Value Buy-out vs Growth Buy-out Discussion from Associate Perspective

With PE on-cycle coming up I thought it'd be a good time to have a discussion on the Pros and Cons of Growth Buy-out vs. Value Buy-out Private Equity from an Associate perspective. I'm trying to hear some people's perspectives on which style of Buy-out firm they'd prefer to work for.

I'm specifically trying to focus on firms that are doing primarily buy-outs (so not special situations or true growth equity)

On the growth side of things are firms like LGP, TSG, General Atlantic where they seem to be totally cool paying 15x+ for businesses that are super healthy and high growth. My understanding is that these types of firms generally are able to develop you better as an investor as you are probably spending more time focused on new investments, looking at lots of different CIMs and are spending less time out visiting portcos / working to make operational improvements. Generally more of a "buy and forget" style.

On the value side of things are firms like American Industrial Partners, Platinum, Cerberus or firms even middle market / lower middle market that do lots of in-house sourcing and are looking to buy cheap businesses and spend a ton of time improving them. My understanding is that you likely are looking fewer deals and are spending a much larger portion of your time doing portfolio improvement, which I think would obviously help you as an investor from an operational understanding but you might not get as many reps.

I'm curious to hear people's perspectives who work in both types of buyout shops.

Do you like spending a ton of time out doing operational work in the field with your portcos or would you prefer to be spending more time looking at new investments? Which do you think is better to develop early on in your career (associate perspective) / which gives you more optionality? Let's say you went to B school after your 2-3 years as an Associate, would it be easier to switch to from Value to Growth or from Growth to Value? Which would you say is tougher from a lifestyle perspective? I'd think growth would be tough if you're just turning millions of CIMs all the time but value / operational work could be tough if you have to spend every other week out in the plant.

Thanks in advance!

Comments (16)

  • Business School in PE - LBOs
May 20, 2020 - 9:33pm

As long as you have brand name pe as an associate everyone will interview you, growth or value. The rest is based on personal interest imo. Will caveat that pre covid lot of firms had begun to move from value to growth eg Marlin equity as folks that maybe targeted "hairy" but not quite deep value saw they had to pay high ish multiples for them too and believed it was better to just pay up a bit more and bid for more quality assets. That's just one example (have a couple more UMM examples) not necessarily true across the board.

  • 1
May 20, 2020 - 10:58pm

Well - the fundamental issue with "growth" is that to make your 15x buyout work, you have to (i) execute on that growth, and (ii) get someone to pay you a similar multiple so you're not taking too much multiple contraction on the exit that will still allow your returns to work. In a world of loose-monetary policy (which trickles down) has the combination of (i) and (ii) generally worked? Sure.

But here - I refer to you want I call the fundamental "laws" of markets - (i) over time, all other things equal, most businesses (with the exception of those with virtuous network effects) tend to grow slower over time, rather than sustain growth (if for nothing else than the law of large numbers). (ii) You have to bet there's a "great fool" out there that will relieve you of your asset at similarly high valuations. You are now compounding two risks together - oh and by the way, they tend to correlate. That is, if you pay a high multiple expecting a lot of growth, and that growth for whatever reason does not materialize, guess what happens to your exit multiple - now your downside is much larger.

The fact is, when you buy "value" businesses that's a little more of a fixer-upper (but not complete turnaround), you simply have more margin of safety. You bought at a low multiple - so if you are confident you can even improve the business by a bit (say -2% revenue CAGR + +2% CAGR and 10% EBITDA margins to 15% EBITDA margins), now all of a sudden you have meaningful EBITDA growth AND multiple expansion. Your downside is also much more protected since you paid a "value multiple" for the business (i.e., basically you have a greater margin of safety).

In the short-term (and the last 10 years), the growth strategy has worked because everyone is slosh with cash and frankly, there is strong incentive to simply deploy capital. Over the medium / long-term, my bet is that value will be a more consistent playbook.

