In today’s private equity environment, with so much capital chasing limited opportunities, and many companies already having gone through one or more buyouts, there aren’t any easy pickings.

PE firms that consistently achieve superior risk-adjusted returns must create real value through operational improvements. That’s not only our viewpoint at TBM from having worked with many private equity firms and their portfolio companies over the years. A recently updated study by Capital Dynamics and the Technical University of Munich took an in-depth look at over 700 deal exits from around the world. They examined detailed data for sales, EBITDA, multiples, net debt, enterprise value and cash flows between investors and portfolio companies. The sample included 55 unsuccessful deals where value was destroyed, and excluded outlier performance more than two standard deviations above the mean.

The researchers found that operational improvements accounted for more than half of all value created in private equity transactions, while leverage made up less than a third. The leverage component even shrank when they compared deals from 2001-2004 to those from 2005-2008. It’s no wonder why the majority PE firms are either building internal capabilities or hiring external capabilities to drive operational improvements. Looking at the multiple expansion which accounted for the remainder of the value created in the deals they examined, the researchers attributed the majority of that to asset value improvements, further reflecting operational gains.

Crossing multiple decades and economic cycles, the extended timeframe of the study (which looked at deal exits from 1990 to 2013) underscores the long-term importance of operational improvement. At TBM we help companies drive operational improvements using LeanSigma processes and tools that also lay the foundation for profitable, organic growth. Working with the operations partners at private equity firms, we help develop and execute the value creation strategy and plan, including initial screening, preliminary due diligence, detailed operational diligence, 100-day plan execution and on-going strategy implementation. Typical priorities include:

  • Reducing costs, eliminating waste and streamlining processes
  • Optimizing asset utilization and production footprints to improve ROIC
  • Management system design and implementation
  • Leveraging enhanced flexibility and responsiveness to improve customer satisfaction, retention and growth.

Starting with due diligence, the first challenge is getting everyone aligned around internal and external priorities. That includes the management team, the private equity team, investors and so on. Then you have to keep everyone aligned quarter after quarter throughout the ownership period.

Source: Value Creation in Private Equity, Capital Dynamics and the Technical University of Munich, June 2014. Average values based on analysis of 701 deals from 1990 to 2013. FCF is free cash flow effect. Combo I is the combination of EBITDA and Multiple, Combo II is the combination of Sales and Margin.