Equity FC Blog

Picking your targets

2012-02-09T13:40:54+00:00

Ever since the financial meltdown in 2008, private equity has been something of a balancing act. The three principles that support deals - leveraging equity with debt, exploiting higher multiples and increasing profits - have all suffered. There's less debt, there's less optimism (hurting multiples) and the economy has remained sluggish (limiting growth).

The evidence of how this has affected the PE market is there in the stats. The value of all UK private equity buyouts dropped by over a third (36%) to £12.1bn in 2011, according to the data published last month by the Centre for Management Buyout Research (CMBOR), sponsored by Equistone Partners Europe (previously Barclays Private Equity) and Ernst & Young. "With the exception of 2009, when only £4.8bn worth of buyouts took place in the immediate aftermath of 'the crash', the 2011 total value is the lowest since 1997 (£9.6bn)." Ouch.

But here's a funny thing. In its report on the European PE scene, the CMBOR figures tell a very different story. The overall value of all European buyouts totaled €59b in 2011, a 6.5% increase from €55.3 billion in 2010. And that's despite a year of turmoil for the Eurozone. (My guess? That currency turmoil made it much riskier to sit on cash - for both LPs and GPs - so there was something of a rush for assets.)

And Europe isn't the only bright(er) spot. Private equity investments in India showed significant activity in 2011 with a 23% increase in deal values over 2010, according to Grant Thornton. It says: "The resurgence could possibly be attributed to sluggish IPO & QIP activity coupled with a cautious return in confidence levels which were seen lacking in 2009 and the first half of 2010. There have been 347 PE deals in 2011 totaling a value of US$7.7bn." Impressive.

And even in the UK, it's worth seeking out the high points. The number of exits increased to 151 in 2011 (2010: 142) with a combined value of £8.5bn. That's despite zero IPOs of backed businesses. (OK, so secondary deals, with one PE firm picking up another's business, are still driving the market. But still...) And best of all for FDs and FCs looking at the mid-market for real value creation opportunities, "The upper mid-market (£100m to £500m range) declined by 40%, with £4.5bn total value in 2011 compared to £7.4bn in 2010. This is in contrast with the lower mid-market (£10m to £100m) which showed a 17% increase from £2.3bn in 2010 to £2.7bn in 2011."

In other words, it's worth looking at the right geographies, the right sectors (business and support services good; retail not so good) and - above all - the right opportunities where strong, disciplined management can still deliver growth and improve the quality of earnings.

PS: Mitt Romney's candidacy for the Republican nomination in the Presidential election has raised the profile of PE over the pond - he used to run Bain Capital. The debates on blogs have been pretty stimulating. Take this piece looking at how the regulation of banks is likely to fundamentally shift their appetite for risk - and how that affects willingness to provide debt to PE. And this primer on PE from The Epicurean Dealmaker is well worth a read.

2012: just a re-tread?

2012-01-05T14:18:18+00:00

The start of a new year ought to be a time for fresh beginnings. But there are already signs that much of the news for UK businesses this year is going to be a re-hash of previous years.

First up, we have a nice reprise of 2008, with dire warnings about a fresh credit crunch from the Deloitte CFO survey. That's potentially bad news for everyone, but promises to be particularly vexing for private equity firms looking to create opportunities from the poor economy. (The good news is that it doesn't look like being as bad this time round.) True, there remains plenty of equity around, and more PE houses seem to be willing to go all-equity on the right deals. But debt always oils the wheels.

Next we'll throw in a bit of 2009-era early-year stock market rally in the face of seemingly terrifying news. That doesn't mean that the big indices are going to have a great year, of course (in 2009, they started from a pretty apocalyptic level). But it does suggest big-ticket equities (most with healthy balance sheets and global exposure) are still seen as something of safe haven. That's also cold comfort for mid-market management looking at a static UK economy and wondering whether the good news is coming from. (Would that we did have a repeat of 2010 and 2011 in store on spending cuts when the government promised much, but didn't actually lay off that many people.) But it also suggests smart companies will copy the blue chips: keep cash on hand, play in reliable markets and get some exposure to economies that are still growing.

