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Sir Ronald Cohen, Founding Partner and Chairman, Apex Partners Worldwide LLP

“Buy-Outs, Deregulation, and Privatization"

We've just heard the fascinating description of what's going on in the early stage hi-tech business, in which my firm devotes, or to which my firm devotes about a 3rd of its capital, of the 13 billion dollars that we manage, about 4 billion is invested or dedicated to early stage companies. The other 9 billion is dedicated to the area of buy-outs, which I will try to give you an insight into this evening.

Now, buy-outs are not necessarily something that any or all of you are familiar with, I know from people I know in the audience that many of you are very familiar and so in the course of the presentation I will explain what a buy-out is. But while I give you some background information could you just bear in mind that a buy-out is supporting a management team to buy a business from a larger business, generally, and I will give you variations on that. So if you look at this aspect of entrepreneurship which complements investment in the creation of businesses, it has gathered a huge amount of momentum over the 30 years that I have been involved in the business.

If we go to the first slide, you will see that in the year 2000, 83 billion dollars was dedicated, this is of equity, you can double to treble that number if you want to take the value of the companies involved, but 83 billion dollars of equity from private equity funds, like those of Carlyle and ourselves, were dedicated to buying out companies which continued to be managed generally by the managers that had led them until then. You'll notice a change, in 1990 and 1995 the sum was quite a lot less, 25 billion, 20 billion, but also Europe was a long way behind the United States. You can see that in 2003 we've actually got to the situation where Europe has overtaken the United States and 37 billion dollars have been invested so far this year in buying companies out. And the other important aspect to note is in the right hand box that you've got over there, as a percentage of total mergers and acquisitions transactions Europe is now running at about 15% of all transactions in terms of money being represented by buy-outs.

Now, what types of transactions do buy-outs finance? They finance many different types of transactions, and I've given on the right hand side some examples of companies that we've been involved in buying out. The first is corporate restructuring. Large companies get into difficulty, in the case of British Telecom, it found itself forced to sell some very substantial assets, it sold its yellow pages, out for 3 billion Euro, it had to do that in order to sort out the problems of its balance sheet. Family businesses, the transition from one generation to another generation, where you've got management that's capable of taking the company forward but that is not part of the family, a company like Kamps, in Germany, which is one of the larger bread bakers in Germany, is the type of company that we have backed. Even in the public markets, public companies have sometimes difficulty in raising money, so the fact that you've got stock market listing does not necessarily mean that it's easy to raise money from the stock market.

We invested 400 million dollars in a company called Philips-Van Heusen, shirt manufacturers in the United States in order to buy Calvin Klein. Government, which is of particular interest I guess minister in this session, a government has focused on the private equity markets in privatizing, because in a lot of cases there are businesses that don’t fit in with other groups and the idea of having a self-standing business which may subsequently be floated is attractive to governments. We privatized for about a billion Euros the petrol stations on all the autobahns of Germany, a company called Thankgrassut, and from time to time private equity investors will come to the end of a life of a fund and then other private equity investor will come along and thanked the management in expanding the market share of the company or the growth, which is what we've done in the do
yourself retail business with Focuswicsk. So these are broad categories of transactions that will generally be described as buy-out transactions.

Now, if you look at the privatization and deregulation processes that have swept Europe in the last couple of decades, they have relied quite heavily on the private equity business. I'll take the example of British Telecom as a case where there was a hybrid solution. If you look at the right hand box in 1980 limited competition was introduced against British Telecom, and then the floatation of 50% of the shares, 1991 – the government sell down shares to 21%, it prepared a White Paper, which I know has certain connotations in Israel, but this is a different type of White Paper, to introduce full competition, and then, as we were just describing, when the company found itself saddled with the debts that were involved in buying all the spectrum licenses they spun an important company off. If you look at Germany, Germany has gone more directly to the private equity community.

If you look at the bottom charts, the bottom line of the left hand chart – 4.4 billion Euros were received by the German government as a result of buy-out firms putting together the leverage transactions to acquire companies. The rest you can read at your leisure.

