Garrett Black January 21, 2015
Andrew Thompson is a principal at Wafra Partners and also serves as a vice president of Wafra Investment Advisory Group; prior to joining Wafra, he worked in the corporate finance group of Navigant Capital Advisors. To kick off our series of Q&As and analysis concerning private equity portfolio management, he was kind enough to share his thoughts on the current state of PE strategies, as well as their evolution over the past few years:
As the PE industry appeared to adopt even more of a buy-and-build strategy over 2014, did you see the shift more as a response to market conditions or the natural culmination of value creation aspects of general PE strategies evolving to focus on operational performance?
Add-on acquisitions have been a long-standing driver in private equity value creation, particularly given the immediate opportunity for accelerating growth and driving synergies. While this strategy is not new to the private equity market, I think we have recently heard more about the strategy due to valuations for platform acquisitions being high and economic growth being relatively low. When you pay a lot for a platform, a buy-and-build strategy can be a great way to lower the effective purchase price. In a low-growth environment, add-ons provide growth from day one, and keep things moving in the right direction when organic growth is challenging. Notwithstanding these two factors, a buy-and-build strategy, when executed well, can be one of the best paths to strengthening companies and creating shareholder value.
With the proliferation of add-ons over the last few years, what would you say makes them most attractive?
Add-ons are very attractive for how quickly they can accelerate a platform company’s growth. To start, there can be structural value drivers in securing a favorable valuation multiple, as well as the potential to structure the transaction with a lower cost of capital. Operationally, there is day one sales growth, along with potential for expansion, which could include product, geographical or channel, along with opportunities for margin improvement and organizational development. If integrated successfully, add-ons can be one of the most effective approaches to value creation.
Have you seen any significant shifts in portfolio management practices by PE teams over the past few years? If yes, what do those changes mainly consist of? If no, why do you think that is?
Operationally focused private equity groups have received a lot of attention the past few years. As we hear so often, being a value-added investor goes beyond basic financial engineering. Valuations are high and processes are efficient, so investors need to remain disciplined and have a well-thought-out approach as to how they will bring value to their investment through accelerating growth, improving margins and enhancing cash flow. We have had success partnering with industry-specific executives to not only assist in sourcing and evaluating investment opportunities, but also to assist our portfolio companies get to the next level.
To what extent do you incorporate ESG concerns in your portfolio management?
ESG is an exciting area that has displayed strong growth and is definitely trending toward mainstream in the marketplace. Like most institutional funds, we only invest in companies that meet certain ethical standards and sensibilities, as well as avoiding certain risks. Once those companies are in the portfolio, we aim to do the right thing, which generally translates to enhanced performance, employee and customer retention, and shareholder value.
Do you expect the increased focus on operational performance improvement as a main component of value creation to continue into 2015 and beyond?
I certainly see the increased focus on operational performance improvement as being here to stay, particularly in the middle market, where companies often have greater room to grow and develop. This is the exciting part as it relates to the value proposition that private equity can bring to this segment of the market, which is large, fragmented and loaded with opportunities to help companies reach their full potential.
Where do you see the most opportunity for buy-and-build with regard to industry?
So long as you have a scalable platform and a team capable of identifying and assimilating accretive acquisitions, a buy-and-build strategy can work across industries, cycles and investing climates. Fragmented industries are attractive, as well as highly scalable business models, where earnings can be accelerated most. Since buy-and-build generally occurs in consolidating segments, there may be attractive exit alternatives, including to a larger consolidator, particularly one that can justify a higher multiple based on anticipated synergies. Other value drivers of the buy-and-build strategy include building a stronger company by expanding footprint, offering and management team, as well as the opportunity for multiple arbitrage since most add-ons have a lower effective purchase price, decrease the cost of capital and deliver synergies, which can lead to a higher multiple at exit.
Featured image courtesy of Wikimedia Commons user MJ-bird.