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FMI Quarterly/March 2015/March 1, 2015

Assessing the Value of Private Equity

PeopleMeetingRoom_imageA private equity transaction could present a “best-of-both-worlds” scenario.

For most owners in our industry, the mental image of a private equity firm does not match their idea of an ideal partner. Since the 1980s, descriptions of the broad private equity industry have included terms like “vultures,” “barbarians” and “predatory corporate raiders.” Hollywood has often used a private equity executive in a movie in the same sort of role it would The Joker or Darth Vader. In 2012 this same broad-stroke rhetoric even became part of the presidential election. Given this press, it is no wonder that many owners see all private equity firms as debt-loving, job-slashing caricatures that are only interested in companies with billions of dollars in revenue and millions of expenses they can eliminate.

The fact, however, is that of the approximate 3,300 private equity firms based in the U.S., there are nearly as many different and distinct investment strategies and cultures. Some firms rely on debt to finance deals, and some firms do not use debt at all. Some firms are generalists looking for the right opportunity, while others are sector-specific and employ executives with deep industry experience. Some target high-performing companies, while others are looking for financially distressed opportunities.

Further, while the large firms get all of the attention (because business press caters to the larger number of stakeholders of big corporations), the majority of private equity firms are not focused on multibillion-dollar acquisitions. Of the 2,124 private equity deals in 2013, over 60% were less than $100 million in deal size, and slightly less than 40% were under $25 million in deal size. All this is to say that not every private equity firm fits into a traditional mold. And while a private equity transaction does not make sense for many companies in our industry, for the right company in the right situation — and with the right firm — a private equity transaction could present a “best-of-both-worlds” scenario.

Why Private Equity?

So why is this relevant now? Throughout the history of its industry, private equity seems to have employed a “follow-the-leader” mentality when investing in business sectors. Once large firms begin spending time or investing in a specific sector, the activity often creates a trickle-down effect, and smaller firms begin chasing similar opportunities as well. And while historically, private equity firms have kept E&C firms at arm’s length, we are beginning to see increased attention paid to large companies in our industry. This is especially true among engineering firms and specialty contractors.

In late 2013 a private equity firm acquired Brand Energy and merged the company with Harsco Corporation’s infrastructure business, creating a $3 billion provider of industrial services to global energy, industrial and infrastructure markets. In August 2014 Pike Corp. agreed to go private in a deal with a private equity buyer that would take the company private, valuing it at slightly less than $400 million. When Balfour Beatty was looking to divest its ownership of Parsons Brinckerhoff, it was widely reported that half of the potential buyers were private equity firms. There are even sureties now with specialized groups focused on working with private equity firms — a concept that seemed implausible several years ago.

Why this increased attention? Unconventional energy plays have created a demand for companies with access to the oil and gas sector. For example, within the past two years, three of the 25 largest pipeline design firms were either acquired or received an equity investment from private equity. Additionally, the “onshoring” of manufacturing has created renewed interest in industrial contractors and engineers. Other private equity firms believe there will be increased construction spend surrounding the country’s water infrastructure and are seeking opportunities to play that investment thesis. Perhaps the most relevant reason is the fact that as of June 2014, private equity firms are sitting on a record $1.1 trillion globally of “dry powder” (i.e., capital that they need to invest).

This increased attention should bring new opportunities for certain companies in our industry and owners should consider whether a private equity transaction would make sense for them and their businesses. Several years ago, FMI published an article on the “Five Reasons to Consider Private Equity.” Those reasons were:

  • Substantial liquidity
  • Growth capital
  • Eliminate personal guarantees and retain operational control
  • Obtain a strong partner with aligned goals
  • “Second bite at the apple”

While these considerations still hold true today, we could simplify the rationale by saying that a private equity buyer is more favorable than an industry or strategic buyer to an owner who:

  • Wants to take some chips off the table while retaining a meaningful equity stake in the business
  • Is committed to continue growing and operating the company
  • Is looking for a value-added partner to help support growth plans — either through an infusion of capital, corporate guidance, help with strategy or other growth initiatives

Once you begin to look at a private equity transaction through that prism, one thing becomes clear: Finding the right partner can be as important as finding the right price for your business. While maximizing value in any transaction is vital, owners who are looking for a capital partner in order to take their businesses to the next level must consider that partner’s merits. Think of it the same way you would look for a new employer — you should be interviewing the company as much as it is interviewing you. This is especially true of owners who are rolling significant equity into the deal alongside their new financial partner.

Key Questions to Ask

Here are several questions owners should ask when evaluating a potential private equity partner:

  1. How does the private equity firm intend to structure the transaction? Does it plan to use debt? If so, how much? Will that amount of debt hinder the growth initiatives you have identified? How much equity does it expect you to invest in the deal? Who will sit on the board of directors? Is it reserving additional capital to invest in the business through add-ons or other growth strategies?
  2. What is its track record of investing in the industry? Has it made investments in similar companies? If so, were they successful? Does it have partners with industry experience?
  3. What does it bring to the table? The right private equity firm should bring more than just capital to the table. Does it have resources to help improve operations? Can it open up new customer relationships?
  4. What is its growth and exit strategy? Every smart firm has an investment strategy for each new company it invests in. That strategy describes how it plans to grow and ultimately exit its investment. Does that strategy align with your vision? How long does it ideally plan to hold onto its investment? In most instances, the private equity firm will have the right to trigger a sale or make decisions regarding major capital spending, so it is imperative that you are on the same page and align interests from day one.

There are other factors owners should consider when determining whether a private equity transaction makes sense for their business and in selecting the right partner. The most successful deals occur when the selling owner and the private equity firm take the time to make sure they share the same goals for the business and align their interests before closing the deal.

To be clear, a private equity transaction does not make sense for every company in our industry, but in the right situation — and with the right firm — a private equity transaction can be an effective way for owners to get some liquidity, while continuing to focus on taking their business to next level. Q

Alex Miller is an associate with FMI Capital Advisors, Inc., FMI Corporation’s Investment Banking subsidiary. He can be reached at 919.785.9234 or via email at amiller@fminet.com.

 

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