest investment firms, including Ardian, Partners Group and CVC Capital Partners, are closing in on $100bn in AuM after raising some of their largest-ever funds in recent years and launching new investment strategies in areas such as infrastructure, credit and real estate. Their rapid growth from single-fund PE shops to multi-strategy asset managers comes as the asset class has matured from a cottage industry 20 years ago to one attracting hundreds of billions of dollars annually from some of the world’s largest institutional investors.

Keeping Pace

The rapid growth of these firms also raises questions about whether firms are expanding their teams and building out the infrastructure sufficiently to keep pace with their growing assets. Money flooding into the asset class in Europe is concentrating in the hands of fewer firms, much like the U.S. market. New York-based Blackstone, for example, manages nearly $500bn, ranking it as the largest firm by assets.

Paris-based Ardian, established in 1996 as the captive private-equity arm of French insurance conglomerate AXA, leads the pack of European managers closing in on the $100bn mark.

Ardian now manages $82bn on behalf of its investors (more than double of what it managed in 2013), but is seeking an additional $25bn in new cash across its various investment strategies, including a flagship buyout fund and a global secondary fund, as well as vehicles focused on North American buyouts, private debt and European infrastructure.

Meanwhile, Ardian’s Swiss rival Partners Group, Europe’s largest listed private-equity firm, has turned itself into a fundraising machine after switching its investment focus a decade ago from backing private-equity funds to making direct investments. The Swiss firm now manages $78bn.

London-based CVC, the former owner of Formula One, is another candidate that could join the $100bn club, although perhaps a bit later than the others. The firm managed some $69bn in assets as of Sept. 30 after collecting €16bn in 2017 for the largest buyout fund ever raised by a European private-equity manager.

Increasing assets under management by moving into new markets means PE firms stand to enrich themselves by boosting the fees they receive from investors. Buyout shops typically make cash by taking a slice of profits from successful investments as well as by charging a 2% fee on the money they manage. The decision to move into different investment strategies has prompted a mixed reaction from some investors. Some see it as an opportunity to put large sums of money to work with a manager they know and trust; others as an excuse to increase the money they make in fees.

Increasing Staff

To keep pace with the growth in assets, many of the largest European firms are expanding into new geographies and ramping up the number of staff they employ. Partners Group for example, employs more than 1,000 executives globally; nearly double the 560 workers Ardian has on its payroll.

Investment firms, including Neuberger Berman’s Dyal Capital Partners and Goldman Sachs’ Petershill unit, buy stakes to gain a cut of the fees firms charge and the profits from their deals.

Bridgepoint, which has recently moved into credit and manages small-cap funds, became one of the first major buyout shops in Europe to strike such a deal when it sold a chunk of itself to Dyal Capital in August.

The continuing flood of capital flowing toward Europe’s buyout giants comes with a risk. Firms will have to be careful to ensure they don’t raise more money than they can prudently spend, as dry powder in Europe reached a record of €220bn as of Q4 2018, pushing asset prices up to an all-time high in 2018.

“This is the kind of environment—marked by too much money chasing too few deals – in which investors should emphasise caution” said Howard Marks (OakTree Capital co-founder).

Sources:

PE News – https://www.penews.com/articles/the-race-is-on-for-europes-firms-to-join-the-100-billion-club20190121

PE Insights – https://pe-insights.org/the-race-to-be-europes-first-100bn-private-equity-firm/

FN News – https://www.fnlondon.com/articles/the-race-to-be-europes-first-100bn-private-equity-firm-20190122

Authors: Qitong Sun and Massimiliano Marchisio

Date	30 November 1988
Type of transaction	Leveraged Buyout
Valuation	7.5-8.0x FY 1988 EBITDA of c. $3.1bn
Bidder	KKR
Target company (sector) Financials	RJR Nabisco (Tobacco & Food) FY1988 Rev./EBITDA $16.9bn/$3.1bn (margin c.18.3%)
Rationale	RJR Nabisco’s operations exhibited moderate and consistent growth, required little capital investment and carried low debt levels.  All these features made it a particularly attractive LBO candidate. Though it had problems of declining ROA and falling inventory turnover, they appeared fixable.

On November 24th, 1988, the board of RJR Nabisco finally announced its acceptance of a revised proposal from KKR, with $25bn ($109 per share). KKR won the competitive process for the ownership and control of RJR Nabisco, a victory that resulted in the largest corporate control transaction in the US, opening the road for large corporate buyouts.

