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Sound decision-making creates enduring value

PUBLISHED : Monday, 19 October, 2015, 5:26pm
UPDATED : Wednesday, 23 March, 2016, 5:09pm

Good investments result from sound decision-making, and good businesses are built with a commitment to operational excellence. Pre-eminent private equity firm Clayton, Dubilier & Rice (CD&R) has firmly established these principles in practice with its success across boom-and-bust cycles. 

Since 1978, when its founders emphasised responsible ownership of portfolio companies, CD&R has created a culture that drives private equity's enduring contribution in the business world. What was a novel idea 37 years ago is today increasingly recognised as one of the industry's best practices: operational improvement is the basis for growth in performance and productivity that drive sustainable investment returns. 

"We have an unusual kind of business because we are as much focused on what happens at the end of our ownership period as we are on the first day," says Nate Sleeper, partner and management committee member. "We have investors that are looking for high returns, so we need to identify good investments that fit our strike zone, accelerate the initiatives to improve a business post-acquisition, and, as transitional owners, be ready to exit when conditions are right." 

Since its inception, CD&R has maintained a craft-based investment approach, meaning that it carefully selects a limited number of new investments each year which can benefit from the firm's combined operational and financial expertise. The firm focuses on mid-sized market leaders whose profit performance can be across a range of industries, including consumer, business services, health care and industrial sectors. Its sourcing is a multi-year process that typically culminates in three or four investments per year in the most promising companies from hundreds of possibilities. 

Financial partners take the lead in conducting due diligence, structuring and financing new acquisitions and managing exit processes. Meanwhile, operating partners make sure that the strategy, operating priorities, budgeting, capital allocation and talent development are all in order in the portfolio companies. 

"I often describe CD&R a little like Noah's Ark - everything is two by two," says David Wasserman, partner and management committee member. "Every decision we make is two by two. Every time we think about a business, an executive we want to hire, a strategy or an operating plan, we get the perspective of both a financial and operating partner. They tend to be different, and it tends to be very valuable." 

To execute CD&R's business plan for a portfolio company, the operating partner builds up its management team. The end goal is sustained success, the condition that makes each company ripe for an exit. Every 12 to 18 months, CD&R adds battle-tested managers with decades-long industry experience to its team of operating partners. This buoys the firm's deep operational capabilities. 

"Many times, we are the preferred buyer in our investments because the owner is not comfortable selling to a competitor; sometimes strategic players shy away from undertaking the challenging transformations that are often required," says Rick Schnall, partner and management committee member. 

Absolute performance and consistency

In Europe, the firm staged one of the biggest London listings last year with B&M European Value Retail. 

The initial public offering (IPO) of B&M, Britain's leading discount store chain, yielded US$883 million. CD&R had acquired a 60 per cent stake in B&M from the Arora family in 2013 and brought in Terry Leahy, a CD&R senior adviser and former CEO of Tesco, and Vindi Banga, a CD&R partner and former senior Unilever veteran, to work closely with B&M's management team, with Leahy serving as chairman of the company. Their combined management expertise supported the remarkable growth at B&M, led by the entrepreneurial passions of the Arora brothers. A rapid expansion of the store network in Britain and B&M's internationalisation preceded the landmark IPO in June last year with a market capitalisation of GBP2.7 billion (HK$31.7 billion). As of March this year, the company's earnings had grown 66 per cent under CD&R ownership. 

The outcome also signals Europe's recovery from the global financial crisis. "The past five years have been a very difficult private equity market as a result of the crisis," says David Novak, CD&R partner and management committee member. "What changed in Europe around the time of the IPO was that public market investors felt like they had more visibility and confidence that extreme volatility, which had prevailed since the financial crisis, was much less likely to reappear." 

The recovery in the United States and selected European markets should translate into more merger and acquisition activity generally, particularly corporate strategic purchases. Periods when large companies sweep up assets to turbo-charge their growth are often followed by an uptick in corporate divestitures, a fertile ground for CD&R. 