From an associate perspective, each has its merits - it doesn't really matter. Reps are important, but at the end of the day you want strong, consistent returns. Personally, the way I think about it is - can I leverage what I learn on the job for whatever future X, Y, Z I want to do? Does learning to invest like a General Atlantic / LGP sound like the type of personal "investing" I'll do in the future? Personally - no. I'm much more likely to buy some small car wash or something, roll up my sleeves, and try to do some roll-ups (which is a skill-set that is closer to the more value-oriented, portco-leaning strategy).

May 21, 2020 - 9:00am

I agree with you on most of this except the forward looking assessment of "everyone is slosh with cash and there is a strong incentive to simply deploy capital"

I don't think there's anything to suggest the world will be any less awash with cash in the future? I would also assume that the premium for growth will still be there, especially in an increasingly low growth world. If both of those are true, does that stimulate any other thoughts or would that change your thought at all?

May 21, 2020 - 10:30am

The last 12 months suggests that the glean of growth is already coming off - starting at the peaky-VC end. WeWork, AirBnB, Uber, Lyft. You name it - everyone is trading off growth at all costs and pivoting to profitability (value). This will trickle downstream. Remember - growth only works because you need someone down the potato line buying your asset at a rich multiple - someone, eventually, needs to make money off the actual cash flow. And as those guys towards the end of the line (SoftBank, public markets) start realizing these "growth" companies eventually will mature (and have slower growth) yet can't really generate the cash flow either to justify their value, then valuations will come down across the board and value will be back in vogue.

I personally always go back to Graham / Buffett - at the end of the day, what is the intrinsic value of a company (or any other asset - a house, a farm, a factory, a small restaurant) dictated by? Cash. Cash. Cash.

Edit: Of course - there will always be the Amazon, Apple, and Netflixes of the world that will emerge. But truly - finding those ahead of time in a highly competitive landscape is really like finding a needle in a haystack and not something that's particularly predictable (hence the VC portfolio approach).

Most Helpful
Jul 31, 2020 - 12:33am

Working in one of the aforementioned firms, will note that investments will have to 1) execute on growth for an investment to work and 2) exit multiple holds up reasonably for investments to generally work out (think ~2x MOIC). If either 1) business executes on growth ahead of plan or 2) exit multiple actually is similar to entry, it will be a great investment (think 3x+ MOIC). When you are buying great, growing businesses, you are certainly paying up but you have multiple ways to win.

To refute ibhopeful's argument, I agree that 1) growth tends to slow unless it's a flywheel business model that constantly feeds on itself to accelerate growth, growth will slow. Your base of business gets larger and growth inevitably will be slowed unless a company can manage to continue "win" at a higher rate. 2) seems correct, but its wrong.

Let's say there is a company that executed on its growth plan and growth slows down the road. When growth slows, you will experience multiple contraction. BUT, when growth slows because company executed on its growth, its book of business is going to be 2x+ larger vs. entry. If you paid 15x for a business and business doubled in 5 years and you exit at 12x, TEV increases by 60%. If you assume 6x leverage and you only paid down 30% given investments required for growth, 2.2x MOIC. If you paid a high multiple expecting a lot of growth and that growth doesn't materialize, that is a bad investment and you won't have a decent return. But risk of capital loss is different (which I would argue is the bible of all investing) vs. "downside is much larger". If you paid 15x expecting business to double and business is only 50% larger and exit at 10x, exit valuation is same as entry. But, you paid down more debt because of less growth investments, 1.5x MOIC. Is it a good investment? No. Did you lose money? No.

On the flip side for "value" (aka low multiple, not true value) side, you can't say you have more margin of safety because you entered at a low multiple. If you bought a business declining 5% p.a. at 7x, thinking you can do a quick turnaround and sell it. You managed to turn it around a bit and company only loses 10% of business over 5 years (first of all, that is easier said than done) and you can sell at 8x. TEV increases by 14%. Assuming 5.5x leverage (skinny equity account) and you paid down debt 30% (these companies typically burn cash and 30% paydown is not conservative by any means), you get 2.2x MOIC. BUT, you couldn't turn the business around and melts faster than you expected. Business declines by 30%. Your exit is now 6x, you still somehow paid down 30% of debt. 0.9x MOIC. Capital loss. If things work out, you have great upside because you have such a skinny account but leverage is a double edged sword.

