The strategic secret of private equity

1. The strategic secret of private equity Based on the article by Felix Barber, Michael Goold Harvard Business Review, September 2007

2. The boom in private equity Global value = $ 1 billion in 2000 Global value = $ 502 billion in 2006 Global value = $ 501 billion in 2007 first half

3. Traditionally cited advantages of private equity High powered incentives for managers Aggressive use of debt Debt imposes discipline Debt provides tax advantages Focus on cash flows and margin improvements No restrictive regulations unlike public companies

4. But the real advantage lies elsewhere The key is the� Buy- to- sell � philosophy Because the business will be sold, it remains in the spotlight and is under constant pressure to perform As investments are liquidated quickly, cash returns on investments can be quickly measured Direct linkages can be established between cash value generated for fund investors and managerial incentives No digression because of attempts to find ways to share costs, capabilities or customers among their businesses. In contrast, a lot of time is wasted by corporate centres of public companies Constant buying and selling by private equity firms result in learning curve advantages

5. Lessons for public companies Try to replicate buy-to-sell strategy. Or at least balance the willingness to hold on to a business in the long run with a commitment to sell as soon as management feels it can no longer add value. Decision to sell or spin off a business can be viewed as the culmination of a strategic transformation, not the undoing of a previous strategic mistake. GE is a good example.

6. Lessons from GE Corporate Centre helps build general management skills Cost discipline Quality focus Corporate Centre helps replicate best practices Offshoring to India Addition of service offerings in manufacturing businesses

7. Broad approaches to portfolio investments Simply make smart investments eg Berkshire Hathaway Invest in businesses and influence their managers to produce better results eg GE Invest in businesses and influence their managers to produce better results and build synergies among portfolio businesses, eg P&G, Nestle Approach differs depending on whether the intention is to sell the business in the short/medium term or keep them in the long run.

8. Replicating private equity Private equity approach makes sense for companies that own a portfolio of businesses that are not closely linked Skills needed in both investing and in streamlining operations Companies which want to have a private equity approach need to ask some basic questions : Can we spot and correctly value businesses with investment opportunities? This in turn means Contacts and networks Skills in forecasting cash flows

9. Replicating private equity(Contd) Do we have the skills and experience to turn a poorly performing business into a star? This involves Putting in place a strong highly motivated, highly incentivised, equity team Ability to poach talent Skills in identifying the one or two critical strategic levers that drive improved performance Financial controls Sharp focus on enhancing the performance basics

10. Replicating private equity (Contd) Can we manage a steady stream of both acquisitions and disposals? Disciplined process for evaluating deals Sufficient no of options must be examined Bids must not be increased to close deals in a hurry Skills in identifying bidders who will pay a good price

11. Conclusion Public companies must overcome traditional aversion to selling a business that is doing well and look for opportunities to adopt a private equity approach.