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With new deals falling off, private-equity firms are hovering over portfolio-company CFOs like never before.
Rob Garver, CFO Magazine
June 1, 2008
In your face. That's the new game plan at many private-equity firms as deal volumes decline and the focus shifts to maximizing the efficiencies of the companies they already control.
Through April, deal activity was down to levels not seen since the beginning of 2005. U.S. private-equity firms bought 429 companies in the first four months of 2008, down from 561 for the same period in 2007. The drop in dollar value is even more telling; those deals were worth only $26.5 billion compared with last year's $171.4 billion.
That doesn't mean, however, that P-E managers are sitting idle. On the contrary: with financing harder to come by and deal flow slowing, they are taking a much harder look at portfolio-company performance. Hands-on management has long been a hallmark of P-E ownership, but these days they are kicking it up a notch. "These guys never stop working on the old deals," says Bob Tormey, a partner with Tatum LLC and a seasoned portfolio-company CFO. "They're always working really hard, they're always overextended, and they never have time on their hands in any environment." Take new deals out of that environment and the stage is set for some intense micromanaging.
And no wonder. The same factors that are keeping deal volume low — tighter credit, enormous leverage, and a widespread economic slowdown — are also dragging down portfolio companies. In this climate, P-E managers expect CFOs to be laser-focused on cash flow. "They have their portfolio companies leveraged up and they need cash flow to cover their fixed charges," says George Bilek, who has been CFO of two portfolio companies, most notably Juno Lighting from 1999 to 2005.
Did we say laser focus? Make that laser foci. Private-equity bosses also expect portfolio CFOs to drive strong returns, and take any and all steps necessary to drive long-term value. That's a lot of pressure, but as Robert J. Gold, CFO of United Plastics Group Inc. in Oak Brook, Illinois (which is owned by Aurora Capital Group), says, if you're delivering results, their level of involvement will be less.
Meet the New Boss
In these troubled times, P-E firms are increasingly adding a new layer of management, a hands-on executive to aggressively shake things up. "These are people with significant industry experience" who are given equity stakes and either function as consultants or hold positions within portfolio companies, says James H. Sullivan, a partner with Alston & Bird LLP. For example, Oak Hill Capital Partners brought in former Spectrum Brands CEO David Jones as senior adviser, and other P-E firms, including Tricor Pacific Capital, WL Ross, and KPS Capital Partners, have all hired ex-CEOs recently.
For the CFOs at these portfolio companies, dealing with these new executives can ratchet up the pressure because the CFO automatically becomes the incoming executive's best resource for information. These CEOs often have a short list of action items they intend to act on immediately, too, things like paying down debt, consolidating operations, reducing excess overhead, and improving global sales. But in their zeal to get results fast, says Bilek, who now runs his own accounting firm in Chicago, P-E executives "sometimes recommend things that can cause as much damage as value."
To prevent that requires tact. At Juno Lighting, for example, revenue flattened when an economic slump left the construction industry far less interested in the company's products. The private-equity owners wanted to keep profits flowing and asked how best to do that. Bilek believed that adopting a program of continuous improvement was the answer, and persuaded the company to bring in a consulting firm to train a broad swath of managers in ways to measure and enhance productivity. The program resulted in significant savings through both cost-cutting and cost avoidance; cash flow improved, the P-E managers were kept happy, and nobody lost his or her job.
Have a Plan B
If real estate is all about location, location, location, P-E portfolio companies are all about cash, cash, cash. If the balance sheet has been depleted, it is often up to the CFO to find ways to generate more. One response is to take an approach to budgeting and forecasting that might not have been considered at a public company. Tormey, for example, recommends working with a 60-month budget rather than the typical 12-month model. In a portfolio company, he says, "your financial model should be really mature" and detailed, with a very granular view of cash flow.
Models can go wrong, of course, and external events can intrude. When that happens, the CFO's job is to present the bad news as quickly as possible. "You don't want to wait until the end of the quarter to tell [P-E managers] that your biggest customer has stopped ordering," says Bilek. At the same time, "you need to have a Plan B," he says. "As long as they get the feeling that management is doing something to generate cash flow, that helps hold them in abeyance."
United Plastics's Gold agrees: "Private-equity firms aren't looking for CFOs to report history. They're looking for business operators. I can't think of any situation, good or bad, where I would sit down with a private-equity group and not have both a description of the subject and an action plan."
Experts are divided as to whether this more intensified hands-on approach is temporary or permanent. It's tied to the fact that "the deal market is slow and choppy," maintains Dominick DeChiara, chair of Nixon Peabody's Private Equity practice. But others see it as the new reality. Or, more accurately, a return to the old reality.
"It is not too different," says Sullivan, "from what private-equity firms did in the days before the loosening of the credit markets." John Rose, senior partner of The Boston Consulting Group, says that P-E firms would be ill-advised to let up the pressure. Rose points out that a recent BCG study found that a "greater percentage of value at these [portfolio] companies was driven by growth and operational efficiencies as opposed to leverage and capital efficiencies."
Permanent or temporary, one thing is clear: portfolio-company CFOs can't mask inefficiencies with mere revenue growth. When private-equity managers demand improved cash flow, CFOs will have to be several steps ahead if they want to retain some control of their company's financial destiny.
Rob Garver is a freelance writer based in Springfield, Virginia.
Where the Jobs Are
Despite the decline in private-equity deals, there is still a need for seasoned CFOs at portfolio companies — well, at least at some portfolio companies.
Christopher Langhoff, a consultant with Russell Reynolds Associates, admits that private-equity CFO searches have "gotten a little quieter" this year. But he adds that he is still seeing "quite a few for companies with annual revenues of $10 million to $20 million."
That may be the sweet spot for some time to come, given that private-equity deals are skewing toward smaller companies due to tight credit. The average P-E acquisition in North America totaled $101 million for the first quarter, compared with $475 million during the same period last year, according to Mergermarket.
Smaller companies of all kinds may offer plenty of employment opportunities for CFOs, Langhoff says. After all, if credit does ease, P-E firms may start shopping again, resulting in top-management shake-ups at many newly acquired companies. And their current focus on performance may prompt competing P-E firms to replace finance executives at portfolio companies that fail to execute.
That may, in fact, become a trend. "Given the volume of private-equity transactions over the past 18 months, a natural cycle will [play] out," says Langhoff. "A honeymoon period will end, and [P-E firms] will decide that some guys and gals are keepers and others are not. Given the economy, private-equity owners will not hesitate to make changes."
Just remember: once they tap you, they may be more inclined than ever to keep their hands on you. — Marshall Krantz