Imagine you're a private equity investor. You focus on the US middle market, with a specialty in food-related sectors.
Your investment team finds a possible target, a trendy ice-cream maker based in California. A big hit with millennials, the brand has a cult-like following in San Francisco and Los Angeles. The company has already tried to expand, with varying results at new retail locations. Restaurant and grocery store sales, however, were up double digits the past three quarters but disguised by low in-store revenues. It turned out that demographics helped explained the discrepancy; younger customers were behind stagnating in-store sales while older customers were fueling grocery sales. To optimize overall growth, the company needed to account for both trends, and reallocate its resources accordingly.
Armed with this insight into consumer behavior, your firm can bid competitively even as others question your team's valuation.
What does this have to do with technology? Not much on the surface—tech poses no immediate threat to the ice cream industry. But technology is playing an increasingly important role when it comes to evaluating a company's growth potential, and it is quickly changing the nature of private equity due diligence.
This is particularly true as it pertains to the use of predictive analytics, which, in PE context, commonly boils down to analyzing how specific clients or users interact with a target company's products or services.
Combining high doses of leverage with cost-cuts is no longer a reliable playbook, and focusing on efficiency measures in a sector like retail, for example, can be like catching a falling knife.
That's where harnessing data and technology comes in.
"Where we've seen a lot of improvement with private equity-backed companies comes back to reporting capabilities," says Chris Stafford, senior manager in West Monroe Partners' Mergers & Acquisitions practice.
Private equity owners are expecting to see value coming from those efforts quickly, he added, in as little as six months. More broadly, PE increasingly emphasizes knowledge sharing among portfolio company leaders with regard to technology capabilities.
"We've seen private equity mature on the operating side," Stafford said. "CIOs are becoming more aware of what their portfolios need within a certain market. Investors and advisors are hosting more conferences where they can share those ideas. And beyond knowledge sharing, we're seeing more centralized services being developed within PE firms. In addition, investors and CIOs are hiring specialists to run portfolio diagnostics and provide recommendations to their CTOs to identify any gaps or opportunities to drive revenue growth."
In some cases, leveraging technology has allowed PE sponsors to better identify add-on targets earlier in the process, and many add-ons today are being negotiated ahead of the platform acquisition itself.
In other cases, it's more about getting answers to more insightful questions, like which customers buy more or more often, and which customers are less active? Which clients or client-types come with higher margins, and which are costlier to serve? Perhaps most important, how are company resources being allocated to those specific products, services or clients?
This line of thinking isn't quite the same as identifying a factory to close or a business line to shut down. Those were blunt instruments that worked effectively in the past, when those situations were more common. But PE has been active for almost 40 years, and after such a long and profitable run, the emphasis on the turnaround play is losing ground to expansion efforts.
Opportunities today are less obvious in a crowded market and more likely to hinge on boosting specific revenues or margins by as little as 10%. That might not seem like much, but knowing that certain resources can be allocated differently can make the difference between bidding confidently for a target versus passing altogether.
Even as buyout multiples won't always be this high and auctions this competitive, predictive analytics are likely here to stay. That would be a good thing for an industry looking to upgrade its image while uncovering even more opportunities in the years ahead.
Check out more articles from the 2Q 2018 PlayBook: