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Answer following questions and write one page (double space) What are the challenges of exiting private equity investments? Is the process harder in Europe or Latin America than in the United States? What are the challenges of exiting private equity investments now in the United States? For the exclusive use of C. Kong, 2016. 9-804-084 REV: SEPTEMBER 27, 2006 JOSH LERNER FELDA HARDYMON ANN LEAMON Apax Partners and Xerium S.A. One bright day in early October 2002, Tom Gutierrez, CEO of Xerium, S.A., looked up from the cluttered conference table at the others in the meeting: Michael Phillips and Korbinian (Korby) Knoblach of Apax Partners, a global private equity firm; Michael Collins, Xerium's retired CEO; and several bankers. They had met in person or over the phone almost every day since April, when they first put Xerium up for sale. Apax had purchased Xerium from its corporate parent in 1999, and after three years of audited financials and a performance that had dramatically exceeded the initial plan had decided to sell the company. But the process had not gone as planned, and the parties involved now faced a difficult decision. Xerium was a global company headquartered in Westborough, Massachusetts, with 42 facilities worldwide. Its plants made \"clothing\" and \"rolls,\" consumable inputs to the paper-making process. Clothing was the highly engineered fabric belt that carried the paper through various stages of the forming process. Rolls included two products: spreader rolls, the small curved rolls that stretched and smoothed the paper and clothing on the machines; and roll coverings, synthetic or natural products that coated the mammoth metal rolls themselves (up to 12 meters long, 2 meters in diameter, and weighing 100 tons). Both products needed frequent replacement and, while a small component of the price of paper, directly affected its quality and were essential to running the machines, which could cost $500 million apiece. Xerium was a solid, steadily growing company, as sales of its products were tied to the amount of paper produced and not to the price at which it sold. While paper prices were notoriously cyclical, paper production increased with global gross domestic product growth, which averaged 3% per year. In October 1999, Apax had purchased Xerium (then named BTR Paper Technology) for $750 million (excluding $33 million in fees)$700 million in cash and the balance in a performance payment. Since then, Xerium's performance (4.5% compound annual growth in revenues and 8.4% in earnings before interest, taxes, depreciation, and amortization, or EBITDA) made it an attractive sale prospect. As there had been little recent activity in the mergers and acquisitions market, investment banks and private equity firms might be interested in any new prospect. Furthermore, the high-yield debt market was stable, facilitating any financing. Phillips knew that Apax could use a quick return to bolster the performance of its Apax Europe IV fund. He wanted to sell the company, but only at the right price, something between six and seven times EBITDA. In April 2002, Apax had formally solicited bids for the company, specifying a minimum offer of $1 billion. ________________________________________________________________________________________________________________ Professors Josh Lerner and Felda Hardymon and Senior Research Associate Ann Leamon prepared this case. HBS cases are developed solely as the basis for class discussion. Cases are not intended to serve as endorsements, sources of primary data, or illustrations of effective or ineffective management. Copyright 2004 President and Fellows of Harvard College. To order copies or request permission to reproduce materials, call 1-800-545-7685, write Harvard Business School Publishing, Boston, Massachusetts 02163, or go to http://www.hbsp.harvard.edu. No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any meanselectronic, mechanical, photocopying, recording, or otherwisewithout the permission of Harvard Business School. This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. 804-084 Apax Partners and Xerium S.A. Now that the field of 40 initial bidders had been narrowed to two, no one in the conference room liked the result. The one all-cash bid, $960 million, was less than Apax's minimum target of $975 million. The one at $1 billion only reached that amount through payment-in-kind dividends. Both prices were likely to drop as the buyers hammered away at performance projections. Gutierrez said, \"It seems to me that we have three options. Michael [Phillips], you and Apax could take the best offer on the table. Second, we can call some of the groups that didn't make the cut and see if we can rekindle their interest. Or we could refinance the company ourselves. I don't know about you, but I'm starting to get really excited about the growth prospects and cost savings we've identified. Maybe we are leaving money on the table if we sell now.\" Phillips knew that a refinancing would probably allow Apax to extract its full cost basis or a bit more from the company, while sharing in future potential gains. As the paper industry was emerging from one of its cyclical slumps, Xerium's sales were likely to grow substantially. A sale at the target price would yield 2 or 2.1 times Apax's investment. But a clean early exit would also send an important, reassuring signal to the investors in Apax IV. What was the wisest course to pursue? The Players Apax Partners1 Apax Partners2 was one of the first global private equity firms. Its \"balanced portfolio approach\" meant that it was active in everything from early-stage investments to buyouts. By 2002, its partners advised on investment pools with a total of $12 billion in equity. The firm had more than 180 investment professionals operating out of offices across Europe, Israel, the United States, and Japan.3 The company invested across the private equity spectrum, from early-stage venture deals through buyouts. Apax's early-stage practice focused on six major sectors: information technology, media, retail and consumer, financial services, healthcare, and telecommunications. Its buyout operations were separate and would consider opportunities in any sector. Recent