Age of add-ons: 4 value-creation strategies for PE portfolio managers
Many people believe that emerging from due diligence with a fresh deal is the most exciting moment in the day-to-day experience of the private equity. While new acquisitions do get most of the media focus, they have stiff competition from the portfolio manager who discovers new add-on value creation strategies for a portfolio company. After all, it’s their responsibility to generate successful returns over the life of each new investment.
As a portfolio manager looks for new growth opportunities, it serves them well to think outside the box to find new opportunities – an expanded use of a product, service or an add-on acquisition can be the key to steering a company through a stagnant period, like a recession.
Add-ons may not make the headlines, but they can add the fuel needed to propel a portfolio company to new heights. They are a key ingredient in delivering a strong exit. While the road to a solid add-on can have many twists and turns, there are four key strategies that deserve close examination.
4 value creation strategies to advance a portfolio
Enter New End Markets
When evaluating the acquisition of a new portfolio company, understanding its existing market potential is essential. Oftentimes, this knowledge is enough to point out a good or bad deal, leading to an investment. While the investment pulls the firm into a ripe market, it also opens the exploration of new end markets.
In a recent engagement, we worked with a private equity firm with a portfolio company that’s widely known as the world’s largest manufacturer of independent precision creep feed grinding. They serve the industrial gas turbine and aerospace industry sectors, and wanted to explore new end markets. While they were deeply rooted in their existing customer segments, they needed to find advisors from OEM manufacturing facilities to help them better understand what they look for in suppliers. The advisors that we provided helped them to better position their business and sales strategy as they ventured into a new end market.
Connecting with advisors outside of their immediate network allowed them to see new end market opportunities with fresh perspective.
Purchasing power comes with the ability to purchase in ever expanding quantities – the more you buy, the cheaper the pricing gets. If a PE firm has a portfolio company that purchases widget/ingredient A on a regular basis, it might make sense to look for other verticals that also use widget/ingredient A.
We recently worked with a private equity client that was exploring cost synergy expansions for their thermal paper portfolio company. By recognizing challenges in their industry’s ability to grow, based on a reduced demand for receipt paper, they were considering a market consolidation strategy. Apex Leaders helped them connect with a broad range of small-roll paper suppliers to gauge market acceptance of combining two major brands. That could allow for purchasing synergies delivering paper from mills at a greatly reduced cost.
Connecting with advisors helped the firm find a less conventional path to expanded profits.
Every portfolio company has a long list of resources, be it personnel, services, or actual goods. Each of those things could have value to an add-on, creating cost saving synergies. For example, imagine you’re Yumm! Brands and you have thousands of KFC franchises throughout the world. You also have Pizza Hut and Taco Bell franchises. All of the above have storefronts and kitchens in operation – why not synergize costs and create fast food restaurants that feature food from all three restaurants?
One of our clients, a private equity firm that owns a major fast food franchise holder, had begun to look at how their current businesses could expand into new franchise opportunities. While they had strong knowledge of their own franchise brand model, they wanted to explore new brands – with hopes of discovering cost synergies based on business model similarities. They were able to do just that by connecting with former owners and competing franchises.
Looking to the competition – the people who understand the business and know the subtle nuances that are hard to see from the outside. They can open up a new world of cost synergy strategies.
Similar to a grocery store filling an end-cap with not just tortilla chips but also salsa, portfolio add-ons can help cross-merchandise complimentary services to current and potential customers.
Of course, this works well beyond chips and salsa. For example, a client of ours owns a pest control company that uses a product with a potential use in the agricultural chemical market. If positioned correctly, the increased demand for new agricultural chemical combinations would allow the client to package pest control and biologicals for farming operations.
Our client quickly learned that vetting a hypothesis with current and former executives in the industry often uncovers new opportunities to cross-merchandise products.
Add-on Strategies Work
Regardless of the path taken for the add-on value creation strategy, success depends on thinking outside the box. Thinking outside the box often requires engagement of third party experts who have been down a road that’s new to you. They know what exits to take, where to turn and when to stop.
Firms like Apex Leaders help portfolio managers get to the heart of the matter to get what they need when evaluating add-ons and help them get there faster.
As firms explore value creation strategies, they can avoid common pitfalls of working alone. For example, without an expert on hand, the internal team may try to gain expertise through internal market research (sometimes as simple as Google searches) or tapping into the portfolio company management team. Google searches turn out unreliable results and many management teams are too into the weeds to see out of the box, while evaluating new add-on opportunities clearly.
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