Operational value-add: Sweat equity

Deep exposure to the operational aspects of corporate investments is arguably the key differentiator between private equity and the rest of the investment industry. As a result, the relatively few groups in Asia that leverage this distinction tend to catch the eye of kindred spirits.

When Patrick Siewert left a string of senior leadership roles at Coca-Cola to join The Carlyle Group as a managing director and Asian operating executive in 2007, he felt at home with the firm’s business-oriented culture. Two of Carlyle’s three founders had corporate resumes, including Dan D’Aniello, formerly of Marriott and Pepsi, and Bill Conway, ex-CFO of MCI Communications.

That DNA has translated into a global operations team of 50 part-time and full-time professionals, including 10 in Asia, of which four are full-time. The philosophy behind building up this muscle has come into focus perhaps most clearly with the firm’s acquisition of McDonald’s China last year alongside CITIC Capital and CITIC Group in a deal worth $2.1 billion.

You need to get everybody to understand that you are not just a financial investor. You are an owner and an industrialist

Siewert outlines an impressive transformation since operational due diligence began, including an increase in the cashless share of transactions from 10% to 80% and an expansion of existing touchscreen point-of-sale kiosks into a system where customers pay via QR code from their tables. In a possible first for both Carlyle and the restaurant industry, the overhaul required adding an approximately 20-strong team of digital experts. 

“IT and digital is an area where everyone in private equity needs to go deeper,” says Siewert. “You can probably continue to outsource it for a period of time, but every industry is being reshaped by it in Asia, and every operations executive is going back to school on technology. It’s something you can jumpstart with outsourcing, but it will need to be core to what happens with full-time operations teams and senior advisors.”

The McDonald’s revamp highlights several trends in approaches to operational value-add in the region, including a recognition that fast-moving markets require greater resources to realize their potential and the idea that meeting unique opportunity sets is not a matter of fulfilling a standard checklist. In this instance, the story was tech. But other themes such as shifting supply chains and the rise of corporate carve-outs require different plans of attack.

An evolving model

Growing demand for technical and business support touches GPs of every size and stripe, whether they’ve mobilized an operations agenda or not. One common thread between the various implementations strategies is the need for internal modifications in culture, processes, and team makeup. This universality speaks to some extent to a direct connection between building terminal value and turnaround success, especially when targeting trade sales.

Generally seen as requiring more demonstrable and quantitative value-add progress during the hold, trade sales have been by far the most consistent and economically robust exit type in Asia for the past decade. According to AVCJ Research, these divestments have grown in total value and volume year-on-year for six of the past nine years. The traction illustrates not only an increasing appetite among operationally demanding strategics but also the growing levels of control in a maturing field of GPs.

“We used to make 70% of our money on the way in by buying the right company at the right price. Now, 70% of the value comes from what we do once we own the company,” says Jean Eric Salata, CEO at Baring Private Equity Asia. “That shift in focus requires a complete retooling of your toolkit as a private equity firm. You need to have an investment team that understands that, operations capability in house, and a deep network of industry executives and advisors you can bring in to execute on the post-investment work.”

Over the past eight years, Baring has built up a resource of 10 operational professionals within a pan-regional investment team of about 90. Like many PE firms, it staffs up with a view to diversifying capacity across industries and geographies. The approach has gradually evolved into a preference for higher-level oversight. Hands-on work with specific projects is still part of the equation, but the focus is more on setting the tone within a portfolio company through the optimal people, plan and governance.

High-altitude chess moves of this kind can be deceptively complex endeavors. As a case in point, Baring pursued a strategic pivot for Indian business process outsourcing player Hexaware Technologies, repositioning the business as a digital analytics company that also offers remote network management services. The renaissance required replacing 15 out of 17 managers including the CEO. This has been realized without making any acquisitions so far, and the turnaround multiple is currently tracking at 4.5x. Baring took control of the company in 2013 through a series of deals worth more than $450 million.  

