Palamon - Assignment PDF

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Palamon Capital Case: Private Equity

FIN 4596-002 Professor Tilan Tang April 16, 2018 Dillon Patel Matthew Mulligan Aesha Patel Hanan Shandler

1.-

Introduce the practice, goals process of private equity investing: Private Equity is composed of funds and investors that directly invest in private companies, or that engage in buyouts of public companies resulting in the delisting of public equity. Institutional and retail investors provide the capital for private equity and the capital can be utilized to fund new technology, make acquisitions, expand working capital and to bolster and solidify a balance sheet. These investment typically result in either a majority or substantial minority ownership stake in a company. The investments can offer very strong return streams that are frequently much less correlated with indices than the returns available in classic public market investment opportunities. -Process of private equity investing: Once a PE firm has retained operating control through a buyout it will proceed with changes that will create value within the acquired entity. This can be through reduction or expansions of existing business, changing management teams, strategic partnerships to gain operational synergies, and increasing overall operational efficiencies. This evolution can take a significant period of time that varies between 3-7 years on average that will always have a high focus placed upon the exit strategy. The market conditions required for a profitable exit will be determined and vetted before engaging in the deal to reduce exposure to risk. - Compare PE investing attributes with public market investing: Public equity investing is buying shares in companies listed on stock exchanges. These companies can range from large established businesses with long track records. The public security market is significantly larger than the private securities market. Because of the size, the public market tends to much more regulated. Generally, public securities have much more active secondary markets where investors can easily and cheaply sell their securities at market prices. Private securities investments are highly illiquid. Private equity is typically investment funds organized as limited partnerships that are not publicly traded. Private equity firms are known for using extensive debt financing to purchase companies that they restructure and sell at a higher price. This kind of equity is usually targeted to high net worth individuals and institutional investors, and they have a greater ability to focus on long term prospects because there is no public pressure for short term results. -Diffusion of PE investing practices around the world: Due to volatile capital market the use of PE investing provides potential for high rates of return that are diffused from traditional financial systems reducing correlation during volatile periods. This has been used to reduce portfolio risk for certain segments while allowing higher than usual return opportunities. - Or how important are exit strategies in the PE market: Exits are central to the private equity investing process and a PE firm will consider a variety of different exit strategies to realize its return on investment. The most successful exits require considerable planning. The sooner you start, the more rewarding your exit is likely to be. PE firms acquire business with the intent to exit at a higher equity value than was initially invested. The focus is on obtaining a higher total equity return more so on receiving the investment back in a shorter time period.

2. The equity value of TeamSystems is the NPV of all cash flows minus the debt (ITL 162,070 million - ITL 46,000 million = ITL 116,070 million ). This does not take into consideration that the discount rate being used is taking the unlevered cost of equity position of TeamSystems. (Appendix 1)

3. Comparable company beta is 1.44x. Therefore, the unlevered beta for Team Sport is 1.246x. (Appendix 2)

4. Since we do not know the 10 year Italian bond rate, we used the July 2007 rate and the March 2011 rate to find an approximate value for July 2010. Using a linear growth rate of 0.483%, we found the rate for July 2010 to be 8.77%. We used the 1.246x unlevered beta and the MRP of 8% to find an unlevered cost of equity of 18.74%, making the value of free cash flows 103,251 million ITL. (Appendix 3)

5. NPV of the tax shield is 6,453 million ITL. We found the tax shield by multiplying each year’s projected interest expense (average of current year and last year debt times interest rate of 6.87%) times the tax rate of 48%. We then found the cost of debt by dividing each year’s long term liabilities by the interest expense. We discounted each year’s tax shield by one plus the cost of debt to the power of t, starting at t0 through t7. (Appendix 4)

6. Adding the NPV of the tax shield (6,453 million ITL) and the NPV of FCF (103,251 million ITL), we found the adjusted present value of the firm to be 109,704 million ITL. Therefore, the PV of the equity value of the firm is 63,704 million ITL (109,704 million ITL minus 46 billion ITL). This value is just 54% of the 116,070 million ITL. The difference is primarily due to the increased discount rate. Using the unlevered cost of equity of 18.74% instead of the WACC of 14% caused our adjusted terminal value to drop from 268 billion ITL to 175 billion ITL. In addition, we discounted the FCF and TV by the higher rate, dropping NPV even more. The increase in NPV from the tax shield did not offset much of the loss from the increased cost of equity. (Appendix 5) To assess whether Palamon’s initial investment of ITL 50.235 billion for 51% of the common shares was prudent financial decision we looked at the non-adjusted equity of ITL 116,070. Removing the long term debt from NPV and then taking 51% of it rendered a value of ITL 59.195 billion. This suggest that Palamon’s was able to purchase the controlling interest at a discount.

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Appendix 2

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