what is the impact of private equity funds on the lbo
TRANSCRIPT
What is the impact of Private Equity Funds on
the LBO value creation?
Financial theory and Biomet case study analysis
Carles CODINA
HEC Paris - Master in International Finance
Patrick LEGLAND
HEC Professor - Thesis director June 2020
Abstract
This study is based on the role of Private Equity funds in LBO value creation. Specifically,
it analyses the value creation achieved for all participants in the investment. It starts with a
theoretical section followed by a proposed framework for the calculation of the value created.
This framework is then applied to the real case of Biomet. An American medical device
manufacturer acquired in 2008 by a consortium of Private Equity funds and sold in 2014
to Zimmer Holdings creating the current industry leader Zimmer Biomet. At the end of this
case it has been concluded that at the exit of the LBO, value was created for the firm, the
shareholders and the debtholders, thanks to several value drivers exploited with good
management during the holding period.
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Acknowledgements
I would like to thank very sincerely Mr Patrick Legland, who as my thesis director has helped
and advised me during all this period of research and elaboration of my thesis. With his
experience, flexibility and closeness has made this time of work enjoyable and fruitful.
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Table of contents
LIST OF FIGURES .................................................................................................... 4
INTRODUCTION ..................................................................................................... 6
SECTION I – THEORY PROSPECT ....................................................................... 7
1. LBOs and Private Equity Funds ....................................................................................... 7
2. Sources of Value Creation and Private Equity funds intervention ............................ 13 2.1. Operational and Financial Engineering ................................................................ 14 2.2. Industry Performance .............................................................................................. 17
3. Conflict of interests between the PE fund and the company objectives .................. 18
4. Measuring the Value Creation ......................................................................................... 19 4.1. Sharing of the value created .................................................................................... 19 4.2. Measuring the risk of the firm ................................................................................ 25 4.3. How current crisis is affecting Private Equity funds and value creation through LBO? ........................................................................................................................ 26
SECTION II – THE BIOMET CASE STUDY ....................................................... 29
5. Pre-LBO analysis - Company and Industry ................................................................... 29 5.1. Company Overview ................................................................................................. 29 5.2. Medical devices and equipment industry overview ............................................. 31
6. Financial Analysis pre-LBO and the delisting in 2008. ................................................ 36
7. Value creation during the holding period (2008-2014) ................................................ 40 7.1. WACC estimation for the holding period ............................................................ 40 7.2. Value creation for the firm ..................................................................................... 42 7.3. Value creation for the shareholders ....................................................................... 43 7.4. Value creation for debtholders ............................................................................... 43 7.5. Digging into the drivers of value creation ............................................................ 44 7.6. Risk analysis............................................................................................................... 51
8. The exit to the new holding Zimmer Biomet ............................................................... 53
SECTION III – CONCLUSIONS ............................................................................ 55
BIBLIOGRAPHY ..................................................................................................... 57
APPENDICES .......................................................................................................... 58
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LIST OF FIGURES
Figure 1: LBO typical financing structure. Source: IB book by Giuliano Iannotta ................ 9
Figure 2: Typical phases in a PE activity. Source: The DVS Group ....................................... 10
Figure 3: PE typical legal structure. Source: IB book by Giuliano Iannotta .......................... 12
Figure 4: Number of closed funds and import committed by LP's (2003-2017). Source: EY
2018 Publication .............................................................................................................................. 13
Figure 5: Activities by PE vs CEO interests. Source The Boston Consulting Group.......... 19
Figure 6: Value Creation Framework. Source: INSEAD and Duff&Phelps ......................... 24
Figure 7: Value Creation Breakdown. Source: INSEAD and Duff&Phelps ......................... 25
Figure 8: Medical Devices Sales Distribution (2008). Source World Health Organization . 32
Figure 9: Top medical device companies by sales (2008). Source WHO ............................... 33
Figure 10: Value and number M&A deals (2000-2012). Source: Thomson ONE ............... 34
Figure 11: Rational behind the largest M&A deals in medtech. Source CapitalIQ ............... 34
Figure 12: Sales evolution (2002-2007). Source:Thomson Reuters ......................................... 36
Figure 13: EBITDA Margin evolution (2002-2007). Source: Thomson Reuters .................. 37
Figure 14: Biomet pre-LBO financial analysis (2002-2007). Source: Thomson Reuters ...... 37
Figure 15: Top 10 biggest PE funds. Source:PE International Data Base ............................. 38
Figure 16: Sources and Uses table of the LBO entry. Source: Own calculation ................... 40
Figure 17: WACC computation for the holding period. Source: Own calculation ............... 41
Figure 18: WACC sensitivity to the ERP and the Beta. Source: Own calculation ................ 42
Figure 19: ROCE vs WACC spread (2008-2014). Source: Own calculation ......................... 43
Figure 20: ROE vs COE spread (2008-2014). Source: Own calculation ................................ 43
Figure 21: ROD vs COD spread (2008-2014). Source: Own calculation ............................... 44
Figure 22: Sales growth evolution. Source: Own calculation ................................................... 45
Figure 23: Gross margin and EBITDA margin. Source: Own calculation............................. 46
Figure 24: Unlevered FCF evolution (2008-2014). Source: Own calculation ........................ 47
Figure 25: Cash Flow analysis and split. Source: Own source ................................................. 47
Figure 26: Capital expenditures evolution (2004-2014). Source: Own calculation ................ 48
Figure 27: WCR Decomposition as % of sales. Source: Own calculation ............................. 49
Figure 28: Operating WCR evolution (2004-2014). Source: Own calculation ....................... 50
Figure 29: Total WCR evolution (2004-2014). Source: Own calculation ............................... 50
Figure 30: Financial Risk metrics computation. Source: Own calculation ............................. 51
Figure 31: Fixed vs Variable costs ratio (2007-2014). Source: Own calculation.................... 52
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Figure 32: Exit details to new holding Zimmer Biomet. Source: Pillar of Wall Street ......... 54
Figure 33: Biomet Balance Sheet (2002-2007): Source: Thomson Reuters ............................ 58
Figure 34: Biomet Income Statement (2002-2007): Source: Thomson Reuters .................... 59
Figure 35: Biomet Cash Flow (2002-2007): Source: Thomson Reuters.................................. 59
Figure 36: Biomet Balance Sheet (2008-2014): Source: Thomson Reuters ............................ 60
Figure 37: Biomet Income Statement (2008-2014): Source: Thomson Reuters .................... 61
Figure 38: Biomet Cash Flow (2008-2014): Source: Thomson Reuters.................................. 61
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INTRODUCTION
The private equity industry and its ways of creating value for investors, often in reprimand
of the company itself, has been throughout history a highly controversial subject. In the same
way, is a business model that has varied greatly over time, adapting to each global situation.
At the present time, with the COVID-19 pandemic causing an economic recession
worldwide, continuing to create value in its funds will be the great challenge for the industry
in the coming years.
In this study, we provide a theoretical review of how private equity funds manage to generate
value in companies. We talk about how to measure this value and how it is then distributed
among the participants in the investment. Moreover, we add a point about how, in this
current crisis situation, these funds may be able to keep their investee companies afloat,
overcome this challenge and continue to extract value from them. Finally, as part of this first
theoretical section, a point is also added to discuss the conflict of interest that often arises in
this type of investments. Where, PE managers and the company's CEO, usually pursue
different objectives.
Afterwards, during the second section, the framework proposed for calculating the value
creation in a LBO, is applied to the real case of Biomet. An American multinational company,
medical devices manufacturer, which was acquired in 2008 by a consortium of private equity
funds. We will analyse in depth, what impact these funds had on the company both at an
operational and financial level during the holding period (2008-2014).
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SECTION I – THEORY PROSPECT
1. LBOs and Private Equity Funds
As it is known, in a leveraged buyout (LBO), a company is acquired by a specialized
investment firm using a relatively small portion of equity and a relatively large portion of
outside debt financing. These leveraged buyout investment firms today are generally referred
to as Private Equity firms.
Private Equity is, in the most simplistic terms, the capital that is held in a private
company. These companies are run by general partners (also called sponsors), who invest
money obtained from investors who work together for a limited time and are therefore called
"limited partners". However, while this practice may seem novel, the reality is that the
concept behind it is very old. The fact that a group of people pool their capital to buy shares
in a private company has been going on since the 18th century. The first prototype was
found in the Massachusetts Bay Company, which used the money raised to finance the
development of the economy of the English colonies in North America. While the colonists
were dedicated to structuring and improving the colonies, those who stayed in England
helped finance the company, hoping to find a return on their investment over time.
Years later, when the economic engine of the United States (US) was the railroad and its
construction one of the most expensive enterprises of the time, the lack of financing from
wealthier families led the major banks to buy controlling interests, restructured business
operations, introduced new administration and helped eliminate corruption. These are all
current components of the modus operandi of private equity funds.
It was not until 1946 that the first modern PE company as we know it today appeared
under the name of American Research and Development Corporation. The industry, on the
other hand, will take several decades to establish itself. In 1970 we found about a dozen PE
companies mostly located in the US. However, this number will rapidly multiply due to:
• The fall of the US stock market in the 1970s.
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• Period of uncertainty from the enactment of ERISA (Employee Retirement Income
Security Act) in 1974, which was extremely damaging to the industry, until its
clarification in 1978.
• Reductions in the maximum rate of capital gains tax (Cendrowski et al, 2008).
The golden age of the PE industry arrived in the United States with the boom in the
high-yield debt market (high-yield debt that is more expensive and more profitable than that
offered by the market). Michael Milken's research, which showed that this type of high-yield
debt produced much higher returns than the more common investment grade debt, led to
the use of the most characteristic activity of a PE, the leveraged buyout (LBO).
This investment method as commented above is characterized by minimizing the equity
package that the investing company must commit, replacing it with debt and benefiting from
the high returns offered by this type of debt, the internal rates of return of the operations
carried out with LBOs financed by high yield debt offered juicy profit opportunities. Between
the years 1980 and 1988, there was an investment in the percentage of the total capital
coming from corporate loans and bonds in the market, going from 57% to 15% and 36% to
61% respectively.
The escalation of LBO operations is notable during the entire decade of the 80s, reaching
its peak in 1988 with the purchase of the American multinational RJR Nabisco by the
investment fund KKR (Kravis Kohlberg Roberts). This purchase operation, worth around
30 billion dollars, which had the market on tenterhooks because of its drama, was the last
major operation by the PE sector in the 20th century.
The private capital market has become a major source of funds for start-ups, companies
in financial difficulty and public companies seeking financing for share purchases. Between
1980 and 1994, the amount of outstanding PE increased from less than $5 billion to $100
billion. Fenn, et al (1995).
The stock market crash of the 1990s caused by junk bonds and the negative
consequences of the Nabisco case led to the purchase.
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The first step in this process is to bring the leveraged buyout into the background, where
it remains dormant in a state of sustained growth until the beginning of the 21st century.
The leveraged buyout model will take hold in the United Kingdom at the beginning of
this century and will take a few more years to take hold in the rest of the old continent, being
definitively implemented in the years prior to the financial crisis of 2007.
After this recapitulation in the history of the sector. We are going to enter in a more
practical level to see what an LBO consists of.
We will first analyse the key drivers in an LBO and its most common financing structure,
to later analyse how the Private Equity fund intervenes in the investment process
collaborating in the value creation of the target company.
