How does PE increase the value of portfolio companies?
So we know that the business of a PE fund is to acquire companies, increase its value and resell it later for a profit, basically it is company flipping.
But how is the value created? I often hear negative views, for example that lots of staff gets laid off to decrease costs and similar actions.
But in a healthy PE fund that actually wants to improve a company, how is this done? Is it usual to change the upper management of a company with the top talents, just invest heavily, or for example there are projects similar to the ones of MBB firms? And if so, what is concretely done to 10x the value of a company in a few years?
When market is saturated a lot of firms acquire assets at high multiples and if things cool off they are forced to cut lots of costs to improve margins to sell again at a reasonable price. If they find an actual good asset- something like a founder owned manufacturing business, they can deploy processes and add experienced people to grow sales and make the company grow faster and add more capabilities. This is less common now because most of America has been acquired and a lot of PE is just bouncing assets between different funds trying to milk them for every penny at the expense of normal workers.
‘financial engineering’ is another method, playing with a firms capital structure to try to extract more value. Like adding an unsustainable amount of debt to max your funds returns over a 5 year horizon without considering the impacts over the next 20 years, often times devolving good businesses that would’ve grown at a reasonable rate over the next 15 years for maximum short term gains.
examples: adding high quality sales people to win new business, outsourcing simple processes to lower costs and allow full time employees to work on more important projects, bringing industry veterans to accelerate and capitalize on growth.
Elaborate on the MS. I took a cynical view but this has been by and large what I've observed and further heard from folks more senior in the industry.
To me, there a couple of different ways...
Would also add acquisitions / bringing that skillset
Nothing, it is exceedingly rare to get those kind of returns, and there is not a single group that does it consistently.
As far as how PE firms create value you're essentially asking us to generalize the strategy of all PE firms. Sometimes, especially on the smaller side it is new management, it's also operational improvements (investing in new infrastructure be it physical or digital), new sales strategies, consolidation, entry into adjacent businesses, vertical integration etc. if it isn't company and industry dependent then it's not a good plan.
My favorite one: Own a bunch of shitty businesses, bundle all them together, and sell it to the next PE fund as the leading company in X field in terms of revenue, employees, etc.*
looks a lot like CDS in the glorious 2000s, yummy
*if you're curious what happens next: The next fund carves out the business because literature says that large companies tend to/could be able to be more valuable splitted because "its parts are worth more than all of it together", and those businesses are then sold to other PE funds (value = divestiture) getting to point 0 making the GP richer and the LP poorer. Or, the path that makes VPs/Principals wet: the holy IPO (value = access to capital markets). If IPO is not an option, bundle them together again taking some sweet mgt. fees and enjoy the ride!!! ;)))
Wonder where this will lead. As long as every firm shows an adequate return/strategy to their LP's I guess from the PE POV it's fine. But the companies themselves are wasting time and resources. So much of the economy has gone private- I feel like if rates stay high / multiples cool off / PE disclosure requirements grow, perhaps we may have a shift towards more public entities again like in the early 2000s. Hitting earnings targets and showing growth to investors for a public company isn't all rainbows either, but I feel like that produces more value than bolt-on acquisitions to go through the process you just described.
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