But there are other reasons for optimism this year if you're running a mid-market business backed by private equity. Because the biggest re-tread of all is that the fundamentals haven't changed in 2012. Backers want to see tightly controlled finances, investment in growth and a willingness to take managed risks. FDs and FCs will always get a pat on the back for outstanding cash management, for example. That was true 20 years ago, never mind two.

And if you can spot distressed assets - there will be plenty coming into the market this year as refinancings bite, the banks tire of shepherding zombie companies and trading catches up with some businesses - then there will be opportunities to do a spot of buy-and-build. PE backers know that their upside is growing the top line and having management in place to ensure plenty of that makes it to EBITDA.And that means having a great finance team in place.

Chairmen look to ease the lonliness of command

2011-12-01T15:11:19+00:00

It was no surprise when EquityFD sprouted an offshoot designed to help backed businesses find great chairmen. Apart from the strong business rationale, it's becoming increasingly common for FDs to look at chairman roles, rather than CEO ones, when they get fed up of the finance function. EquityChair draws on talent from across the business world, of course, it's not just finance managers. And that means it has its own specialist resource here at the web site. So I'm delighted to introduce the first post for the CindyChairman Blog.

EquityChair co-hosted the first of a number of Chairman dinners with Smith and Williamson last week. It was a great opportunity for a small group of Chairmen to network with their peers and to make very useful contacts across relevant businesses. For example, one of the guests chairs a building supplies business - and another a building services business. Their meeting was of great mutual benefit.

A number of guests commented on how rare it is to be able to meet other Chairmen in such an informal setting and how valuable it is to be able to do so. Networking with your peers is so useful not only where there are synergies across businesses – and therefore the ability to cross-refer; but also where you have the opportunity to discuss common issues faced by boards of private equity backed and growing businesses. We have encouraged the group to keep in touch by sharing contact information and I look forward to seeing some real value created amongst the group.

We have teamed up with Smith and Williamson to host a number of these events over the next year and we are looking forward to extending invitations across our Chairman network once dates and locations are confirmed.

I have always been a great believer in getting small, manageable groups of people together and the enormously positive feedback from the guests this week has only served to strengthen that belief. It can be a lonely job – so enabling Chairmen to build a community of peers with whom they can discuss issues has got to be of benefit not only for the Chairmen themselves, but to the businesses they help run.

Turnaround in 2012?

2011-11-07T09:20:38+00:00

Turnaround is an art. It even has its own trade body, the Institute for Turnaround. (Members can add the splendid letters MIFT after their names - which makes them sound perpetually discontented.) But the basics are familiar to every finance exec: cash and forecasting. I was chatting to two US CFOs in PE-backed businesses last week, and they were clear: right now, everything should be geared to free up capital in the business. That's not just cash - one of them pointed out that it was worth investing in HR systems to free up the "human capital" of managers from paperwork so they could concentrate on generating sales.

“We just have to forecast a lot,” added one retail FD. “Monitoring all the internal and external drivers is a huge job. With the unexpected shocks we’ve seen, it’s also impossible to anticipate and model for every eventuality. But you can still have a range of models that give you some visibility into different scenarios. And plan for the downside – until you can see clearly that you’re in a base case scenario or better.” That's true of all businesses, but many PE investors are on the edge of their seats right now and will reward proactive, accurate forecasting. Look at it this way: the general partner has limited time, and will probably be harassing the FC or FD who isn't showing they've modeled for a double-dip or a run on RBS.

Turnaround also demands hard talking - and an ability to hold fellow managers to account. "You must challenge the performance of the entire management team,” says serial PE FD Colin Bramall. “Done well and respectfully, it leads to a great working relationship. And if you’re a tight group, pressure for better performance strengthens the team, not weakens it."

Ironically enough, while many PE professionals expected lots of turnaround-related deal activity in 2011, it just didn't materialise. Generous payments terms from HMRC (although you still have to pay in the end...), banks letting so-so companies stumble on and a genuine improvement in the quality of financial management compared to previous recessions has meant fewer distressed sellers. Even without a lot of leverage, that's going to change in 2012. So one other aspect of turnaround for FCs and FDs: look for opportunities. When deals do pick up next year, there could be bargain opportunities to execute buy-and-build strategies for portfolio businesses with a sound enough plan to persuade their backers to fund M&A deals.

