Article

Lessons For Tyco in Private Equity Firms

Since he took over as Tyco chief executive in July, Edward Breen has had to run flat out just to stay in place.

Par Paul Rogers and Dan Haas

First published on octobre 20, 2002
min


Since he took over as Tyco chief executive in July, Edward Breen has had to run flat out just to stay in place. He's had no choice but to prioritize damage control and crisis management amid the day- to-day business of making and marketing everything from fire extinguishers to surgical staples. But to win back the confidence of investors, management will have to focus again on operations and operating profit. Breen's challenge is to maximize returns from Tyco's existing assets. For that, Tyco would do well to study some of the best in the business: the turnaround masters at private equity firms. The world's leading private equity firms have performed at twice the rate of the Standard & Poor's 500 over the past decade. These returns were achieved not just through financial engineering, but also by adding value to ongoing operations. Our study of more than 2,000 private equity transactions reveals a similarity to the management disciplines practiced by top private equity firms. Successful private equity managers clearly define their investment thesis and set a time limit, hire managers who act like owners, and focus on a few key measures of success. They also make their capital work hard and redeploy underperforming assets quickly, and they help their cause by being active shareholders. For Tyco, and other public companies trying to rebuild performance cultures, these disciplines can jump-start growth. The first thing private equity firms do when they acquire a business is to define a simple, three- to five-year investment thesis for each major business in their portfolio. Consider Bain Capital's purchase of contact lens maker Wesley Jessen from Schering-Plough in 1995. Wesley Jessen, once a leader in specialty contact lenses, stumbled in the early 1990s when it faced Johnson & Johnson and Bausch & Lomb in the mass market. Bain Capital refocused the company on its core specialty lens business and its core customers, eye doctors. Less than two years later, Wesley Jessen went public, realizing a 45-fold return on equity. Private equity firms hire managers who act like owners, not administrators, and who possess a relentless will to succeed. Private equity firms motivate their hires and compensate their nonexecutive board members by giving them equity in the company they are running. This will be a tough sell at Tyco, but it's crucial to give the new management a large enough stake in the shareholder value they create—and make them share in the downside, as well. Private equity firms focus on a few key metrics. They measure financial performance in cash, not as easily manipulated as earnings. But private equity firms avoid imposing one set of measures across their entire portfolios. The fourth commandment of private equity: Make capital work hard. The average private equity firm finances about 60 percent of its assets with debt, versus 40 percent at a typical public company. This scarcity of cash forces managers to urgently redeploy underperforming capital. Finally, private equity firms make the center an active shareholder—leading corporate staffers to make unsentimental investment decisions. "Every day you don't sell a portfolio company, you've made an implicit buy decision," says James Coulter of private equity firm Texas Pacific Group. At Tyco, Breen appears to have set up a process to objectively determine which businesses to keep and which to divest, something the best-performing private equity firms routinely do. Corporate centers at private equity firms run lean. According to a Bain & Co. analysis, the average private equity firm employs only five head office employees per billion dollars of capital managed. For Tyco, that could mean returning to its roots in Exeter, N.H., where overhead was the enemy. Tyco is notorious for wasting shareholder funds on follies like $16,000 umbrella stands. But imagine what Tyco could earn if it ran as smart, focused, and lean as a private equity firm. OPINION Paul Rogers is a Bain & Co. director in London who leads the firm's organization practice. Dan Haas is a Bain vice president in Boston and helps lead the private equity group.

Since he took over as Tyco chief executive in July, Edward Breen has had to run flat out just to stay in place. He's had no choice but to prioritize damage control and crisis management amid the day- to-day business of making and marketing everything from fire extinguishers to surgical staples.

But to win back the confidence of investors, management will have to focus again on operations and operating profit. Breen's challenge is to maximize returns from Tyco's existing assets. For that, Tyco would do well to study some of the best in the business: the turnaround masters at private equity firms.

The world's leading private equity firms have performed at twice the rate of the Standard & Poor's 500 over the past decade. These returns were achieved not just through financial engineering, but also by adding value to ongoing operations.

Our study of more than 2,000 private equity transactions reveals a similarity to the management disciplines practiced by top private equity firms. Successful private equity managers clearly define their investment thesis and set a time limit, hire managers who act like owners, and focus on a few key measures of success. They also make their capital work hard and redeploy underperforming assets quickly, and they help their cause by being active shareholders. For Tyco, and other public companies trying to rebuild performance cultures, these disciplines can jump-start growth.

The first thing private equity firms do when they acquire a business is to define a simple, three- to five-year investment thesis for each major business in their portfolio.

Consider Bain Capital's purchase of contact lens maker Wesley Jessen from Schering-Plough in 1995. Wesley Jessen, once a leader in specialty contact lenses, stumbled in the early 1990s when it faced Johnson & Johnson and Bausch & Lomb in the mass market. Bain Capital refocused the company on its core specialty lens business and its core customers, eye doctors. Less than two years later, Wesley Jessen went public, realizing a 45-fold return on equity.

Private equity firms hire managers who act like owners, not administrators, and who possess a relentless will to succeed. Private equity firms motivate their hires and compensate their nonexecutive board members by giving them equity in the company they are running. This will be a tough sell at Tyco, but it's crucial to give the new management a large enough stake in the shareholder value they create—and make them share in the downside, as well.

Private equity firms focus on a few key metrics. They measure financial performance in cash, not as easily manipulated as earnings. But private equity firms avoid imposing one set of measures across their entire portfolios.

The fourth commandment of private equity: Make capital work hard. The average private equity firm finances about 60 percent of its assets with debt, versus 40 percent at a typical public company. This scarcity of cash forces managers to urgently redeploy underperforming capital.

Finally, private equity firms make the center an active shareholder—leading corporate staffers to make unsentimental investment decisions. "Every day you don't sell a portfolio company, you've made an implicit buy decision," says James Coulter of private equity firm Texas Pacific Group. At Tyco, Breen appears to have set up a process to objectively determine which businesses to keep and which to divest, something the best-performing private equity firms routinely do.

Corporate centers at private equity firms run lean. According to a Bain & Co. analysis, the average private equity firm employs only five head office employees per billion dollars of capital managed. For Tyco, that could mean returning to its roots in Exeter, N.H., where overhead was the enemy.

Tyco is notorious for wasting shareholder funds on follies like $16,000 umbrella stands. But imagine what Tyco could earn if it ran as smart, focused, and lean as a private equity firm.

OPINION Paul Rogers is a Bain & Co. director in London who leads the firm's organization practice. Dan Haas is a Bain vice president in Boston and helps lead the private equity group.