large transactions had included the acquisition of Yell (British Telecom's yellow pages) and Damovo (Ericsson's division specializing in sales and services of corporate telecommunication solutions).4 Apax had a complicated history. In 1969, Alan Patricof had founded Alan Patricof and Associates in the United States. The firm became a thriving private equity operation. Three years later and completely independently, Ronald Cohen and Maurice Tchnio had established MMG, a firm that provided corporate financial advice to and invested in high-growth businesses from offices in Chicago, Paris, and London. In 1977, the two organizations joined forces in an entity named MMG Patricof. Alan Patricof and Associates continued to operate in the U.S.; MMG Patricof did European mergers and acquisitions consulting work and began to establish a presence in European private equity. MMG Patricof renamed itself Apax Partners in the mid-1980s. Apax raised its first pan- 1 This section informed by Josh Lerner, Felda Hardymon, Antonio Alvarez-Cano, and Borja Martinez, \"Apax Partners and Dialog Semiconductor: March 1998,\" in Lerner and Hardymon, Venture Capital & Private Equity: A Casebook, Vol. II (New York: John Wiley & Sons, 2002), pp. 177-178. 2 In classical Greek, \"apax\" meant something that occurred once and only once. The name was chosen to symbolize both the group's unique role and its full integration across activities and frontiers. 3 , accessed December 31, 2003. 4 . 2 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. Apax Partners and Xerium S.A. 804-084 European fund in 1999. Two years later, in 2001, Alan Patricof and Associates and Apax merged their U.S. and European operating companies under the name Apax Partners. Apax described the reason for its global orientation as follows: \"As the global economy becomes more and more developed, it is our view that those private equity firms that operate on a global basis will be able to spot emerging trends early, support the growth of global companies and use the world's stock markets most effectively.\"5 Apax Europe V, a 4.4 billion ($4.1 billion) pan-European multi-stage, multi-sector private equity fund, had closed in March 2001. The preceding pan-European fund, Apax Europe IV, had closed in April 1999 at 1.8 billion ($2 billion) and had been fully invested by June 2001. By late 2002, Apax, like all other private equity firms, was struggling with the protracted global downturn. While it was admittedly too early to draw firm conclusions on performance, median internal rates of return (IRRs) to European private equity overall had slumped since the mid-1990s (see Exhibit 1 for returns to European private equity over time). Returns had not always been so bleakone Apax fund showed an 85% IRRbut 1999 vintage funds, of which Apax IV was one, were contending with the difficult exit environment and poor performance from their early-stage investments.6 Phillips observed, \"An early exit from Xerium, which was doing well, would be helpful for Apax IV.\" Xerium Xerium, S.A. was initially BTR Paper Technology (BTRP), a division of a U.K.-based engineering and process control conglomerate that was founded in 1798 and had changed its name numerous times until taking British Tyre and Rubber (BTR). Exactly what BTR stood for continued to vary with the times, but the initials did not change. In 1976, BTR acquired two companies that made rolls and roll coverings, disposable inputs for the paper-making industry, and established a subsidiary, BTR Paper Technology, or BTRP. A few years later, BTRP acquired a paper machine clothing maker, establishing a position as a supplier of two crucial inputs to the industry (see Exhibit 2 for a diagram of a paper machine and where these products are involved). While other continuous process industries such as textiles and fiberboard used similar products, the paper industry was by far the biggest consumer. By the 1990s, BTRP had expanded to a worldwide presence, both through acquiring other companies and by establishing its own manufacturing plants, some under license (see Exhibit 3 for the acquisition history and Exhibit 4 for a map). It also invested in research and development to create more highly engineered and thus higher margin products. BTRP developed an extremely decentralized organization. Its 18 offices in 17 countries operated 38 plants almost independently, using the brand names Weavexx for North American clothing, Huyck for non-U.S. clothing, Stowe-Woodward for roll covers, and Mount Hope for spreader rolls. The head office of BTRP, in Westborough, Massachusetts, contained 10 people. From 1965 through 1993, CEO Owen Green led the parent BTR through hectic acquisition activity, took it public in 1982, and headed its unprecedented 1991 hostile takeover of Hawker-Siddeley, a 5 Ibid. 6 John O'Donnell, \"Apax goose stops laying golden eggs,\" The Sunday Times, May 4, 2003. 3 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. 804-084 Apax Partners and Xerium S.A. troubled aircraft manufacturer known for its work during World War Two.7 Recalled Michael Collins, former Group CEO of the paper division (see Exhibit 5 for Collins's biography): Green believed in a very flat organization. He created a very unique culture, with lots of little aphorisms, such as, \"Sales is vanity, profits are sanity.\" It was a very detail-oriented company; every group CEO was expected to have a deep understanding of the business operations. And there was a clear, organization-wide understanding that every year was to be an improvement on the one before. The budget wasn't called a spending plan but a profit plan. It may not seem like a big thing, but it really made a difference. In 1998, after Green had been succeeded by two different CEOs, BTR merged with its rival, engineering and controls giant Siebe. The merged company changed its name first to BTR/Siebe and then to Invensys. It was, general opinion held, \"one of the most value-destroying mergers in history.\"8 Collins commented, \"It became very clear that Invensys had to sell assets. It had enormous debt and was hemorrhaging cash. Because BTRP was a solid, cash-generating division, we knew it would be sold early.