Operational partners focused on supervisory guidance are inevitably industry veterans with decades of experience ascertaining strategic directions, identifying improvements, driving top line growth, taking out costs, and managing teams. The traditional target profile for many PE firms has been the quintessential “grey-haired” executive with pattern recognition strengths in areas such as marketing, procurement and supply chains.

Professionals in this mold, however, often have little interest in detail work and low familiarity with the nuts and bolts of the newer aspects in a given industry. The most senior executives with rare skillsets across operations and deal-making can be expensive as well, which makes them difficult to deploy cost-effectively on a full-time basis. This implies risks related to motivation through paychecks rather than carry, including job transience. Top operational advisors are said to have an average tenure of only 2-3 years in Asia.

Younger executives are therefore seen as essential to many value-add playbooks, but the reputations and respect that comes with age still count for a lot, especially in the more conservative Asian cultures. The most common fix is to focus on an early win in efficiency improvements in order to boost confidence among existing management in an unproven operations team. Other solutions include experimentation with layers of seniority.

Partners in their late 40s are often said to be a good hedge. The idea is that they have enough experience to move as peers among veteran founders and CEOs but also claim recent enough in-shop experience to be willing to roll up their sleeves and be relevant at a more granular level. 

“We look for people who are biased to action, keen to work across multiple industries, intellectually nimble, with high EQ and a very low ego,” says Matthew Claughton, a managing director focused on Asia Pacific for KKR Capstone. “They are people who understand that credibility is not based on past experience, but rather gained through results achieved working with KKR’s portfolio companies.”

Alignment issues

KKR Capstone makes for an interesting example of how some firms are addressing issues of team alignment as well. The firm, which includes a global team of 90 with 20 in Asia, is a separate entity to KKR that licenses the name for branding purposes and works exclusively with its partner GP. The idea is that the operating partners have an interest in the success of the broader KKR franchise as it is the only stream of new business. For most firms, global best practice for alignment is compensation on the same terms between deal and ops partners, including carry.

Alignment is also increasingly being achieved through integration. When portfolio companies are not handed over from deal team to operations team and representatives of both camps sit on the board, it cuts down on blame in the event of failure as well as adding cross-functional insights throughout the investment lifecycle. Formalized policies around this overlap remain uncommon in Asia outside of the global firms, which leverage the strengths of both teams not only in functional expertise but geographic familiarity.  

“The ability to leverage knowledge around the globe on different topics is something that’s becoming more important in operations,” says KKR Capstone’s Claughton.  “We’re seeing a lot more cross-border deals and international expansion, so it’s becoming increasingly critical to have an international network that have local insights, that are highly coordinated and aligned while working with management on the ground anywhere around the world.”

Scope of an operational resources is not necessarily an indicator of performance, however. A number of small firms across Asia have demonstrated an ability to create support ecosystems within their communities through creative use of talent. This approach can be especially effective in underpenetrated markets and frontier economies, where even dedicated outside service providers can be insufficiently specialized.     

“Regional GPs that, unlike ourselves, do not have the luxury of an on-the-ground team are typically going to rely on outside consultants to execute a strategy project,” say Chad Ovel, a partner at Vietnam-focused Mekong Capital. “But those consulting firms are used to working with robust data that gives them the ability to do analytics. That falls short in a place like Vietnam, so the advice becomes very qualitative and theoretical. The problem is most CEOs don’t really know what to do with advice based on theory – they need actionable insights”

Mekong’s in-house resources include six deal leaders who handle only 1-2 deals each and are directly supported on portfolio company work by nine principals and associates. There are also two functional teams comprised of two digital transformation specialists and four talent and culture professionals. The staff can spend upwards of 16 hours a week on site with portfolio companies.

The rest of the operational program is largely based on networking relevant talent with a focus on cost-effectiveness. This includes insisting on the introduction of an independent, non-executive director in portfolio companies. Appointees are typically elder veterans in the targeted sector, hand-picked to help professionalize management without the direct ties to PE that many entrepreneurs find intimidating. Separately, Mekong maintains a “value optimization board” of industry experts that offer high-level advice.