Bramall has one more lesson for FDs on that score: get agreat financial controller. “Ultimately, asFD, you can’t be distracted by the numbers issues the whole time,” he says. “You have to know they’re taken care of. It creates the headroom to let you fulfil all the other aspects of the role.” Which include planning the execution of the upside activities that a turnaround creates.

It’s the operational leverage, stupid!

2011-10-20T12:06:47+00:00

Bill Clinton's 1992 presidential campaign coined the phrase "It's the economy, stupid!" to remind staffers that they would win if they focused on the obvious areas where the competition was weak. Well, since the demise of the debt markets - and the disappearance of the financial leverage used to deliver returns in many private equity deals - we, along with many others, have been saying: "It's the operational leverage, stupid!" to remind ourselves that being a better business is the best way to create value, not financial engineering.

And now the message seems stronger than ever, thanks to research (download here) conducted by Professor Christoph Kaserer of the Technical University of Munich and presented at the European Venture Capital Association's (EVCA) conference. He claims mid-market private equity profits have always been driven by earnings growth at portfolio companies and not by the leverage used to fund buyouts. According to the report in the Wall Street Journal: "The research... analysed some 330 European companies bought by private equity firms between 1990 and 2011... Secondary buyouts, where private equity firms sell to each other, generated the highest returns making on average 3 times the amount of capital put into the investment. Sales to trade buyers and initial public offerings produced an average money multiple of 2.4, the research showed." Sales growth (15%) and earnings enhancement (30%) are the big IRR contributors; and although leverage is third (14%), it's followed closely by cash flow improvements with a 10% boost to IRR.

That's important for FDs and FCs in backed businesses for two reasons. First, it emphasises that the finance function has to do a lot more than simply keep score and hold management's feet to the fire (a common misconception about life under PE). You have to work out ways to support and lead operational transformation using your vast knowledge, only part of which is gleaned from the financials. (Although, obviously, that cash flow thing remains a biggie...) And second, you have to play a long game. Even if you plan to cash out when your PE backer exits, there's a good chance that anything swept under the carpet or massaged numbers will be found out during that secondary deal. Even trade buyers are super-hot on due diligence these days.

As one PE partner put it to me the other day: "You have to leave something on the table for the next guy." That means a clear path to further growth - and more opportunity for greater operational leverage.

What to do with the cash?

2011-10-17T08:27:17+00:00

There's no news value in the revelation that - collectively, at least - companies have maintained very healthy balance sheets through this recession. Stung by the speed of the dot-com crash and related downturn in 2001, corporates have been hoarding cash aggressively since 2002 as a bulwark against unexpected catastrophes. (It's no co-incidence that theories like the Black Swan has come to prominence in the same period. CFOs know only too well that the risk that kills you is the one you couldn't foresee.)

But the level of cash on corporate balance sheets is getting... well, silly. According to Credit Suisse, it's now $3.3 trillion (£2.2trn) globally, and research firm Treasury Strategies puts the UK figure alone at a mighty £780bn. Across the Eurozone, there's nearly €2trn in cash sitting on corporate balance sheets. That's enough to make up for the government deficits of the entire Eurozone for about six years. Although, of course, given the breathing space, the governments would probably just spend even more money. UK corporates could plug the capital black hole that threatens the Eurozone banking system about four times over.

But, it turns out, those hair-brained ideas might actually be a pretty good use for all that cash. Because, frankly, where else do you FDs put it? You can forget yield (as the Economist has recently pointed out in an excellent article). Mitigating losses used to be a question of chucking it into government treasuries - but even sterling is facing doubts about its AAA rating. So the best corporates are hoping for is not to lose too much of their dry powder.