\" Late in 1998, Invensys decided that BTRP was \"non-core\" and engaged Morgan Stanley to find a buyer for the organization. The Buyout Michael Phillips, a partner in Apax's Munich, Germany office and a member of the leveraged transactions team, was aware of the action around BTRP (see Exhibit 6 for biography). He said, \"In this business, we generally know what's going on. If the first time we hear of a transaction is when we receive the book [the seller's presentation of the business to be sold], we're in trouble. That's very rare. We'd heard the rumors about BTRP being on the market but had discounted them. In fact, when we were offered the chance to bid, we turned it down because it wasn't in our direct field of interest.\" Shortly thereafter, in late 1998, Phillips received a call from a former Apax corporate finance expert who had become a global mergers and acquisitions advisor. This individual had a mandate to sell Wangner-Finckh, a German-based family-owned maker of paper industry consumables with 1998 revenues of roughly $70 million and EBITDA close to $13 million. Phillips commented: Normally, we wouldn't have been interested because family businesses are challenging and Wangner-Finckh was too small to be a stand-alone investment. But we knew BTRP was in play. Although neither of them interested us separately, the synergies of the two together were significant. Wangner had great engineering and would be a perfect fit with BTRP to expand its European presence. BTRP had been under-invested because Invensys was draining its profits to service the debt, but it was highly profitable and had great management. In addition to its European market presence, Wangner also had information on an historically opaque industry. Few clothing and rolls makers were public, limiting the information that Phillips and his team could access before declaring their formal interest in BTRP. Wangner, however, had a wealth of information and insights across the industry and even into BTRP itself. 7 Information from December 30, 2003. , accessed 8 \"Mea culpa, Invensys . . . \" Investors Chronicle, April 25, 2003. 4 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. Apax Partners and Xerium S.A. 804-084 It was also clear that BTRP would be sold. \"With revenues of $450 million per year,\" Phillips explained, \"BTRP was too small for an initial public offering [IPO]. And because the sector wasn't hot, the price would not be high.\" In early 1999, the Apax team formally entered the bidding process for BTRP. Apax created two teams and ran the acquisitions of Wangner and BTRP simultaneously. \"We knew there wouldn't be an auction for BTRP,\" said Phillips. \"It was in the paper industry, which is not an exciting sector, there were a limited number of consolidation options, and it wasn't hugely scalable. It wasn't glamorous. It was a solid, cash-generating company growing 3% to 5% per year. \" After the initial flurry of activity, only three other firms were interested: CVC Capital Partners, Doughty Hanson, and Bain Capital.9 None seemed particularly threatening to Apax, as Phillips explained: CVC, for instance, was capacity constrained. It wasn't really focused on BTRP but was bidding on another Invensys asset and wanted to be perceived as serious. Bain did little business in Europe and wouldn't be able to execute a global buyout. In fact, both of these had contacted us to see if we'd be willing to team up, as neither was well-positioned regarding the asset. Lastly, through the interaction with Wangner-Finckh, we knew Doughty Hanson wasn't a serious contender. \"So within a month,\" Phillips continued, \"we had all good signs. We had good insights, a good asset, a distressed seller, and no real competition in the deal. As soon as we started due diligence, things got better. BTRP had high cash assets and potential cost savings, we identified ways to increase profits at Wangner, and the deal was still uncontested.\" The process of due diligence was intense. Along with research, the team made site visits, met management, and did financial and market analysis. BTRP's decentralized structure both helped and hindered the work. Phillips explained: It wasn't a company really but a group of separate operating units. BTRP Canada ran Canada, BTRP Argentina ran Argentina. There were no group-wide control systems, just a collection of individual country accounts. The headquarters made pro-forma statements as if a company existed. This made it very difficult to do the analysis of the physical business units. We had to take the pro forma, disaggregate it to the country level, and then reaggregate it. There were big exchange movements during the three years that constituted history, so even merging accounts or standardizing them in a single currency during the period was complex. Our ability to produce consistent results was, to say the least, limited. But the advantage was that this further reduced the enthusiasm of our competitors. Not only was the time investment significant, but we incurred huge fees for financial and legal due diligence, something in the neighborhood of $3 million. We learned from the market how much our competitors were willing to spend on due diligence. In effect, we out-due-diligenced and out-spent the competition. One of the reasons Apax was willing to make the investment was that Invensys needed to sell. \"A big risk is always that the vendor decides not to go through with the transaction,\" said Phillips. \"One reason we were willing to spend so much time and money on due diligence was that we knew we had a distressed vendor. Invensys needed cash desperately. The CEO had to sell something by year's end.\" 9 Richard Rivlin, Peter Thal Larsen, \"Four in running for Invensys paper unit,\" The Financial Times, July 1, 1999. 5 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. 