Linkages between the Public & Private MarketsLinkages between the
Public & Private Markets
Georgiana FungSmall Cap Strategist, MLPF&S
212-449-9189 · [email protected]
May 2007
Georgiana FungSmall Cap Strategist, MLPF&S
212-449-9189 · [email protected]
May 2007
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.11
Merrill Lynch does and seeks to do business with companies covered in its research reports. As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report.Investors should consider this report as only a single factor in making their investment decision.
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.2
Background Public Market Structure Relationship to Private Equity
Private Equity Outlook Investments Exits
Background Public Market Structure Relationship to Private Equity
Private Equity Outlook Investments Exits
OutlineOutline
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.3
BACKGROUNDBACKGROUND
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.4
For Every Large Cap, there are 10 Smaller Cap NamesFor Every Large Cap, there are 10 Smaller Cap Names
Source: Merrill Lynch Small Cap Research
Greater than $9.8B, 348 companies
$549M-$2.9B, 1442 companies
$2.9B-$9.8B, 497 companies
$10M-$107M, 1093 companies
$107M-$549M, 1590 companies
NANO
MICRO
SMALL
MID
LARGE
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.5
The Linkages between the Public and Private Equity MarketsThe Linkages between the Public and Private Equity Markets
Source: Merrill Lynch Small Cap Research
PRIVATE PRIVATEPUBLIC
Venture Capital
Small Cap
LargeCap
Small Cap
Buyout
AGE OF COMPANY
Going public through IPO
Going private through LBO
SIZE
OF
CO
MPA
NY
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.6
Similarities of Smaller Cap Stocks and Private EquitySimilarities of Smaller Cap Stocks and Private Equity
Characteristics of Smaller Cap stocks & Private Equity vs. Large Cap stocks Less transparent Less recognized Less liquid Faster growth
Characteristics of Smaller Cap stocks & Private Equity vs. Large Cap stocks Less transparent Less recognized Less liquid Faster growth
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.7
Information Flow Reduces as Company Size DecreasesInformation Flow Reduces as Company Size Decreases
Source: Merrill Lynch Small Cap Research, IBES
Analyst Coverage by Size
2
4
7
12
18
0
2
4
6
8
10
12
14
16
18
20
Nano Micro Small Mid Large
Ave
rage
Num
ber o
f Est
imat
es
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.8
Managers of Less Liquid Assets are More Likely to Provide Value AddedManagers of Less Liquid Assets are More Likely to Provide Value Added
Source: Merrill Lynch Small Cap Research, Lipper
Average Proportion of Active Equity Fund Managers Beating their Respective Size Benchmarks
48%
41%
34%
0%
10%
20%
30%
40%
50%
60%
Small Mid Large
Ave
rage
, 199
2-20
06
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.9
Smaller and Less Liquid Assets have Outperformed the S&P 500Smaller and Less Liquid Assets have Outperformed the S&P 500
Source: Merrill Lynch Small Cap Research, Venture Economics
10-yr Annualized Returns - Public vs. Private Marketsas of 9/2006
8.6% 9.1%
12.4%11.2%
0%
2%
4%
6%
8%
10%
12%
14%
S&P 500 Russell 2000 MLSCR MicroCap*
Private Equity
Tota
l Ret
urn/
IRR
* Proxy for Private Equity
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.10
PRIVATE EQUITY OUTLOOKPRIVATE EQUITY OUTLOOK
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.11
Private Equity OutlookPrivate Equity Outlook
Investments Capital markets supportive of buyouts Opportunities in smaller cap public equities
Exits IPOs expected to be healthy M&A to remain a key driver
Investments Capital markets supportive of buyouts Opportunities in smaller cap public equities
Exits IPOs expected to be healthy M&A to remain a key driver
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.12
INVESTMENTSINVESTMENTS
Capital markets supportive of buyoutsCapital markets supportive of buyouts
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.13
Fund Raising Has Gone from Strength to StrengthFund Raising Has Gone from Strength to Strength
Source: Merrill Lynch Small Cap Research, Venture Economics
Commitments into Private Equity
0
20
40
60
80
100
120
140
160
180
200
1993 1995 1997 1999 2001 2003 2005 Q1/06 Q3/06
$ B
illio
n
Venture Capital Buy out/Mezzanine
Last 4Qtr
Breakdown
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.14
Investors are Suspect over High Expectations among the Mega-50Investors are Suspect over High Expectations among the Mega-50
Source: Merrill Lynch Small Cap Research, I/B/E/S
5 Year Expected Growth RatesLarge Cap Stocks
11.0%
12.6%12.8%
10.0%
10.5%
11.0%
11.5%
12.0%
12.5%
13.0%
Largest 20 Largest 50 Largest 100
Ave
rage
5 Y
ear C
onse
nsus
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.15
Anything but LargeAnything but Large
Source: Merrill Lynch Small Cap Research, Lipper, ML High Yield Strategy, Venture Economics (*) Bond issuance and PE data is Quarterly as of Q4/06.
