The Deal

Soapbox: Leverage lessons

Soapbox: Leverage lessons

In The Deal Newsweekly Orit Gadiesh and Hugh MacArthur of Bain & Co. discuss the strategies PE funds are using to cash in on returns down the road.

  • min read


Soapbox: Leverage lessons

In The Deal Newsweekly Orit Gadiesh and Hugh MacArthur of Bain & Co. discuss the strategies PE funds are using to cash in on returns down the road.

Now more than ever, PE funds are sticking with their winning recipe for generating big returns from dramatic improvements in operations. The results speak for themselves: The top 25% of U.S. funds raised between 1969 and 2006 have earned internal rates of return averaging 36%, through good times and bad.

The PE masters follow six disciplines that any senior executive can employ for similar results.

Define full potential. Top PE firms begin their hunt for operating value by building an objective fact base—scrutinizing demand, customers, competition and details of how money is actually made. Only then do they pursue a few core initiatives to reach full potential.

After Bain Capital LLC and Charlesbank Capital Partners LLC bought Sealy Corp., they learned that product differentiation, not complexity, was crimping margins. Shelving plans to expand midpriced offerings, Sealy changed its core mattress line from a costly, two-sided design to a "no-flip" technology and concentrated on premium price points.

Result: Ebitda improved by 22%.

Develop the blueprint. PE blueprints choreograph actions to turn the few core initiatives into results.

TPG Capital affiliate Newbridge Capital used this approach to transform Korea First Bank, now Standard Chartered First Bank Korea Ltd., from a bankrupt industrial creditor into a world-class financial institution by converting the bank's costly institutional branch structure into a network to serve retail customers. Mapping a plan to consolidate branches, Newbridge closed some locations, removed back-office functions from the rest and refocused them on customer sales. Result: Profits jumped $50 million within a year.

Accelerate performance. Top firms mold the organization to the blueprint and monitor a few key metrics. Such urgency helped CVC Asia Pacific Ltd. and CCMP Capital Advisors LLC reinvigorate Yellow Pages (Singapore) Ltd. (SYP) With an 87% market share, the telephone directory publisher had grown complacent. Advertisers were defecting along with demoralized salespeople. Revenue tumbled 40%.

Revamping sales, SYP began tracking customer retention rates and new-account sign-ups. It also introduced incentive-heavy compensation for top performers. Result: an IPO within a year of the deal yielded a gain exceeding 2.6 times the owners' investment.

Harness talent. Top PE firms create the right incentives for employees to act like owners, and they assemble hands-on boards. So do some smart companies. Nestlé SA introduced short-term bonuses paid out against clearly defined targets, increased the variable part of its compensation package and moved 1,400 key managers into long-term incentive plans that made them shareholders. Result: Shareholder returns have exceeded 15% annually since 1996, more than twice the industry average.

Make equity sweat. Top firms embrace leverage. Scarce cash compels managers to manage working capital aggressively, discipline capital expenditures and work the balance sheet hard.

DLJ Merchant Banking Partners purchased Mueller Water Products Inc., a U.S. maker of fire hydrants, high-pressure valves and fittings, for $938 million—including just $231 million of equity. Closing uncompetitive foundries and establishing leaner manufacturing methods freed up cash to fund growth and establish a presence in China. Result: DLJ earned a 4.6 times return on equity when it sold Mueller for $1.9 billion.

Foster a results-oriented mindset. PE owners create repeatable processes that spur performance improvements again and again.

Nike Inc. has achieved such PE-like repeatability. Beginning as an athletic shoe company, it has become a lifestyle company. Nike revisits a formula with each sport, from running to golf and now cricket. Nike first establishes a leading position in shoes, then launches a clothing line endorsed by the sport's top athletes. This category expansion forges new distribution channels and locks in suppliers. Result: "Swoosh"-branded products have become ubiquitous.

Companies that are not clear industry leaders cannot afford to ignore how the best PE firms are transforming the business landscape. But our research has shown even leaders often perform below their true potential. Heeding lessons from private equity can benefit them greatly.

Orit Gadiesh, chairman of Bain & Co., is an expert on management and corporate strategy. Hugh MacArthur a partner with Bain & Co., is the leader of the firm's global private equity practice.

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