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MBA 62111/15/16Case 47: Palamon Capital Partners / TeamSystem S.p.A.Group 7Nicole GuerinCharity KamauBaxter KnightHayes PeaceThomas SuttonPrivate equity is capital that is not noted on a public exchange. 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. This type of equity generally refers to equity-related finance designed to bring about positive change in a company, such as:Growing a new businessBringing about operational changeFinancing an acquisitionTaking a public company privatePrivate equity comes primarily from institutional investors (“nonbank” or organizations that trade securities in large enough share quantities or dollar amounts that qualifies them for preferential treatment and lower commissions) or accredited investors, (person or entity that can deal with securities not registered with financial authorities by satisfying one of the requirements regarding income, net worth, asset size, governance status or professional experience) who can dedicate substantial sums of money for extended time periods. Palamon has positioned itself as a company that is owned by several partners. They are a capital investment worth 440 million Euros and are known to manage some of the largest pools of funds.Private equity differs from public equity in multiple ways. First, a company looking to go public has to hire an underwriter—usually an investment bank—to handle the sale. In that respect, an underwriter is almost like a wholesaler. The underwriter sets the price of the stock and then takes the responsibility of selling it to its ultimate buyers. The opening price has to be low enough to appeal to investors, yet high enough to be worth the issuer’s while.One the other hand, a company performing a private placement doesn’t need nor want that broad appeal. Instead, it sells itself to accredited investors who are experienced in the market and able to withstand losses. Private investors typically have a longer horizon in mind. A capital group that’s in the business of buying companies doesn’t care about daily fluctuating stock prices. Instead the focus is on increasing profitability, and/or perhaps market share rather than what ought to be the secondary short-term goal of appreciation.
Private equity isn’t subject to the requirements of Sarbanes-Oxley, which means more freedom and less liability for directors and officers.However both equities share similar fee structures and are both very liquid.Palamon was interested in TeamSystem for the growth opportunity that is represented in a fast-changing software market. Palamon, a generalist private equity fund, seeks investment opportunities that meet a few criteria. First, Palamon does not limit themselves to any specific European country or any specific industry. TeamSystem is an Italian software firm. Second, Palamon limits their investments to those small to mid-sized companies that range between EUR10 million and EUR50 million. Palamon has the opportunity to purchase a 51% stake in TeamSystem for EUR25.9 million. Third, Palamon aims to earn a 35% return on any given investment. Palamon believes that they would be able to improve TeamSystem’s return based on the greater than 20% growth expectations for software firms and the fact that TeamSystem represented 14% share in the Italian market, just 1% behind the company that represented the largest share in the market. Being a generalist fund, Palamon’s goal was to create a portfolio of companies looking to move from a small privately-owned enterprise to a publicly traded enterprise. Management was also a consideration for Palamon, as the transition from private to public ownership required both funding and management ability. Based on Palamon’s investment strategy preferences, TeamSystem would be a good fit for Palamon’s portfolio.In determining the value of the 51% investment, two valuation methods are utilized: multiple-based and discounted cash flow. For the multiple-based approach valuation, due to the absence of TeamSystem’s public trading information, a baseline was generated by taking the market data from exhibits 10 and 11 and finding the median. Refer to Table 1 for the multiple-based valuation. For the discounted cash flow valuation (DCF), we see that leverage decreases the Weighted Average Cost of Capital (WACC) from an initial 14.0% to 12.6% (leveraged). It is also noticed that the cost of equity increases from 14.0% to 15.5% (leveraged), which benefits Palamon. If we can assume a similar corporate tax rate of 48%, and assuming a 15%/31.6% sales/EBIT annualized growth rate (see Table 2) we can determine that the pre-leverage valuation of TeamSystem’s common equity is worth, at worst case, 52.8 M EURO. This would make a 51% investment worth approximately 26.9 M EURO (Table 3). Based on the valuations, Palamon Capital should take the deal with TeamSystem, as it is 1 M EURO cheaper than the valuation. With TeamSystem’s market centered mainly on small to medium sized companies, expansion and growth are promising in the future.