Q&A with PitchBook: U.S. private equity Q2 2021 trends

 This Q&A originally appeared in PitchBook's Q2 2021 US PE Breakdown. 

Sean Adkins delivers value for private equity clients across a wide range of investment by working at the intersection of technology and operations. He believes in challenging common thinking patterns with new ideas that are grounded in data-driven decision making.

Brian Jacobsen leads the firm’s co-investment arm, West Monroe Capital, which aligns our interests with private equity clients by investing in select businesses where West Monroe will be able to drive value post-investment. He is a former partner of several private equity firms and a long-time West Monroe client.

What are the most underrated origins of alpha/value creation for PE fund managers in the current environment? 

Sean: Everyone talks about using data, but it is usually in the context of operations and running the business better. I think many fund managers are missing an opportunity to use their data to optimize revenue from an existing platform by identifying cross-selling and upselling opportunities. Add-on acquisitions have become an increasingly common value-creation strategy. But I would challenge investors to consider this question: If you weren’t able to make another acquisition, how could you use data to optimize revenue? The data is there, as are the capabilities for analyzing it. 

Brian: Another is the discipline with which investors combine businesses when executing on an acquisition- led growth strategy. Investors are consistent with respect to the intent to integrate businesses to achieve that goal. But there is still a lot of inconsistency in execution and, surprisingly, a lot of value left uncaptured from these add-on acquisitions.

How do those drivers vary across sectors, and which ones are best primed in the current environment, given broader macroeconomic and market factors? 

Sean: I think the biggest variance depends not so much on the sector but on the underlying complexity of the business. Companies—typically in the consumer products, manufacturing, and retail sectors—that have large numbers of customers and/or stock keeping units or offering types are probably under-optimized with respect to revenue growth potential. Thus, they have the biggest untapped opportunity to benefit from data. 

Brian: One area that I see as particularly well-primed to use data to grow revenue is around the convergence of retail and healthcare. Whether that is with the application of retail principles to healthcare or vice versa, it is about doing more with the same consumer. Looking at the healthcare consumer as a “customer” is a new concept for many providers. Technology and data are game changers. Think about how you could use customer information to understand and predict the market (with consideration for regulatory requirements, of course)—not just selling, but focusing on health.

Given the overall levels of competition, what are the best practices for balancing between speed in closing and due diligence? How do priorities stack up today? 

Brian: The speed at which today’s market is moving requires investors to set priorities for the diligence process and determine what makes a go/no-go decision, or when something may cause them to want to pay a materially different price. Of course, you want to avoid the catastrophic risks: “I won’t buy if these certain things don’t check out.” But below that is a second tier of risks, the potential impact of which can be estimated, ring- fenced, and dealt with post-closing.

Sean: Back to the topic of data, another important practice is to go into the process armed with data- modeling capabilities, whether your own or a partner’s tools, that you can deploy quickly. For example, what if you had the ability to ingest transaction data quickly and predict future demand or the strength and potential of specific customer segments? That capability is out there. Brian: A third good practice is simply thorough preparation and doing your work ahead of time — understanding the industry and players before diving into a process that you know is going to move quickly. In other words, know the pond in which you are fishing so you are not navigating in the dark. Have your market diligence done and your thesis on the sector complete, or at least well-advanced.

What are the biggest challenges in post-merger integration for PE buyers today? 

Sean: Systems and people. It sounds simple, but it often comes down to that. Particularly in situations where you are integrating multiple companies, not just two, you need to get them all on a single sheet of music. That is not easy or inexpensive. Sometimes, we see investors choose to defer integration because of the complexity. If you have 20-year-old systems, you will need to fix that, but sometimes the integration work is left as upside for the next owner.

Brian: I agree on people. The biggest challenge I see is the buy-in of senior people and leaders when a PE firm is leading the charge on add-on acquisitions. Say a CEO or a couple of division heads don’t fully believe in doing what it takes to put the businesses together. If you don’t have leadership support around the “why,” then the “how” becomes much more difficult.

Sean: Systems should be downstream from that. Some integration efforts start with implementing a common enterprise resource planning system but struggle because the support at the top isn’t there. 

Brian: In situations where the investors and executives are completely on-board with integration and spend the time and money to make sure the businesses are truly integrated, amazing results can happen. It can be really powerful.

How do those challenges vary across target company size, as well as by type of transaction—for example, carveouts versus add-ons? 

Sean: The challenges of people, culture, and processes are the same, regardless of size. Size, though, may determine the resources available to focus on integration. Smaller companies tend to be very lean. It is hard to run the business and focus on the integration. On the other end of the spectrum, with bigger deals, people tend to be more locked into established ways of working. It can be like trying to change the course of the Titanic. 

Brian: We do see some differences when it comes to types of transactions. Carveouts generally don’t have competing priorities. So, in that sense, they are relatively straightforward, provided you are working with advisors who have done it before and understand where the pitfalls lie and how to get around them. 

Similarly, small tuck-ins are about adding on to an established platform. The challenges there are usually lack of resources or of a playbook for how to onboard and integrate a smaller acquisition. If you are attempting multiple add-ons, then the complexity goes up, and it becomes critical to have a well-conceived process in place for moving them onto the go-forward platform. 

Mergers of equals tends to be the most challenging because you have to define the go-forward team and platform. That’s where you are most likely to run into the challenges of buy-in and culture.

What are PE fund managers not talking about that they should be considering? 

Sean: We can’t really say firms are not talking about technology, because they have been for years. The issue is that, in many cases, they’re just talking about it—many still do not have a technology strategy across the portfolio. 

Every PE firm needs to understand technology and how to apply it to optimize investments. Investors have been able to get away with not having a technology strategy and expertise, but five years from now, that will not be the case. 

Brian: From a market perspective, it looks like today’s high volume will continue at least for the next couple of quarters, but we don’t know what comes after that, especially given the rumblings about tax law changes. 

Investors will need to think more critically about how they can make the business better in a way that another buyer cannot. You need to have a point of view about why you are the best owner for this business versus another firm. 

Sean: The investors who are most successful stay within their area(s) of expertise. They know the industry and have the right executives to deliver on the thesis. It is more critical than ever to ask the question: Are we the right firm to buy this company? Finding new ways to assess revenue optimization and improve performance during the hold period is imperative, not just for PE firms but for the partners that provide them with services.