Flows Continue to Migrate from U.S. Large Cap Vehicles to Any Other Asset Class
12 Month Trailing Flows as of 12/2006 (*)
$7.7 $10.2
$117.9
$172.1
-$47.9
$151.5
-$100
-$50
$0
$50
$100
$150
$200
U.S. Large CapFunds
U.S. SmallerCap Funds
EmergingMarket Funds
Global & Int'lEquity Funds
High YieldBond Issuance
(*)
Private EquityFunds (*)
12-M
onth
Tra
iling
Flo
ws
($B
)
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.16
Capital Markets to Facilitate Deal MakingCapital Markets to Facilitate Deal Making
Source: Merrill Lynch Small Cap Research, Merrill Lynch High Yield Strategy
Use of Proceeds Raised in High Yield Market - M&Avs. High Yield Quality Spreads
2006, $60B
$0
$10
$20
$30
$40
$50
$60
$70
1983 1987 1991 1995 1999 2003
M&
A H
Y Is
suan
ce, F
ace
Valu
e ($
B)
200
300
400
500
600
700
800
900
1000
Spreads, HY less 10-yr Treas (bp)
Face Value Spreads
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.17
LBOs of Smaller Public Companies on the RiseLBOs of Smaller Public Companies on the Rise
Source: Merrill Lynch Small Cap Research, Securities Data Corp.
Leveraged Buyouts among Smaller Firms(Market Capitalization below $2 Billion)
24
44
82
34
127 8 6 5 6
1115
10
29
50
2024 23
29
39
59
0
10
20
30
40
50
60
70
80
90
1986 1988 1990 1992 1994 1996 1998 2000 2002 2004 2006E
Tota
l Ann
ounc
ed -
Com
plet
ed &
Pen
ding
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.18
Relative Values are Not ExtremeRelative Values are Not Extreme
Relative Small to Large CapPrice to Sales
0.71
LT Av erage 0.67
0.2
0.3
0.4
0.5
0.6
0.7
0.8
0.9
1.0
74 77 80 83 86 89 92 95 98 01 04/Q4 05/Q4
Smal
l/Lar
ge P
/S
Source: Merrill Lynch Small Cap Research
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.19
Cost of Being Public Weighs on Smaller CompaniesCost of Being Public Weighs on Smaller Companies
Merrill Lynch Smaller Firms SurveySM
Anticipated Increase in Cost of Complying with the Sarbanes-Oxley Act
48%
30%
38%
30% 29%35%
0%
10%
20%
30%
40%
50%
60%
Q1/05 Q2/05 Q4/05 Q1/06 Q2/06 Q3/06
% o
f Res
pond
ents
Source: Merrill Lynch Small Cap ResearchSource: Merrill Lynch Small Cap Research
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.20
More Opportunities in Small Cap StocksMore Opportunities in Small Cap Stocks
Inexpensive Public Equities with Low ROEby MLSCR Size Benchmarks
13
27
1514
0
5
10
15
20
25
30
Micro Small Mid Large
Num
ber o
f Com
pani
es
Source: Merrill Lynch Small Cap ResearchSource: Merrill Lynch Small Cap Research
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.21
EXITSEXITS
IPOs likely to be healthy; M&A to remain the driver
IPOs likely to be healthy; M&A to remain the driver
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.22
IPOs Expected to be HealthyIPOs Expected to be Healthy
Risk taking to curtail appetites for IPOs in the near-term
However, healthy markets, a lower cost of capital and rising issuance go hand in hand
Risk taking to curtail appetites for IPOs in the near-term
However, healthy markets, a lower cost of capital and rising issuance go hand in hand
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.23
Over 400 Companies were Sold by VCs in Each of the Past 3 Years, a Solid FigureOver 400 Companies were Sold by VCs in Each of the Past 3 Years, a Solid Figure
06 (E), 512
Venture Capital backed IPO vs. M&A
0
100
200
300
400
500
600
700
95 97 99 01 03 05 06/1Q 06/3Q
IPO M&A
Last 4Qtrs
Breakdow n
Source: Merrill Lynch Small Cap Research, VentureOne
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.24
Risk Appetites Unwinding and will ContinueRisk Appetites Unwinding and will Continue
Source: Merrill Lynch Small Cap Research, VentureOne
Risk Posture Barometer in Relation to Venture Capital-backed IPO
0
10
20
30
40
50
60
70
80
1/1988 1/1992 1/1996 1/2000 1/2004
Num
ber o
f IPO
0
1
2
3
4
5
6
7
Risk Posture B
arometer
<= Speculative Defensive =>
VC-backed IPO RPB
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.25
An Improving IPO Backdrop can Fuel a Spate of Additional Fund RaisingAn Improving IPO Backdrop can Fuel a Spate of Additional Fund Raising
Source: Merrill Lynch Small Cap Research
Fund Raising Mark to Market Returns
Where the public and private markets meet
Favorable Credit Cycle
InvestmentsExits via IPO or M&A • Liquidity events
• credit for smaller firms• equity market eases
• Performance track record
• Commitments to PE funds
• Disbursements
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.26
M&A a Key DriverM&A a Key Driver
Hunt for growth by larger firms through acquisition
Especially true in Healthcare
Hunt for growth by larger firms through acquisition
Especially true in Healthcare
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.27
Healthcare Increasingly becoming a more Meaningful Part of the Consolidation WaveHealthcare Increasingly becoming a more Meaningful Part of the Consolidation Wave
Source: Merrill Lynch Small Cap Research, Securities Data Corp.
