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December 2013

Recent lessons learned and client examples for successful portfolio company value enhancement

In our last mailing to the topic, we commented on the challenging environment of the German private equity mid-cap market and the importance of active portfolio company value enhancement to achieving target IRRs. Given the recent development of the market and particularly the high number of deals being pulled, we feel strongly confirmed regarding our view on the current situation:

  • Many target companies of only moderate quality
  • Overly optimistic management plans in terms of market projection and competitive environment
  • Highly competitive M&A processes with stunning price expectations
  • High availability of equity and financing leverages of 45-55% far away from past peaks

As a result, many of the current private equity deals will only generate attractive IRRs, if the ambitious management plans projected in partially tainted sales documents will be realized. Very often, management plans have to be revised/adjusted to realistic levels and additional value enhancement initiatives will have to be identified and implemented.

In our observation, the new owners are regularly confronted with unexpected negative surprises and have to experience that more issues and developments turn and work against them than in their favor. Thus, they have to put full emphasis on immediate operational hotspots and “daily business” issues instead of being able to concentrate on a thoughtfully casted and implemented value enhancement plan including strategic roadmaps, ambitiously realistic business plans and prioritized and well organized implementation initiatives. In one word: The Principal`s key role of adding value through strategic and organizational step changes is pushed down the priority list and the resolution of operational shortcomings require his and the organization`s full attention.

In order to justify high acquisition prices and realize projected investment returns, three key success rules should be followed to differentiate from average private equity peers and enhance the likelihood to create superior value despite strong headwinds:

  • The best private equity firms lay the basis for a post-acquisition value enhancement roadmap already before taking control, both in a focused dialogue with management AND from an independent, own perspective
    • Identify and close the knowledge gaps to really understand the business`s driving success factors, e.g. what is the business’s real profitable core?
    • Understand the downside risks and in parallel identify the business potential beyond management plan: Develop core hypotheses and challenge them
    • Do not only seek insight from management but also form your own, independent view generated from fresh external perspectives
  • The top players apply a systematic approach to develop a joint value enhancement roadmap to sharpen the company’s strategic direction immediately after closing
    • Take a clean sheet of paper and start from scratch to eliminate the hype of the sales/divestment process
    • Take the freedom to diligently evaluate the business’s value enhancement options
    • Focus on facts, facts and facts instead of predominantly relying on historic individual or institutional opinions and beliefs
    • Develop the strategic agenda as a key priority for the company and keep the discipline to stay on track: Sharpen everybody`s mind that private equity is about time value of money to become immune against being pulled down into operational battlefields
  • The best take an active role in co-managing the roadmap implementation – facilitated by standardized and proven methods, structures and processes
    • Do not leave management alone with implementation. Assume, resources are already fully utilized and give support in the prioritization of tasks and procurement of adequate resources, if required
    • Be tough in insisting on procedures, targets and tasks; be softer on how to get there and give support on framing structures, processes and methods

Selected examples from our recent work with private equity owned midcap businesses show that the “View of the World”, important aspects of strategy and priority value creation initiatives often change quite significantly after a “100 Days Full Potential Program”:

Case 1: Leading niche provider of mobile software solutions

Client Situation   Key Issues
  • Company recently acquired by PE firm in highly competitive process
  • Investment case requires value enhancement efforts beyond management plan to secure target IRR mid- to long-term
  • Management plan with ambitious topline growth in core businesses and some ideas for further growth into new business segments
  • Revenue potential and cash contribution of new segments unclear
  • What is the company’s full potential in terms of both topline growth and cash generation?
  • Which new business segments provide the most attractive returns and should be selected?
  • How should the target segments be initiated and ramped-up?
  • How to derive a five-year financial plan and an action-oriented implementation roadmap with clear milestones and responsibilities?
Approach and Role of R&Cie.   Key Results
  • Evaluation of new business segments based on extensive market analyses as well as discussions with industry experts and mgmt.
  • Prioritization of most promising business segments along market attractiveness and ability to win, rigorous focus on cash impact
  • Development and agreement of business plan in close collaboration with management and PE owner
  • Ambitious timeline, 6 weeks project support with intensive management and shareholder interactions
  • Fact base developed for each segment, business potential per segment determined/sub-stantially revised: Several B2B segments much more attractive than expected
  • Most promising segments determined and selected with management and PE owner
  • Cash-return-oriented decision-making culture established in management team
  • Full potential of the company (sales, EBITDA, cash) determined and commonly agreed
  • Key segments detailed into prioritized actionable measures with clear financial impact, implementation plan and dedicated owners

Case 2: Niche manufacturer of electric motor components

Client Situation   Key Issues
  • Company acquired by PE firm as part of a larger company portfolio transaction
  • Flat revenue development and outlook, profitability significantly above industry level but starting to erode
  • Unclear cash returns on some major investment proposals of management
  • Strategic action plan required to achieve ambitious target IRRs
  • How to direct the company towards a clearly cash-generating business?
  • Where are the company’s profitable growth areas?
  • How can the company’s strategic direction best support the equity story/a 5-year exit?
  • What is a realistic but ambitious financial target (“stretch goal”)?
  • How to translate the selected initiatives into a three-year business and financial plan?
Approach and Role of R&Cie.   Key Results
  • Strategy project set up to define ambitious yet realistic growth strategy with management
  • Project covered analysis of company’s profitable core, market and competition, growth options and strategic point of arrival
  • R&Cie. to provide substantial outside-in perspectives and analytical approaches on all relevant aspects
  • 5 weeks project support, three interactive workshops as integral part of the process
  • Overall vision, 3-yr. financial targets, strategic imperatives, operational cornerstones defined
  • List of about 60-70 initial sales ideas “all over the place” focused on 8 most attractive strategic growth initiatives
  • Growth options systematically assessed by attractiveness/ability to win, impact and risk
  • Revised quarterly topline, EBITDA and cash/CAPEX plan with clear financial targets and impl. plan developed for each initiative

Rothgordt & Cie. has a long track record in helping its private equity clients in portfolio company value management. In our practice we clearly realize a transition of our private equity clients towards portfolio company optimization and add-on acquisitions instead of chasing divestment auctions