FDs in private equity backed businesses rarely face this problem. In leveraged deals, the whole point is to carry debt on the balance sheet, pay it off and sell up to get the big equity multiple. In the (rather more common these days) "operationally leveraged" deals, you need that cash to invest in new businesses, expansion and competitiveness. PE GPs - and their LPs - haven't given you loot just to sit on it making marginal post-inflation losses. They want growth.

So perhaps corporate FDs need to learn a thing or two from their mid-market PE brethren. Start splashing the cash. Invest in assets - intangible and physical - to lay the foundations for the next 20 years. We're never going back to any kind of notion of what "business as usual" was, so it's imperative to get some options in play if you're going to be a leader in the near future. That spreads money through the system - via suppliers and buying up or investing in smaller, disruptive companies - and hopefully boosts the economy for everyone. Get stuck into corporate venturing. Open up that new R&D centre. Lend some of the cash into your supply chain or customer base.

Because sitting on it is wasting it. In the current environment, governments are going to lose it for you, inflate it away or take it off you. Use it - or lose it.

The world is your coach

2011-09-29T11:07:12+00:00

One of the great things about the web - and particularly social media like Twitter and LinkedIn - is that you can very easily get a wide variety of advice about different situations. Take this piece from Forbes magazine's web site. It comes from social media source Quora and although it's ostensibly about start-up CFOs, it's full of interesting advice for anyone in a PE situation. After all, many of the same truths are evident: you need to watch the cash, be capable of adapting the business plan and deliver excellent, clear feedback to managers and shareholders.

I particularly liked this:

For every minute you spend helping keep bad things from happening at your company, you should spend ten trying to make good things happen. If you go out of business, it will be because you didn’t hire the best people, make the right product, or sell it effectively. It won’t be because someone hacked into your conference call because you didn’t rotate the 10-digit code.

Always look on the bright side

2011-09-06T14:13:08+00:00

I've been chatting to angel investors and VCs for a story over the past fortnight, and many seem quite bullish about the start-up scene - and PE investing generally. Why? After all, there's talk of a great depression, the euro is heading for the knacker's yard and billions are wiped off shares every other day. Why would PE - and early-stage in particular - look attractive?

Well, one reason is the economic downturn itself. Alex van Someren, serial entrepreneur-turned-VC at Amadeus, reckons that the economy can't get much worse - and if you're trying to grow a business, it's quite good when the only way is up.

But I also liked two other comments. Alex White at BDO pointed out: "Fear [of uncertainty in the economy] is infectious and prevents people from taking decisions. But that's the opportunity for entrepreneurs. While others fret and prevaricate, the winners for the next decade will be those that take the plunge.” That's pretty upbeat - and although corporate balance sheets remain in pretty good order, the kind of economic upheaval we're in for is bound to disrupt markets. And if there's one thing PE firms love to see - especially from young companies - it's disruption of the status quo.

The other comment came from Anthony Clarke at the British Business Angels Association. He thinks more high net-worth individuals might be tempted in to angel right now. “The recession has made everyone more focused, more realistic, more sensible about valuations,” he says. “Early-stage and seed funding is still an attractive option – especially when property and the stock markets are actually quite risky.” But, of course, there's also an updraft from that sentiment into larger buy-out funds. When real returns on gilts and even equities are negative, and property and gold remain pricey, why not take a punt? Even the risk-averse institutional investors have nothing to lose.

That view is borne out by two other datapoints. First, many VC funds are adding development capital into the mix. They like early stage for its growth potential - but they need to bulk up their funds (and their fees) with bigger deals. So if you're looking for mid-market action, there are likely to be more players right now. And according to Prequin, LPs in the US are far more turned on by small and mid-market deals (49%) than any other PE opportunity. (The next closest was distressed businesses at 23%; LBOs scored a tiny 9% among institutional investors.)

Conclusion? Take a risk. Get involved with a business or an entrepreneur who's got some manic idea to make a difference. Sure, as FD or FC you need to be challenging recklessness in any business you're involved with - PE backers expect nothing less.

But there's a heady mix at work in mid-market PE right now. Investors are pumping in the capital. There's plenty of dry powder still in funds. Many market incumbents are suffering. Technology is still revolutionising almost every sector. And with the economy this bad, if you survive the next 18 months, at the very least you'll benefit from rivals disappearing. And at best, things will pick up - and a rising tide lifts all boats.

