A recent article in The Economist about the private equity (PE) industry brought to light the one unique outfit in this dismally uncreative field: Clayton, Dubilier & Rice.
The PE industry playbook calls for leveraged buy-outs, piling debt on companies’ balance sheets and ruthlessly cutting costs to ensure the piled-on debt is serviced first and foremost. Operations, the debt-paying machine, come next; then, just milk every cent of remaining value. It’s not a going concern; it’s a paying concern, and once the payments are done the concern should be sold off, hopefully at a profit. The problem is that quite often milking the companies for quick payback results in their operations falling apart. As The Economist says, “Operational improvements in a portfolio company [of a private equity firm] has often meant little more than promising colossal bonuses to sitting chief executives if they meet ambitious growth targets.” The carcasses of companies brought to their knees by PE decay all over the globe.
In such an industry Clayton, Dubilier & Rice is indeed a standout. CD&R actually improves the operations of the companies in its portfolio. It revitalizes companies. According to industry experts, margins at CD&R’s portfolio companies are double their industry standards; that is, their companies compete better than those under other PEs’ care. So while other PEs compete by buying and selling portfolio companies based on ambitious goals driven by ambitious CEOs, which sometime works and often does not, CD&R competes by actually making their companies more competitive. While other PEs use the venerable venture-capital model of “you hit a few jackpots and that covers the many that fail”, CD&R tries to win every time.
CD&R’s ability to compete in the PE industry comes from using heavyweight former Fortune 500 executives actively to oversee the operations of the portfolio companies, and, if needed, become CEOs again. Success stories include Lexmark, Kinko, Hertz, David’s Bridal, Sally Beauty, US Foods, and others. CD&R enjoys good returns on the companies they sell, ranging from 20-40%.
Most PE companies also install heavyweight former executives on their payroll. These are hired guns. What distinguish CD&R is that their heavyweights get one-third to one-half of the profit from the total portfolio; they are partners, not firearms. Moreover, while PE firms’ star power and control is with the financiers, CD&R shares the power with the operational guys.
Other distinct activities supporting a strategy of focusing on operational improvements: CD&R does not raise funds in the stock market. It raises only the amount it thinks it can invest profitably in companies. It turns down funds it cannot use. It has only 17 companies in its portfolio so it can give each the operational attention it needs. It focuses on US and Europe, where corporate fat and mismanagement are relatively easy to fix. Its management assumptions are refreshingly consistent with its activities: as its chairman stated, the financial “wizardry” in PE deals is not that complicated. “You don’t have to be amazingly adept at financial matters.”
Contrast CD&R’s strategy with those of Hollywood talent agencies. In a recent announcement, a celebrated marketing agency, Droga5, sold 49% of its equity to a celebrated talent agency, William Morris Endeavor. WME is buying into Drago5 because WME is worried about its rival, CAA, another iconic talent agency which is making noise in marketing brands with its stable of celebrities and which has created its own marketing agency.
So, WME and CAA are in a classic me-too race. You can bet whatever one does, the other will so imaginatively follow. Instead of distinguishing themselves they go for competitive convergence; they don’t play to succeed, they play not to be at a disadvantage. They don’t intend to converge, but that’s what they are accomplishing. The result is that success becomes dependent on the relationships each agency can forge and maintain, and that’s not a distinct focus.
Now here is a farfetched idea: is it possible WME and CAA are so unimaginative because they are owned partly by unimaginative PE companies? CAA is owned in part by TPG. Droga5 has been owned in part by Henry Silverman of Apollo Global Management. WME is backed by Silver Lake Partners. TPG, AGM, SLP: all PE.
Looking from outside, these copycat steps questing after “economies of scope” or scale or elusive synergies represent nothing more than the unimaginative use of capital by PR financial wizards.
If CD&R waded into this territory (which I assume they are too smart to do), what would they do? Just imagine Jack Welch (who, incidentally, works with CD&R) storming Sterling Cooper Draper Pryce Cutler Gleason and Chough, or as they came to be known on the “Mad Men” TV drama, Sterling Cooper & Partners. It took them eternity to just improve that name…