High prices, fierce competition and few opportunities for multiple arbitrage have made the going tough for private equity funds. Never mind buying at a low price and selling high – those days are gone, at least for now. What sets successful private equity managers apart from the pack is an ability to find value where others cannot.
But how? There’s the challenge.
In a new report from PwC Strategy& Germany, my colleagues Olaf Acker, Steve Roberts, Michael Schneider and Elena Naydenova identify the one still largely untapped area that offers opportunities for value creation: Digitization.
Whether a company is fully digitized may well determine if and by how much it can prosper or, for that matter, whether it will even be around for very long. PwC’s 2015 global Digital IQ Survey found that companies in the top quartile of digital sophistication were twice as likely to achieve rapid revenue and profit growth as those with lower scores.
Key for investors is to do their homework, and that begins with recognizing the right questions to ask in six critical areas:
1. Business model, products and services
2. R&D and innovation
3. Purchasing and production
4. Supply chain and logistics
5. Marketing, sales, and customer service
6. Enabling functions (HR, IT, finance)
Investors must exercise prudence – costs need to be measured against potential returns, and the necessary capital should be available – but make no mistake, there are compelling reasons to act: evidence underscores that digital investments often pay off within five years or less, which could potentially make up for cash flow shortfalls early on.
Digitally advanced companies may have a stronger first-mover advantage.
A fully digitized company can then be branded as such, making it more likely that buyers will be willing to pay up – and often at higher multiples. Hard to argue with the idea that it’s far easier and quicker to integrate a digitized firm. Likewise, private equity funds may also be willing to pay higher multiples when exercising buy-and-build strategies.
But what if a company has been slow in hopping aboard the digital train? The savvy investor could also use that to an advantage by weighing several questions: Is the discount to the digital leaders large enough? How much upside can be realized through digitization? Is the gap between the leader and laggard too large to close? If it’s so big, could the target company be valued as distressed? One highly effective strategy might be to find an industry where all the players are digitally challenged, that way a novice firm could quickly go from laggard to leader.
Executing a successful strategy requires experience and specialized skills. Before taking on a search for digital targets, a private equity firm might be wise to take inventory of its own digitization efforts. But with the right strategy, and armed with the answers to the right questions, a firm may avoid potential losses while maximizing the value of its portfolio, as well as its reputation for preparing firms for future success.
For more information, visit our Private Equity homepage>