As the main steps driving any Private Equity investment activity we are going to define
the (a) purchase price and the financing structure used in the acquisition, (b) the operating
evolution of the company during the 5-10 years after the transaction close, and finally, (c)
the selling price in the exit through either an IPO or a sale of the target company.
i. The purchase price in a LBO depends on three factors: the estimated terminal value
of the company at the end of the investment period (5-10 years), the debt capacity
of the target firm, and the return required by sponsors. Regarding the capital
structure used in the acquisition, each component relates to a piece of the financing
package that is used to purchase the company. Each LBO is structured slightly
differently. However, the typical financing structure is represented in Figure 1. In the
section on financial engineering we will go into more detail on how this financing is
carried out and legally structured for maximum optimization.
Figure 1: LBO typical financing structure. Source: IB book by Giuliano Iannotta
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The amount of debt usually provides between 60 and 90% of the value of the deal
(Kaplan and Strömberg, 2008). In large LBOs there are multiple layers of debt, mezzanine
and equity. Each of these sources of finance comes from different institutions. Financial
institutions such as banks or insurance companies provide PE firms with the senior debt that
would be the layer with the highest repayment seniority as well as the lowest interest rate.
Second, comes subordinated debt, which can be either high-yield (junk bonds) or privately
placed debt with a lower seniority, higher interest rate and usually with bullet repayment.
Another proportion of our funding is mezzanine debt, usually from mezzanine funds. With
high interest rates (Paid in Kind). Finally, the equity portion comes from the General and
Limited Partners, explained in detail below.
ii. Once the company is acquired, certain operational improvements can be
implemented making the business run more efficiently (e.g., through organic growth,
acquisitions, and/or increased profitability). Lately we will go into more detail on
these operational improvements and see how they directly affect value creation. By
the end of the investment horizon, ideally the sponsor has increased the target’s
EBITDA and reduced its debt, thereby substantially increasing the target’s equity
value.
iii. Most sponsors seek to exit or liquidate their investments within a 5-10 years retention
period in order to provide a timely return on their LP. These returns are typically
realized through a sale to another company (commonly called as a "strategic sale"), a
sale to another sponsor, or an initial public offering (IPO).
Figure 2: Typical phases in a PE activity. Source: The DVS Group
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Once we have gone through a quick look to the drivers governing any PE activity, we
are going into more detail on how the investment is structured. We have seen the debt equity
ratios that are normally used in these investments but the process is not as simple as it seems.
As illustrated in Figure 3, the typical LBO structure consists of a series of SPVs (Special
Purpose Vehicles) each founded for a debt or equity instrument. On the one hand, there is
the equity of the General Partners (GP's) members of the Private Equity, who contribute a
very small proportion of the total equity used for the transaction. On the other hand, through
an LPA, the commitment of the contribution of the rest and the great majority of the
necessary equity is signed with the Limited Partners (LP’s). These LP's are external investors
such as pension funds, insurance companies or high-net worth individuals who invest in the
fund.
The LPA document sets out certain points committing both parties. The main points
covered are:
• The laws and regulations that will govern the agreement.
• The purpose of the agreement and the type of investments to be made in that fund
(industry, geography, etc.).
• The duration of the fund, normally 10 years with the option of two one-year
extensions.
• The capital to be contributed by each LP through capital calls over the duration of
the fund.
Once the capital it’s “collected” (committed by LP’s) in the fund, capital flows from one
SPV to the other until it reaches the so-called "BidCo", the legal entity that executes the
acquisition of the target company.
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Figure 3: PE typical legal structure. Source: IB book by Giuliano Iannotta
Having seen both the financing structure and the legal structure of a private equity
fund, it is concluded that one of the most important phases in this type of investment is
fundraising. That is why, before continuing with the creation of value once the participation
in the company is held, the keys to good fundraising are set out.
The private equity industry has good skills in raising capital in any kind of economic
cycle, but a redefinition of business relationships is needed. It is recommended that
companies:
• Work on new channels to access other sources of capital: Sovereign wealth funds,
family offices and pension funds have increased their holdings as LPs in the industry.
• Take advantage of the dynamic relationship between GP and LP: Possible future
fund movements include the allocation of capital to separately managed accounts
(SMAs), co-investment mechanisms and direct investment in private companies.
• Treating innovation as an imperative: One of the fastest growing strategies is the
issuance of private debt (the weight in the total assets managed by the industry has
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risen from 16% in 2007 to 31% in 2017) as a complement to capital on the balance
sheet, which offers investors various interest rate and return options. The key is to
remain attentive to the market, broaden the offer and look for synergies.
• Capitalize on the open window to raise capital: Firms should take advantage of the
fact that today there is an open window to raise capital. A change of cycle would
close it and there would not be the availability that there is today.
Figure 4: Number of closed funds and import committed by LP's (2003-2017). Source: EY 2018 Publication
As can be seen slightly in the figure above, taken from a study by Ernst and Young of the
private equity industry in 2018 The private equity industry has a strong cyclical component,
and the previous peak was reached in 2008 with a volume of capital commitments of $634
billion from LPs.
2. Sources of Value Creation and Private Equity funds
intervention
Firstly, we start analysing in a qualitative way, which are the main drivers of value
creation that can be used by private equity funds in LBO acquisitions. These drivers can be
divided into four groups. Operational and financial engineering, Industry performance, Tax
shields and Corporate Governance Mechanisms. This division allow us to look at value
creation for the whole company, and not just from the shareholder's point of view. Later on
we will see how the value created will be shared between the firm, the shareholders and the
debtholders.
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2.1. Operational and Financial Engineering
We define in this section two other drivers used by PE sponsors, to increase their target
value. On the one hand we have the value creation through the management of the capital
employed (Total Assets – Current Liabilities) also called operational engineering, and on the
other hand the financial engineering which consists in create value by optimizing and
managing the invested capital (improving the capital structure, providing liquidity, financing
or enabling the company to access to Debt and Equity Capital Markets).
2.1.1. Operational Engineering
The leveraged buyout industry has become increasingly competitive, forcing private
equity firms to adapt and improve. During the 1980s and 1990s financial engineering was the
main source of value creation, but as financing became cheaper in the 21st century all
industrial companies acquired financial engineering capabilities. Financial engineering, while
still important, has moved from being a differentiator to a requirement for remaining
competitive. Amidst a myriad of views on the sources of value creation in an LBO,
operational engineering is being highlighted as the main driver of performance improvement.
Operational engineering refers to the expertise and actions provided by the private equity
firm and how it is used to enhance the value of the portfolio companies' operations.
Now, let’s go deeper into the levers for operational value creation: the sales growth, the
gross margin improvement, overhead reduction, capital efficiency and shared services.
• Sales Growth: Boosting revenue growth through increased sales volume is the
preferred lever for the value creation. New market entry, new product introduction
and improving sales force effectiveness are some of the initiatives employed to
drive sales growth.
• Gross Margin Improvement: PE-baked companies drive the margin
enhancement through a combination of improved sales and cost savings. Price
increases, supply chain and distribution optimization, and improved capacity
utilization are the main initiatives chosen for this purpose.
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• Overhead Reduction: Reducing overhead is one of the most common lines of
value creation immediately following the PE-fund's investment in a company in its
portfolio. This reduction of the overhead causes a quick win for the bottom and
short pay-back periods. They usually focus on reducing general and administrative
costs, and tend to outsource non-core functions, while focusing the effort on
research and development of products with the highest commercial potential.
• Capital Efficiency: PE investors work closely with their portfolio companies to
optimize the use of their capital. Managing the use of capital is particularly
important in leveraged buyouts (LBO's), as excess cash can be used to repair debt
or pay early distributions to PE investors and thus improve the internal rate of
return (IRR). On the one hand, short-term capital management is focused in the
optimization of working capital through inventory reduction and improvement in
payment and collection contracts with suppliers and customers. On the other hand,
the optimization of fixed assets is focused on ensuring that capital expenditures
generate value during the investment period and identifying those assets that must
be shut down or sold to generate immediate cash.
• Shared Services: PE funds can obtain improvements in the profitability of the
companies within their fund by sharing services between them and leveraging the
combined negotiating power of the companies within the portfolio. The most
common services that are shared are insurance related or back-office and business
services.
2.1.2. Financial Engineering
Historically, leverage has been the primary means of creating value in an LBO by
taking on a large amount of debt in acquisitions. Both the amount of debt, the specific
conditions of the debt, and the layers of debt can substantially increase the return for equity
investors.
As mentioned above, financial engineering was the basis of private equity activities
in the past. It has been seen how private equity funds create financial packages composed by
debt tranches and equity capable to cover the enterprise value of the target company
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including its equity value (with any premium to be paid) plus the need to refinance or repay
its existing borrowings as well as cover the transaction costs.
The use of debt (leverage effect) benefits the PE in two ways:
• It reduces the upfront cost when acquiring the company thus amplifying the return.
It is important to note that leverage does not boost returns, it amplifies it. Making
good investments better and bad ones worse.
• Even though you will have to pay back either during the investment period or on
your exit the money borrowed for the acquisition, since money today is worth more
than tomorrow, the IRR increases by more if you can reduce your investment cost
by $100 today than if you can increase your proceeds $100 at the exit.
As a result of this leverage effect the so-called tax shield arises. Leverage can enhance
the firm value through the tax deductibility of interest. Tax shield can boost returns by
increasing the cash flows available to capital investors through the reduction of tax expenses
each year. However, this creation of value by the leverage effect and the tax shied it entails,
carries a risk. The use of leverage is to some extent threatened by the risk of bankruptcy.
That is why it is key to compute and define the optimal debt level.
It seems largely clear in the literature that the contribution of the taxes in LBOs must
not be underestimated. Nevertheless, the tax shield present in the LBOs has declined over
time due to some regulations. For instance, in 2008 the German government issued a
measure designed to restrict excessive leverage in LBOs by limiting the tax-deductible
interests to 30% of EBITDA. Similarly, in the U.S., legislators are currently reviewing various
regulatory measures, including limits on rate-deductible interest, with the intention also of
reducing the leverage of U.S. private equity fund portfolio companies.
The second key driver of value creation through financial engineering is the optimization
of the capital structure. Decreasing the WACC by utilizing more debt, which is cheaper than
the cost of the investors’ equity is a key driver behind the outsized returns obtained in a
successful LBO.
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2.2. Industry Performance
In this section we will go into how we can add value to our investment through market
timing (we call this market multiple expansion). To create value through market or industry
timing, the fund managers should try to buy when the markets or the industry to which the
target company belongs, are in a bad state or with a period of growth nearly expected. It is
difficult to predict the industry multiple expansion, since it depends on the general sector
performance or external factors such as political, social, environmental, or industry-specific
factors. That’s why this driver is considered external to the management of the company as
opposed to the operational and financial engineering studied above which can also cause a
multiple expansion occasionally.
In order to track the fund managers market timing ability, we define the industry multiple
expansion as the delta between the average industry multiple at investment and the average
industry multiple at the exit.
Thus, the ability of the fund's managers to try to take advantage of the expansion of the
multiple caused by the performance of the industry or the market in general, is based mainly
on keeping themselves very up to date and make the right decision on when is the best time
to invest and then know how to choose the right time to exit.
To give a practical example on how sometimes independently of our operational and
financial management with the company and independently of leverage effect of the
acquisition used by PE’s we can obtain value too by just choosing the right moment to
undertake the operation. Let's look at the current state of the economy:
Wall Street closed on Friday 20th March 2020 its worst week since 2008. The respite of
the European and Asian stock markets could not erase the heavy losses of previous days and
the price of oil fell for the fourth consecutive week. The unbridled spread of the Covid-19
and the Russia-Saudi fight over oil prices were the two ingredients of an explosive cocktail
that led the stock markets to one of the darkest weeks in several years.
