How Private Equity buyers create value for investors

Started 1 week ago | Discussions thread
LarsPolarBear
LarsPolarBear Contributing Member • Posts: 525
Not really in this case... this is a distressed investment, different rules...
41

If you don't want the Investment background, you might be interested in the section why this is relevant for you as a photographer and client (scroll down).

Memoochi wrote:

Okay, lot of Olympus dead or not dead threads here. I work in Private Equity (PE), so allow me to share my view (limited as it is European-centric) of how PE buyers create value when they carve out a company.

Your insight is true if it were a "normal" PE investment in a well functioning company with high cash flows, however is is an investment in a "distressed asset" and different rules apply here (yes, I might not be the greatest photographer, but I have over 20 years of experience in distressed investment around the world, including being MD for large international funds).

Buying it:

1) They do a leveraged buy out. This means they borrow most of the money to buy the business. Usually they borrow at least half and sometimes up to 80%

JIP is a very small fund with less than US$150 million under management, dispersed over several funds.  They normally don't invest much of their own money and the possibilities to finance a distressed transaction are very limited.  A fund in general would normally not invest more that 10% of its asset in one investment, therefore the max. investment here is less than US$15 million, probably much less, since it is distributed over several funds.

Depending on jurisdiction, it is quite normal in this kind of situations to pay $1 (in words: one dollar) for the business, which includes the assets (anything tangible as well as intangible) and liabilities (all forms of debts, including supplier liabilities and personnel liabilities - e.g. pension liabilities) and the personnel contract. This would be done in an "asset deal" where all is transferred to a new company (NewCo). It would be also not surprising if Olympus Inc. actually pays a "negative purchase price", meaning Olympus Inc. will give some money for the business to continue for a limited time period (can by one or two years of losses, depending on how much they cut the cost before the transfer of the business).

I would be very surprised, if the Olympus brand would be part of the deal. Normally it would be licenced to the NewCo for a certain time period and only for its own use. Therefore, the idea (Robin Wong), that the Olympus brand would live on in camera market without the core business is very unlikely.

This seems to be just a face saving transaction for Olympus to get out of the business, this transaction is not about the future of the camera business, thy only want to cut their losses.

2) The rest they invest from their fund, which is usually filled with money from sovereign funds, extreme wealthy private investors (think Bono, Ellen, Zuckerberg-types).

Actually in these kind of small funds it in normal that the owner/managers invest their own money, often reinvesting money made on former transactions, there are normally no institutional investors involved, since the investment sum is too small.  However, that means that all profits will go to the managers of the fund (not just a smaller percentage of the profits as it is with a normal PE fund). This is very important, since this means the absolute return expectations are not that high and making $10-15 million will be still attractive to the investors (since they have invested only $1, the return on equity is obviously outrageous).  However, that means they don't need to sell the business on as a profitable going concern, as long as they have "milked" it for they own profit before.

3) Their interest is to grow the bottom-line earnings (EBITDA)

That is kind of true, but selling off assets (e.g. patents, receivables etc.) can be also very profitable, especially if 100% of earning go to you (see above).  It will all depends on how the transaction will be structured (nothings signed as of now, according to press release).

4) They usually value the business at a multiple of EBITDA, so if the EBITDA is say $50m, they might pay a multiple of 10x, so buy the business for $500m, of which $250m is debt at a very low interest rate, and $250m is their investment

Growing it:

1) To make a good return on investment, they need to grow the EBITDA

yes, as any business that is unprofitable, or sell of assets.

2) Step 1 is to cut costs. So, bargain on high cost areas to get cut, most likely PRO lens development, or Olympus' legendary service.

Olympus is doing part of the cost cutting for them already according to the press release.  JIP will focus on strengthening the management (I think most of us would agree that this is one of the problem area) and streamline the product offering as well as doing more cost cutting (e.g. renegotiate supply contracts, outsource production or start producing for other camera brands etc. etc.).

3) Cutting costs is not enough, they also need to show continued EBITDA growth. So they will usually buy a few other related businesses and bolt them on.

I doubt, that they will follow the strategy here, since there is little synergy with other camera producers.

So, why should I care about this as a photographer or client?

First of all it is important to note that apparently nothing has been signed as of now and the deal can still fall apart or another investor might step in.

I would have been much more happy if it would have been a strategic investor (another OEM e.g. Panasonic or Sony), since they would have had a long term interest in the business and support new R&D developments.  However, PE investor have a rather short term view and especially this type of small restructuring funds will not invest much, if anything, in the business. Yes, they can achieve a lot by reducing fat structures, but a big problem at Olympus is that their investments in new technologies has been rather minimal in the past years and there is a huge backlog in software and hardware development that this company in its current state will not be able to stem without outside investments.

Hoping that Olympus  Camera will come up with lots of new and exciting developments, as some have voiced here, is wishful thinking.  It will be a slow (or perhaps in the current state of the market a rather fast) decline to death.  If you are heavily invested in the system and you rely on the resale value of your equipment to buy new ones, I would get out asap.  However, if you just enjoy the system in its current state, and you don't care about the resale value, I would look for good deals to compliment your current equipment, but I would steer clear of problematic equipment that might need a lot of service (e,g, 14-42 EZ lens with its problematic zoom mechanism, E-M5 III with it breaking of the bottom plate etc...)

Well, these are my thoughts on this rather sad development...

Cheers,

Lars

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