How do PE Firms Create Value Beyond Margin Improvement and EBITDA Growth?
Hello,
Could anybody perhaps offer insight on some of the more nuanced tricks private equity firms use to create value in their portfolio companies?
For instance, do they sell all real estate and lease instead, try to reduce underfunded pensions in some way, do other accounting / finance tricks to increase exit multiples?
Thnx for all your inputs!
MULTIPLE EXPANSION. Read about it, dream about it - few live it.
"Illustrative multiple expansion" the not-so-secret juice for every investment case.
lmao
I see you've flirted with some multiple expansion once or twice. ;-)
Check out the SummitReheis, Inc. deal by One Rock Capital Partners. The company primarily makes the chemical that goes into antiperspirants that stops you from sweating. They bought the business from MVC in March 2012 for $66 million (EBITDA $15-20 million, 3.3-4.4x). They then purchased some assets in Germany from Israel Chemical in 2015 that added about $50 million of Revenue and at max $6 million of EBITDA (don't know what they paid but it definitely wasn't much). In 2017 they sold that shit for $360 million (EBITDA ~$30, 12x) to Elementis. The dream is real.
A PE firm's goal isn't to create value generally (i.e. for society) - the goal is to create value for the PE fund's shareholders. So the answer can be as simple as buying at a cheap valuation.
If you are asking more about what PE firms can do to improve portfolio companies, it also doesn't have to be very complicated - it could be as simple as optimizing the capital structure for the right mix of debt and equity or by injecting new money where it is needed.
Bolt on acquisitions are big one for some firms as well. You can hopefully buy smaller competitors for cheap, take out the overhead, and have a fatter EBITDA figure that should realize a better multiple since it's a bigger company with better scale. All of this assumes everything goes well, which isn't always the case.
In a traditional sense I would agree, but those concepts aren't mutually exclusive: you can achieve both goals of creating social value and financial value at the same time. One major trend is that you'll start to see more and more funds focused on impact investing in the future. TPG Growth, Bain Capital, and some emerging markets investors for example, alongside family offices and foundations that have already been doing it for a while.
Previous post nailed it. add-on acquisitions at cheap valuations and then cutting redundant costs (i.e finding synergies) is a big part of PE. More scale is always a good thing.
There are quite a lot of interesting studies out there on the sole impact of PE ownership and how the market perceives the reputation of the backing PE firm. Proponents of 'singaling' would argue that ownership by a respectible PE shop (read KKR, Warburg Pincus, H&F, although probably more applicable to growth shops such as Advent) indicates the firm is of high quality and thus drives up the exit valuation.
You missed probably the biggest one, for LBOs at least... pay down debt. Doesn't necessarily create value at the portfolio company, but creates equity value for the fund, which is the real goal.
I think most portfolio company management teams would agree that the way PE firms add the most value is through their sound board-level advice and deep understanding of industry dynamics ;-).
10 / 10 interviewed portco CEOs agree that their PE partners think they could do the CEOs' jobs better.
All about the debt.
This is a situation specific example. One of the PE firms that my firm works with bought a private, US-based company whose revenues were primarily earned in Euros. The company had previously converted those cash flows to US $ at spot rates on a quarterly basis. The dollar had been appreciating relative to the euro resulting in lower absolute amounts for Debt Repayment (in $), CapEx (in $), etc. The PE firm directed the portfolio company to hedge this exchange risk by entering into a forward contract that effectively froze the conversion rate. The previous management team did not have the appropriate financial markets depth to consider this option prior to the PE companies ownership....still "financial engineering" i suppose but not with traditional leverage.
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