The initial impact of the epidemic on economic activity was felt mainly in sectors such
as tourism (airlines, travel agencies, hotels...) and in those more dependent on the
international supply chain (automotive industry, footwear and textiles, high technology and
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household items), but concern about the effects of the epidemic is spreading to all sectors
and sub-sectors of the economy. Being clear that the effect is negative for the vast majority
of industries and sectors. Like every crisis, it brings with it interesting investment
opportunities for those who want to take advantage of this doubtlessly tragic situation. For
the private equity funds this situation creates a double effect. On the one hand, current
investments suffer a significant loss in value. But on the other hand, a lot of new
opportunities arise. The crisis is leaving the vast majority of companies very undervalued,
giving a potential return within reach of all those able to detect the opportunity. As we have
said before this is a clear situation where the market is leaving low entry multiples and just
as this pandemic will eventually be remedied, the markets will eventually recover with it
regaining the lost value to those companies that are being affected. Considering the risk that
some of them may not be able to cope with this situation and may not be able to stay afloat
when they go bankrupt, this is a great opportunity to take advantage of the strong changes
in the market to create value in your investments.
3. Conflict of interests between the PE fund and the company
objectives
Over time, diverse opinions regarding the roles and responsibilities in a PE-backed
company can lead to certain tensions between the management team and the PE owners.
According to the survey conducted by Boston Consulting Group (Schneider and Lang,
2013), there is a significant divergence of views regarding the importance of the role of the
PE firm in relation to the operational management of the company. The main sources of
conflict appear during the first 100 days post-investment and the definition of KPIs, two
activities that are normally focused on by the owners of the PE fund. Other sources of
tension include lack of transparency, accountability, and of course poor business results.
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Figure 5: Activities by PE vs CEO interests. Source The Boston Consulting Group
4. Measuring the Value Creation
Having gone deep into the sources of value creation in an LBO This section is
dedicated to study how to quantify the value created at the end of the investment, and in this
way to be able to assign the total value obtained to each of the sources and distribute it to
each of the parties of the LBO investment. The framework used during this section will be
used later in the case study to analyse the specific real case of the Biomet’ LBO.
4.1. Sharing of the value created
The first step will be to quantify the total value obtained from the investment for
each of the parties involved in the investment: (3.1) The Firm, (3.2) The Shareholders and
(3.3) The Debtholders. It is important to note that these are all approaches, using frameworks
that are as close as possible to reality.
The method used consists of estimating the difference between the return obtained
and the cost that has been incurred by each of the parties. The drivers that will increase the
returns for each of the participants in the investment are those explained above.
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4.1.1. The firm
At the global level of the firm, the value created is defined as the spread between the
company's ROCE and WACC. As part of the basic rules of finance it is said that if you
achieve a return on invested capital greater than the cost of capital you are creating value.
And consequently, in the opposite case, value is destroyed. So the spread will be measured
as the ROCE-WACC.
i. WACC computation
The WACC is basically the sum of the cost of debt and the cost of equity, calculated as a
weighted average of their percentage in the value of the company. Therefore, in order to
calculate the WACC, the formula below is used.
𝑊𝐴𝐶𝐶 = 𝐾𝑑(1 − 𝑡)𝐷
𝐷 + 𝐸+ 𝐾𝑒
𝐸
𝐷 + 𝐸
t: Corporate tax.
D: Financial Debt.
E: Equity.
Kd: Cost of Financial Debt (Kd). Is the cost that a company incurs to develop its activity or
an investment project through its financing in the form of credits, loans or debt issuance. In
the subsequent case to be studied of Biomet, this cost will be calculated as the net cost of
the debt year by year over the period of the LBO. Important to note that such cost is tax
deductible.
Ke: Cost of Equity (Ke). A common method for calculating the Ke is the CAPM (Capital
Asset Pricing Model). Which is the result of adding a market risk premium (e.g. historical
stock market return minus historical government bond return) to the risk-free return of a
fixed income (e.g. a bond). Conditioned by the volatility of the stock in relation to the market
(𝛽 ).
𝐾𝑒 = 𝑟𝑓 + 𝛽(𝑟𝑚 − 𝑟𝑓)
For the subsequent study of Biomet's case, a risk free rate equivalent to the 10y-US
government bond will be used. On the other hand, the Equity Risk Premium (rm-rf), will be
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assumed as the difference between the return of the NASDAQ, index in which Biomet was
listed before privatization, and the rf. Regarding the calculation of the Beta, it is said that it
represents the correlation between the return of the market and those of our stock. This
volatility can only represent the risk of the industry in which the company is located
(Unlevered Beta), or it can also include the risk of the company's leverage level (Levered
Beta). For the calculation of the Cost of Equity, the Levered Beta will be used. Based on the
Unlevered Beta extracted from the industry peers' average, using the formula below the
company's own leverage is added.
𝛽𝐿𝑒𝑣𝑒𝑟𝑒𝑑 = 𝛽𝑈𝑛𝑙𝑒𝑣𝑒𝑟𝑒𝑑 (1 + (1 − 𝑡)𝐷
𝐸)
i. ROCE computation
𝑅𝑂𝐶𝐸 =𝑁𝑂𝑃𝐴𝑇
𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑙𝑜𝑦𝑒𝑑
NOPAT: Net Operating Profit After Taxes. It is calculated in a very simple way by
subtracting taxes from operating profit (EBIT), thus obtaining something similar to the
operating margin for shareholders in a company without debt.
Capital Employed: The capital employed is less clear, since depending on the company or
the context, various criteria can be used. For our case the capital employed will be assumed
as the Fixed Assets + Working Capital.
The problem with using the ROCE to quantify value creation is that it is an indicator that
can easily be artificially increased. For example, by lowering the Capital employed
automatically increases the ROCE, which does not have to mean greater value creation in
the future. This is solved by using the EVA for the value calculation (explained below).
Secondly, a decrease in taxes paid or in the D&A would also result in an increase in ROCE.
To avoid the effect of manipulating taxes, in the case of Biomet, effective constant tax rate
will be used.
I has been chosen to use the ROCE spread over the WACC to calculate the total value
creation of the firm. But as mentioned in the previous paragraph, another option is to use
the EVA (Economic Value Added). The method is very similar, with the only difference
being that it is multiplied by the Capital Employed. As seen in the formula below, the EVA
is based on the ROIC which is the Return on Invested Capital. Despite not being exactly
- 22 -
true, it will be assumed as equal the capital employed and capital invested, consequently
assuming equal ROIC and ROCE for simplicity.
𝐸𝑉𝐴 = (𝑅𝑂𝐼𝐶 − 𝑊𝐴𝐶𝐶)𝐶𝑎𝑝𝑖𝑡𝑎𝑙 𝐸𝑚𝑝𝑜𝑦𝑒𝑑
4.1.2. The shareholders
The calculation of the return from the shareholders' perspective will be very similar. But in
this case it will be necessary to compare the ROE (Return on Equity) with the Ke (Cost of
Equity). The ROE is easily calculated as the return on equity invested by the fund. And the
cost equity as shown in the previous section using the CAPM.
𝑅𝑂𝐸 =𝑁𝑒𝑡 𝑃𝑟𝑜𝑓𝑖𝑡
𝐸𝑞𝑢𝑖𝑡𝑦
Discomposing the ROE
Two additional indicators
The two most typical metrics for a PE fund to measure how attractive an investment is or
to evaluate the outcome of an investment already at the exit is the IRR (Internal Rate of
Return) and the C/C multiple (Cash-on-Cash). Both are indicators that focus on cash flows.
The IRR is defined as the rate of return that would generate a zero NPV of the cash flows
of the period. The C/C multiple is the division between the equity you receive and the one
injected into the fund. In this way, using this multiple you are not taking into account the
value of money in time, since it does not differentiate when the cash inflows or outflows are
made. That’s why the C/C is not considered an indicator of the value created in the
investment. Similarly, the IRR, even taking into account the value of money over time, it
does not serve as an indicator of value creation for three reasons:
• The IRR may give different values, and the results may conflict with the Net present
Value criteria.
• The second and probably the most important, the IRR ignores the cost of capital. It
is really in the comparison of the return with the cost of financing where you see
whether the value has been created or destroyed in the investment.
- 23 -
• Finally, with the IRR you are assuming a constant discount rate throughout the
period. If, on the other hand, evaluating year by year the spread between the ROE
and the COE allows you to work with a varying discount rate.
Discompose de IRR/C/C
The method used to decompose the return focused on cash flows is based on a
research paper made in 2016 by INSEAD Business School in cooperation with the company
Duff & Phelps, leader in valuation tasks. And in the same way we will decompose the value
created in the Biomet LBO case study.
At the end of an LBO, the value extracted from that investment can be divided into
two big groups:
i. Operational effect:
ii. Leverage effect
The operational effect at the same time can be divided in three main groups: (a) EBITDA
impact, (b) Multiple impact and (c) FCF impact.
a) EBITDA impact - The impact of EBITDA measures the portion of value
created that can be attributed to operational changes during the holding period.
EBITDA is used as a proxy for operating cash flow, and as a measure of the
operating portion of the company without regard to accounting standards or
different capital structures. However, this point includes improvements that may
have occurred in the industry in general, i.e. not caused by management
improvements during the period. In the case that we would like to measure only
the impact of private equity funds on value creation, as is our case, we should be
able to isolate the growth of EBITDA coming from the improvements brought
by private equity in the management of the company at the operational level from
the growth generalized in the industry.
b) Multiple impact - The impact of the multiple quantifies the price variation to
be paid per unit of EBITDA between the entry and exit. Just as we discussed in
the impact of EBITDA, this simple measurement does not differentiate between
the change in multiples attributable to market or industry cycles and the
company-specific changes.
- 24 -
c) FCF impact/Net Debt impact - The variation in net debt during the holding
period is measured in dollar terms and represents the cash generated for
shareholders. It is known that the cash generated each year can be used either to
repay debt, dividends to shareholders or can be kept on the balance sheet. How
you manage your operational cash flow by repaying debt, whether mandatory or
voluntary, is especially relevant in LBOs. However, this does not measure the
impact of leverage on return on investment.
Figure 6: Value Creation Framework. Source: INSEAD and Duff&Phelps
All this value created can be attributed to operational improves and external market
evolutional conditions. Hence, if we add to this amount the benefit provided by the leverage
effect, we will have the total value created.
Therefore, if you represent the return on investment based on the money multiple
(MM) which is the same as the C/C. We can break it down into return on leverage effects
and return on operational improvements and market conditions. To which we can add one
more layer of granularity from the previous framework (Figure 7).
The operational improvements could be divided in changes in sales, margin or both.
And at the same time, the variation of multiple can be broken down multiple variation caused
by changes in the market, in the company itself or in both. In this way we are left with a
- 25 -
more detailed framework for the attribution of the value created. Note that the numbers are
not real and only to understand the breakdown.
Figure 7: Value Creation Breakdown. Source: INSEAD and Duff&Phelps
4.1.3. The debt holders
Finally, it will be time to measure the value created for the third major investment
participants, the debtholders. By far, it will be the most straightforward calculation. The value
creation will be equivalent to the difference between the ROD (Return on Debt) and the
COD (Cost of Debt). In this case the return on the debt (ROD) for the bank is equivalent
to the cost of the debt (Kd) for the target company seen in the previous section.
On the other hand, the cost of the debt (COD) for the banks is equal to the risk-free
rate plus the credit default spread (CDS) of the sector where the company requesting the
debt is located.
4.2. Measuring the risk of the firm
To end up this section of value creation. The different ways to evaluate the risk of
the target company will be discussed. These methods will then be used to measure the risk
in the Biomet LBO case. Two factors are proposed to address risk in an LBO: financial
leverage and operational leverage.