History of the RJR Nabisco takeover

• 1985 – RJR Nabisco was formed in 1985 when Nabisco merged with RJ Reynolds tobacco. The CEO F.Ross Johnson, originally from Canada, was known for a risky, bold decision making process inside the boardroom.
• 20th October 1988 – Johnson decided to take the company private and proposed a $17bn LBO. Company shares rose sharply on the news. Sherson Lehman Hutton announced they would take the company private at $75/share.
• 26th October 1988 – KKR & Co. made an offer $20.4bn, but the deal was rejected. Salomon Brothers, Forstmann Little, Shearson Lehman Hutton, Goldman Sachs, First Boston, Merrill Lynch, Morgan Stanley, and more are all trying to get in on the action. A few days later, RJR Nabisco gave KKR confidential financial data about its operations.
• 2nd November 1988 – KKR and RJR Nabisco tentatively agreed to join forces, but just after one day, the agreement failed. After that, RJR Nabisco upped the ante by making a $92/share offer (i.e. $20.9bn).
• 18th November 1988 – Fist Boston put together a deal. Working with the Pritzker family in Chicago, offering between $23.8bn and $26.bn.
• 29th November 1988 – Management offered $22.9bn, KKR offered $24bn and First Boston offered $23.38 to $26.1bn. The stock price jumped to $90.88.

30th November 1988 – Finally, the company went to KKR for $24.9bn or $109 a share. Mr Johnson received $53m from the buyout, $23m after taxes.

The RJR Nabisco transaction warrants particular attention. Not only is it the largest LBO on record, but it also features a particularly wide range of sophisticated players, a complex set of innovative financial instruments, and a challenging valuation process.

Successful LBOs are generally characterized by both low business risk and moderate growth. RJR’s unlevered beta was 0.69, which means the firm was relatively insensitive to market-wide fluctuations. Although the growth rates of tobacco and food were 9.8% and 3.5% respectively, most analysts had forecast a slower long-term growth rate in both units. Together with the firm’s little capital investment requirement and low debt levels, RJR Nabisco was a particularly attractive LBO candidate.

ESCP PE-Team View

How did KKR win if its offer was low?

By traditional standards, RJR management should have won the bidding war. Its offer, $112 a share, was higher than KKR’s by nearly $700m, its cash portion of the offer (i.e. $84) was higher than KKR’s ($81), its members were all industry experts with an intimate knowledge of the company and management was on good terms with the board members. Nevertheless, when the bidding ended, traditional factors did not determine the winner. The management group lost.

Why?

Here the following factors had led to the success of KKR’s lower bid:

• The break-up factor – KKR promised to keep the tobacco and most of the food business intact, which matched the board’s will to keep the company as intact as possible. While KKR promised to keep the tobacco and most of the food business intact, the management group planned to keep only the tobacco business. Indeed, KKR specified that it would sell only $5bn-$6bn of RJR assets in the near future, while the management group planned to sell the whole food business (estimated at $13bn).

To sum up: Better negotiations carried out by Henry Kravis and George Roberts (co-founders of KKR). The reality is the KKR kept its options open, not disclosing its long-term pans.

• The equity factor: The board’s five person committee wanted to provide existing share-holders with an option to participate in the buyout and thus share in any future KKR profits from the transaction. The desire was to leave some portion of the company’s stock in public hands. While KKR proposed to distribute 25% of the equity in the future company to existing shareholders, the management grup offer included only 15%.

To sum up: Better terms and proposal deriving from a higher expertise in meeting boards’ requests.

• Financing structure: Based on an analysis performed by the advisors to the board’s committee, KKR was offering $500m more equity than the management group, which again accommodated the board’s objective of maximizing current shareholders’ participation in future profits.

To sum up: Better understanding of businesses’ capital structures and again higher expertise in meeting boards’ requests.

• Post-LBO leadership: The intensive bidding war affected all parties involved (including management, employees, communities and the bidders themselves). During the bidding period, the uncertainty was high and business was affected. In the interest of restoring stability, the board’s special committee assessed each offer in terms of its effects on RJR’s identity and culture. KKR quickly read the board’s mind and announced its plan to install J. Paul Sticht as the new CEO (vs. management which proposed Johnson to continue as CEO). For various reasons (i.e. most expensive fleet of corporate jets and poor public relation) the board associated MR. Johnson’s group with greed, lavish spending and insensitivity to employee and community needs.

To sum up: Again KKR demonstrated higher expertise vs management in meeting boards’ requests.

The board assessed each offer in terms of its effects on RJR’s identity and culture, and finally placed more preference on KKR. KKR was able to recognise that financial factors, as well as the acquiring group’s goodwill, would play a decisive role in the game.

