A Holistic Model Is Suggested For Diverse Portfolios: LBO Sponsors Weigh Pooled Purchasing, Tighter Controls to Increase Returns

The traditional approach to managing private equity portfolios as a grab bag of isolated businesses may be headed for a severe shakeup. Challenged by the harsher conditions in the leveraged marketplace, a growing number of sponsors are weighing a strength-in-numbers model to boost overall value and heighten returns by cutting costs and improving operations of component companies. As an opening gambit, LBO firms are trying to pool the purchasing power of controlled companies to, in effect, get volume discounts on products and services ranging from health care insurance to office supplies. Other coordinating steps may follow. Greg Peterson, transaction services partner at PricewaterhouseCoopers, says the moves toward more unification represents a “continuum” in a state of the art that has been evolving since LBOs became institutionalized in the 1980s. More recently, the shift in oversight techniques has been accentuated by the tough times in securing transaction credit, less favorable deal structures, and increased problems in operating businesses amid a soft economy and continual changes in product and service markets. Peterson is a principal architect of PricewaterhouseCoopers’ new Portfolio Maximizer, which posits a more “holistic” approach toward portfolio management by sponsors. A play on the corporate concept of “shared services,” the offering encompasses a series of services that provide an early warning system for emerging problems at portfolio companies, aim at increasing efficiencies of controlled properties, and create common purchasing programs where appropriate. A veteran consultant to private equity firms, Peterson says that the new approach stemmed from recognition that while LBO personnel are masters at deal execution and financial engineering, they frequently need outside help to monitor the operating businesses under ownership. Much of his work involves advising clients serving as directors of portfolio firms to dissect and analyze the information they receive from operating personnel, coaching them on what additional data they should be getting from operating managers, and guiding them in investment and growth decisions. “It requires a different skill set to do the due diligence on whether you want to do a transaction compared with the ongoing monthly or quarterly monitoring of what’s going on in the business to identify where things might be headed,” he says. “That’s where you have to bring the different skill sets to the board other than the engineers of the deal. You may need people with a background in operations and broader management to supplement just the deal skill set that the private equity firm has. Some firms do that very well, but others don’t have anybody other than their own people on those boards. That’s where they get themselves in a little bit of trouble.” Sometimes, Peterson says, problems may be fermenting while everything seems to be going well and the signs of future woe elude the less operationally attuned. He cited a case in which his group detected that a client company would have a problem 18 months out in adhering to its financing covenants. “We made some suggestions about how to fix it with basic capital management and some consolidation of facilities,” he says. “We fixed where the covenant needed to be in 18 months and the company averted the problem. If we weren’t doing that for him, he (the client) might not have become aware of the fact that as the covenant was rising, something was going to happen.” However, Peterson acknowledges that the more important breakthroughs are being forged on the less sexy matter of joint purchasing, which appears easier to sell to sponsors. There are, he points out, demonstrable impact on the bottom line and less chance of intruding on the turfs in the traditional portfolio relationships. “Now they are recognizing that buying is easy but that owning it and maximizing value is more difficult today,” he says. “You’ve got to be all over it. They are saying that any trick they have to make it work better they ought to be using.” Insurance pools for starters As a result, Peterson reports, more LBO sponsors are hacking away at two heavy cost centers by purchasing risk management insurance on a pooled basis and are trying to arrange health care insurance across the board. That can give them as much clout with vendors as a large corporation with thousands of covered employees. They also are working on multi-firm purchases in real estate, telecommunications services, office supplies and equipment, computers, furniture, travel, and other general and administrative costs. These are relatively easy areas to handle, he says. “Anything you can do to tweak the bottom line, and some of these things you can do fairly quickly, is beneficial,” he comments. He warns, however, that joint purchasing has its limits. The program, he says, must be flexible enough to allow individual companies in different businesses to buy the specialized products or services that they need on their own. And he says the best purchasing paradigm should recognize that most sponsors will exit a business in three to five years and that the company has to go on from there. “You have to allow that company to disengage from whatever you’re doing or to be able to continue to receive those benefits,” he states. “You can’t just cut the strings because that would be disruptive.” Although there has been progress on the purchasing front, Peterson admits there is still resistance to overcome from the most tradition-bound players in the industry. These include sponsors who are wedded to the historical model of buying businesses and allowing managers to operate with complete autonomy. Another group of recalcitrants includes partners who did specific deals, continue to oversee the companies they brought in, and “don’t want anybody messing with my deal.” A third line of objection comes from the operating managers who don’t want to cede any purchasing authority. Peterson says he has been able to break down some of the resistance by hitting the numbers and demonstrating the savings. But not all. Some sponsors and portfolio companies may sign on in their entirety while others will agree only to partial enrollment. “It’s all over the board as to the reactions we are getting,” he says.