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When talking about an LBO, the first thing that comes to mind is a substantial
increase in financial leverage. But as you know, with the potential additional return that this
leverage can give you comes an extra risk that must be monitored in some way. The most
common ratios for analyzing and keeping this risk under control are:
𝐷𝑒𝑏𝑡
𝐸𝑞𝑢𝑖𝑡𝑦
𝑁𝑒𝑡 𝐷𝑒𝑏𝑡
𝐸𝐵𝐼𝑇𝐷𝐴
𝐸𝐵𝐼𝑇𝐷𝐴 − 𝐶𝑎𝑝𝐸𝑥
𝐶𝑎𝑠ℎ 𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡
DSCR ratio = 𝑁𝑒𝑡 𝑂𝑝𝑒𝑟𝑎𝑡𝑖𝑛𝑔 𝐼𝑛𝑐𝑜𝑚𝑒
𝐷𝑒𝑏𝑡 𝑃𝑟𝑖𝑛𝑐𝑖𝑝𝑎𝑙+𝐼𝑛𝑡𝑒𝑟𝑒𝑠𝑡𝑠 + 𝐿𝑒𝑎𝑠𝑒 𝑝𝑎𝑦𝑚𝑒𝑛𝑡𝑠
On the other hand, the operational management of the target company during the
holding period also involves a risk that must be monitored. There are two very simple ways
of measuring that risk. The first consists of measuring how fixed costs vary with respect to
total costs (fixed + variable), and in this way we can see how we are varying the break-even
point. Another way of measuring operational risk is by means of the DOL (Degree of
Operating Leverage), calculated with the following formula:
𝐷𝑂𝐿 = % 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝐸𝐵𝐼𝑇
% 𝑐ℎ𝑎𝑛𝑔𝑒 𝑖𝑛 𝑆𝑎𝑙𝑒𝑠
This is a good indicator of operational risk since an increase in fixed costs carries
more risk for the company and we would see a higher DOL.
4.3. How current crisis is affecting Private Equity funds and
value creation through LBO?
To conclude this section in which we have entered in depth in a theoretical way into
the operation of private equity funds as well as their sources of value creation through LBOs.
Given the global crisis situation, mainly caused by the COVID-19, this point is dedicated to
analyze how this exceptional economic situation affects the activity of private equity funds,
and in turn, see what challenges both GPs and LPs will face in order to receive value through
LBOs.
- 27 -
One of the main virtues of private equity funds is their ability to generate value in
the long term, in contrasts with quoted funds whose daily valuation, in many cases, makes
them incur in a certain short term mentality. The standard format of private equity funds (5-
10y investments) enables their managers to carry out a strategy to add value to the target
company and generate a sale of the company (Exit) at the highest possible multiple.
In an environment such as the current one, the private equity manager or sponsor
(General Partner) should have management and financing levers that allow him to build a
"scorecard" that helps his participated companies to navigate the crisis by identifying both
their operational and financial needs. On the operational side, they should face multiple
fronts depending on the needs of the company in which they have a stake. Areas such as
maintaining the productivity of displaced personnel, optimizing supply chains, cost
containment in companies with sharp falls in demand, and customer and supplier
management should be a priority. With regard to financing, the manager should consider
providing capital, either directly through the company's own resources or through a third
party that provides equity or debt.
Another important requirement for the fund manager, since these are unlisted assets
and therefore less transparent, is communication with the unit-holders (Limited Partners)
who, in addition to being informed of the activity carried out by the managers, should be
aware of the fund's valuation on a regular basis and not just once a year as provided by the
law regulations. To this end, although it is not the most common thing in the sector, having
an independent valuation of the invested companies made by a third party, in line with the
standards suggested by the IPEV (International Private Equity and Venture Capital
Valuation) and which would serve as a contrast with the fund's internal valuation, would be
very useful for both the manager and the fund's participant.
Large listed private equity managers with a market price, such as Partners Group,
KKR, Carlyle, Blackstone or Apollo have all lost between 35% and 40% of their value in the
last month, over the 29% drop in the S&P 500 and, in the world of venture capital, the giant
Softbank has fallen 50% on the Tokyo stock exchange. This explains why the value of the
underlying of this type of fund immediately reflects the ups and downs of the economy.
However, even if there is a correlation between the market valuation of a listed and an
unlisted company within the same sector, for many reasons we cannot assume that the
- 28 -
valuations of these vehicles must be a pure mirror of market circumstances. To this end,
there is nothing better than having a transparent periodic valuation scheme in which both
participants and managers can have a clear idea of the fund's situation at any given time.
In conclusion, in the current environment, private equity funds have a fundamental
advantage in creating value compared to listed asset funds, deriving from their greater control
over their investee companies. This control means that their managers can implement direct
support measures both in managing the crisis, helping them to overcome any operational
difficulties that may arise, and through explicit financial support, injecting capital or
facilitating the search for capital. And it is at times like the present, through effective and
transparent management with regard to its participants, that this sector has its opportunity
to continue demonstrating the benefits of the investment model.
- 29 -
SECTION II – THE BIOMET CASE STUDY
This second section is dedicated to working on the Biomet Inc. case. It will start
with a company and sector analysis prior to the LBO carried out by a consortium of private
equity funds between 2008 and 2014. This will be followed by a detailed analysis of the
company's operational and financial performance during the holding period, value creation
and its sources. Finally, its exit through the sale of Biomet to the strategic buyer Zimmer, to
create the new entity Zimmer Biomet.
5. Pre-LBO analysis - Company and Industry
The case study begins with an overview of the company to be studied by Biomet Inc.
Its history prior to privatisation and its position within the medical device industry. A section
is then dedicated to studying the situation of the sector at the time of the acquisition in order
to understand the rationale behind the operation and to put us in the picture.
5.1. Company Overview
Biomet, Inc was a medical device and equipment manufacturer based in Warsaw,
Indiana (USA). The company specialized in reconstructive products for orthopaedic surgery,
neurosurgery, craniomaxillofacial surgery and operating room equipment.
Biomet Timeline:
November 30, 1977: Dane A. Miller, Ph.D., Niles L. Noblitt, Jerry L. Ferguson, and M. Ray
Harroff realized their vision of providing patients with the highest quality, most advanced
orthopedic products on the market. In the first year, Biomet recorded sales of $17,000 with
a net loss of $63,000. These results did not discourage the founders, who maintained their
vision of the future of orthopaedics.
1984: Biomet expanded its manufacturing operations into Europe with the acquisition of
Orthopaedic Equipment Company (OEC). OEC provides the company with an extensive
line of internal fixation devices and operating room supplies.
- 30 -
1988: Biomet acquires Electro-Biology, Inc. (EBI), which offered an excellent product line
in both the electrical bone growth stimulation and external fixation markets. Today EBI is
still active under the trade names Biomet Trauma and Biomet Spine.
1990: Biomet enters the arthroscopy market with the acquisition of Arrow Surgical
Technologies, further expanding its product range. The arthroscopy product range has
continued to evolve under the name Biomet Sports Medicine.
1992: Acquisition of W. Lorenz Surgical, Inc. an established leader in the craniomaxillofacial
market, which opened up another avenue for Biomet to gain further experience. Today WLS
is still active under the name Biomet Microfixation LLC.
1994: With the purchase of Kirschner Medical Corporation, Biomet had the opportunity to
expand further in the area of reconstructive products.
1998: Biomet Inc. and Merck KGaA of Darmstadt (Germany) pooled their resources to form
the Biomet Merck joint venture. The company quickly expanded throughout Europe and
enhanced its product range, using the knowledge and skills of both partners. Biomet Inc.
brought established excellence in the orthopaedic sector, while Merck KGaA attracted a
wealth of knowledge about biomaterials, based on a heritage of over 300 years in the
pharmaceutical sector.
1999: Biomet entered the dental reconstruction implant market with the purchase of Implant
Innovations, Inc. (now Biomet 3i LLC). 3i continues to be a market leader in the
development of new products and technologies such as dental implants.
2004: In June 2004, Biomet Inc. purchases Merck KGaA's interest in the Biomet Merck Joint
Venture and renames it Biomet Europe Group.
September 2007: Biomet is delisted from the NASDAQ being acquired by a consortium of
private equity firms consisting of The Blackstone Group L.P., Goldman Sachs & Co.,
Kohlberg Kravis Roberts & Co. L.P. and TPG Capital. Biomet was.
- 31 -
April 2014: Zimmer Holdings announced a $13.4 billion offer to acquire Biomet upon the
exit of the LBO.
October 2014: The European Union's anti-fraud regulators opened an investigation into
Zimmer's offer on the basis that the agreement could lead to a substantial reduction in
competition in certain markets.
June 2015: The verdict finally allowed the merger to take place in June 2015, becoming the
world's second-largest seller of orthopaedic products behind Johnson & Johnson.
5.2. Medical devices and equipment industry overview
Before going into detail on the Biomet LBO that took place between 2008 and 2015
by the consortium of PE’s and its corresponding exit to Zimmer Holdings. At this point we
are going to put ourselves in the situation. How was the medical equipment sector at that
time (2008)? What were the projections for the following years in that industry? In this way
we can understand the rationale behind the acquisition of Biomet by the Private Equity
Funds.
We are at the end of 2007. By then, the market for medical equipment was a little
over US$ 210 billion achieved by an industry that comprises more than 27,000 medical device
companies worldwide employing altogether about one million people.
In order to enter a little deeper, the distribution of these sales is shown in Figure 8. United
States led the ranking with more than 40% of sales, followed by Japan and Germany which
together accounted for 18% of sales.
- 32 -
Figure 8: Medical Devices Sales Distribution (2008). Source World Health Organization
On the other hand, in Figure 9 10 top medical device companies by sales (2008) are
displayed. Large conglomerates such as Johnson & Johnson, GE, Philips or Siemens lead the
industry. Biomet, company to be studied, is positioned at the 29th with sales of $US 2135
million. Also noteworthy is Zimmer's 15th position, company acquiring Biomet in June 2015
at the exit of the LBO, climbing up then the sector ranking to enter the top-3 medical device
companies by sales in 2015.
- 33 -
Figure 9: Top medical device companies by sales (2008). Source WHO
Following the industry analysis over the years of the PE consortium's acquisition of
Biomet. At this point we will take a look at the M&A deals of the time and especially analyse
the motives behind the major transactions.
The financial and capital market conditions of the time were the main obstacle to
M&A transactions in the industry. The years before the 2008 crisis witnessed a strong M&A
momentum with a significant amount of large deals (>$1 billion). However, during 2009,
given the difficult conditions, there was a significant drop in transactions in the sector. Over
the next two years the industry recovered. And despite a difficult second half of 2011, the
- 34 -
M&A market returned to growth driven by private equity firms, which again had a significant
presence armed with substantial amounts of bank financing. A clear example was
Blackstone's astonishing $16 billion bid for Synthes in late 2011. In the following figure
(Figure 10), we can see the evolution of M&A transactions in the medical device industry
from 2000 to 2012.
Figure 10: Value and number M&A deals (2000-2012). Source: Thomson ONE
According to a 2012 report made by BCG, during the period under study the main
motives for which medical devices companies had chosen to use M&A to achieve were: (a)
market segment consolidation, (b) strategic portfolio extension, (c) access to some
technology or R&D, (d) private-equity investment and (e) strategic entry by non-medtech
players. These are the top five rationales, individually or in combination, that drove
transactions worth more than $1 billion in the medtech industry from 2005 to 2012. Time
frame in which the Biomet acquisition took place.