804-084 Apax Partners and Xerium S.A. The Apax team bid $1 billion as a starting figure. It was, as Phillips explained: . . . the way these things work. The investment bank tells you what you need to bid to be part of the transaction. Then during due diligence, you learn more and more and develop a credible alternate business plan. With our deep insight into valuation details and industry trends, we could argue against the business plan that the bank and the company had devised. For one thing, no one had transparent audit accounts for the past. We had a solid defensible base case very different from that of the company. Yet we also knew we could build the business. We knew the company better than the vendor. We even had an estimate of group pension liabilities, which Invensys didn't have. The items that reduced Apax's opening bid fell into two categories. Some were financial issues, such as pension liabilities and deferred capital expenditures, which reduced the final price but did not benefit Apax or anyone else, as they were true financial costs that would have to be borne. The others were differing assumptions about the business plan. By viewing potential growth opportunities conservatively and taking a sober view of future challenges, Apax built a business plan that contained lower projections than Invensys' base case. Collins, the Group President of BTRP at the time, commented: Management is always torn in a buyout. The information given the bidders often embellishes the company's potential, increasing its value and the price the vendor can get. The management is in the middle, because potential sellers are wooing you to get your information and the vendor is urging you to support the official position. The biggest issue is that you don't want to make promises you can't keep. If you support a price that burdens the company with debt, it's not fair to the employees who have to work in such constrained circumstances. While vendors may argue that it's \"pain that goes away,\" it's not fair to anyone if you set unrealistic expectations. The quality of prospective buyers varied. Collins recalled, \"Apax was extremely thorough. Some bidders were so casual that they hadn't even decided what questions were important before they showed up. People who didn't understand the business were worried about the margins; they didn't see how they could be sustained.\" Apax's thoroughness showed in the final purchase price of $750 million. This included the cost of the company, $651 million, and of paying off $99 million of debt. The total consideration, including fees of $33.1 million and $7.6 million of cash injected into the business, came to $790.7 million. The deal was structured as an asset sale. Sources of the financing included $510 million of senior debt, $170.7 million of equity, and $110 million in seller financing. Invensys provided an interest-bearing subordinated note of $50 million and received a $60 million earn-out contingent on very high performance. The earn-out, however, was not included in the computed purchase price. Invensys also reinvested $18 million for a 10% share in the new company. The deal closed in October 1999, six months after Apax had started its due diligence (see Exhibit 7 for details). The mechanics of the deal were complex, as each of the 17 operating units was purchased individually and the debt held on the balance sheet of each country's office, to be written off against goodwill. The transaction was structured as tax-advantageously as possible given each country's regulations. Phillips said, \"We did upstream mergers, downstream mergers, whatever was most taxefficient.\" The holding company was headquartered in Luxembourg to ensure that profits could be repatriated tax-free. A few months later, Apax completed the acquisition of Wangner and merged it into BTRP, renaming the entity Xerium. The sellers, the Wangner family, received 10% of the combined 6 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. Apax Partners and Xerium S.A. 804-084 company. Including the refinancing of $10 million of existing debt, Wangner was valued at $87 million, or 6.8x EBITDA. BTRP, for contrast, was valued at 5.0x EBITDA. Wangner's higher valuation stemmed from assumed cost synergies and avoided capital expenditures. Including these reduced the multiple to 4.6. Unlike BTRP's management, Wangner's management did not receive a stake in the new business (see Exhibit 8 for schematic and details), but the company's owners did. At the end of this merger, Invensys owned 10% of the combined business, the Wangner family 10%, BTRP's management 6%, and Apax the balance. Selling Xerium By April 2002, the market environment looked favorable for selling BTRP (now Xerium). Xerium, in turn, looked like a good sales prospect. The Apax team had already refinanced it once, repaying some of the high-coupon debt.10 The company had also acquired two small rolls companies since the merger with Wangner (see Exhibit 9). The old decentralized structure had remained. The head office had grown to 16 people as Xerium took on tasks such as treasury, tax, human resources, and risk management that had previously been handled by Invensys. Collins, who had been on the verge of retiring when Apax purchased BTRP, had recruited Tom Gutierrez from another Invensys division in August 2001 to take his place as CEO. Gutierrez had run BTR's sensors business and later worked for Collins running the electronics division, moving eventually to lead the $3 billion power systems unit (see Exhibit 10 for biography). He said, \"Michael [Collins] and I have the same approach to business. He wanted to turn Xerium over to someone who shared his view of a lean profit-focused operation with a thin organizational structure. After I joined the firm, I spent six months traveling the world with him to learn the business.\" Xerium had out-performed Apax's business plan substantially (see Exhibit 11). EBITDA had reached $160 million for the year ending December 2001, up over 8% since 1998, its last full year with Invensys. The company had restructured, closing plants and selling some businesses. Phillips observed, \"It's the private equity effect. When people can earn big bonuses for hitting targets, they tend to hit them.\" In selling Xerium, Apax faced an unusual conundrum. Gutierrez said: The first time around, Apax got a good deal because it could create value in the company. But deals are highly contextual. You have to have an angle to add value, and you must not overpay. The problem here was that the company had performed so well that no one could see the upside. And it wasn't glamorous. You wouldn't get high-tech type growth. But you would get 3% annual growth, cash generation, technological leadership, and the ability to survive in downturns. You wouldn't be able to buy it cheap and restructure it because it was already running very well. The Industry and Competitors All was not well in the paper industry. It had been in a protracted slump since the beginning of 2000. While paper prices did not affect Xerium's sales directly, the resulting cash constraints would 10 Lisa Bushrod, \"Xerium,\" European Venture Capital Journal, December 1, 2002. 