Insource or outsource?

These methods offer examples of workarounds to third-party consulting, which can be prohibitively expensive for small and large GPs alike. Outsourced services range from using global accounting firms for an in-depth sweep of an entire company to calling on solo former executives and niche technical experts as a sounding board for a particular entrepreneur. Focus areas include financial consulting, commercial studies, and management assessments such as psychometric testing. 

“It’s usually not a huge time burden to engage with a third-party expert that might have a particular view. For all our investments, we would bring in some sort of consultancy or market researcher to help, and they stay on for a period of time,” says Bert Kwan, a managing director at Southeast Asian GP Northstar Group. “That said, there’s nothing like one entrepreneur, who’s actually operated through both implementation and strategic challenges, talking to another entrepreneur who’s facing similar challenges in another market. Those introductions can be surprisingly effective.”

Groups like Korea’s Hahn & Company, which specializes in buyouts and restructurings in heavy industrial sectors, use external help for high-level strategy creation around global trends and data analytics but execute practical operational activities through in-house resources. Others such as fellow Korean VIG Partners bring in industry specialists for more detailed marketing plans and customer surveying.

VIG is following this approach with its investment in camera lens manufacturer Samyang Optics, which completed a domestic IPO last year. The PE firm bought a 100% stake in the company four years ago and still holds 60%. Value-add has focused on tightening distribution networks, broadening the product portfolio, and replacing a management team distracted by too many strategies outside of the company’s core business.

“If you don’t have the right core management who are industry experts and who really know how to run the company effectively, you can hire all the consulting firms in the world and you’re not going to get anywhere,” says Jason Shin, a managing partner at VIG. “The consulting firms are only as good as the management teams that are implementing effectively based on the advice they provide.”

This view speaks to the idea that sometimes the best value-add strategy is to leave the companies to themselves. Sensitivity to this point is particularly evident in GPs with operational backgrounds. In these instances, support can be more a matter of knowing fellow corporate executives to cross-reference on specific issues or identifying industry-connected professionals as potential board members for a portfolio company.

“In private equity, we don’t run anything, we own things, but we’ve got to make sure we have the right talent, which is generally a CEO who pick a management team that can deliver on the strategy,” says Carlyle’s Siewert. “By the time a PE firm is putting people from the fund into a company to run it, they’ve already neutered management, and that never works well. Sometimes you have to do that to rescue a bad situation, but it’s not a situation you want to find yourself in on a sustained basis.”

Outside of bringing in new leadership, lighter-touch operational changes tend to concentrate on supplying existing management with the necessary tools for self-improvement and holding the company accountable through regular monitoring. These efforts may involve support with M&A and decisions such as introducing accounting software or other technologies. Important considerations are the opportunity costs that come with committing time and capital to a project that might not pan out.

No firm can claim expertise across all its target segments, but it should at least have immediate access to critical capabilities in its primary markets. Best practice for achieving this adaptability is to diversify the knowhow of an operational team across sectors and geographies as it expands while keeping partners focused on the functional aspects of investments. Supply chains, HR, and branding are among the key recruitment areas.

“You need to get everybody to understand and adopt this idea that you are not just a financial investor. You are an owner and an industrialist,” says Baring’s Salata. “That also informs the people you hire on the investment team. You are going to hire more people that have different kinds of backgrounds – less investment banking and more working in consulting firms or other areas where they’ve had more experience inside companies.”

The effort to make sure these resources are driving specific performance goals has resulted in more operating talent getting involved at the earlier stages of the deal process, where basic hygiene factors around budgets and governance are considered. The idea is not only to flag areas where quick efficiency gains can be realized, but also to incubate cultures based on “kaizen” business practices where internal operational synergies promote continuous self-improvement.

The go-forward agendas formed in this process, often called a 100-day plan, can take up to nine months to execute, especially in the hard-to-penetrate bureaucracies of Asia. For firms in this situation, the US-style model of an operational program, where in-house industry veterans are deployed to drive change, may have to be adjusted to suit local conditions.