About RJR Nabisco – was an American conglomerate, selling tobacco and food products, headquartered in the Calyon Building in Midtown Manhattan, New York City. RJR Nabisco stopped operating as a single entity in 1999; however, both RJR (as R.J. Reynolds Tobacco Company) and Nabisco (now part of Mondelēz International) still exist.

 About KKR & Co. – is a global investment firm that manages multiple alternative asset classes, including private equity (corporate buyouts, infrastructure and real estate), credit, and through its strategic partners, hedge funds. As of September 30, 2018, Assets under Management were $195 billion.

SOURCES

• The New York Times (1988) https://www.nytimes.com/1988/12/02/business/history-of-the-rjr-nabisco-takeover.html
• Duke Law Journal (1989) https://scholarship.law.duke.edu/cgi/viewcontent.cgi?article=1278&context=faculty_scholarship
• Financial Analysts Journal (1991) https://homepage.univie.ac.at/youchang.wu/RJB.pdf
• Fortune Magazine (2003) http://archive.fortune.com/magazines/fortune/fortune_archive/2003/10/13/350888/index.htm
• Business Insider (2012) https://www.businessinsider.com/rjr-nabisco-lbo-private-equity-deal-2012-1?IR=T#meanwhile-pe-firm-forstmann-little-played-with-entering-the-race-but-ultimately-decided-not-to-which-caused-the-stock-to-plummet-9
• Investopedia (2018) https://www.investopedia.com/articles/stocks/09/corporate-kleptocracy-rjr-nabisco.asp

By Ricardo Mühle, Felix Paul Schäfer and Massimiliano Marchisio

Date	October 1st 2018
Type of transaction	Public delisting tender offer
Valuation	15-15.5x LTM 2018 June EBITDA of c. €410m
Bidder	Cinven-Bain Capital consortium
Target company (sector) Financials	STADA AG, “STADA” (Medical – Pharmaceuticals) FY17 Rev. / EBITDA: €2.3bn / €0.4bn (17.4% margin)
Advisors (first bid) Advisors (second bid)	Evercore, PWP, Deutsche Bank (sell-side) JP Morgan, Jefferies, Barclays, Rothschild, UBS (buy-side) JP Morgan (buy-side)
Rationale	STADA has a leading position in the pharmaceuticals space with potential for value appreciation via organisational changes, operational efficiencies, M&A build-ups and concentration of product portfolio

August 16th 2017 – Cinven and Bain jointly announced the successful takeover of 63.87% of STADA, initially valuing the German drug maker at €5.3bn, making it the largest buyout in this sector in over four years. One year after, the two PE giants acquired a further 13.5% stake in the company and in October 2018 decided to launch a final public tender offer on Stada’s remaining shares.

HOW IT ALL STARTED? – THE FIRST ACT AND BIDDING WAR

• May 2016 – the starting points for the STADA acquisition were the “informal” talks between STADA, the London-based private equity firm CVC Capital Partners and the activist investor, Active Ownership Capital.
• February 2017 – these talks led to the start of a competitive process and two non-binding offers were received from Cinven/Bain and Advent International/Permira.
• April 2017 – the Cinven-Bain consortium emerged as the winner of the bidding war with an offer worth €66.00 per share (€65.28 +  €0.72 dividends per share). However, by June 2017 the Cinven-Bain offer did not reach the minimum acceptance threshold and eventually expired.  
• August 2017 – Cinven/Bain reinitiated the voluntary public takeover, increasing the offer price by €0.25 to €66.25, leading to the acquisition of 63.87% of STADA for €5.3bn (2.4x FY17A Revenue, 13.0x FY17A EBITDA).

THE SECOND ACT: SUCCESSFUL BIDS AND DELISTING

The offer on the remaining outstanding shares was an all-cash bid equal to €81.83 per STADA share, representing a premium of approximately 24% on the offer price per STADA share during the successful takeover offer in 2017 and a premium of 0.3% over STADA closing share price of €81.12, one day prior to announcement (28 September 2018). Simultaneously, Elliott Management, the famous activist hedge fund, agreed to sell its stake in the company. The combined offers value the entire business between €6-6.5bn (15-15.5x June 2018 LTM EBITDA).

DEAL RATIONALE

Private equity firms are typically not interested in participating in a firm’s administration for a very long time. However, this won’t be a touch-and-go operation.

Both PE firms have a consistent track record of growing companies through their global networks, having successfully invested in businesses for over 30 years and have expanded many of these through buy-and-build strategies.

