Will value creation be sustainable?

Erin Griffiths at PEHub raised an interesting question yesterday. After citing statistics on PE value creation, she asked:

“Is the value creation permanent and sustainable? Did the company wilt without the PE firm’s pressure, best practices, and drive for improvement? Was the company overburdened with leftover LBO debt? The answers to these questions are important in addressing the general public’s negative image of private equity. Without taking a long term look, it’s like a High School that says, “100% of our graduates go to Harvard,” but doesn’t say whether any of those students made it out of Cambridge with diplomas.”

The question is important whether the seller is a PE firm, or a public or private company. Clearly, the answer varies with the management style of the seller, and the buyer must look for clues during due diligence. We have two tips for buyers who want to assess value creation sustainability:

1. Know your seller. Management styles vary considerably, even within a particular PE firm. Look for clues in the post-sale performance of similar portfolio assets or previously-sold business units.

2. Watch for warning signs. On the IT side, aging infrastructure, historic CapEx underspending, inadequate network performance, and low employee retention rates are among the many clues that value creation via cost-cutting initiatives may have been too aggressive to sustain going forward.

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