“We don’t believe you can do a 100-day plan, bring in outside advisors and change a Chinese company,” says Stuart Schonberger, managing director at Beijing-based CDH Investments. “Our approach is to enable management and give them additional tools. We started imitating the developed markets, but we realized that doesn’t work in China. What works for CDH is real operational heavy lifting, and we think the best way to do that is through corporate partners.”

Cleaning up

Despite some lack of compatibility with traditional operational team building, China could prove to be one of the biggest trendsetters in implementation. Digital technology uptake and environmental, social, and governance (ESG) concerns appear in most operational playbooks and China offers plenty of opportunities in each area.

Indeed, Alvin Lam, a principal focused on operations at CVC Capital Partners, ranks them among the strongest emerging value-add themes. His team, which includes five senior operational professionals in Asia and an additional five globally, has engaged a digital expert and directed its China operations team to help with digital support. It is evaluating whether to hire a dedicated operational team member to focus on digital but is not doing so for ESG.

“ESG is less about getting a dedicated expert and more about being systematic within a portfolio,” says Lam. “We’ve engaged an external ESG consultant to help us, but it’s our operations team’s responsibility to make sure ESG is incorporated into what we’re doing day-to-day. Over the last year and a half, we’ve started to standardize those processes within each portfolio company together with a platform to collect and analyze data.”

ESG will be a particularly important factor in Chinese operational efforts for industries that are inherently prone to pollution such as manufacturing. Regulatory crackdowns are expected to be even more disruptive to local supply chain players than US tariffs since they encompass business areas that do not rely on exports.

“As a value-add operating partner you need to operate within the exiting regulatory framework and in the past China was very relaxed in this area, and people became complacent,” says Kyle Shaw, founder and managing partner at Shaw Kwei & Partners. “In the past couple of years, China has become much more adamant about enforcing those regulations. The rules are more serious and full-bodied, and companies that cannot afford or do not want to spend the money on this will be put out of business.”

Manufacturing, along with a number of other heavy industries, represents riskier value-add propositions because it requires larger capital expenditures to realize meaningful upgrades. There are also a number of unique variables at the factory level, from technical problems to labor costs, which can make it difficult to build up competence or even outsource the appropriate services.

“You can’t value-add in industrials unless you have the domain knowledge because it’s a complicated sales process and it often has to be based on design-wins if you want to scale up,” says Wai San Loke, founder of Novo Tellus Capital Partners, describing a manufacturing industry technique of securing future growth through component customization. “It’s about creating a product roadmap and investing in capability. It can’t just be cost reduction and putting in systems to squeeze working capital and free up some cash flow.”

Novo Tellus has only one operating partner by title, Irwin Lim, but every member of the senior management team has an engineering background, including Loke, and contributes directly to portfolio company operations. Recent successes include Singapore’s MFS Technology, a circuit maker that the firm exited earlier this year as a minority stakeholder alongside Navis Capital Partners.

The complexity of MFS as a business (it produces customized flexible circuits for next-generation industries such as data storage) highlights an important concern in approaching new economy deals. An increasing need for technical specialization has put pressure on investors to evaluate more carefully the plausibility of a proposed value-add plan.

Operational difficulties in these situations stem not only from the niche nature of the businesses but the fact that communication can break down with capable, independent, and in-demand entrepreneurs.

“If it’s a situation that doesn’t require any involvement from the private equity partner nor is it desired by the founder, it probably isn’t the right situation for us,” says Alex Emery, a partner and head of Asia at Permira, which has a team of 10 full-time operating partners globally, including one based in Asia. “We think hard about whether we are the right partner. It affects how you think about how the investment will perform. If there is no meeting of minds with the vendor or management, we aren’t going to do that deal.”  

 

SIDEBAR: Inside story – Operating partner

The day-to-day of an operating partner can range from the tedious to the tumultuous, especially in the less formal and often unpredictable business environments of developing Asia. Success in this role therefore demands not only on a combination of technical and social skills, but also an ability to improvise, adapt, and be diplomatic when needed.

Brian Bunker joined The Riverside Company in 2008 as an operating partner and managing direct for Asia. The US-based firm’s global operating team numbered about 20 at the time and has almost doubled in size during the past 10 years. Bunker is based in Hong Kong, one of two partners in Asia Pacific. Rather than being allocated 2-3 businesses like other full-time players in the team, he works across the Riverside portfolio.

This remit encompasses some 85 companies with potential to do businesses in Asia, about 30 of which are already operating in the region. Travel is a significant part of the job, although Bunker is most often deployed in nearby locales in Greater China. The UK native speaks fluent Mandarin, French, Italian, Nepalese, and Spanish, key tools in the delicate game of establishing trust, especially where family-run businesses dominate the landscape.  

Riverside invests in the small to middle ends of the market, where many companies may not have a proper CFO. In one instance, the firm was exploring a possible investment in a door-and-window company in China. No bid had been made, and only a non-disclosure agreement had been signed for a preliminary visit. When Bunker made the trip, only he and the seller were aware that the early stages of a diligence process were underway.

“I arrive and the whole factory is barricaded by angry people shouting and waving banners. There was a ring of police around the site, so it was difficult to get access, and I asked the police if they were workers who hadn’t been paid,” says Bunker. “They said they were actually suppliers who hadn’t been paid because the company was bankrupt and hadn’t paid anybody for months. That was a really easy due diligence to decide to pass on.”

For Bunker, such experiences hammer home the need for on-site due diligence, if not the realities of a typical pre-deal routine. In many cases, companies are well prepared, and diligence is squared away in about a week. Other inspections can digress into ramshackle discoveries like a “cupboard of financial statements all in Chinese” where extra personnel have to be called in and timelines become exaggerated. This can be especially problematic with companies operating across multiple sites or countries.

Complexities in this vein have to be handled with care given that an operating partner’s presence in a diligence exercise is a matter of some discretion. In addition to making a personal connection with the top leadership of the targeted company, it is important not to alarm the lower-level management and employees. Few things can spoil morale and spark a talent drain in a prospective investment like jitters around a mystery buyout. 

Communication with the staff in these scenarios is mainly the responsibility of the seller, who has to pick the right time to tell employees that the company is up for sale. Bunker highlights how operational partners and their teams have to be nimble enough to manage moments when this matter of protocol and counterparty obligation breaks down. 

“I was deployed with all the accountants, lawyers, and tax experts to a company’s location in Henan province, but the seller, which was a local financial group, hadn’t told the management what was going on,” he says, describing a site visit with one of his previous firms before joining Riverside. “When the management found out they were being sold, they promptly went on strike until they wrangled a loyalty bonus from the selling financial group.”

Bunker joins Riverside’s deal partners dissecting the accounts during the due diligence process but is perhaps more uniquely effective on the factory floor. This is where capacity vulnerabilities can be detected in the minutia of infrastructural decay and where knowing eyes assess supply chain reliability in terms of earthquake zones and power grid connections.

“You’ve got to have both transactors and operational partners when you’re looking at a business to get the whole picture,” he says. “The transactors might pick up financial and legal things that I’ll miss and then say the factory looks fine. But I’ll see things like the watermarks on the walls where there’s been flooding or the fact that expansion plans will be too expensive. That’s why for us, we always have both a transactor and an operator on the board.”

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• Topics
• Greater China
• North Asia
• Southeast Asia
• GPs
• China
• Vietnam
• South Korea
• Singapore
• Asia
• Operating partners
• The Carlyle Group
• Baring Private Equity Asia
• KKR
• Mekong Capital
• Northstar Group
• VIG Partners
• CDH Investments Management
• CVC Capital Partners
• Shaw Kwei & Partners
• Permira Advisers
• The Riverside Company
• Consumer
• manufacturing
• Technology
• ESG