Now, what is it that private equity firms do when they invest in buyouts? Well, first of all they are providing capital, clearly. They are providing capital in the form of equity which is the basis upon which debt is borrowed from the banking system, and in this respect the previous session when it was talking about certain aspects of regulation, was touching the issues that I'm particularly concerned with. What it does above all, is to align and incentivise management. I'll be showing you a chart which breaks down the buy-out effect, but basically when you take a company private which has been part of a government organization or when you buy a company out from a large group the management shifts from feeling that it has a boss to feeling that it is an owner-manager, and the efforts of all of the company pretty well are focused on achieving the objectives because all of the top management team will have a financial interest in the form of options or shares in the company and sometimes the whole of the workforce will have that. It provides greater discipline because you are living within constraints which are imposed by the banks that lend you the money, you are living within the constraints that firms like my own, that sit on the board of a company impose in terms of performance. And the people who sit on the board are professionals who have acquired a lot of experience over the years in these types of situations and usually who understand the sectors in which the companies operate.

There is a strange thing that I should just touch on which you may have seen occurring in the world of finance around you which is that all of a sudden we are interacting with the public markets more frequently than previously. Basically, financial markets, stock markets have become very short term, they've become very volatile, you can see that share prices in the period 2000-2003 were 35 times more volatile than they were at, you know, at the low end of the previous year and times of the previous period of 1990-97, share prices move up and down a lot more, companies have to deliver quarterly profits, if they don't their share price gets hammered and the private equity firms which raise their money from pension funds and insurance companies can afford to look through a period of lower profitability and therefore will often finance a public company to make an acquisition, for instance, as I was describing in the case of Calvin Klein. Now, what is the buy-outs effect, and how do buy-outs create value? If I can just take you briefly through the numbers on the left hand side: if you have a company who's sales are 100 at the time of purchase and at the time of your exit they've increased to 120, if its earnings have improved from 10 to 15 and if you bought it at 9 times its earnings and you sell it out at 10 times its earnings, you can see that the value of the company has gone from 90 to 150. But if you bought it with 45 of debt and 45 of equity, equity being shareholder's capital, and you repaid 15 during the life of the buy-outs so the debt goes down to 30, you can see that the private equity investor has seen the value of his stake increase from 45 to 120, and that's why pension funds and insurance companies invest in buy-out funds. Of all of these different factors the buy-out effect is usually felt most in the area of profit improvement, so you have all of these different factors, which I haven’t got time to go into in great detail, but management just becomes very motivated to deliver results when it earns the company.

Now, coming back to the micro picture, private equity is a significant driver of economic growth, I don’t think we need to do along on that, but you might be surprised to know that 18% of the private sector workforce in the United Kingdom is now owned, or now works within companies that are owned or partly owned by private equity groups. Private equity backed firms grow the profits and their employment at about 20% a year when public companies grow them at only 7 to 12%, and European statistics lend credibility to the same situation in other European countries as the UK.

So what does a conducive environment for buy-outs really involve? And this is where this subject comes close to the last session. Where Israel is concerned, clearly, the cultural aspects are not the issue. This society is very supportive of entrepreneurship and wealth creation. The strong legal framework to protect investor interest, somebody talked of regulation being like cholesterol, certainly the protection of investors in Israel is very high. Taxation and financing are the two areas where changes have to be made for buy-outs to become easier to effect in Israel. You need an environment that is supportive for interest relief, if you are part of a group that it is possible to borrow and to offset interest, lower down in subsidiaries of the group against the original borrowing, and you need to have an environment that does not levy capital gains taxation on foreign investors on the way. And the financing area comes right back to the session that we had before where the regulator of banks is very keen to ensure that banks don't take too high a level of risk, on the other hand you need availability of debt if you are going to be able to do leveraged buy-outs. An active stock market – Israel has access to international stock markets, increasingly it will have access to European stock markets, in the past it relied primarily on NASDAQ, and the development of a pool of experienced private equity investors – well, there are some homegrown teams now in Israel but there are also lots of international firms that are prepared to do business here. And so my final slide – I think buy-outs can be an important catalyst in Israel, just as venture capital has been, but in the area of larger companies. Primarily in the area of privatization and deregulation, in the restructuring of larger companies and occasionally in the succession issues of family companies, but it will require some twicking of regulations and tax changes. Thank you very much.

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