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Running head: The Private Equity Asset Class
The Private Equity Asset Class
Investment Rationale, Valuation Exercise & Modern
Financial Techniques
Wilmington University
Student: Hedi Chaabouni
MBA Finance
Instructor: Mr. John J. Bish
February, 22, 2008
Table of Contents
Acknowledgments Page 3 / 102
Introduction Page 4 / 102
Part I- The Rationale behind Private Equity financing
Page 8 / 102
Chapter 1: PE Asset Class Page 10 / 102
Chapter 2: PE Value Chain Page 17 / 102
Chapter 3: PE Strategic Power Page 31 / 102
Part II- Private Equity and Valuation Page
42 / 102
Chapter 7: PE Value Chain & Valuation Page 44 / 102
Chapter 8: PE & Value Based Management Page 47 / 102
Part III- Modern Financial Techniques & Private
Equity Page 55 / 102
Chapter 9: Portfolio Theory in PE Page 57 / 102
Chapter 10: Risk Management & Financial Engineering in PE
Page 62 / 102
Chapter 11: International Financial Management in PE Page 67 /
102
Conclusion Page 74 / 102
Appendixes: Cases in Emerging Markets
Appendix 1: Emerging Market Definition & Risk Profile Page
75 / 102
Appendix 2: DCF Valuation in Emerging Markets, the SPAM model
Page 78 / 102
Appendix 2: A Case Study in Emerging Markets Page 92 / 102
References Page 102 / 102
Acknowledgments
I would like first to thank my finance instructors at Wilmington
University who devoted time to teach me the concepts I need to become a well
enlightened finance student. I especially thank Mr. John J. Bish for having
taught me what the price of everything is; with his insight he gave me the keys
to the secrets of finance.
I especially thank Mr. Aziz Mebarek, cofounder and managing
partner at Tuninvest, a Private Equity firm with whom I made my first steps in
the field in 1997 as a member of the board of a family business this investment
firm invested in. With his unique insight, he inspired me and insufflated in me
the passion for the Private Equity industry. He also gave me some feedback
about his emerging market experience that helped me bridge the gap between
theory and practice when writing this thesis.
Finally, a part of my acknowledgments goes to Mr. Majdi
Chaabouni, a family member, today a top executive at a leading Arab bank in the
Middle East. He is the one behind my dynamic of finance studies and English
language graduate education. He taught me to go beyond my limits and passed me
the passion of writing.
Introduction
In this recent time where Private Equity funds are thriving
globally and becoming a very serious alternative and sometimes a
«trendy» way to raise money and finance industrial
operations and business acquisitions, I thought that a contribution to an open
debate in a somewhat close financial industry would be an interesting and
healthy endeavor for the educational and business communities. Indeed, many
formal books already exist on Private Equity; they describe the investment
process from A to Z and the different types of transactions that could take
place in terms of timing, type and size of the company invested in.
Yet, my interest in the industry made me wander in spaces I never
intended to visit. This year, when performing my MBA Finance, I first started
working on some papers related to Private Equity and found that each paper was
somewhat related one to the other. From this fact stemmed the idea of a thesis
encompassing several related articles describing and outlining the hot topics
today debated around Private Equity.
The first draft of this thesis was therefore entirely dedicated
to explore what issues matter today in the industry, and what is the rationale
behind PE investments. Its purpose was then to answer questions about PE
specific hybrid nature, the reasons behind its phenomenal returns and the
breakdown of its value chain, and how this type of investment has gained an
indisputable power amid other financing tools.
But after a while and this thesis continuing germinating in my
mind, I found these issues to be just a starting point and decided to push the
reflection further and try to explore new fields in the industry by broadening
the traditional scope of discussion about Private Equity. I had my part one for
this thesis but what about the rest?
As the valuation concept and techniques are at the core of the
Private Equity process I decided, with the advise of my finance instructor, to
devote the whole second part to it. After all, neither value chain, nor
strategic power, exists without a sound valuation process and techniques.
Valuation being an important part of my finance curriculum, this academic
thesis aiming also to encompass all the concepts I touched on in my MBA
program, it was natural to describe and analyze this concept from the
beginning.
As and when I kept touching on new subjects and topics in the
finance courses I'm actually taking, many other questions arose in my mind
about the structure of Private Equity. Issues like modern portfolio theory or
risk management and the use of derivatives within PE funds fully retained my
attention. What if a PE fund applies some of the principles of portfolio theory
a mutual fund uses? And what if a PE fund starts using derivatives to hedge a
stake acquired in a privately held business? Obviously, in Private Equity
today, these are not conventional practices. Nevertheless, many unconventional
practices in the past time became conventional today after researchers and
practitioners gained footings in spaces formerly recognized insurmountable.
Here came the idea of the last part of this thesis which I call the prospective
technical part. Its purpose is dual: first to start a reflection on the
practice by the PE industry of modern financial techniques today widely used in
financial markets, and second to dig in some technical aspects Private Equity
is nowadays exposed to as international investing.
Finally, an appendix part is devoted to study a specific and
today topic in economy and finance, the emerging markets. The choice to tackle
the emerging market issue is probably dictated by my belonging to a country and
region classified as so. In this part, the emerging market definition and risk
profile are reviewed, and a Discounted Cash Flow Analysis valuation technique
specifically applied to emerging markets is highlighted and deeply explained.
View differently; this PE thesis is tackled through four
different and complementary angles. First, the rationale driving the industry
is deterred to reveal the reasons behind the value creation engine in PE;
second a closer look is given to valuation and how its process and techniques
impact PE process; third modern financial techniques are cited to explore new
and unconventional scopes in PE daily management, and finally the merging
market issue in economy and finance is highlighted. The objective of this
thesis is hence to make readers better grasp the Private Equity industry
practice and challenges and in the same get acquaintanced with a today hot
topic on the global business place: the emerging markets.
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