Value Creation in Private Equity, a summary of the lecture presented by Rafael Gonzalo

21.02.2019

Value Creation in Private Equity, a summary of the lecture presented by Rafael Gonzalo as seen by Cori Gramescu, MSM RO5 alumna.

The event was hosted on Feb 12th in the familiar space of Maastricht School of Management Romania, one that is filled with emotions and energy for all MSM alumni. For me the additional courses offered by MsM are always a rich inspiration source and they always bring me knowledge and new ways to think of my business.

When the “PE presentation” (as my colleagues named it) was announced, I candidly realised that I had little actual knowledge of what makes a Private Equity  business successful.

  • By the definition, Private Equity is an alternative investment class that consists of capital not listed on a public exchange. It is composed of funds and investors that directly invest in private companies or that engage in the buyouts of public companies thus resulting in delisting of public equity. The capital for private equity is provided by institutional and retail investors. A private equity fund has Limited Partners who typically own 99% of shares in a fund and have limited liability, and General Partners who own 1% of shares and have full liability while being responsible for executing and operating the investment.

  • The Private Equity Model –Private Equity is an asset class that is privately locked for some years, which means that deploying capital at the right rate is crucial for the success of the fund. The question that PE raises is “What is it that you bring to the table, what makes people bring money to risk them on the fund’s investments?”. Well, the answer is experience and expertise that will allow a 20% return on the investment. The personal background, the deep knowledge of the market and previous success in scanning the right opportunities are aspects that actually make thePrivate Equity model a very personal and human-based model in order to bend the risk curve to a more palatable area.

In choosing the right General Partners and the right investments, decision-making process is essential- choosing between supporting growth strategies or restructuring are not only different ways of making money, but also require a different team, since it is quite rare to find individuals to master both strategies with equal success.

ThePrivate Equity business is a cyclical business that follows macroeconomic cycles but is at the same time adds a lot of value through a diversity of investments, while baring a lot of risk as well. Around 25% of funds hold “dry powder”, meaning that the money is not actually invested as the fund mandate requires. This percentage only increases on different asset classes.

“WHAT IS IT THAT YOU’LL DO TO DOUBLE THE VALUE OF THE COMPANY?” – this is the main question thatPrivate Equity has to answer. With a Net debt/EBITDA ratio similar to 2009, the risk thatPrivate Equity faces is increasingly dangerous.

Also, since the number of companies that can be sold is quasi-stable and many new funds are competing for them, the performance of a fund is also correlated with finding a niche with less competition. In the market, the multiples gap is narrowing between publicly and privately traded companies.

The average promised return to funds is around 25%, with a median of actual returns at 14% in Europe, so this leaves plenty of space for improvement.

  • Private Equity value chain

How large should a fund be, how focused and with how many partners? – the answer is that when it comes to funds, more is not necessarily better. Knowing the industry/sector is essential for the fund’s success and all comes down to having the right set of skills and proper strategy to create value. Also, the fund should fire the old management team soon enough to ensure promised growth rates are sustainable.

The Private Equity strategies are:
1. Buy Cheap: identify and follow new trends, or create a different outlook in order to increase value
2. Value creation – restructure the company and work hard while repositioning the company’s strategy. This could be named “the true art of management”
3. Leverage
4. Growth

Out of 100 potential deals in Private Equity, only 1.2 deals close.

“The Private Equity environment in Romania can be imagined by looking at the present Spanish situation, probably in some years Romania will be comparable to what is now happening in Spain” – S. Negut.

“Romanian companies are less educated aboutPrivate Equity, and most Romanian entrepreneurs suffer from what we call <the valuation baby> issue. Many of them are in love with their baby and rarely accept valuations that are lower than their expectations” . – Simona Gemeneanu

“Romanian companies are not usually ready to sell. The transition generation has not matured enough and most of the company creators are still running their companies. In about 10 years we will observe the generation of children refusing to run family companies, and then we will easily buy Romanian companies. We see it better in Poland now, and Romania will follow” – Silviu Savin

“ We are always surprised to discover companies that make maybe millions in sales that do not have marketing and sales departments, and most of them are not data-driven businesses. A big part of local companies still rely on managers’ intuitions and gut-feeling. “ – Simona Gemeneanu

“Private Equity shouldn’t be a “cash cushion”, and one mistake we did was to let capital be spent too comfortably. In time we learned to put the right amount of pressure to deliver results, and that became a successful approach” – Silviu Savin

“ Romania has no real benchmark when it comes toPrivate Equity, because after 2010 everything went well in the industry. [with a new crisis probably happening 3-5 years from now] if one bets against the cycle in Romania they will lose, because the market is so small and volatile” – Silviu Savin

Rafael Gonzalo is Managing Director, Operations, Strategy & Corporate Development, at Link Financial, parent company of LCM Partners, where he joined in 2003 to launch their Spanish operations. LINK is one of the leading funds in Europe investing in distressed consumer receivables and providing direct lending opportunities.

At IE Business School, he has been lecturing since 2001 on Entrepreneurship, Venture Capital and Private Equity topics at full-time and executive programs where he has received numerous awards.

He has extensive experience in strategic and management consulting and in the financial sector, advising senior management of major Spanish, Latin American and European companies and private equity groups on strategic issues, focusing primarily on M&A, competitive dynamics, growth opportunities, and sales and marketing strategies.

He has worked for Bain & Company, Merrill Lynch, PwC and Banesto. In 2000, Rafael participated, as Chief Investment Officer, in the set-up of a venture capital fund (DOING), focusing primarily in broadband-related technology and content projects
Rafael is a member of the advisory board for Spain & Portugal at Wolters Kluwer, member of the academic counsel at FIDE Foundation, Vice-President of INSEAD’s alumni association in Spain and advisor and board member in different companies.

Simona Gemeneanu – Simona holds a BA in International Relations from AI Cuza University and an MBA degree from London Business School. She has over 15 years of experiencein Finance, Strategy and M&A roles in Europe.

Silviu Savin – Silviu has a background in Physics that he’s very proud of, with an MSc from Stanford University, holds an MBA degree from Insead and is currently a partner in Ascenta Management, investment fund specialising in real estate.

It was a pleasant talk, a wonderful opportunity to harvest knowledge and relax and even get some useful perspectives regarding my own business.

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