Figure 11: Rational behind the largest M&A deals in medtech. Source CapitalIQ
- 35 -
i. Market Segment Consolidation - As we can observe above (Figure 11), the majority
of medtech deals (almost 75 percent) were motivated by the aim of being
consolidated in an specific market segment. Companies strived to make use of
customer relationships and complementary geographic sales footprints to increase
revenues of combined product portfolios in a specific therapeutic area.
ii. Strategic Portfolio Extension - The second dominant reason why companies in
the sector use M&A is to expand their product portfolio. Representing 61% of those
studied. This may include simply expanding existing products with additional
complementary services. Specifically, in the medical equipment sector one could see
for example dental implant companies acquiring computer-aid-ed design and
manufacturing software which allows the laboratory to design customized implants
for its clients.
iii. Access to R&D Technology - Access to a R&D pipeline for 30 percent of the
deals studied. These transactions are symbiotic agreements, where large medtech
companies acquire smaller entrepreneurial and innovative companies. And both
parties gain from the deal.
iv. Private equity investments - 25 percent of the deals analysed involve private-equity
funds attracted by high margins, solid growth and good exit opportunities throw a
sell to strategic competitors, or an IPOs. Because medtech companies did not focus
in the past on being lean and mean, there are substantial opportunities for private
equities to create value through operational improvements. Our case of Biomet is a
clear example of a consortium of private equity funds taking advantage of the
opportunity of a company with solid growth and an attractive exit sale to a strategic
competitor such as Zimmer.
v. Strategic entry by non-medtech players – Finally, a 14 percent of the M&A
transactions analysed involved companies without previous presence in the medical
devices sector. Usually representing pharma companies attempting to counter the
challenges of their industry, such as the expiration of certain patents. Another option
may also be the objective of these companies to offer integrated medtech-
pharmaceutical products.
- 36 -
6. Financial Analysis pre-LBO and the delisting in 2008.
The financial situation in the years prior to the LBO is shown in Figure 14. The strong growth
in sales during the 5 years prior to the LBO with a CAGR of 12.1% (Figure 12) stands out,
especially when compared to the global growth of the sector. This growth is largely due to
acquisitions and joint ventures during the period. The best example is the joint venture with
Merck in 2004.
Following with the operating pre-LBO analysis, a fall in the EBITDA margin can be
seen during this same period (Figure 13), which together with the stability in the generation
of cash flow and the strong increase in sales generates a range of possibilities for the creation
of value through operational engineering.
On the investment side, it can be seen how the Working Capital requirements are
significant during all the studied period (c.50% of sales), which undoubtedly also means room
for improvement in the management of this Working capital during the LBO. Not
surprisingly, much of the value creation will eventually come from improvements in WCR
management reducing it to represent 24% of sales at the end of the holding period.
Finally, Biomet is in an attractive position in terms of leverage. It can be seen how
during this 5-year period prior to the acquisition by the private equity consortium, the
company's net debt is practically zero or even negative in some years. This situation,
considering that it is a company with very stable cash flows, offers the possibility of taking
advantage of the leverage effect through the LBO, without exposing the company to
excessive risk.
Figure 12: Sales evolution (2002-2007). Source:Thomson Reuters
CAGR 12,1%
0
500
1000
1500
2000
2500
3000
2002 2003 2004 2005 2006 2007
Sales (millions USD) evolution
- 37 -
Figure 13: EBITDA Margin evolution (2002-2007). Source: Thomson Reuters
Figure 14: Biomet pre-LBO financial analysis (2002-2007). Source: Thomson Reuters
26.00%
27.00%
28.00%
29.00%
30.00%
31.00%
32.00%
1 2 3 4 5 6
EBITDA Margin evolution
Biomet financial analysis 2002-2007: pre-LBO period
(millions USD)
Normative tax rate (t) = 30% 2002 2003 2004 2005 2006 2007
Revenue 1191.9 1390.3 1615.25 1879.95 2025.74 2107.4
% Growth 16.6% 16.2% 16.4% 7.8% 4.0%
Gross Profit 859.2 983.0 1153.1 1346.6 1443.6 1456.3
% Gross Margin 72.1% 70.7% 71.4% 71.6% 71.3% 69.1%
EBI TDA 370.7 426.5 487.9 570.1 608.4 586.6
EBITDA Growth 15.1% 14.4% 16.8% 6.7% -3.6%
EBITDA Margin 31.1% 30.7% 30.2% 30.3% 30.0% 27.8%
D&A (2) 47.8 45.7 58.2 69.6 82.2 97.0
% Margin 4.0% 3.3% 3.6% 3.7% 4.1% 4.6%
EBI T (1) 322.9 380.8 429.7 500.5 526.2 489.6
% Margin 27.1% 27.4% 26.6% 26.6% 26.0% 23.2%
CapEx (3) 62.27 59.77 61.34 97.37 108.9 142.5
% Revenue 5.2% 4.3% 3.8% 5.2% 5.4% 6.8%
FCF = (1)* (1-t)+(2)-(3) 211.562 252.478 297.663 322.566 341.62 297.22
% Cash conversion 57.1% 59.2% 61.0% 56.6% 56.2% 50.7%
Fixed Assets (4) 219.06 253.45 268.83 322.89 357.63 427.4
WCR(5) 620.45 696.24 678.26 768.85 850.58 820
% Sales 52.1% 50.1% 42.0% 40.9% 42.0% 38.9%
Capital Employed = (4) + (5) 839.51 949.69 947.09 1091.74 1208.21 1247.4
Net Financial Debt -94.8 -148.87 -59.62 166.52 109.22 -149.1
Gearing = Net Debt/ Equity NA NA NA 0.6x 0.3x NA
Leverage = Net Debt/ EBI TDA NA NA NA 0.3x 0.2x NA
ROCE = EBI T * (1-t)/ Capital Empl. 26.9% 28.1% 31.8% 32.1% 30.5% 27.5%
ROCE -WACCPro
f.
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- 38 -
After analysing the situation of both the company and the sector in the years prior
to the LBO, and before analysing the creation of value during the holding period, we expose
some information regarding the funds participating in the Acquisition along with the
financing structure of the acquisition is defined at this point.
As commented above the acquisition was carried out by a consortium of private
equity funds formed by: The Blackstone Group, Goldman Sachs, KKR and TPG Capital. If
we look at Figure 15 we can see how three of them are among the biggest funds in the world.
Important to note that Goldman Sachs it is not among them since it is considered an
Investment Bank despite the fact it contains an strong participation in the Privat Equity
market.
Figure 15: Top 10 biggest PE funds. Source:PE International Data Base
Ranking Name City, Country (HQ)
1 The Blackstone Group New York, United States
2 The Carlyle Group Washington, United States
3 KKR New York, United States
4 TPG Fort Worth, United States
5 Warburg Pincus New York, United States
6 NB Alternatives New York, United States
7 CVC Capital Luxembourg, Luxembourg
8 EQT Stockholm, Sweden
9 Advent International Boston, United States
10 Vista Equity Partners Austin, United States
- 39 -
A Sources & Uses table has been created for this purpose. Here, on the one hand,
the cost of the acquisition (Uses) is indicated and, on the other hand, the sources of financing
used.
On the Uses side, the Equity value paid by the private equity funds consortium is in
the first place. This data has been extracted from press reports of that year and is equal to
10.9 billion dollars (44$ per share). This amount includes a premium of 27% over the
company's market capitalization as of April 3 of that same year, the trading day before the
market started considering the company a takeover target. Once the Equity Value paid is
fixed, the net debt assumed by the buyer must be added, which in this case Biomet had a
negative debt of 149 million dollars. Finally, to this value it is included the fees paid to any
type of advisor.
The side of the sources is more complex, and certain assumptions had to be made.
On the one hand, the financing is divided into debt and equity, representing about 60% and
40% respectively. In turn, the debt is obtained from various sources (banks, Mezzanine
Funds, Hedge Funds, etc.) through the so-called SPV's ordered from lower to higher
seniority. The percentages of each source can be seen in the table below (Figure 16). On the
equity side, the contribution comes from 4 large investors mentioned above, of which more
details are included in the Appendix: The Blackstone Group, Goldman Sachs, KKR and
TPG Capital. We can note that the proposed/required stake for the founders and
management of Biomet is near 41 million dollars, which gives them control of 1% of the
company. It can be seen that the EBITDA multiple paid on the acquisition is 18.8x, a
multiple in line with sector acquisitions.
- 40 -
Figure 16: Sources and Uses table of the LBO entry. Source: Own calculation
7. Value creation during the holding period (2008-2014)
At this point, being already in the picture. Having seen the situation of the company
in the industry and the structure of the acquisition by the group of private equity funds. This
section is dedicated to studying the operational and financial management of the company
by the new owners. The value created will be calculated, and the sources of this value creation
will be studied. Finally, one point will be dedicated to studying the risk assumed during the
period.
7.1. WACC estimation for the holding period
i. Risk-free rate and Equity Risk Premium computation
As explained in previous points the risk-free rate is estimated as the 5-year US
government bond. As a personal input it has been considered that the 10-year government
bond would be too long for a typical LBO investment. However, we have chosen to add
15bps to the 5-year bond in an arbitrary way to make a sort of average between the 5-year
and the 10-year bond. However, this decision does not significantly affect the outcome.
EBITDA2007= 586.6
(million USD) (million USD)
Value % xEBITDA Value
Term Loan A 1800 16% 3.1x Equity Value (100%) 10900
Term Loan B 1500 14% 2.6x Net Debt to refinance -149
Term Loan C 1500 14% 2.6x Fees 290
Total Senior Debt 4800 43% 8.2x Implied fees % (as % of Total EV) 2.7%
Enterprise Value 10751
Mezzanine Facility 1600 14% 2.7x
Total Acquisition Debt 6400 58% 10.9x
Total Equity 4641 42% 7.9x
o/w The Blackstone Group L.P 1500 32%
o/w Goldman Sachs & Co. 1500 32%
o/w KKR & Co. 1000 22% % of Total Equity
o/wTPG Capital 600 13%
o/w Biomet founders 41 1%
Total Sources 11041 18.8x Total Sources 11041
Sources Uses
Sources and Uses table
- 41 -
On the other hand, regarding the Equity Risk Premium, a constant value of 6% has
been taken for each year of the LBO, and a sensitivity table will be shown later on to see the
effect of a variation in this value.
ii. Beta computation For the period of the LBO, it has been considered an equity beta based on:
• A sectorial Unlevered Beta of 0.8, considered fixed for the whole period (obtained
from brokers’ reports).
• A market capitalization of 10.9 billion dollars, based on the price paid in the
acquisition.
• And finally the level of net debt and the effective tax rate corresponding to each year.
The bridge formula between unlevered beta and levered beta is computed in the previous
section.
Finally, once obtained de cost of equity we compute de WACC weighting this cost with the
cost of debt equal to the interest paid on the debt year by year.
Following the premises taken and discussed, the following figure (Figure 17) summarizes the
WACC computation for each year.
In addition, in Figure 18, a sensitivity table has been elaborated to see how the value of
WACC varies depending on the Equity Risk Premium taken and the Unlevered Beta of the
industry.
Figure 17: WACC computation for the holding period. Source: Own calculation
WACC computation
2008 2009 2010 2011 2012 2013 2014
Cost of Debt 8.2% 8.9% 8.8% 8.3% 8.2% 6.7% 6.2%
Cost of Equity 10.8% 10.1% 9.7% 9.3% 8.4% 8.9% 9.4%
rf (5y bond + 15bps) 3.0% 2.4% 2.1% 1.7% 0.9% 1.3% 1.8%
ERP 7% 7% 7% 7% 7% 7% 7%
Unlevered Beta 0.8 0.8 0.8 0.8 0.8 0.8 0.8
Levered Beta 1.12 1.11 1.09 1.09 1.07 1.09 1.08
Net Debt (million USD) 6173.2 5997.1 5707.4 5651.1 5332.9 5610.8 5472.8
Market Cap (million USD) 10900 10900 10900 10900 10900 10900 10900
Effective Tax Rate 30% 30% 30% 30% 30% 30% 30%
%D 36.2% 35.5% 34.4% 34.1% 32.9% 34.0% 33.4%
%E 63.8% 64.5% 65.6% 65.9% 67.1% 66.0% 66.6%
WACC 8.95% 8.72% 8.49% 8.11% 7.55% 7.49% 7.69%
HOLDI NG PERIOD
- 42 -
Figure 18: WACC sensitivity to the ERP and the Beta. Source: Own calculation
7.2. Value creation for the firm
Once the WACC and its evolution during the holding period has been calculated, it is time
to compare it with the ROCE obtained during this same period to estimate the total value
creation for the firm.