7 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. 804-084 Apax Partners and Xerium S.A. incline paper manufacturers to curtail production, shut down machines, and extend the use of clothing and rolls beyond their recommended life, thus indirectly reducing sales of rolls and clothing. Compounding the pricing pressure on Xerium, the paper industry was consolidating. Three significant mergers had occurred since Xerium's acquisition. At the same time, other trends increased the need for Xerium's products and put a premium on its research and development efforts. New machines ran faster (up to 2,400 meters per minute), putting extreme stresses on the clothing and roll coverings. New paper types, such as those using recycled products, required different types of consumables, as did the effort to make higher quality paper from lower quality raw materials. Despite the dismal macro environment, which pressured sales and orders, Xerium's market share of clothing had grown from 12% in 1999 to 14% in 2001, while its share of the rolls business had risen from 45% to 46%. Part of this was due to its acquisitions, but much stemmed from its research and development efforts. Capital expenditures had run at roughly 8% of annual sales from 1993 to 1998, 50% higher than the level of major competitors. The company was exceeding its profitability targets due to restructuring and product price increases, made possible both through its own innovative products and the on-going consolidation in the clothing and rolls business. Xerium's two product groups had very different characteristics. While both comprised a very small proportion of the cost of paper and were crucial to its final quality and the ability of producers to use their expensive machines, clothing was considered a commodity and rolls a specialty item. Clothing was part of \"cost of goods sold\" and thus purchased centrally through the customer's central office. To differentiate itself, Xerium had invested heavily in research and development, developing two- and three-ply products that generated margins dramatically higher than commodity one-ply clothing. It also focused on the high-margin \"forming fabrics\" and \"press felts\" rather than low-margin \"dryer felts.\" Roll coverings, on the other hand, were considered the domain of individual maintenance departments, and the primary focus was not on price but reliability and quality. Given the rolls' cost and specificity (there were no standard paper machines), a plant would have only one back-up for each roll. Should the back-up roll fail while the original roll was being re-covered, the entire machine would shut down, at a cost of $10,000 per hour. The sheer size and weight of the rolls meant that most of their maintenance had to be performed on site, a clear advantage for Xerium's roll companies with their 30 locations worldwide. While the fragmentation and regional nature of the rolls business meant that most contracts were negotiated directly with the plant in question, Xerium had the only two centrally negotiated preferred supplier contracts in that sector. Xerium also bundled mechanical services with its roll re-covering and would do routine maintenance on the internal workings of the rolls while they were off the machine and conveniently accessible. This helped the paper makers avoid using multiple suppliers and paying transportation charges. Xerium had leading positions in both of its markets (see Exhibit 12 for competitor financials). It was tied with J.M. Voith, a paper-machine maker with a clothing division, for the number two position in the clothing market behind Albany International (NYSE: AIN), which had a 30% share. In rolls, Xerium led the world market with its 46% share, over twice that of Voith's 21%.11 Xerium's performance had allowed it to pay down its acquisition-related debt ahead of schedule. By the time Apax was considering a secondary buyout, Xerium had paid an extra $77 million and reduced its total debt to $475 million by the end of 2001, bringing its leverage to 2.5x EBITDA. 11 Xerium information. 8 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. Apax Partners and Xerium S.A. 804-084 The Sales Process Apax began the sales process in January 2002 with a beauty contest. Gutierrez described it saying: In a single day, a bunch of banks come through to tell you what they think the company is worth, how they'd market it, and why they're the best group for the job. Morgan Stanley's U.K. branch had handled the original deal for the vendor, so we chose them because they already had a background with the business. That's extremely important; you have to be sure the bank understands the business. We spent about two months building the selling caseeven as I was still learning the details of the business. We prepared the presentation and the financials, and the bank developed the preliminary marketing pitch for the asset [the teaser]. We agreed on the groups that would receive the book. We didn't, for instance, want any competitors because they're likely to raid the data room, learn your secrets, and never get serious. It was pretty clear even then that only another financial group would buy the company. This process took about two months. In addition to the book, the process and presentation were important. Gutierrez went on: Coming from the high-tech industry, I understood the process. To present effectively, you have to have sales skills, presentation skills, and the ability to think on your feet when you're asked tough questions. The buyers bring experts and consultants to chip away at your story and drive down the value of the business. As the vendor, you may have a really good operations team that can't present, or a team of very polished presenters that don't know the business. Neither works. The key is to build the presentation to include the entire management team, because it would look funny if key people weren't there, but you showcase the people who have the best blend of business understanding and presentation skills. We prepared for presentations and practiced answers to questions for quite a while. The teaser, sent in April 2002, generated 40 responses. One reporter commented, \"The Xerium sale is already attracting interest on Wall Street.