Where’s the ‘F’ in CFO?

2011-08-09T14:12:03+00:00

What's the most unusual non-financial job that FDs and FCs end up doing? A few years ago, I asked that question of the readers of Real Finance, and the answers were amazingly varied. Test driving new fleet cars, negotiating supplier contracts, handing out staff presents at Christmas, reviewing legal drafts, chairing disciplinary panels - even re-filling the towel dispensers in company bathrooms.

Then there are a host of other FD duties that don't even fall under the label "unusual", but which don't feature in the boilerplate job description. Board responsibility for HR, for example, and IT. (Let's leave the "softer" skills to one side, for a moment - we've covered them on this blog a lot of late…)

They're both huge issues for any business. Both fall to FDs thanks to their history. Long before appraisals and diversity were corporate issues, payroll was the core function of HR - and that's a financial transaction. Equally, the first IT systems handled the accounts - and even today, the core function of ERP systems is accounting and financial reporting. No wonder, as the vogue for board-level IT directors recedes, FDs are again becoming de facto Chief Information Officers.

(I was chatting to Jim Buckle over at LoveFilm the other days. He's a bit of a poster-boy for mid-market PE-backed finance execs, having taken the business from humble beginnings, through PE ownership and now into the corporate arms of Amazon. Relatively recently, he went from being CFO to Chief Operating Officer. At which point, he dropped HR and legal services from his remit! Sadly, his PA is in charge of facilities management - so he still gets roped into those discussions…)

Most FDs I talk to kind of love this multi-faceted role. (And it's one of the reasons I love talking to mid-market FDs and FCs more than FTSE 100 ones. They're lives are just more interesting.) But there is a danger: where does finance itself fit in to this polymath existence?

Well, of course, it's the buy-in, the FD's ante in the game of boardroom poker. Mess up the accounting, reporting or planning, and no amount of clean towel dispensers or network uptime is going to save you. That's more true in PE-backed businesses than anywhere else, too. Of course investors want the HR function to have that bit of rigour and strategic integration that an FD brings. But not if it means your cash-flow forecast is getting soft.

So while the accountancy institutes probably ought to step up the CPD options for senior finance folk to include some of these other functional areas - and there's lots of management thinking about carving out a "FD" role, rather than just a senior accountant role - it's vital to remember that there is an 'F' in CFO. The rest of the business (and its investors) will never ('F' in) forget that.

Deals of the day

A quick look 'down under' for news of the sale of MYOB, the financial software maker that's now up for sale by Archer Capital and HarbourVest Partners. They bought the business in 2008 for A$450m and hope to reap A$1bn with potential interest from Bain and KKR. It's notable because the acquisition happened in the depths of the financial crisis - and the acquirers still stand to make a packet. Proof that even when deals are done at "unfashionable" times, there's money to be made from solid businesses generating good profits (in MYOB's case, A$100m EBITDA).

Liquidity alert: can this private exchange succeed?

One of the tenets of mid-market private equity is that firms like to take a controlling stake and jealously guard it until exit. But the launch of a new trading platform for privately-held shares could result in the model being tweaked. FirstPex will run auctions for equity in private businesses, opening the door for partial exits. Well, in theory. It's perhaps more interesting for managers with vested share options - I can't see many PE houses shifting small stakes this way. But founder Patrick Gruhn reckons that in the US the secondary market for private company shares is worth $7.1bn. So you never know...

Ride the hype, don’t buy it

2011-07-05T14:03:56+00:00

It's hard to prove there's a link between trends big LBOs and mid-market deals; and between the global, US and UK PE scenes. But global investment attitudes to PE do exist – and the different markets are responsive in similar ways. So a glance at the stats at the end of Q2 make for interesting reading, even if they're not UK specific.

Prequin reported this week that PE funds globally raised $11.2bn in Q2, up from $8.9bn in Q1 and $7.1bn in Q4 last year. Wow. The caveats? The bulk of the commitment was to US funds; and real estate is the dominant sector.