The ROCE used is the called normative ROCE, which includes the normative tax rate, and
which uses a “normative capital employed” excluding the revaluation of intangible assets in
the LBO acquisition.
Looking at Figure 19 it is confirmed the importance of studying the evolution of the
ROCE during the period, since despite the fact that a decrease in WACC is achieved between
2008 and 2013 the significant change is observed in the ROCE.
In 2008 (the first year of the investment period), it is clear that value is being
destroyed. This is due to the negative EBIT of that year (-271.5m$), caused by an increase in
costs that were not reflected in an increase in Revenues until the following years. This fact
can be demonstrated also by observing the evolution of the EBITDA margin, which was
8.4% in 2008 and 29.6% in 2009.
From 2009 onwards, considerable value creation can be observed as shown in the
second graph of the figure, reaching a maximum spread of 16.3% in 2012.
Wacc sensitivty (2008 value as example)
8.95% 0.6 0.7 0.8 0.9 1
6.0% 7.17% 7.70% 8.24% 8.77% 9.31%
6.5% 7.44% 8.01% 8.59% 9.17% 9.75%
7.0% 7.70% 8.33% 8.95% 9.58% 10.20%
7.5% 7.97% 8.64% 9.31% 9.98% 10.64%
8.0% 8.24% 8.95% 9.66% 10.38% 11.09%E
RP
Unlevered Beta (sectorial)
- 43 -
Figure 19: ROCE vs WACC spread (2008-2014). Source: Own calculation
7.3. Value creation for the shareholders
Having calculated the total value created for the firm, the next step is to measure the
spread between the ROE and the COE during the holding period. In this way, the value
created for the shareholders is obtained as mentioned in the previous points. The following
figure illustrates the evolution of ROE and Cost of Equity (Figure 20). It can be seen how in
the first 3 years of the investment period value is destroyed as the cost of equity (which drops
slightly but remains at around 9%) is greater than the return obtained. However, from 2011
onwards, mainly thanks to the operating improvements in the EBIT, value is created for the
shareholders. The right-hand side of the figure shows the evolution of this spread between
the two metrics.
Figure 20: ROE vs COE spread (2008-2014). Source: Own calculation
7.4. Value creation for debtholders
As explained in the previous sections, the value for debt holders is estimated as the
spread between the cost of debt (computed as the 5y-US government bond yield plus a 5-y
- 44 -
Credit Default Spread) and the return on debt (ROD) equivalent to the ratio between
financial expenses and the gross debt for each year.
In this case, as shown in the figure below, value is created for debtholders throughout
the period, as the cost of financing is and remains very low.
Figure 21: ROD vs COD spread (2008-2014). Source: Own calculation
7.5. Digging into the drivers of value creation
At this point, this section is dedicated to go into detail in the creation of value and
see the sources that have caused it. This task is done following the method discussed
previously, based on a research paper made in 2016 by INSEAD Business School in
cooperation with the company Duff & Phelps.
Giving an input equity of 10,892 million dollars and output equity of 14,887 million
dollars both extracted from press news from the time. A return was obtained at the end of
the period of IRR= 6.3% and CoC=1.5x. These are considered low returns for the sector
and for the type of investment exit to an strategic buyer (Zimmer). However, it is interesting
to go into detail about the drivers that have led to the creation of this value.
i. Sales evolution (Internal vs External growth)
The first driver of operational improvement to the company during the period (2008-
2014) is the boost in sales. Therefore, revenue growth is analysed in this point. However,
since the focus is on the impact of private equity on value creation, it is necessary to
differentiate between the overall growth of the sector (external growth rate) and the growth
achieved internally by good management of the company (internal growth rate). The sum of
these two metrics results in Biomet's total growth year over year.
- 45 -
Figure 22: Sales growth evolution. Source: Own calculation
The figure above (Figure 22) represents the three metrics discussed:
• External Sales Growth: Represents the global growth rate from the medial
devices industry extracted from 2014 industry reports.
• Internal Sales Growth: The sales growth achieved by the good management of
the company in parallel with the global growth of the industry. In this way, it is
a growth that represents a gain in market share over competitors.
• Biomet Sales Growth: Biomet's total growth is computed as the sum of external
growth plus internal growth.
Looking at the graph it can be seen how the Biomet outperforms the global growth of
the industry by far during almost every year except 2011, when after the global crisis, growth
slowed down significantly.
ii. Cost structure evolution
Having analysed the sales trend this section studies the evolution of costs during the
period. Firstly, the improvement in margins (Gross margin and EBITDA margin) are
0.0%
2.0%
4.0%
6.0%
8.0%
10.0%
12.0%
14.0%
2008 2009 2010 2011 2012 2013 2014
External vs Internal Sales Growth (2008-2014)
External Sales Growth Internal Sales Growth Biomet Sales Growth
- 46 -
analysed. Not only the evolution between 2008 and 2014 but also taking a step back and
comparing it with the margins they were obtaining before privatisation.
Figure 23: Gross margin and EBITDA margin. Source: Own calculation
As can be seen in the figure (Figure 23), the low return obtained in the LBO is largely
caused by poor cost management. It can be seen how the boost in sales is not accompanied
by an improvement in margins. And although EBITDA ends up increasing at the end of the
period with respect to the years prior to privatization, it does not do so on the same scale as
sales, since the EBITDA margin suffers a significant drop, especially during the first years of
investment. At the beginning of the period, the company was generating a gross margin and
an EBITDA margin of 70% and 30% respectively. After the acquisition and coinciding with
the global crisis, margins of 50% and 10% respectively were reached. Then, during the three
years prior to the exit, these margins recovered although not reaching the levels of 2007.
iii. Operating Cash Flow evolution, Cash Flow from investing and Free Cash
Flows (FCF)
Although it is difficult to draw conclusions from the evolution of the Unlevered FCFs.
It can be seen (Figure 24) how the trend is in line with the evolution of operational metrics
such as EBIT. This is because the cash flow from investments as represented in Figure 25 is
not particularly volatile (except for 2013) and in any case, does not significantly exceed
depreciation. Another important factor affecting these FCFs is the management of Working
Capital. Both the evolution of CapEx with respect to Depreciation and the variation of
Working Capital will be seen in more detail in the following sections (iv, v).
- 47 -
Figure 24: Unlevered FCF evolution (2008-2014). Source: Own calculation
Figure 25 shows the cash flow separated into operating, investing and financial activities.
It is important to note that the first year of investment (2008) has been omitted since the
financial cash flow, due to the enormous amounts of equity and debt that had to be issued
at the beginning of the investment, would have disfigured the entire representation.
During 2008 and 2009 the financial cash flow was positive as these were years of
financing issues (debt and equity). From 2010 onwards, interest payments and debt
repayments predominate, making cash flow negative and fairly constant.
Figure 25: Cash Flow analysis and split. Source: Own source
- 48 -
iv. Capital Expenditure evolution
The following figure (Figure 26) shows the evolution of Capital Expenditures as an
absolute value and relative to sales.
Figure 26: Capital expenditures evolution (2004-2014). Source: Own calculation
On the one hand, it can be seen that in the years prior to Biomet's privatization, CapEx
was rising, and this was not being accompanied by an increase in sales in the same proportion
as the ratio was also increasing. This means that either capital expenditures were not being
used to drive sales, they were just simply maintenance expenses or that they were investments
with long-term objectives.
However, if we look at the evolution of both metrics from 2008 onwards, once the
company was in hands of the consortium of private equity funds It can be seen how the
period began with strong CapEx investments in 2010, 2011 and 2012, moderated slightly in
the following two years. And what seems more interesting is to see that CapEx as a
percentage of sales decreases during this period. This means that sales grew at a higher
proportion, and therefore despite having to assume higher capital expenditures these were
compensated by higher sales growth.
v. Working Capital management
As with Capital Expenditures, this section analyses the management of Working Capital
before and during the LBO. For this purpose, the WCR is divided into the two different
definitions. On the one hand, we will see how the so-called operational WCR, defined as
- 49 -
Accounts receivable + Inventories – Accounts Payable. And on the other hand, we will see
the trend of the total WCR including in the previous calculation the Other Currents Assets
and Other Current Liabilities.
In this first figure (Figure 27) the operating WCR has been broken down into the
Accounts Receivable, the Inventory and the Accounts Payable as a percentage of sales. In
this way we can see how each of them has been managed separately.
Figure 27: WCR Decomposition as % of sales. Source: Own calculation
Analysing this first figure (Figure 27) it is already possible to detect the good management
of the WCR during the LBO. If we compare the ratios with respect to sales, we can see how
both the Accounts Receivable and the Inventory are reduced by approximately 5% (2007 vs
2014) with respect to sales. This means that from the sales of each year you are getting 5%
more conversion to cash (i.e. by receiving the money from customers before).
In addition, Accounts Payable as a percentage of sales is increased by about 10% (2007
vs 2014), for example by improving contracts with suppliers. In this way you also achieve a
shorter cash cycle.
- 50 -
Figure 28: Operating WCR evolution (2004-2014). Source: Own calculation
As expected, this figure (Figure 28) shows how, from the acquisition in 2008 to the exit
of the operation in 2014, a decrease in Operating Working Capital of around 15% is achieved
with respect to sales. It is concluded as one of the good operational management during the
LBO period.
Figure 29: Total WCR evolution (2004-2014). Source: Own calculation
Finally, if the analysis of the evolution of the total WCR is carried out adding the Other
Current Assets and the Other Current Liabilities to the previous calculation (Figure 29). The
good management during the LBO is confirmed, since the reduction of the WC is even more
accentuated.
- 51 -
7.6. Risk analysis
As exposed in the last point of the first section (4.2) the study of value creation is closed
with a risk analysis.
Firstly, in order to have an accurate approach to the risk evolution it is important to
separate it into financial risk and operational risk. Starting with the study of the financial risk,
3 metrics have been computed. All three represented in the figure below (Figure 30).
Figure 30: Financial Risk metrics computation. Source: Own calculation
The three metrics for the year prior to the LBO and for the entire Holding Period have
been computed to see how risk has been managed during the period.
Firstly, if we look at the Debt Equity ratio, we see that although in 2007 it was 0.2x,
throughout the period it has remained around 1x and therefore stable and with a
reasonable value.
Not so stable was the Net Debt/EBITDA ratio. As expected, in 2008, as the leverage
through debt skyrocketed, net debt increased and operating results (EBITDA) did not
boost until 2009 as we have seen throughout the section. This caused this ratio to jump to
the worrying value of 31x in 2008. However, it is a risk that was successfully assumed, since
from 2009, this ratio stabilized between 6x and 7x until the end of the period.
- 52 -
Finally, the ratio between EBITDA-CapEx and interest payments on debt has been
computed. The evolution of this value seems a little more worrying. In 2007 it was around
20x and after a fall to negative values in 2008 it stabilised slightly at around 1x, which puts
the company at risk of not being able to cover interest expenses. Of course, it must be
taken into account that no other investment or financing income that the company might
have is being taken into account.
