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The inexpensive capital availability era is over. For a decade now, private equity (PE) firms have enjoyed the tailwinds of ultra-low interest rates. In such an environment, multiple expansions and financial engineering easily hid the underlying operational weakness. However, today’s macroeconomic context has rendered such a playbook entirely ineffective.
With capital costs on the rise in this high-rate world, General Partners (GPs) are under greater pressure to stimulate real, organic growth. To do so, the spotlight is shifting back to operational value creation. Still, that requires truly innovative, efficient data ecosystems. This post will thus discuss PE value creation and smarter portfolio monitoring.
The Paradigm Shift: From Financial Engineering to Operating Excellence
The rules of engagement have undoubtedly altered. BCG’s Global Private Equity Report 2023 also finds that when market multiples expand, about 40% of the value created in a successful deal is captured by that multiple expansion. By contrast, more than 50% of value creation now comes from margin expansion and revenue growth. So the dealmaker cannot raise debt on an expensive portfolio company (PortCo) and hold it out for a rising tide of multiples.
As a result, GPs need to find out where the operation bottlenecks are. Thus, they must start pulling on growth levers right after purchase. Yet, the internal teams are commonly too busy to coordinate deal origination and aggressive operational oversight.
Hence, to navigate this structural constraint, many funds leverage private equity outsourcing for their back-office and middle-office functions.
Delegating the transactional accounting and data-loading activities to outside specialists allows deal teams to spend their hours on strategic, value-add interventions. In other words, they can be working directly with management.
What Smarter Portfolio Monitoring Actually Looks Like
Conventional portfolio monitoring focused on hard, fixed values using the reports contained in spreadsheet templates, the most familiar being Excel. However, in the days when portfolio managers needed to translate this data in order to formulate a strategy, it was already history. That has undergone changes.
The Rise of Tech-Enabled Transparency
Modern industry participants instead leverage sophisticated enterprise software to aggregate data ingestion. For instance, products such as S&P Global’s iLevel, Chronograph, and Cobalt take unstructured PortCo data into dynamic, board-ready dashboards.
Top-of-mind discussion amongst industry leaders is that proprietary data equates to the new alpha. Another hot subtopic in PE tech trends at the moment is predictive analytics. That involves using machine learning algorithms to predict cash flow crunches or churn well before they make an impact on the bottom line.
Broadening the Metrics: ESG & Cyber Security Risk
Financial KPIs are not enough anymore. Institutional investors and limited partners are demanding robust measurement of Environmental, Social, and Governance (ESG) metrics, in addition to enterprise cybersecurity enhancements.
Smarter monitoring systems will thus alert you about carbon footprint abnormalities, software patch compliance issues, or other anomalies across the entire portfolio of assets. Tracking these non-traditional metrics also helps avoid hidden downside risks that could pierce a future exit valuation.
Industry Specific Value Creation in Action
In what ways does this enhanced PE PortCo monitoring enable real-world value creation? Here is a look at specific industry use cases that show the benefit of visibility to granular data.
Healthcare: Standardizing Fragmented Roll-Ups
Imagine a middle-market PE company rolling up dental or veterinary clinics. It thus acquires dozens of small owner-operated clinics, each on legacy practice management platforms. An intelligent monitoring system pulls multiple data sources into one source of truth, enabling decision-makers to compare information such as:
- Patient acquisition costs
- Staff utilization
- EBITDA margin
All that occurs on the fly between practices. Operating partners can, therefore, immediately identify that Clinic A has some great practices in place to keep costs under control. If Clinic B has excessive overhead, it should immediately switch practices to improve the whole medium.
Manufacturing: Optimizing Supply Chain Resilience
Industrial and manufacturing businesses are still struggling with high borrowing costs. So, connecting a PortCo’s ERPs to the GP’s general monitoring platform enables analysts to monitor inventory turns, supplier lead times, and flow velocity in real time.
When a major offshore supplier enters a period of rising delays, the system flashes an alert to the PortCo executive team. The PE operating partner is also included here. That is why they can actively de-risk their supply chain and safeguard revenue, ensuring existing cash flow is sustained.
Scaling Capabilities Through Specialized Support
Still, technology is not enough to erase the data-specific challenges, even in a world where complicated software packages are more readily available. Each new company also introduces its unique mix of legacy data, idiosyncratic accounting codes, and reporting cadences. Extracting, mapping, and normalizing all of that information thus takes tremendous and sustained human labor.
In response, rather than employing armies of internal analysts to manipulate their complex data formatting, many of the leading funds are turning to external specialists in data management.
By engaging private equity portfolio monitoring services, firms ensure their data infrastructure is built, maintained, and optimized by dedicated specialists.
This alliance, hence, connects unstructured PortCo data to the strategic leadership needed by management. Tenequity, for instance, has developed a solution to utilize the software without exhausting GP resources.
Conclusion: Data is the New Deal Maker
To prosper in a high-rate environment, GPs must display robust operational agility, complete transparency, and impeccable execution. No amount of financial engineering will now salvage an average deal.
Today, sustainable value creation hinges on the speed and precision with which GPs identify, analyze, and manage PortCo performance. With the right tools, data analytics, and operational expertise, private equity firms must thus protect their investments. They must more thoughtfully grow their portfolios and deliver the returns investors demand.