Mr. Weidenfels – STADA’s CEO – in June 2016, outlined two key objectives for the company: “commit to a more focused strategy of concentrating the product portfolio on performing branded and generic drugs with clear growth potential. He also underlined the importance of focusing on costs reduction, particularly with regards to COGS, as well as simplifying group and operating structures”.

A private equity ownership could now accelerate the reaching of those goals. Moreover, Bain and Cinven share the strategic objective to strengthen STADA’s position as a global healthcare company and could support investments in new products, organic expansion and, more likely, accelerating its growth through bolt-on acquisitions.

What’s certain, is that the implementation of their strategy will take time, efforts and additional capital to realize STADA’s full potential. But, if the business model works, volume growth and consequent economies of scale would reward both the company and its investors.

ESCP PE – TEAM VIEW:

The STADA deal is very attractive due to its “uniqueness”. Private equity firms tend to be reluctant to invest in pure drug makers pharmaceutical companies due to the very high structural valuation of the sector and extremely strong competition potentially arising from strategic buyers. This successful story on the one hand is a clear indicator of the increasing attractiveness for drug makers (stable and recurring cash flows; favourable industry trends; multiple areas to create value and high margins), while on the other hand, is an indicator for the massive amount of dry powder private equity firms hold in their pockets (see graph 2) and lack of outstanding assets available on the market. The tender offer made by the Cinven and Bain a year after the acquisition of 63.87% is a logical step, needed to take the company private and becoming the sole shareholder. Being the sole majority shareholder was a necessary step for Cinven and Bain to have full control over the business, exploit operational efficiencies and implement the proposed growth plan to be able to generate an attractive return for its LPs.

An obvious risk in the STADA buyout is the high price Cinven and Bain decided to pay (around 15x based on LTM 2018 June EBITDA of c. €410m), which could potentially lower returns at exit, especially in a downturn macroeconomic scenario. However, with multiples continuing to rise and the opportunity for STADA to strengthen its position as a global player (STADA is expected to grow organically but also through acquiring complementing businesses) the deal seems promising. For comparative purposes, larger generics listed companies like Teva, Mylan and Aspen Pharmaceuticals are trading at multiples around 9x-10x EBITDA, and, earlier this year, Zentiva was acquired by Advent at 12-12.5x.

Graph 1: Healthcare & Pharmaceuticals – Trading multiples over the last 12 quarters (Source: PWC eValuation 2018).

Graph 2: Increase of Dry power of GPs (Source: McKinsey Global Private Markets Review (2018). The rise and rise of private markets.

About STADA Arzneimittel AG is a Germany-based pharmaceutical company engaged in development and commercialization generic and branded of pharmaceutical products. Its best-selling products are generic Viagra and Grippostad C.

About Cinven Partners LLP, founded 1988, is a London-based private equity firm focused on building European and global companies. Its funds invest in six key sectors: Healthcare, Business Services, Consumer, Financial Services, Industrials, and Technology, Media and Telecommunications (TMT). Today, Cinven has over €15.0bn in AuM.

About Bain Capital Private Equity, LP, founded 1984, is a leading international private equity and alternative investment firm, investing across asset classes including credit, private equity, public equity, venture capital and real estate. Its funds invest in industries including healthcare, consumer, financial & business services, industrials and technology. Today, Bain Capital has over €91.0bn in AuM.

SOURCES

• Cinven (2017); https://www.cinven.com/media/news/170818-takeover-offer-of-bain-capital-and-cinven-for-stada-successful/
• FinancialTimes (2017); https://www.ft.com/content/79c33100-8406-11e7-94e2-c5b903247afd
• Handelsblatt (2016); https://www.handelsblatt.com/finanzen/maerkte/aktien/ermittlungen-gegen-stada-investor-bafin-nimmt-aoc-ins-visier/13943498.html?ticket=ST-3600799-qGmCJ0VOG0EnzU7GNPNO-ap5
• Mergermarket (2017); Deal ID: 835776
• Mergermarket (2018); Deal ID: 950146
• Reuters (2018); https://www.reuters.com/article/us-stada-m-a-bain/bain-cinven-make-higher-offer-for-rest-of-generics-maker-stada-idUSKCN1MB2NR
• STADA (2018); https://www.stada.com/press/press-releases/detail-view/news/detail/News/stada-invites-the-holders-of-the-stada-bond-to-participate-in-the-bondholders-meeting-and-to-vote-i.html
•  The Wall Street Journal (2017); https://www.wsj.com/articles/german-drugmaker-stada-supports-takeover-offer-from-bain-capital-cinven-1491804550