Value creation is the core concept of any successful business. It refers to converting the resources into something valuable through hard work. It encompasses creating tangible products and services by describing the process of generating extra value for stakeholders, going beyond the initial investment or input, and enhancing the overall value of an enterprise or an investment.
Private Equity Value Creation
Many investors in the private equity industry mainly focus on ‘traditional’ value creation levers, such as buying and building, enhancing efficiencies, geographic expansion, people, and talent. They also get a chance to explore comprehensive value levers with the help of an explosion of data available. There is also an improvement in the competition for assets and much better availability of unique data sources coupled with advanced analytic tools.
A consequential shift in the accentuation of the private equity deals from ‘risk avoidance’ to ‘creating value.’ According to the Market Insights Survey, 80 percent of responses stated that private equity value creation always helps rank well in a competitive auction. Value creation thinking was earlier in the deal process with more sophisticated tooling and diligence. The value creation specialists are highly influential and play an essential role in dealing processes, especially in the US and UK private equity markets.
Private Equity Middle Market
The private equity middle market is a segment where enterprise revenues range from USD 10 million to USD 1 billion. The middle market takes up a fair share of the economy, with around 200,000 mid-market enterprises registered in the United States alone. Several mid-market companies are based on private equity investments to grow their assets and enhance their value in the long term. The middle market is attractive because it’s neither too large nor too small, ensuring enterprises are flexible during growth or uncertainty.
Private Equity Value Creation Strategies
Every private equity value creation strategy is based on research for the industry and the economy to enhance the performance and value of their portfolio organizations. Some of them are:
· Operational Improvements
This strategy helps in the efficiency and effectiveness of an organization’s operations to improve profitability and competitive advantage for streamlining the operations to reduce costs and maximize the procurement processes. This strategy also focuses on increasing sales through marketing, sales strategies, and expanding into new markets or segments. It also applies lean manufacturing techniques, Six Sigma, and other methodologies for better efficiency and reduced waste.
For example, KKR has successfully implemented the operational improvements strategy at HCA Healthcare, which resulted in cost savings and revenue growth. In the same way, Carlyle Group enhanced the operational efficiency of their portfolio organization for Axalta Coating Systems via strategic procurement and supply chain optimization.
· Financial Engineering
Financial structuring and leveraging techniques are essential for optimizing the capital structure for enhanced returns. This strategy leverages debt to finance acquisitions, maximizing the potential returns on equity. It also involves the balancing of the debt-to-equity ratio for managing the risk. It also focuses on reducing tax liabilities and generating more cash flow.
For example, Blackstone has applied financial engineering in the LBO of Hilton Worldwide, which has helped to optimize the capital structure to support growth and profitability. Similarly, Apollo Global Management applied LBO during the acquisition of ADT, offering significant returns via enhanced financial structuring.
· Strategic Repositioning
Strategic Repositioning is all about realigning an organization’s strategic direction to improve the market position by gaining a competitive advantage. It helps start the business in various new geographical markets or customer segments for driving growth. It also ensures transforming the private equity industry’s business model to capture new opportunities, which include shifting from product sales to subscription services.
For instance, TPG Capital has repositioned Ducati with its product line by entering the latest markets to increase market value. Canada Goose also signed an investment deal with Bain Capital to accelerate global growth by expanding its retail presence and diversifying its product offerings.
· Governance Enhancements
This strategy focuses on improvising governance structures and practices in an organization to ensure effective management and accountability. It includes restructuring the board of directors so that experienced and independent members can provide strategic guidance and oversight. It also installs better leadership to enhance the existing management teams to drive performance and growth. It also creates performance-related compensation structures to align management incentives with shareholder interests.
Silver Lake Partners has implemented this strategy for better governance at Dell Technologies by installing a robust board and aligning management incentives with company performance. Warburg Pincus also focused on making governance changes at Aramark by restructuring the board and applying performance-based compensation plans.
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Ending Notes
Private equity value creation strategies encompass a range of approaches to drive PE firms for significant value growth, ultimately enhancing returns for the investors. Each strategy needs a tailored approach based on the needs and circumstances of the portfolio organization.
