Valuing a company is the easy part; creating that value in the first place so you can measure it is a more formidable task. Determining value is more art form than science. True value can only be established at the time of a transaction, where willing buyer tenders payment and willing seller accepts it in exchange.
Investing in under-performers and rebuilding value has become a more acceptable practice. It can be very profitable if you know what to look for and how to execute, as many buyout firms and investors are finding out. You must:
- ascertain if a company is turnable;
- know how to fix the problems;
- avoid spending money on past-sins;
- obtain at the right price;
- manage the turnaround; and
- sell at increased value.
This is simply stated yet tricky to implement. But there is a process to provide positive results.
This niche market allows investors to capitalize on initial positive results, which may have become stalled investments. Seek enterprises with a critical capital shortage, with future potential. Selectively acquire companies that can provide quality products at competitive prices that are severely undervalued due to ineffective management, and/or lack of market direction and unacceptable penetration. There are opportunities that require capital, yet lack competitive market experience and essential managerial skills where the economy is masking the real situation. Take advantage of distressed level asset pricing and invest cents on the dollar in exchange for large returns. The infusion of capital put into the hands of a leader and guiding board with a sound strategy and a return-on equity goal in mind can be a powerful motivator.
The key to returns from investing in under-performers is to build properties future buyers want to invest in. Build an enterprise with the sole purpose of selling it at maximum value — concentrate on exit strategies from the start. Build ‘going concern value’ to yield peak results. Provide what future buyers look for:
• Consistency of businesses that create value;
• High probability of future cash flows;
• Marketing-oriented management team;
•Track record demonstrating ability to sell and compete, develop, produce and distribute products, thrive and grow;
• Realistic return potential from their fair entry valuation.
There is value in shining up or rebuilding an entity and setting it on a path toward long-term growth — then making your exit.
There are many buyers who accept lower return rates for stable growth and shy away from underperformers until they have been fixed. Leave some future enticement for your buyers.
Whether you invest in a new entity or a portfolio property gone bad, the recovery cycle is much the same. This cycle starts with a mismanagement slide into trouble, you determine viability and invest, renew the entity’s health, and ultimately sell the property.
All troubled entities reach that state through a progression of mismanagement — from officers to board members to investors. The current owners have the opportunity to repair the damage and rebuild value into the company. When the entity is at a precipice there is opportunity. Owners, lenders and other stakeholders will have little choice but to bargain, and deals can be made. Be cautious however: Many wait too long and while doing so allow the value to deteriorate completely. Avoid the pitfall of investing in an insolvent company with no fix available. As surprising as this sounds, many do.
Determine turnaround viability by truly understanding the two or three things wrong within the company causing its breakdown. Don’t be fooled by symptoms, and never listen to current senior management; if they knew what was wrong they should have fixed it before now.
Make certain you have solutions to fix the real problems that no one else has used, perhaps because you can bring new non-cash resources or applications to influence the revitalization. Take advantage of mispriced material inputs, labor, assets or capacity and intellectual property. The answer is never, “just add cash”, and always requires new leadership guidance to implement change.
Negotiate acceptable terms that allow for substantial upside when your work is done. Now you can invest. If there are no solutions, creditors won’t cooperate, or the price unrealistic, go on to the next deal. Finding good turn-able deals is fundamental to success.
There must be a successful turn before the entity can be sold. Never leave this to chance. Always take active control of the entity: Passive investing if managed by prior management alone is like a placebo, and you will lose your investment. Passive positions are only acceptable if they contribute to an investor pool with an active lead participation. New leadership is a key.
Many equity investors approach an under-performer in their own portfolio by applying strictly financial considerations. These same financial investors compound their problems when they take control of their company to determine salvageability or whether it’s a candidate for sale or liquidation. When sold, which is often the case, they write-off their investment. The scenario reveals a fundamental problem: Purely financial consideration is not enough when an operational or revenue-driven turnaround is required. While many investors have run financial or investing institutions, few have run companies as well and are ill equipped to do so. This certainly leads to opportunity for those who can run them.
Substantial value is derived from investors with senior operating leadership experience in their background. They can determine whether one strategy or another can affect the revitalization, and why others didn’t work in the past. Many private equity firms and hedge funds are adding operating executive (CEO) talent to complement their managing partners.
Thomas Paine said, “Lead, follow or get out of the way.” When there is an underperforming entity, it is time for existing management to get out of the way. They guided the company in this mismanagement slide. Why allow them to further complicate the situation?
Process of recovery
There is a process to guide an entity through corporate renewal. It involves utilizing a transferable set of skills to revitalize the property and restore it to a sale-worthy state. Then sell the entity and realize returns.