Still, new funds committed implies cash is recycling in the system - and the news that the volume and value of US venture-backed IPOs rose again in Q2 is also welcome. Twenty-two flotations accounted for $5.5bn - and although some are tainted by the "Web 2.0 bubble" tag, it means more money is likely to flow back to businesses looking for development capital for disruptive models. Remember, VC-backed IPOs numbered just 6 in 2008, 12 in 2009 and 75 for 2010. So YTD of 36 is good going.

The downside? Bloated warchests. The US private equity overhang - what they got limited partners to commit but haven't yet spent on buying businesses - stood at $376bn at the start of 2011. That's a lot of cash looking for a home, even with the froth around M&A.

But that might be a plus point for those of you hoping to get into a mid-market deal. In the absence of big leveraged deals, many firms are re-branding as mid-market players, keen to burn some of that dry powder. (OK, so in the US, "mid-market" means $200m to $999m, but the point is valid). And in Europe, says research from Coller Capital, small buyouts (sub-$200m) are even more popular than mid-market deals.

One general partner (GP) who runs the European arm of a big US PE firm told me last month that his funds were certainly looking at smaller deals and had switched their focus from mainly turnaround to development capital opportunities. The firm is active and because - even with the return of bank lending - debt leverage is still much lower than 2006/07, he needs sharp management with a compelling and well-worked growth story. Good news for commercial FDs, then.

So let the Americans build up a head of steam for PE as an asset class, touting the mega-fundraisings and ploughing cash into property. Then forget the hype and look out for interesting opportunities as European general partners get stuck into manageable deals with operationally driven growth opportunities.

Mind your language

The other trend worth picking up on is international M&A. The stats are amazing. Q1 2011 was the biggest quarter for UK companies buying abroad since the end of 2007 - a massive £18.3bn spent on foreign acquisition, compared to just £3.8bn in Q4 2010. (Note that UK acquisitions by UK companies remains in the doldrums...)

My aforementioned GP contact noted that there was certainly a feeling that these days it's hard to be a regional or even national player and have much credibility. A product or service that can go international is a huge plus. And that means either opening up or buying abroad.

(I recently attended an ICAEW event where former Kidde FD John Nicholas explained how the company painstakingly built relationships in Brazil to establish its presence in that huge market - but the decisive act was (years down the line) acquiring their key distributor in the country. Email me if you'd like to hear more.)

That's got to make multi-lingual management teams a big plus for PE investors. And for FDs, it means not just speaking the language, but also knowing how the financial culture, accounting rules, currencies (plus FX risk) and regulations work. That's not easy - but if you have the skills, get ready to be in demand.

Deals of the day

So, is there a bubble in tech? KKR doesn't think so - judging by its purchase of web hosting giant GoDaddy for $2.25bn. Actually, that's a bad example to cite, since domain name management and web hosting are pretty safe businesses even in the event of a bubble in tech valuations bursting. But it makes a nice contrast to the way the public markets lapped up shares in the IPO of "technically insolvent" web plugger Groupon. We'll mark that up as a win for PE...

Meanwhile, further proving that public shareholders tend to be less blessed with brains than PE folk, it seems 3i is facing calls for a share buyback programme rather than reinvesting capital in the portfolio. Let's just say accounting and fund management legend Terry Smith might be favouring CEO (and ex FD) Michael Queen on this one. And if you want to be FD of a PE backed business, you might, too…

Finally, check out the BVCA Portfolio Company Awards, just announced, to get a feel for what passes for a good deal these days. I'm delighted to say I'm having coffee this week with Jim Buckle, CFO/COO of LoveFilm which won the exit management team of the year gong. I'll ask him if he has any tips for would-be exiting FDs...

Web quickie

In the last two posts, we've flagged up some good PE and FD/FC resources on twitter and the web. Here's another one to add to the list of potential reads - remember, be selective and if you don't already, play with RSS feeds (using a dead simple tool like Google Reader) - it's http://www.financeblogs.co.uk/ which lists a bunch of sources in different categories. (Although there isn't one for private equity or accounting... yet!)