A confluence of external factors and a difficult performance outlook are forcing private equity firms to take a hard look at each of their portfolio companies’ prospects and rethink their portfolio strategies. For private equity companies, this will require focusing leadership teams on prioritizing operating margin overgrowth and pressing teams to lean into scenario planning.
Additionally, portfolio talent will need to be assessed to ensure leadership teams have the capabilities, agility, and ownership support to meet expected challenges. More than ever, PE leaders need to provide their businesses with stewardship.
Q4 2022 hedge fund letters, conferences and more
Gates Capital Management Reduces Risk After Rare Down Year [Exclusive]
Gates Capital Management’s ECF Value Funds have a fantastic track record. The funds (full-name Excess Cash Flow Value Funds), which invest in an event-driven equity and credit strategy, have produced a 12.6% annualised return over the past 26 years. The funds added 7.7% overall in the second half of 2022, outperforming the 3.4% return for Read More
A New Playbook For Private Equity Companies
For operating companies to successfully emerge from the recession in a position to lead, businesses will need to rapidly develop a new playbook of countermeasures. The new playbook must return organizational focus to operationalization from a period of growth, often through bolt-on acquisitions.
This change can most effectively be accomplished by deploying an agile, small footprint team that supports local leadership to prioritize and swarm to high value operational opportunities.
The team should be well-versed in leveraging data to identify opportunities and prioritize and quantify the impact of changes. The team should be able to peer around corners and see opportunities and risks that may not otherwise be apparent to the leadership team running the day-to-day operations.
Often from within, it can be difficult to see what is happening. For example, we worked with a chemical business that had a sales team with discretion on prices and limited incentive structure to reward high-margin business.
Consistently, applying pricing rules and incorporating market data resulted in a $20M (~10% of revenue) improvement to annual EBITDA. In instances like these, having an external viewpoint can prove particularly valuable.
Further complicating matters is the fact that the environment now and tomorrow are very different from yesterday and most leadership teams have never encountered these market conditions. Leadership teams were built to optimize growth through acquisition and integration.
The period between the end of the Financial Crisis in late 2009 and the beginning of the COVID-19 pandemic in 2020 marked the end of a 10+ year bull market. By contrast, the average tenure of a CEO is 7 years.
This represents an experience gap that is intensified by teams either having operating experience that wasn’t leveraged or that put less emphasis on hiring for operating roles. Current market circumstances may create opportunities to level up teams, enhance operating leadership, and acquire talent previously considered unavailable.
Given the uncertainty of what the future holds, it is difficult to know what the next risk will be.
The foreseeable future will likely feature high variation with more risk and turmoil than sustained growth. Teams need to be able to drive agile change around hairpin corners. Businesses need to address risks in parallel and should create at least two plans to manage through market uncertainty, one anticipating a significant volume downturn and another anticipating flat to increasing demand.
Plans should be agile, with regularly scheduled reviews and updates to respond to a dynamic macro environment. With less slack in the system, teams now more than ever need agility to manage through adversity. A zero-based budgeting approach is often useful for identifying strategies to react to evolving market realities with pre-identified cost reduction strategies aligned to target thresholds.
A second scenario should also be modeled which reflects flat to increasing demand identifying key OpEx opportunities to create capacity for growth. Having this second scenario will provide visibility and ensure alignment around the growth vision, allowing the business to quickly react to potential improvements in the marketplace.
It should be noted that companies who are still performing with fortress balance sheets may have a unique opportunity to steal market share by acquiring and investing in companies that are well-positioned to quickly recover once the economy improves.
These companies should consider investing ahead of the curve to capture organic market share (offensive attack) and scale to be more cost effective.
2023 will create significant challenges, but opportunities exist for those portfolio companies that take the requisite steps to weather the storm and prepare for growth on the other side. Countermeasures will not be enough as they will very likely underestimate or overestimate what is necessary and required.
These macro factors are new for most operators, so private equity owners should be prepared to provide more stewardship and work with advisory firms to identify opportunities that require courageous action in the face of global headwinds.