Could transformation trump transaction in today’s Private Equity markets?

Private Equity (PE) firms continue to seek effective strategies to boost the value of their portfolio companies – an approach that is becoming increasingly critical in navigating today's unpredictable market cycles. 

PE has historically focused on carving out and divesting non-core assets to streamline operations and focus on areas that provide a competitive advantage. 

The concept of leveraging transformation to facilitate transactions suggests a different route, however. By transforming non-core assets, these assets can become significantly more attractive – or boost the overall value of the portfolio company – before moving to an exit or sale. 

Here, we explore how PE firms can leverage a growing trend for transformation and assess when it should be prioritised over a more direct route to traditional transactions strategies.

Typical transformation scenarios

PE firms and portfolio companies must identify when to prioritise transformation efforts and a number of options will likely be explored:

• Integration of non-core assets/businesses: Integration can unlock synergies that result in cost savings and revenue enhancements.
   
• Refocusing operating models and strategies: Aligning the operating model and strategy with market demands can ensure a business remains relevant in highly competitive environments. 
   
• Operational efficiency improvements: Streamlining operations to reduce costs can aid margin management, particularly in a period of elevated input costs.  
   
• Digital transformation: Leveraging technology to improve business processes, the customer experience, and data management is critical. 

Why take on transformation instead of moving directly to transaction?

Successful transformations should lead to measurable increases in short-term cash flow, often realised through synergies or cost reductions. An effective transformation should also prepare an entity for scalable growth and increased market share, achieved by improving operational efficiency to reduce costs and enable faster expansion. 

Should the natural deal lifecycle still point towards exit or sale, the additional lustre applied by transformation efforts will increase the likelihood of a premium valuation. 

The business transformation challenges ahead… and how to overcome them.

Despite its huge potential, transformation comes with its own set of obstacles to overcome.

Multiple or extensive transformation projects can lead to change fatigue among employees, meaning it's crucial to clearly communicate the benefits of this activity – and frequently update on progress. Without transparency and a clear line of sight regarding rationale and outcomes, uncertainty can set in, leading top talent to become disillusioned and seek opportunities elsewhere.

As with divestments, transformations can be costly, too, if not executed efficiently. Cost overruns are common when there is limited support, misalignment amongst senior portco executives, PE owners – or both, or when project scope is not clearly defined.

In our experience, we see four key considerations that will help PE and portfolio leadership teams successfully achieve their transformation goals:

1. Clear communication plans: As mentioned earlier, effective communication is vital for managing employee and stakeholder expectations. Develop clear, consistent messaging about the transformation's objectives, benefits, and timelines. Regular updates will go a long way to maintain transparency, trust, and collective engagement in the process.
    
2. Executive sponsorship: Strong support from senior executives and PE owners secures the necessary resources and oversight are always available. Executive sponsorship can also help in removing obstacles and ensuring timely decision-making, which will be critical to any transformation’s success.
    
3. Stringent cost management: Robust cost management practices and regular reviews must be implemented to keep activity on budget and on schedule. Deviations from the plan – which are understandable in longer, more complex projects – should be identified and actioned quickly and decisively to maintain momentum. 
    
4. Retention programmes: Developing and implementing retention programs will safeguard from the loss of key talent during the transformation process. This may include offering financial incentives, career development opportunities, or doubling down on the development of a more inclusive culture that demonstrates the value it places on employee contributions.

The PE landscape remains challenging today, and firms must look beyond traditional transactions to unlock value in their portfolio companies. Backed by the right business case, prioritising the transformation of non-core assets can better prepare these assets for sale, enhance overall portfolio value, and gain a competitive edge in the market. 

Successful transformations will require rigorously managed communications plans, executive alignment, stringent cost management, and careful monitoring of employee flight risks but, if navigated successfully, PE firms can lock in the financial and operational rewards on offer to catalyse a prosperous business future – or maximum value when the time for a transaction arrives.

In our upcoming article, we will explore how PE firms can maximise portco valuation when exit approaches.