Private Equity and Digitization: The hidden equity story

22 August, 2016

Andrew Cristinzio
Partner, PwC US

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 AckerSteve RobertsMichael 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

  • Does the company have a digital strategy and model?
  • Does it have a digital organization including a chief digital officer or equivalent?
  • Which products and services are threatened by digital disruption, and which are less at risk?
  • How will digital trends affect the overall business model? Can it develop new products, services and ecosystems?

2. R&D and innovation

  • How innovative is the company?
  • Is it using digital prototypes? 3D printed prototypes and simulations to create new products?
  • Are products and services co-created with customers, suppliers and partners?
  • How effectively is the company using data and analytics?

3. Purchasing and production

  • How automated are tenders and the evaluation of suppliers?
  • How integrated are production processes throughout the company?
  • Which digital technologies are supporting these processes, and what gaps still exist between the current operations and the systems needed to provide value?
  • How flexible is production?
  • How extensively has data analytics been incorporated into sourcing and operations management?

4. Supply chain and logistics

  • How well integrated are the company’s suppliers, customers, and logistics providers?
  • Does the company have end-to-end logistics visibility?
  • Does the company use smart warehousing?
  • With what level of inventory (vendor products, intermediate products, and final products) is the company operating?

5. Marketing, sales, and customer service

  • What marketing channels is the company using?
  • What percentage of the marketing budget goes to each channel?
  • How integrated is marketing?
  • What digital sales channels are offered?
  • What percentage of customer interaction goes through digital channels? Which of these channels are also used to manage customer relationships?
  • What data is gathered, and how is it used?

6. Enabling functions (HR, IT, finance)

  • Is there sufficient talent to take advantage of digital trends?
  • How easily can the company meet new staffing needs?
  • Does the company hold training sessions to cultivate digital skills?
  • How is knowledge sharing and collaboration managed throughout the company?
  • How digital is the overall culture?
  • Does the chief information officer have a leadership role in the company’s digitization strategy?
  • How well is IT supporting business functions and processes?
  • To what extent are data and applications in the cloud?
  • How well is the finance department integrated with other business functions?
  • Does the chief financial officer play a leading role in determining the organization’s digital strategy?
  • Has the finance department improved its own efficiency through digitization?

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.

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