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Private Equity

UBS View
Prefer small-/mid-cap buyout in US / emerging markets; distressed debt in Europe

• Private equity deals in today's volatile and uncertain markets are conservatively financed, with an average equity cushion of 40%. We like mid-market buyout strategies, which offer long-term exposure to attractive corporate assets and which rely less on large bank debt syndications.
• Our house view sees large parts of Europe in a stagnation, and business owners are reluctant to sell their companies, reducing PE deal flow in the region significantly. We therefore prefer North America, which will see continuous (albeit suboptimal) growth, and emerging markets, which show positive fundamentals.
• Prices for PE transactions have corrected by around 10% this year, although they are still 20% above the attractive levels seen during the successful years between 2000 and 2004. However, significant dry powder and high cash positions at corporations keep competition high and hinder prices from falling much further.

Positive scenario
Prefer small-/mid-cap buyout and secondaries
• An abating Eurozone debt crisis and improved business confidence would increase deal flow and exit opportunities for private equity managers, but would also increase entry prices. In such a positive scenario, we would perceive commitment strategies to secondary funds as attractive for building exposure to an invested private equity portfolio.

Negative scenario
Prefer distressed debt
• A renewed escalation of the debt crisis would significantly impact deal activity, the availability of debt and company owners' willingness to sell. At the same time, it would offer attractive opportunities within distressed strategies and lower entry prices for long-term private equity investors.
Note: Scenarios refer to global economic scenarios (see slide 7)

Recommendations
Strategic (1 to 2 years)
• We prefer small-/mid-cap buyouts in North America given the better economic outlook vs Europe, higher transaction certainty and more attractive entry prices.
• Investors looking for downside protection and stability during economic uncertainties can consider large-cap buyouts in the US, which offer exposure to large, diversified companies at more attractive prices.
• In Europe, the crisis and ongoing deleveraging have led to attractive opportunities for special situations. We thus recommend investing in distressed debt to benefit from the macroeconomic adjustment process and selling pressure for many European banks.
• We advise investors make an ongoing allocation to private equity in emerging markets, which offer an attractive way to capture superior long-term growth and provide access to small/mid-cap companies not available through the stock market.

What we're watching
Credit markets
Why it matters
Availability of leverage and credit spreads are important signs of the health of buyout markets. Small/mid caps are currently financed at 4.3x EBITDA (vs 4.6x for large-caps) and are more attractive given their lower reliance on bank financing in a period of ongoing bank deleveraging.

Capital overhang
We track deal/exit activity to understand the pressure to invest, future price dynamics and draw-down profiles for investors. More than USD 930bn of uninvested capital and expiring investment periods will keep prices elevated.

Purchasing prices (Enterprise value / EDITDA)
Price multiples offer valuable insight into private company valuations. YTD May 2012, buyouts occurred at 8.1x, down from 8.8x seen in 2011. Large-cap buyouts have come down 10% from the peak last year to 8.6x.

Private equity deals continue to be defensively financed amidst economic uncertainty
[Chart showing PE backed high yield issuances and Equity cushion in LBOs from 2004 to YTD May 12]
Source: S&P, UBS CIO, as of May 2012
Note: Past performance is not an indication of future returns.

UBS
For further information please contact CIO's asset class specialist Stefan Brägger, stefan.braegger@ubs.com
Please see important disclaimer and disclosures at the end of the document.
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Note: We emphasize the equal importance of fund manager selection and the commitment strategy. Please note that private equity is an illiquid asset class and must be held at least until the end of the fund (10+ years).
Please note that UBS might not have a product available which reflects our UBS CIO private equity recommendations. Private equity is only suitable for qualified investors (> USD 5m investable assets).
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