Realising enterprise value

Since its inception, the firm has managed investments in 65 businesses with an aggregate transaction value of more than US$100 billion. The firm's most recent fully invested fund, the US$5 billion Fund VIII, began investing in 2009. According to industry data provider Preqin, Fund VIII was generating a 27 per cent net internal rate of return as of June this year. Approximately half of the investments made by Fund VIII were made in partnership with the sellers of the businesses.

"We have proposed partnerships where we offered the seller a compelling combination of cash upfront, but also the ability to participate in the equity going forward," Sleeper says. "They often choose us because they are convinced that we can actually create the value that they see in the business."

Hussmann, a Missouri-based global manufacturer of refrigerated display merchandising equipment and refrigeration systems for the retail food industry, is an example. It had become a noncore division of Ingersoll Rand (IR), prompting an auction wherein higher bidders initially prevailed, but eventually fell away due to complexities in the divestment. 

In September 2011, CD&R acquired operational control of Hussmann with IR retaining a minority stake. Through value-building initiatives in distribution, manufacturing and services and the introduction of innovative technologies, it recaptured market share. Sales have improved since 2011, with the company gaining new regional accounts in the US and key international partners. 

"The great thing about evaluating risk is that by definition it incorporates all perspectives," says Sleeper, who led the Hussmann investment and serves on the company's board of directors. "We have to think about the overall environment, how the company will operate in that environment, what the potential is to change and how the company is positioned." 

Finding great opportunities

CD&R is investing its ninth institutional fund, a US$6-billion vehicle created in 2013, which remains focused on distinctive businesses across the consumer/retail, health care, services and industrial sectors. Over the next five years, the firm expects to continue to see attractive health care investment opportunities, driven by structural upheaval across the sector and a need to improve system efficiencies. 

"We spend an enormous amount of time on health and wellness because we're big believers that reducing costs in our health care system is about keeping people healthier for longer," says Schnall, the CD&R partner who led the firm's investment in Envision Healthcare, among other businesses in health care services. 

A leading provider of physician-led, outsourced medical services, Envision is well-entrenched in the integrated services and community-based medical transport services segments of the US health care market. Though strategically positioned to improve clinical outcomes in elderly care, it was stymied by market fragmentation. 

Acquired by CD&R in May 2011, Envision expanded integrated services, drove revenue growth with new acquisitions and operational improvements, and launched a comprehensive management platform for post-acute care. 

"Simply put, our job is to find inefficiencies, whether that be through our network or through relationships we have with the management team, a seller or a bank," Schnall says. "The challenge in our business is finding the great opportunities, the ones that are different as spelled out by their risk and return numbers."

Envision successfully completed an IPO in 2013 and a series of subsequent secondary offerings and block trades that allowed Fund VIII to fully realise its investment by March this year. Under CD&R's ownership, the company expanded earnings by 68 per cent. 

Asian prospects

Asian investors have become increasingly aware of CD&R's ability to take businesses to their next stage of development. Today, approximately a quarter of the firm's aggregate capital commitments come from Asia-Pacific investors, a clientele that accounted for around 1 per cent 15 years ago. 

CD&R believes that investors in the region will be important long-term strategic partners. Indeed, several large Asian investing organisations have partnered with CD&R over the past five years to invest in businesses in Europe and North America, including Envision, B&M and SPIE, Europe's leading multi-technical services business. The firm believes that Asia-based companies, as they aspire to acquire US and European businesses and become global powerhouses, may also look for opportunities to partner with CD&R in the future.

"CD&R's operational capabilities and reputation as a trusted counterparty make the firm well-suited for partnerships with Asian companies looking to make strategic investments in North America and Europe," Wasserman says. 

The firm's differentiated investment strategy is built around five pillars: tight integration of investment and operating skills at every stage in the investment process; disciplined, consistent and clearly defined transaction parameters; active industrial approach to post-acquisition ownership; careful crafting of capital structures; and maximising exit opportunities. 

The Harvard Business Review once applauded CD&R for providing important "insights into what constitutes best practice in the ownership and governance of corporate enterprises". 

This high standard, which has rewarded multinational companies, family businesses and public shareholders in North America and Europe, is one which Asian investors and companies will likely take into account as they assess the global private equity landscape. 


Clayton, Dubilier & Rice: