Price: The Hidden Asset
Private equity portfolios swelled with new companies during the boom years of 2003-2007, and now these portfolios face the most challenging climate our economy has experienced in decades. To survive a bleak period that could potentially last for some years to come, managers at private equity firms will need every possible tool at their disposal to sustain and improve profitability, unlocking cash flows even from assets whose potential they had never considered.
Private equity (PE) firms find themselves sitting on an unprecedented number of portfolio holdings, each of which requires full and undivided attention to value maximization. Over the course of this decade to date deal flow grew at historically high levels both in the large-cap and the mid-market sectors. The beginning of the present decade to June 30, 2007 witnessed the creation of over $2.5 trillion in enterprise value, representing more than 10,000 leveraged buyout (LBO) transactions around the world (Kaplan 2008). As the number of holdings grew the eventual competition for exits on economically favorable terms intensified, though this was at least in part masked by the favorable economic climate of the period that engendered massively liquid debt markets and an active market for corporate M&A. However the music for this cheerful quadrille came to a screeching halt in 2008, and now the realities of the more competitive landscape are brutally clear. Managers of private equity portfolios need new tools for improving performance. These tools need to be fast, they need to be scalable and they need to result in significant financial impacts for each situation as well as for the portfolio as a whole. They need to look in places previously not considered to be sources of potential value. This would be a demanding challenge in any environment – but it is taking place in what many regard to be the most serious economic downturn our economy has faced since the 1930s. Thus PE firms are faced with the most challenging economic climate they have experienced since the business of leveraged buyouts (LBOs) originally took shape in the latter half of the 1970s1. The asymmetries of the current market – a historically high supply of private equity holdings chasing a sharply constrained 1 We use the present day convention of firms engaged in leveraged buyout transactions referring to themselves as “private equity” firms, and this is the meaning we ascribe in our usage herein, as opposed to other types of non-publicly traded equity investment flows such as venture capital.
The pool of investment demand – leave no room for error in extracting every bit of value possible out of portfolio holdings. In this environment the traditional sources of private equity exit opportunities are severely compromised and holding periods are likely to continue to lengthen, a trend already underway. The collapse in US equity markets in 2008 reversed the favorable trend for EBITDA multiples that had prevailed for the middle part of the 2000s. Without the forgiving tailwinds that enabled PE firms and their portfolio companies to prosper during this period, and with lower earnings from depressed consumer and business spending causing debt-to-cash flow ratios to hover menacingly over highly leveraged firms like the sword of Damocles, intense focus will accrue to the measures PE firms are taking to improving the operating performance of their holdings. Using the language of the portfolio management profession, managers at these PE firms now more than ever need to demonstrate their unique ability to create and sustain alpha.
The purpose of this paper is to demonstrate a path to value creation via operating performance that few companies follow but is nonetheless achievable with tools and methods available today. We present an approach and strategic toolkit that private equity firms can swiftly deploy across all their holdings, where the effort of deployment will yield outsize benefits. The approach centers on the strategy of revenue optimization, a means for companies with thousands upon thousands of price permutations to establish a rational framework for mastering their demand environments at the granular level of each discrete transaction. Revenue optimization is a solution that is applicable with demonstrable cost efficiencies to both large-cap and mid-cap holdings. For large cap companies competing for leadership in highly competitive sectors revenue optimization is a strategic means to securing sustainable competitive advantage. For mid-cap companies revenue optimization is a tool to swiftly unlock cash flows from thousands of daily pricing opportunities that would otherwise remain unseen.