Before taking on a portfolio company, there are two main ways to understand and project its revenue. The first is by looking at its current performance. Compare its year-on-year earnings, look at its position within the existing market, and use current trends to project its future performance, aka understanding a company from the bottom up.
The second way is through post-investment private equity value creation. In this top-down approach, private equity firms apply their industry expertise to implement changes to the target company’s existing strategies and operations.
Over the years, private equity (PE) involvement in value creation has changed significantly. Previously, PE firms mainly used financial leverage to boost the internal rate of return, but increasingly they are taking a more hands-on approach to value creation. The contribution to value added through operational improvements increased from 18% in the 80s to 48% in 2012.
But while it’s acknowledged that operational improvement is a powerful method of private equity value creation, there are few guidelines articulating opportunities and how to identify them.
Identifying PE Value Creation Opportunities
In his article for Insead, Graham Oldroyd, former partner and Head of Manufacturing & Industrial Investment at Bridgepoint Private Equity, shares twenty-two areas of focus for operational improvements. These include major and minor acquisition integration, factory relocation/closures, implementation of LEAN manufacturing, and energy use reduction.
Oldroyd identifies four implementation risks that are worth weighing up before deciding on whether to action an operational improvement strategy.
- Complexity – how difficult it would be to implement
- Delivery risk – whether all concerned parties will cooperate and deliver
- Senior executive time commitment – how much senior executive involvement would be needed.
- Effect on publicity – would there be a positive or adverse effect on PR
These four risk factors can then be compared against the potential financial uplift that you could expect as a result of these changes.
For example, you could stand to gain a huge uplift from major acquisition integration, but that would entail a high degree of complexity, a huge senior executive time commitment, a substantial delivery risk and would likely harm publicity. Meanwhile, waste reduction is comparatively risk-averse, requires little input from senior execs and would have a positive publicity effect.
Choosing the Right Operational Improvement Strategy
While the operational improvement areas listed by Oldroyd are a useful reference point, and all can potentially add value, they aren’t equally effective or equally valuable in every circumstance.
There is evidence to suggest that private equity firms with specialisation are more likely to successfully implement operational changes.
Choose no more than three or four areas to focus on at once so as not to overburden resources and management. Too much change all at once can cause errors, workplace stress and demotivation.
Before taking on a target company for your portfolio, you should know whether they have already made attempts at any of the operational improvement strategies listed. For example, does the company already have waste management and energy use reduction policies? How successful have their previous marketing and pricing efforts been?
It’s also prudent to perform a brand health check before making any decisions with a high risk of adverse PR. Does the company have a loyal customer base that would be willing to overlook the changes? What is the current customer’s sentiment regarding pricing? Would a price hike provoke a customer exodus?
Many of the questions above can be answered using publicly available information and our advanced natural language processing (NLP) technology.
NLP technology can be used to automatically identify topics, sentiment and emotions in any written text. Publicly available data sources include corporate policy documents, news articles (industry-specific, national and international), forums, social media channels and review sites.
Here are some of the ways Symanto’s NLP technology can help private equity firms decide on the best value creation strategy for their target company.
Identify existing policies
Instead of manually sifting through hundreds of pages of corporate documents, NLP can automatically extrapolate all relevant information so that you can quickly and easily get up to date with existing policies, efforts and strategies.
Assess marketing campaigns
Symanto’s NLP technology can be used to count the number of brand mentions over time. Peaks in brand mentions can alert you to successful marketing or PR campaigns.
This same metric can also inform you of PR disasters that may affect the publicity impact of your operational improvement strategy.
Measure brand health
Find out what percentage of their customer base is loyal and what influences brand loyalty. Analyse customer sentiment to find out which areas are performing well and which need work. Find out how the target company fares against its competitors regarding customer sentiment and share of voice.