\"12 The valuations ranged between $850 million and $1.2 billion; a sale at the upper end of the range would give Apax a 50% IRR.13 The 40 contenders were reduced to seven based on their reputation, their credibility, and the likelihood they would actually complete the deal. These received the full book, full access to the management team, site visits, and the presentation. Gutierrez explained, \"You can't really handle more than seven serious bidders. It's incredibly time-consuming.\" By July 2002, the group of seven had fallen to two, a New York-based investment bank consortium and a U.S. conglomerate. Gutierrez said, \"If you just give one buyer an exclusive, you could be left standing at the altar and then have to generate interest from groups you'd jilted in the past.\" Neither of the two deals was perfect. The one bid that came in above $1 billion included preferred-payment-in-kind notes14; the \"clean\" deal offered $960 million. And the financial markets were falling. 12 Jeremy Adams, \"Apax hopes to sell Xerium,\" The Financial News, April 2, 2002. 13 Ibid. 14 That is, notes that paid interest in the stock of the company. 9 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. 804-084 Apax Partners and Xerium S.A. Options Gutierrez said, \"At this point, we really had to consider our options. We had not even thought of recapitalizing the company at the beginning. Apax wanted to get out. But now I was really up to speed with the business, and it seemed we had some options.\" Refinance and Try Later The paper industry downturn had been substantial and almost exactly coincided with Apax's ownership of Xerium. \"If we could grow market share and margins in a downturn,\" mused Gutierrez, \"what could we do when this turns around?\" Analysts projected that the paper industry would start to recover in 2003. In addition, the company could take advantage of some of the growth and cost-cutting opportunities that the management team had identified in preparing for the bidders' questions. Another possibility included making acquisitions of complementary businesses or of competitors that would consolidate Xerium's position as number one and two in its markets. While future acquisitions to its dominant position in the rolls market might bring up antitrust concerns, Xerium could either expand into other paper industry consumables or acquire its competitors in the clothing industry, where it had held periodic talks with some of the smaller makers. Yet refinancing would not give Apax IV the same boost as a sale. One could also wonder how long the \"buyout phenomenon\" would maintain the company's enthusiasm for hard work and cost-cutting. Nonetheless, there was nothing to guarantee that a buyer would offer a better price next time. Apax's Phillips said, \"It's just not glamorous. Buyers get confused between its products and the paper industry. Yet Xerium has high margins and it's part of a small group of producers in a wonderfully stable market. Financial buyers, though, just don't get excited about something that grows at 3% to 5% per year and won't ever grow at 10% like a software firm.\" If Apax did recapitalize, it needed to have a capital structure that gave the company sufficient cash flow. The cash flow would be used to pay down the existing debt, repay the $50 million vendor loan to Invensys, and repay the shareholder loans15 with their 10% coupons. Phillips estimated that Xerium's debt would rise from $425 million to $775 million. Part of the question, then, would be how much of the higher-interest but non-amortizing16 senior A debt should be in the package as opposed to lower-coupon, but amortizing,17 senior B and C (see Exhibit 13 for one possible refinancing scenario). Refinancing, Phillips estimated, would pay out 1.2 times the original investment. This was a far cry from the return of more than 30% that Apax would have received from a sale at anything above $975 million. Go Back to the Well Contacting non-finalist buyers had some allure. For one, they knew the company to a certain degree, so Xerium's team would not be starting from scratch. Some of them even called from time to time. Yet going through the process took vast amounts of management time. Gutierrez said, \"Reopening the process would be hideous. During 2002, the management team did very little but 15 Shareholder loans were given by all investors except management. This helped to create \"sweet equity\" for managers, as they invested on the same terms in the nominal equity of the company but did not have to give a shareholder loan, which gave them a relatively higher stake in the company. 16 A non-amortizing loan requires the payment of interest only until a due date, when the principal must be paid. 17 An amortizing loan requires the payment of interest and principal over its life. 10 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. Apax Partners and Xerium S.A. 804-084 handle the selling process. If we hadn't been so decentralized, I think it would have sunk the business. If we assume a multiple of seven and figure that our profit fell by $5 million due to management distraction, our investors lost $35 million in enterprise value.\" It was a distinct option, though. The third-best bidder, which had dropped its bid from $1 billion to $900 million when it thought it was Apax's only option, kept calling. Xerium was continuing its strong performance, and the paper industry rebound was getting closer every day. A Bird in the Hand . . . The final clean bid, after intensive due diligence, was likely to fall to $935 million.18 The company would have endured 10 months of total management distraction and was going to pay $30 million in fees regardless of which option was chosen. If Apax exited at $40 million less than its asking price, would that be the worst possible option? The Final Exit One question everyone had was the final exit for Apax. Gutierrez commented, \"We know Apax is not a long-term owner. An exit is problematic. We can't go public with the public markets as they are, and we're too big to be purchased by a paper company. Where do we go except to another private equity house? \" Former CEO Michael Collins said, \"We need to find this company a home somewhere. It would be a great holding for a family office. It's a good, cash-generating company, but it's paid $77 million in takeover transactions fees over the past three years. That can't continue.\" 18 Benjamin Wottliff, \"Paper blow to Invensys windfall,\" Sunday Business, October 20, 2002, p. 1. 11 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. 804-084 Apax Partners and Xerium S.A. Median Returns to European Private Equity by Vintage Year 25 20 15 10 5 2002 2001 2000 1999 1998 1997 1996 1995 1994 1993 1992 1991 1990 1989 1988 1987 1986 -5 1985 0 1984 Median Internal Rate of Return (%) Exhibit 1 -10 -15 Source: Adapted from Venture Economics, , accessed January 9, 2004. Data are calculated as of June 30, 2003. Exhibit 2 Rolls and Clothing in Paper Machines Press Felts Dryer Fabrics Dry End Spreader rolls Forming Fabrics Wet End Typical Speeds: 360 - 2,400 mpm Source: Xerium information. 12 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. Apax Partners and Xerium S.A. Exhibit 3 Year 1976 1980 1980 1988 1988 1989 1990 1990 1990 1995 804-084 BTRP's Acquisition History to 1999 Division Rolls Clothing Rolls Clothing Rolls Rolls Rolls Rolls Clothing Rolls Company Stowe Woodward/Mount Hope Huyck Becker Nortelas Nokia Irga Boetcher Plastex Niagara-Lockport Wittler Locationa U.S. U.S. Germany Brazil Finland Italy Germany Germany Canada Germany Sales ($MM) b NA 170 13 11 14 14 4 5 86 10 Source: Apax Partners information. aPrimary location. bSales of the most recent full year before acquisition. Exhibit 4 BTRP's Locations as of 1999 Global Headquarters Source: Xerium information. 13 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. 804-084 Exhibit 5 Apax Partners and Xerium S.A. Biography of Michael Collins Michael Collins is now non-executive Chairman of Xerium, S.A., the corporate parent of a 38-plant global operation that manufactures consumables for the paper industry. Since September 2003, he has also been Chairman and CEO of Damovo, S.A., a telecommunications integrator with operations in 19 countries. From 1993 through 2002, Collins served as Group President of BTRP, having joined BTR in 1980. During his career at BTR, he was Chief Executive of eight different Groups, at one point simultaneously managing four groups with 13,000 employees and combined revenues of $1.3 billion. Prior to joining BTR, he was President of Becton-Dickinson, a U.S. medical devices manufacturer. He holds a degree in Chemistry and Physics from London University. Source: Apax information. Exhibit 6 Apax Team Bios Michael Phillips: Leveraged Transactions, Germany Michael Phillips joined Apax Partners in 1992, focusing on leveraged transactions, buyouts and investments in retail and consumer. A graduate in engineering chemistry from Queen's University in Kingston, Canada, Michael also holds an MBA from INSEAD, where he graduated with distinction. Upon graduating from University, he worked at Ciba Geigy Canada Ltd. as a manager in the plastics additives division. He then spent three years at OTTO Holding Ltd. in Cologne, one of Germany's largest waste management companies, as the general manager of an operations subsidiary. Korbinian Knoblach: Leveraged Transactions, Germany Korbinian Knoblach is a member of the leveraged transactions team, specializing in business and financial services. Before joining Apax Partners in 2002, Korbinian attended the University of Regensburg, Tulane University in New Orleans (USA) and graduated with distinction from Leipzig Graduate School of Management. During his studies, Korbinian undertook internships in private equity (Apax Partners), mergers and acquisitions (Donaldson, Lufkin & Jenrette), management consulting (Roland Berger Strategy Consultants) and the automotive industry (Siemens Automotive). Source: , accessed February 11, 2004. 14 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. Apax Partners and Xerium S.A. 804-084 Structure of Apax's purchase of BTRP Exhibit 7 Uses of Cash $ Million Total enterprise valuation ~ Net Debt ~ Purchase price for 100% of equity 750.0 99.0 651.0 Sources of Cash $ Million 33.1 Cash injected into business 7.6 Total Uses of Financing 790.7 300.0 110.0 100.0 110.0 Total Equity ~Shareholder's Loan (10% coupon) ~0% Interest Loan 170.7 138.7 Comment 620.0 510.0 A Senior Facility B Senior Facility C Senior Facility Subordinated Debt Transactions cost Total Debt Total Senior Debt ~Nominal Capital Shares of the total Equity + BTRP Mgmt +Invensys +Apax Total Sources of Financing 30.9 1.1 $ 2.2 $ 18.2 $ 150.3 LIBOR + 200 bps LIBOR + 250 bps LIBOR + 300 bps All held by seller, some contingent. From all investors except management. From all investors pro rata to equity. Held by all investors. 7.0% 10.0% 83.0% 790.7 Source: Apax information. Note: At the time of the buyout, the 90-day LIBOR rate was 5.25%. BPS = basis points, 1/100 of 1%. Exhibit 8a Position of Xerium after Wangner Acquisition Items $ Millions Items $ Millions Total enterprise valuation ~ Purchase price ~ net debt ~ Wangner purchase of newco $ 837.5 Total Debt $ 706.6 ~Senior Debt $ 109.0 ~Sub Debt $ 21.9 $ $ $ 680.0 570.0 110.0 Transactions cost $ $ $ $ $ $ $ $ $ $ 207.7 172.1 34.4 1.1 2.2 19.7 163.8 21.9 887.7 Ownership Cash injected into business Total Uses 39.0 Equity ~Shareholders' loan $ 11.2 ~0% Interest loan ~Nominal Capital + BTRP Mgmt +Invensys +Apax +Wangner $ 887.7 Total Sources 6.3% 10.0% 73.7% 10.0% Source: Apax information. 