Dollar Value of M&A* Activity among Smaller Stocks (Market Capitalization Below $2 Billion)
Healthcare
$0B
$5B
$10B
$15B
$20B
$25B
$30B
1986 1989 1992 1995 1998 2001 2004
Tota
l $ V
alue
of D
eals
Ann
ounc
ed -
Com
plet
ed &
Pen
ding
0%
5%
10%
15%
20%
25%
% of Total D
eals
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.28
Expectations for Large Pharma Continue to Grind DownExpectations for Large Pharma Continue to Grind Down
Source: Merrill Lynch Small Cap Research, I/B/E/S
Large Cap Drugs Long-term Expected Earnings Growthvs. Market Expected Growth Rate
7.0%
9.0%
11.0%
13.0%
15.0%
17.0%
19.0%
21.0%
23.0%
1/85 1/87 1/89 1/91 1/93 1/95 1/97 1/99 1/01 1/03 1/05 1/07
Large Cap Drugs Market
Growth Gap
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.29
Micro Cap Healthcare Offers Higher GrowthMicro Cap Healthcare Offers Higher Growth
Source: Merrill Lynch Small Cap Research, I/B/E/SSource: Merrill Lynch Small Cap Research, I/B/E/S
Long-term Expected Growth RatesPrivate Equity/Micro Cap Proxy vs. Large Cap Equities
23%
13%
18%
13%
0%
5%
10%
15%
20%
25%
MLSCR PEMCP (*) MLSCR LargeCap Comp
HealthCare/Drugs Universe* Private Equity/Micro Cap Proxy
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.30
Smaller Biotech/Drug Sell Below Long-term Average ValuationsSmaller Biotech/Drug Sell Below Long-term Average Valuations
Source: Merrill Lynch Small Cap Research
Relative Lower Market Cap Price-to-Sales Biotech & Drugs / HealthCare/Drugs
LT Average 4.26
2.0
3.0
4.0
5.0
6.0
7.0
8.0
9.0
10.0
12/84 12/88 12/92 12/96 12/00 12/04
Rel
ativ
e to
LM
C S
ecto
r
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.31
Large Cap Healthcare Companies are Hunting for GrowthLarge Cap Healthcare Companies are Hunting for Growth
GlycoFi Merck & Co. 4.40% $400
Venetec International C. R. Bard 14.40% $166
Conforma Therapeutics Biogen Idec 14.10% $150
12.70%
23.50%
* 3-5yr Expected Growth Rate from I/B/E/S as of 6/2006.
Target Company
Public Equities Expected Growth*
Large Cap
Micro Cap Healthcare
Source: Merrill Lynch Small Cap Research, VentureOne
Top VC-backed M&A in Healthcare – Q2/06
Acquiring CompanyAcquiror’s
Growth* Price ($M)
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.32
Final RemarksFinal Remarks
Source: Merrill Lynch Small Cap Research
Fund Raising Mark to Market Returns
Where the public and private markets meet
Favorable Credit Cycle
InvestmentsExits via IPO or M&A • Liquidity events
• credit for smaller firms• equity market eases
• Performance track record
• Commitments to PE funds
• DisbursementsPUBLIC
PRIVATE
Refer to important disclosures on slide 33.Refer to important disclosures on slide 33.33
DisclaimersDisclaimers