Finally, in order to assess operational risk, it was decided to compute the evolution of
the ratio between fixed and variable costs (Figure 31). As commented in the theory section,
an increase in fixed costs in relation to variable costs entails more risk for the company as it
makes it difficult for the company to reach break-even point.
Figure 31: Fixed vs Variable costs ratio (2007-2014). Source: Own calculation
Looking at the result of the evolution of the ratio between fixed and variable costs, it
can be concluded that operational management was carried out without added risk. It can
be seen how the ratio decreased in the year of the acquisition. This means that as an
operational improvement a more affordable break-even point was achieved for the
company, consequently, a lower risk for the company.
- 53 -
8. The exit to the new holding Zimmer Biomet
Having seen and analysed the acquisition and value creation of Biomet by the consortium
of private equity funds, it only remains to study its exit to the strategic buyer Zimmer
Holding, Inc. through a cash and equity acquisition of near $14 billion.
Zimmer Holding at that time was a public medical equipment company, founded in 1927
based in Warsaw as part of an industry cluster. However, in 2001 it was spun off from the
cluster (Bristol-Myers Squibb) and started trading alone on the NYSE under the ticker
"ZMH". After several other strategic acquisitions in 2015 the ticker became "ZBH" as a
result of the studied acquisition of Biomet on its exit from the LBO.
On October 24, 2014 Zimmer announced the agreement to purchase Biomet for nearly
$14 billion. However, it was not an easy acquisition. Since, following the announcement of
the offer, EU’s regulators opened an investigation into Zimmer's bid for Biomet concerned
that could significantly affect some competition markets. Finally, Zimmer was able to
complete the acquisition by becoming Zimmer Biomet Holdings.
Entering into the strategic and rationale fit behind the merger, Zimmer Biomet became
a market leader, with a highly diversified portfolio of musculoskeletal solutions. Zimmer
Holdings strengthened its presence in all major markets worldwide and at the same time
increased its presence in emerging markets. Similarly, Zimmer Biomet estimated the creation
of operational synergies that would drive shareholder value.
The acquisition was intended to be double-digit accretive for Zimmer. In large part due to
net annual synergies of $350 million in the third year but anticipated by nearly 40% in the
first year. The directors of Zimmer Holdings also saw future cross-selling opportunities while
leveraging their scalable platforms.
Finally, after the closing of the merger, the board of directors of the new entity increased by
12 members. The presence of Michael Michelson from KKR and Jeffrey Rhodes from TPG
is noteworthy. As both were part of Biomet's board of directors during the LBO period.
In the table below (Figure 32) the details of the exit are exposed:
- 54 -
Figure 32: Exit details to new holding Zimmer Biomet. Source: Pillar of Wall Street
- 55 -
SECTION III – CONCLUSIONS
To conclude this research paper, this section is dedicated to expose the conclusions
drawn after reviewing the theory behind how private equity funds can extract value from
their LBOs, and after having analysed the real case of Biomet Inc's LBO by the consortium
of Private Equity funds. Therefore, we conclude this research by commenting on the results
obtained by applying the theoretical methods and frameworks outlined in the first section to
the Biomet's case study.
First, by observing the evolution of the ROCE-WACC spread. It has been possible to
verify that during the LBO, this spread was able to be turned it into positive and increased
during the period and thus create value for the whole firm. This value was then distributed
by estimating the ROE-COE and ROD-COD spreads among shareholders and debtholders
respectively. In both cases this resulted in a positive outcome at the end of the investment
period. Therefore, it can be concluded that the impact of private equity on Biomet through
the LBO was value creation for all its participants.
Secondly, it has been detailed the path that has been followed to enable all the
participants in the operation to obtain value in the end. In general terms, a Cash on Cash
multiple (C/C) of 1.5x has been obtained, equal to the one set as a target prior to the
acquisition. On the one hand, in operational terms, this return has been generated by a sales
growth significantly higher than the overall sector growth during the holding period, an
efficient Working Capital management and a cost structure optimization. On the other hand,
the other two causes of the value boosting have been the leverage effect and a positive
multiple impact. This last one, mainly caused by a low entry multiple, being a period of global
economic crisis (2008), and by a high exit multiple in the sale to a strategic buyer with which
significant synergies were generated ($350 million per year).
Finally, following an analysis of both the financial and operational risk of the LBO, it has
been studied the rationale behind the Biomet acquisition by Zimmer Holdings at the exit of
the LBO, and how the new entity Zimmer Biomet has become an industry leader.
In parallel, two additional interesting topics have been addressed during the first theorical
section:
One is the conflict of interests that very often exists between PE owners and the
management team of the invested company. This conflict arises when making decisions,
especially in the operational management of the company in the holding period. However,
- 56 -
based on a survey carried out by The Boston Consulting Group, it has been observed that
there are many points of high common interest to face and which generate value for all
participants in the investment. Some examples would be the exit planning, the balance sheet
management or the governance.
The other interesting point developed at the end of the first section is the analysis of the
effect of the current situation caused mainly by COVID-19 on the Private Equity industry
and, more specifically, the challenge it represents in terms of value creation in LBOs. It has
been concluded that PE managers should now find operational and financial measures to
keep afloat and help participated companies navigate this crisis. Identifying what each
company in its portfolio will need depending on the sector it is in. And with regard to
financing, they should also have to consider increasing capital through their own resources
or third parties.
Besides, it has also been considered important in these times to maintain constant
transparency with investors (LPs). As a proposal, it is suggested the possibility of contracting
third parties to provide regular independent valuations, which would be very useful for both
the managers and the participants of the fund.
Finally, on this point it is concluded that private equity funds currently have a
fundamental advantage for the creation of value with respect to listed asset funds, coming
from the greater control they have over their invested companies.
As two last conclusions, we would like to mention the limitation of any single
methodology for the estimation of value creation, and possible additional studies that could
be carried out.
The case of Biomet has served to highlight the limitation of using a single method for
measuring the effect of an LBO on a company. Neither accounting ratios (ROCE, ROE,
etc) nor other metrics such as IRR or CoC are sufficient to understand the whole effect of
an LBO on a company. It is necessary to understand in depth the situation of the sector and
the company Pre-LBO, during the LBO and Post-LBO.
Finally, since this is a very general and infinitely extendable subject, it is considered that
additional studies could be carried out to complement this one. For instance, it would have
been very interesting to add a practical case about a failure LBO, with an overall destruction
of value for the firm at the exit. This would open up a range of possibilities for understanding
what can cause the objectives of an LBO not to be met.
- 57 -
BIBLIOGRAPHY
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Databases: Thomson Reuters Eikon, Thomson ONE, Statista, ACSI, Factiva.
- 58 -
APPENDICES
Biomet Financials Pre-LBO period (2002-2007)
Figure 33: Biomet Balance Sheet (2002-2007): Source: Thomson Reuters
1- Balance Sheet
(millions USD)
ASSETS 2002 2003 2004 2005 2006 2007
Current Assets
Cash & Short-Term Investments 185.27 262.99 169.27 115.67 167.34 230.9
Accounts Receivables 414.67 472.36 465.95 495.73 524.76 498.7
Inventories 335.35 356.27 389.39 469.79 534.51 540.4
Prepaid Expenses 17.66 20.14 21.88 35.98 32.34 45
Other Current Assets 0 0 69.38 75.11 75.19 136.8
Total Current Assets 952.95 1111.76 1115.87 1192.28 1334.14 1452
Non-Current Assets
Long-term Investments 201.25 155.61 66.34 61.41 58.13 43
PP&E 219.06 253.45 268.83 322.89 357.63 427.4
Other Non-Current Assets 14.78 13.78 16.23 14.91 11.84 12.7
Intangible Assets 8.53 10.87 53.57 87.83 79.5 74.6
Goodwill 125.16 126.71 262.07 435.62 441.4 448.4
Total Non-Current Assets 568.78 560.42 667.04 922.66 948.5 1006.1
Total Assets 1522 1672 1783 2115 2283 2458
LI ABILI TI ES
Current Liabilities
Accounts Payable 129.75 140.08 180.02 232.65 241.03 264.1
Short-Term Debt 90.47 114.12 109.65 282.19 276.56 81.8
Other Current Liabilities 17.48 12.45 18.94 0 0 0
Total Current Liabilities 237.7 266.65 308.61 514.84 517.59 345.9
Non-Current Liabilities
Long-Term Debt 0 0 0 0 0 0
Deferred Taxes 3.33 7.03 26.09 31.25 26.99 21.2
Other Non-Current Liabilities 0.41 0.46 0 0 17.88 41.6
Total Non-Current Liabilities 3.74 7.49 26.09 31.25 44.87 62.8
Total Liabilities 241 274 335 546 562 409
SHAREHOLDERS' EQUI TY
Common Stock 277.1 307.9 227.64 300.44 323.16 368.5
Retained Earnings and Reserves 1003.19 1090.12 1220.57 1268.4 1397.03 1680.7
Total Shareholders' Equity 1280.29 1398.02 1448.21 1568.84 1720.19 2049.2
Total Liabilities & Equity 1522 1672 1783 2115 2283 2458
Check TRUE TRUE TRUE TRUE TRUE TRUE
ACTUAL
- 59 -
Figure 34: Biomet Income Statement (2002-2007): Source: Thomson Reuters
Figure 35: Biomet Cash Flow (2002-2007): Source: Thomson Reuters
2 - Income Statement
(millions USD)
2002 2003 2004 2005 2006 2007