Also, there aren't many firms that can actually add value to portcos. If managing a business is as easy as it is typically said, no companies would fail. Only a handful of investors can actually turnaround a business. Also, value investing is paying a good price for a business, not paying low multiples. For a great business, even if price is high, it can still be "value". Low price for a shitty business doesn't automatically make it "value".

  • 8
Jul 31, 2020 - 12:16pm

To chime in on the associate perspective, experiences on "working" is very similar but just different approach and different outcomes. I work on the growthier side as mentioned but have close friends working in what people call "value" side (i.e., HIG, Centerbridge, Apollo, etc.), so hopefully will be insightful perspective I am sharing.

"Growth" - your day isn't flipping through millions of CIMs. As an associate, you probably get ~2 CIMs a week (for my fund, at least), but for most (I would say 90%) work ends after just going through the CIM - for "growth" funds, investment check boxes are very clear and there aren't many companies that check those boxes. What you do see is, sponsors, banks and companies reach out to you prior to launching a process (sometimes even before fireside chats/gold card) for a good business that are more likely to check the boxes *this is because you are known to pay good prices for good business. You talk with the bankers, company and sponsors, if the team loves it >> pre-empt and sprint to the end (might be as short as a month for signing, closing probably 2-3 months) / sometimes great assets know there is certainty of transaction and just runs a full auction to get best price >> move aggressively in the auction. If the team likes it, but don't love it >> stay around the process to learn more and see if anything changes your mind >> typical process. Portco management, as ibhopeful mentioned, isn't as much - you buy, let the good management team run the business day-to-day vs. owners trying to say we know the business better than management team with 20+ years of experience. We help out with strategic aspects, long term plans (just adding value as board members). From the "growth" side, our work is to know which managements can be backed, which companies are poised to grow within an industry (more likely a market leader thou) and understand the multiple ways to win. (One thing I would mention is that roll-ups happen as frequently on growth side vs. value side (if not more) - ask yourself the question of does roll-up make sense when there is multiple arbitrage? YES, buy at 10x and sell at 12x (assuming its not just slopping businesses together, which some companies absolutely do). One great part of being on growth side is you get to see the action, but companies have the team in place and you don't have to go through the pain of having to review quickbooks, etc.

"Value" side (HIG, Centerbridge) - you don't get any proprietary deals or first looks. You try to scavenge assets from bank books. There is a business that looks interesting from a bank book - you stay in the auction. You do the work and go down to the most absurd minuscule details because you need to make sure business is what it actually says it is. You torture yourself on a single line item that has NO impact on the model. Work is finally done. Team likes the business, but at a certain price. We like it at 10x but we don't like it at 10.5x+. Someone comes in at 10.5x and you lose the deal. Start over again. There are some mega home run deals (mostly structured deals) but only a small portion of work actually materializes into deals (capital deployed at a slow pace).

I will note that "Value" side above are for funds that are somewhat stuck in a limbo. Not a growth, nor deep value or contrarian. For funds like Apollo, you are working on deals that people just don't like touching (particularly because its so complex and requires so much hands on management) >> you can actually buy businesses at low multiples with extremely skinny equity account. How do these investments work out? You have a few going to 0, but you also have a few mega home runs because of extremely skinny equity accounts.

Ultimately, in terms of work you are actually doing, they aren't much different from an underwriting perspective. What differs are 1) business quality you look at, 2) level of deep dive *determined by business quality you look at, 3) portco work (wouldn't say terribly different thou), 4) pace of capital deployed, 5) type of investor hat. If you want reps of super deep dive diligence without caring whether deals close, "value" is your way. If you want to build reps on thinking about good businesses and seeing capital deployed, "growth".

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