By Yaser Anwar, CSC of Equity Investment Ideas

Jonathan Knee is a Senior Managing Director at Evercore Partners. Mr. Knee teaches Media Mergers and Acquisitions and co-teaches Strategic Management of Media with Professor Bruce Greenwald at Columbia Business School.

Prior to becoming an investment banker, he was Director of International Affairs at United Airlines and served as Adjunct Professor of Law at Northwestern University. Before joining Evercore in 2003, Mr. Knee was a Managing Director and Co-head of Morgan Stanley’s Media Group. He was previously Publishing Sector Head in the Communications, Media and Entertainment Group at Goldman Sachs.

In 2006, Mr. Knee took us inside the world of investment banking, like never before, through his book, The Accidental Banker.

Y: Mr. Knee thanks for taking time out for the interview.

Y: With a record 2006 for M&A activity, and deal volume in Jan & Feb exceeding last year, a lot of me-too firms are venturing into the Private Equity business. How does one firm distinguish itself from another?

JK: In the early 90’s when I got into investment banking, there weren’t a dozen PE firms with $1 billion funds. Today there are around 200, and it is getting harder and harder to find truly proprietary deals. Industry knowledge and focus are the key differentiator.

Y: In Emerging Markets, what do governments need to do in order to promote sound public policy, including on tax, trade and securities issues and regulatory bodies to bring about a strong, effective and internationally competitive venture capital and private equity industry?

JK: I am not an expert on emerging markets and in my business of advising on M&A they represent a tiny fraction of overall deal flow.

Y: The rise of club deals has been one of the main trends of this private equity investment cycle. Some financial sponsors are discovering that being part of a consortium can be problematic. Despite the trend, do you think buyout firms prefer going solo?

JK: On any transaction a PE firm is looking for an angle. A consortium where different firms bring different area of expertise can represent an angle. But within their overall portfolio, most PE firms will want to ensure that they have a healthy mix of consortia and solo deals.

Y: The SEC has been investigating whether club deals lead to collusion, but as we see bigger and bigger deals take place, we’ll see more firms working together to finance the deal. Do you think the SEC is right to worry? If so, what should they be worried about when it comes to club deals?

JK: I do not know what facts the government is looking at but these are intensely competitive firms and it strikes me as highly unlikely that they would or could effectively collude.

Y: Keith McGregor, an insolvency partner at Ernst & Young, said the complex nature of many private equity deals was likely to make them more prone to collapse if they suffered a downturn in sales or increase in costs. “The quality of the debt has dropped off in the last few years. Debt with a CCC rating has a one in three chance of going bust within two years. But it is the fastest growing element of debt in private equity structures,” he said. What are your thoughts?

JK: I think the flexibility of the terms on many of the deals will make it easier for the companies to manage through the next cycle than the last. That said, obviously if there is an extended downturn, highly leveraged companies will be exposed.

Y: Private Equity firms want to maximize the amount of levered debt being used in an LBO because higher leverage levels increase the returns on their invested equity. Do you fret that this may lead to value destruction because the acquired firm is overextended with debt?

JK: It certainly makes it critical that you understand the underlying business and structure the debt appropriately. It is not unusual today to see firms turn down the maximum debt made available by lenders.

Y: The recent private equity boom has been driven by skyrocketing fund sizes and low interest rates globally. This has led to the emergence of ‘Fundless Equity Sponsors, who eschew the fund model all together, and acquire companies without first raising capital from and then answering to, limited partners. What are your thoughts on these so called Fundless Equity Sponsors?

JK: In a market as competitive as the current one, I think this puts them at a significant disadvantage!

Y: With the record M&A deals of the past two years, the debt financing markets are hot. What are the trends in structure and pricing, given that multiples are steep and competitive debt financing?

JK: The major change has been the ability to secure so-call “convenant-lite” financing, which provides significantly more flexibility. Deals that a few years ago could secure only 2-4 turns of bank debt can now satisfy the entire debt structure to double those levels exclusively with bank debt. That is very good news for borrowers. It has had a particularly strong impact on the middle market where subordinated bonds are typically not available.

Y: That’s all sir, thank you very much for sharing your erudite knowledge and time.

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