Revenue 1191.9 1390.3 1615.25 1879.95 2025.74 2107.4
Growth 16.6% 16.2% 16.4% 7.8% 4.0%
Cost of Operating Revenue 332.73 407.3 462.17 533.36 582.11 651.1
Gross Profit 859.17 983 1153.08 1346.59 1443.63 1456.3
Gross Margin 72.1% 70.7% 71.4% 71.6% 71.3% 69.1%
SG&A and Other Operating expenses 488.48 556.5 665.17 776.51 835.25 870
EBITDA 371 427 488 570 608 587
EBITDA Growth 15.1% 14.4% 16.8% 6.7% -3.6%
EBITDA Margin 31.1% 30.7% 30.2% 30.3% 30.0% 27.8%
D&A 47.83 45.66 58.22 69.6 82.18 97.00
EBIT - Operating Profit 323 381 430 500 526 490
EBIT Margin 27.1% 27.4% 26.6% 26.6% 26.0% 23.2%
Financing Income/(Expense) -11.66 -9.16 -4.25 -4.4 -3.38 -9.3
Other Non-Operating Financial Income/(Expense) 8.8 23.84 18.3 11.57 14.27 21.3
Normalized Pre-Tax I ncome 320 396 444 508 537 502
Non-recurring Income/(Expense) 0 5.8 -1.25 -26.02 0 0
Pre-Tax I ncome 320 401 442 482 537 502
Pre-Tax Income Margin 26.8% 28.9% 27.4% 25.6% 26.5% 23.8%
Taxes 0 0 0 -193.25 -209.43 0
Net I ncome 320 401 442 288 328 502
NI Margin 26.8% 28.9% 27.4% 15.3% 16.2% 23.8%
ACTUAL
2 - Cash Flow
(millions USD)
2002 2003 2004 2005 2006 2007
Net I ncome 320 401.32 442.49 288.38 327.66 501.6
D&A 47.83 45.66 58.22 69.6 82.18 97
Stock Based Compensation 0 0 3.46 2.74 2 17.7
WC Increase/(Decrease) -118.4 -32.78 1.19 -48.37 -75.6 56.6
Income Taxes pais/(Reimbursed) 0 0 0 0 0 0
Other Non-Cash items to reconcile -65.19 -103.92 -119.27 98.57 77.16 0
Cash Flow from Operating Activities 184.24 310.28 386.09 410.92 413.4 672.9
CapEx -62.27 -59.77 -61.34 -97.37 -108.9 -143
Acquisition and Disposal of Business or Assets -6.74 0 -307.48 -266.23 0 0.00
Investment Securities -5.43 44.02 116.54 4.45 -12.8 -64.70
Other Investign Cash Flow 1 -1.53 -1.21 -3.95 -2.98 -6.50
Cash Flow from I nvesting Activities -73.44 -17.28 -253 -363 -125 -214
Dividends Paid -24.27 -26.42 -38.6 -50.87 -62.5 -73.5
Stock Issuance/(Retirement) -191.65 -197.84 -144.52 -215.02 -192.3 15.8
Debt LT&ST Issuance/(Retirement) 26.99 1.44 -11.49 167.62 -2.7 -196.8
Other Financing cash Flow 0 0 0 0 0 3.2
Cash Flow from Financing Activities -188.93 -222.82 -194.61 -98.27 -257.5 -251.3
Foreign Exchange Effects 1.31 3.58 -4.41 -6.5 -0.6 4.3
Change in Cash -76.82 73.76 -66.42 -56.95 30.62 212
Cash BoP 126 126 126 126 126 126
Cash EoP 49.18 200 59.58 69.05 157 338
ACTUAL
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Biomet Financials during the holding period (2008-2014)
Figure 36: Biomet Balance Sheet (2008-2014): Source: Thomson Reuters
1- Balance Sheet
(millions USD)
ASSETS 2008 2009 2010 2011 2012 2013 2014
Current Assets
Cash & Short-Term Investments 127.6 215.6 189.1 369.2 494.9 355.6 247.6
Accounts Receivables 535 531.1 471.7 485.5 496.6 538.7 577.3
Inventories 539.7 523.9 507.3 582.5 543.2 624 693.4
Prepaid Expenses 46.7 39.1 72.6 109.7 124.1 134.4 202.9
Other Current Assets 100.7 78.4 64.3 71.5 52.5 119.9 149.9
Total Current Assets 1350 1388 1305 1618 1711 1773 1871
Non-Current Assets
Long-term Investments 41.3 27.4 23.3 33.1 13.9 23 12.5
PP&E 640.9 636.1 622 638.4 593.6 665.2 716
Other Non-Current Assets 118.9 -615.4 120.9 62.6 56.8 102.8 93
Intangible Assets 6208.2 6384.3 5190.3 4534.4 3930.4 3600.9 3439.6
Goodwill 5422.8 4780.5 4707.5 4470.1 4114.4 3630.2 3634.4
Total Non-Current Assets 12432.1 11212.9 10664 9738.6 8709.1 8022.1 7895.5
Total Assets 13782 12601 11969 11357 10420 9795 9767
LI ABILI TI ES
Current Liabilities
Accounts Payable 357.3 476.9 412.7 437.9 418.4 467.6 658.7
Short-Term Debt 75.4 81.2 35.6 37.4 35.6 40.3 133.1
Other Current Liabilities 131.8 73.1 70.2 64.1 56.5 56.2 53.4
Total Current Liabilities 564.5 631.2 518.5 539.4 510.5 564.1 845.2
Non-Current Liabilities
Long-Term Debt 6225.4 6131.5 5860.9 5982.9 5792.2 5926.1 5587.3
Deferred Taxes 2112.5 1816.3 1674.9 1487.6 1257.8 1129.8 968.6
Other Non-Current Liabilities 43.1 181.6 181.2 172 177.8 206.1 256.3
Total Non-Current Liabilities 8381 8129.4 7717 7642.5 7227.8 7262 6812.2
Total Liabilities 8946 8761 8236 8182 7738 7826 7657
SHAREHOLDERS' EQUITY
Common Stock 5547.7 5584.4 5605.1 5614.1 5628.8 5667.5 5687
Retained Earnings and Reserves -711.4 -1744.1 -1871.6 -2439 -2946.7 -3698.9 -3577.8
Total Shareholders' Equity 4836.3 3840.3 3733.5 3175.1 2682.1 1968.6 2109.2
Total Liabilities & Equity 13782 12601 11969 11357 10420 9795 9767
Check TRUE TRUE TRUE TRUE TRUE TRUE TRUE
HOLDING PERIOD
- 61 -
Figure 37: Biomet Income Statement (2008-2014): Source: Thomson Reuters
Figure 38: Biomet Cash Flow (2008-2014): Source: Thomson Reuters
2 - Income Statement
(millions USD)
2008 2009 2010 2011 2012 2013 2014
Revenue 2383.3 2504.1 2698 2732.2 2838.1 3052.9 3223.4
Growth 13.1% 5.1% 7.7% 1.3% 3.9% 7.6% 5.6%
Cost of Operating Revenue 1246.8 1204.2 1192.5 1200.1 1102.7 1187.2 1347.4
Gross Profit 1136.5 1299.9 1505.5 1532.1 1735.4 1865.7 1876
Gross Margin 47.7% 51.9% 55.8% 56.1% 61.1% 61.1% 58.2%
SG&A and Other Operating expenses 937 559 601 550 790 967 1,062
EBITDA 199 741 904 982 946 898 814
EBITDA Growth -66.1% 271.9% 22.1% 8.6% -3.7% -5.0% -9.3%
EBITDA Margin 8.4% 29.6% 33.5% 36.0% 33.3% 29.4% 25.3%
D&A 471 538 548 549 509 495 501
EBIT - Operating Profit -272 203 357 433 436 403 313
EBIT Margin -11.4% 8.1% 13.2% 15.9% 15.4% 13.2% 9.7%
Financing Income/(Expense) -516.6 -550.3 -516.4 -498.9 -479.8 -398.8 -355.9
Other Non-Operating Financial Income/(Expense) -9.1 95.1 72.1 46.9 571.2 127 253.1
Normalized Pre-Tax I ncome -797 -252 -87.70 -18.60 528 131 210
Non-recurring Income/(Expense) -479 -668 -54 -1046 -1118.6 -872.2 -250.3
Pre-Tax I ncome -1,276 -920 -142 -1,065 -591 -741 -39.90
Pre-Tax Income Margin -53.5% -36.8% -5.3% -39.0% -20.8% -24.3% -1.2%
Taxes 0 0 0 0 132 117.7 115.8
Net I ncome -1,276 -920 -142 -1,065 -459 -623 75.90
NI Margin -53.5% -36.8% -5.3% -39.0% -16.2% -20.4% 2.4%
HOLDING PERIOD
2 - Cash Flow
(millions USD)
2008 2009 2010 2011 2012 2013 2014
Net I ncome -1276.2 -920.4 -141.7 -1064.6 -458.8 -623.4 75.9
D&A 470.3 537.7 548 549 509 495 501
Stock Based Compensation 25.8 33.9 22.4 12.7 16 38.3 18.2
WC Increase/(Decrease) 78.4 26.3 -98.2 -43.9 -5.6 45.9 134.7
Income Taxes pais/(Reimbursed) 0 39.4 9 46 -29 -38.4 29.5
Other Non-Cash items to reconcile 0 0 0 0 0 0 -230.5
Cash Flow from Operating Activities -701.7 -283.1 339.1 -500.8 32 -82.2 529
CapEx -190 -185 -183 -167 -165 -190 -226
Acquisition and Disposal of Business or Assets -11,638 0.00 -10.20 -18.40 -21.10 -298 -152
Investment Securities 128 3.10 11.60 -19.40 41.70 -0.90 13.40
Other Investign Cash Flow -10.20 -13.00 0.00 0.00 0.00 0.00 0.00
Cash Flow from I nvesting Activities -11,711 -195 -182 -205 -144 -489 -365
Dividends Paid 0 0 0 0 0 0 0
Stock Issuance/(Retirement) 5519.1 2.8 -1.7 -3.7 -1.3 -0.1 1.3
Debt LT&ST Issuance/(Retirement) 6047 39.70 -158 -47.70 -36.80 3280.8 672.6
Other Financing cash Flow -83.2 0.00 0.00 0.00 0.00 -3415.4 -947.8
Cash Flow from Financing Activities 11482.9 42.5 -159.9 -51.4 -38.1 -134.7 -273.9
Foreign Exchange Effects 2.1 -3.4 -6.10 15.00 -30.60 18 2
Change in Cash -928 -439 -8.90 -742 -181 -688 -108
Cash BoP 230.9 127.6 215.6 189.1 369.2 494.9 355.6
Cash EoP -697 -311 207 -553 189 -193 248
HOLDING PERIOD
- 62 -
Private equity funds participating in the Biomet LBO
We have considered interesting, add a section in this appendix giving an overview of the
funds PEs who participated in the Biomet LBO
The Blackstone Group
Stephen Schwarzman and Peter Peterson founded the company as an M&A firm that
gradually expanded its range to become the number one private equity firm and the largest
land owner in the world. Those $400,000 that Blackstone started with in 1985 have now
grown into a group of 2,500 employees, 23 offices worldwide and $512 billion in assets under
management, surpassing the iconic half-trillion figure for the first time. The firm's first
transaction was the merger between investment banks EF Hutton and Lehman Brothers in
1987, which earned Blackstone a $3.5 million fee.
The keys to the firm
Name: Blackstone Group.
Headquarters: 345 Park Avenue in New York.
Founded: 1985.
Chief Executive Officer: Stephen Schwarzman is its founder and CEO. Peter Peterson,
also a founder, serves as non-executive chairman.
Assets under management: $512 billion.
Main activities: Private equity, hedge fund, debt and real estate.
KKR KKR emerged in 1976, during a meal that Henry Kravis and George Roberts held at Joe and
Rose restaurant in New York. Six years later, the manager captured the first public funds
coming from the pension funds of Oregon, Washington and Michigan, until in 1984 he raised
the first institutional fund for a billion dollars. The fund expanded its scope in 1998 by setting
up an office in London and now has a presence in the main regions of the world, with
subsidiaries in Hong Kong, Dubai and Mumbai.
The keys to the firm
- 63 -
Name: KKR
Headquarters: Solow Building in New York.
Founded: 1976.
Chief Executive Officer: Henry Kravis and George R. Roberts
Assets under management: $148.5 billion.
Main activities: Management Buyouts, Leveraged Finance, Venture Capital, Growth capital
TPG Founded in 1992 by David Bonderman , James Coulter , and William S. Price III . Since its
inception, the firm has raised over $50 billion in commitments from investors through 18
private equity funds.
The company has offices in North America, Europe, Asia and Australia.
The keys to the firm
Name: TPG
Headquarters: San Francisco California
Founded: 1992.
Chief Executive Officer: Jon Winkelried and James Coulter.
Assets under management: $75 billion.
Main activities: Leveraged buyouts, growth capital and venture capital.
Goldman Sachs Goldman Sachs is an international investment bank based in New York called "The No. 1
Wall Street Broker". The firm was founded in 1869 by Marcus Goldman and changed its
name to Goldman Sachs in 1885 with the addition of Goldman's son-in-law to the firm.
Goldman Sachs enjoys a reputation as one of the world's leading investment banks, whose
clients include governments, private clients and corporations. The firm is a prime broker in
U.S. Treasury securities and has supported initial public offerings of many companies since
1906.
- 64 -
The keys to the firm
Name: Goldman Sachs
Headquarters: 200 West Street, New York
Founded: 1869.
Chief Executive Officer: David M. Solomon
Assets under management: $1.859 trillion.
Main activities: Asset management, Commercial banking, Commodities, Investment
banking, Investment management, Mutual funds and Prime brokerage