15 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. Source: Apax information. Exhibit 8b Acquisition of BTRP and Wangner 804-084 -16- For the exclusive use of C. Kong, 2016. This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. Apax Partners and Xerium S.A. Exhibit 9 Year 1999 2001 2002 804-084 Xerium's Acquisitions Since Apax Purchased BTRP Division Clothing Rolls Rolls Company Wangner Trelleborg Robec Locationa Germany Sweden Germany Sales ($MM) b 67 6 3 Source: Xerium information. aPrimary location. bSales of the most recent full year before acquisition. Exhibit 10 Biography of Tom Gutierrez Tom Gutierrez joined Xerium in 2001 after working for Invensys over the prior five years. He served as CEO of Invensys Power Systems (1999-2001), a $3 billion multinational business, where he successfully executed three major acquisitions and significantly improved profitability during his tenure. Prior to being appointed CEO of Invensys Power Systems Group, he served as CEO of Exide Electronics (1997-1998), a subsidiary of Power Systems, which achieved 30% profit growth in his first year. He was also Group Chief Executive of BTR Sensor Systems Group (1995-1997) and COO of Pulse Engineering (1992-1994). Mr. Gutierrez has over 30 years of experience in product development, manufacturing, marketing, sales, and general business management. He received his BSEE from Florida Institute of Technology in 1972. Source: Xerium information. 17 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. 804-084 Apax Partners and Xerium S.A. Exhibit 11a Xerium's Financial Results (based on management numbers) $ Millions 2000 2001 2002 Total Sales Jan 2000 Plan @ 1999 Exch. Rates 515.3 524.4 533.7 Jan 2000 Plan @ 2002 Exch. Rates 459.1 467.3 475.7 Actual @ 2002 Exch. Rates 492.2 495.9 513.5 Actual vs. Plan 7.2% 6.1% 7.9% Jan 2000 Plan @ 1999 Exch. Rates 163.6 173.0 178.3 Jan 2000 Plan @ 2002 Exch. Rates 146.1 153.9 158.6 Actual @ 2002 Exch. Rates 158.0 157.5 167.0 Actual vs. Plan 8.2% 2.3% 6.6% EBITDA Credit Statistics Total Debt/EBITDA 3.3x 3.0x EBITDA/Cash Interest 3.4x 3.8x $560.0 $475.0 Debt (millions) Source: Xerium information. Exhibit 11b Xerium's Projections as of End of 2001 ($ millions) Sales % growth 1999A 453.8 2000A 492.2 8.5 2001A 495.9 0.8 2002E 513.5 3.5 2003E 535.8 4.3 2004E 559.5 4.4 2005E 587.2 4.9 Variable Contribution % margin 267.6 59.0 293.6 59.7 287.9 58.1 305.4 59.5 318.5 59.4 332.7 59.5 348.5 59.3 EBITDA % margin 133.9 29.5 158.0 32.1 157.5 31.8 167.0 32.5 177.6 33.2 188.3 33.6 199.3 33.9 Depreciation & Amortization 57.5 59.9 52.4 51.2 50.8 52.3 52.6 46.4 40.0% 38.0 36.6% 32.2 35.9% 36.0 34.4% 41.0 34.0% 41.0 34.0% 41.0 34.0% 92.2 136.1 135.3 122.3 131.1 140.9 147.4 Capital Expenditures Working Capital as a % of Sales Free Cash Flow Source: Xerium information. 18 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. Apax Partners and Xerium S.A. Exhibit 12 804-084 Competitors' Financials ($ Millions) Est. 2002 Sales 1-Year Sales Growth Est. 2002 Net Income 1-Year Net Income Growth Est. Long-term Debt (YE 2002) Beta Market Capitalization Albany International $816.0 -2.5% $49.0 52.2% $221.7 0.9 $1,037.2 J. M. Voith $3,226.9 6.8% $62.4 -28.3% $652.3 NA NA Source: Adapted from OneSource and Hoovers. Note: NA - Not Available. Exhibit 13a Xerium's Balance Sheet in October 2002 Item Assets Cash & equivalents Net non-cash working capital Total Assets Amount ($ millions) $711.3 50.8 206.3 $968.4 Total current liabilities Total provisions Long-term liabilities ~Long-term senior debt Senior A Senior B Senior C ~Other long-term debt Shareholder loans ~10% loans ~0% loans Vendor note Equity (retained earnings) Total Liabilities & Equity $109.2a 4.9a 448.5 229.2 115.5 103.8 68.7a 264.5 231.6b 32.9a,b 67.8 4.8 $968.4 Source: Apax information and Global Financial database for the information on risk free rates and tax rates. a Unchanged after possible refinancing. b Because Xerium is a Luxembourg-based entity, the capital structure is euro-dominated. The balance on the shareholder loans is higher here than in Exhibit 8a due to exchange rate movements between the euro and the dollar. Notes: The Luxembourg corporate tax rate as of October 2002 was 30.38%, the long-term corporate bond rate was 5.15%, and the risk-free rate was 4.6976%. Luxembourg's long-term benchmark bond rate was the 10-year Belgian government bond. 19 - the 10-year risk-free rate at Germany in October 2002 was 4.1%; - the marginal tax rate of Xerium was approximately 30%; - the "Other Long-Term Debt" had an interest rate of LIBOR + 2% 19 EIU Country Commerce Report on Luxembourg, 2002. 19 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. 804-084 Exhibit 13b Apax Partners and Xerium S.A. Xerium's Proposed Financing in 2002 Facility Term Loan A Term Loan B Amount ($ Millions) $302.0 $150.0 Coupon LIBOR + 2.25% LIBOR + 2.75% Term Loan C $150.0 LIBOR + 3.25% Total Senior Term Debt $602.0 Mezzanine Term Loan Facility $122.1 Existing Cash Total Funded Debt $50.8 $774.9 Revolving Facility $50.0 Maturity Amortizing over 7 years ending 2009 Amortizing over 8 years ending 2010: 1% per annum for the period 2003-2009 and the remainder in two instalments in 2010 Amortizing over 9 years ending 2011: 1% per annum for the period 2003-2010 and the remainder in two installments in 2011 LIBOR + 5.00% Cash + 6.00% PIKa Bullet repayment in 2012 LIBOR + 2.25% $10 M cancelled after 30 months; $40 M final maturity in 2009. Not used but arranged at the same time. Source: Xerium information. Note: The amortization period is the time during which payments of principal and interest must occur. a PIK (payment in kind) is interest in the form of additions to the debt; that is, the interest will accrue and be added to the debt at a rate of 6.0% per year. This amount will be capitalized at the end of each month (and thereafter accrue interest) and will be paid on the final repayment or prepayment of the facility. Exhibit 13c Uses of Refinancing Uses of Refinancing Refinance existing bank debt Transaction cost Repay Vendor Note Repay 10% Shareholder Notes Net impact of interest and exchange rate movements Total Uses $ Millions 448.5 31.9 67.8 231.6 -4.9 774.9 Source: Apax information. 20 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016. For the exclusive use of C. Kong, 2016. Apax Partners and Xerium S.A. Exhibit 13d 804-084 Tranche Allocation Across Currencies/Countries Country U.S. U.S. Canada Italy Austria Luxembourg Luxembourg Denomination Senior A US$ 63% EURO 0 Canadian $ 6% EURO 7% EURO 7% EURO 17% US$ 0 Total (US$ millions) 302.0 Senior B 58% 0 22% 20% 0 0 0 Senior C 33% 67% 0 0 0 0 0 Mezz. 0 0 0 0 0 46% 54% Total 45% 14% 7% 7% 3% 15% 9% 150.0 150.0 122.1 724.1 Source: Apax information. 21 This document is authorized for use only by Chenlu Kong in Private Equity and Venture Capital taught by Zsuzsanna Fluck, Michigan State University from March 2016 to May 2016