At Private Equity International’s Value Creation Forum in Shanghai this week, two key points emerged: first, how crucial operational improvement is to private equity returns in Asia these days; and second, how bad firms in the region are at actually doing it.
A recent study by AlixPartners and PEI (the results of which were unveiled at the conference) found that although 60 percent of GPs operating in Asia described their operational programmes as “mature”, 64 percent admitted that they did not even have a structured way of measuring key performance indicators at their portfolio companies.
Moreover, 66 percent admitted that Asia lagged behind other markets on value creation (25 percent of whom felt it was ‘far behind’).
As Michael Thorneman, managing partner at Bain & Company, said in his opening keynote: “Almost every firm says that this is one of their differentiators and they are focusing on it. But I think it is fair to say that not too many funds have really cracked it, really offering up a repeatable model for having the right value creation process, team and capabilities, in-house or externally.”
To be fair, firms in the region face some tricky roadblocks. Most obviously, it’s not easy to drive significant operational changes when you’ve only got a minority stake, particularly when you’re working with strong-willed entrepreneurs. According to our survey, 85 percent of GPs felt this was a barrier (and minority positions are the norm in the three markets considered the most difficult in value creation terms – China, India and Indonesia).
Linbo He, head of private equity at China’s $575 billion sovereign wealth fund China Investment Corporation, also pointed out in his speech at the event that in the good old days, when Chinese companies were enjoying double-digit growth, there wasn’t the same need to use operational improvements to boost returns – so there hasn’t been the same incentive for Asian GPs to hone their skills in this regard.
But times have changed. Today, said He, operational improvements can improve returns by as much as 60 percent – so this capability has become “a very important, if not the most important, factor” in the way LPs like CIC choose their managers.
So what should Asian GPs be doing to raise their game?
He suggested that GPs should focus their resources on connecting costs with sales and expanding the areas of the business with the greatest growth potential.
Bain’s Thorneman put forward five key components for a good operational strategy: build a proprietary network, do your investment thesis due diligence, focus on value creation, have a clear exit path and employ a strong talent pool.
He also argued that “activism pays off – the earlier the better”. According to Bain data, private equity firms globally that intervened in a portfolio company within the first year of investment achieved an average return of 3.6x. By contrast, ‘late intervention’ portfolio companies returned about 2.5x to investors; while the overall industry average (including investments without any operational value-add) returned just 1.4x.
No wonder, then, that He thinks value creation “has a very obvious positive impact … [and] will become the core competitiveness of leading [GPs].”
In other words: firms in the region that have so far ignored value creation need to change their ways, quickly – or LPs are going to start voting with their feet.
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