Creating Value In A Maturing Private Equity Market

As the private equity industry has matured, massive capital inflows and the proliferation of industry professionals has created competition across all segments of the marketplace. As in any industry, over time this competition has diminished both expected and actual returns on capital deployed. The era where astute financial engineering alone is sufficient to generate superior returns is over. Indeed, competition and the quest for outsized returns has forced successful PE firms to become more refined in their investment strategies and more instrumental in driving shareholder value.

As the markets have matured we have adapted and evolved as an organization. Historically, private equity funds, ourselves included, have been comprised of financially oriented professionals. Beginning with MCM II, we recognized the value of developing and leveraging a solid core of operational expertise and formed a Board of Operating Executives. Today, as we continue to evolve, in addition to our Board we have added Operating Partners at the Fund level to improve investment diligence and drive shareholder value during our hold period. Consequently, as we begin to raise our third institutional fund, we believe we are well positioned to execute on our three tenets for a successful investment: “buy right”, “run right”, and “sell right”.

“Buy right” begins with focusing our search efforts in industries with growth rates we believe will exceed GDP during our investment period. Favorable growth rates may result from many reasons such as material substitution (e.g., composite materials and engineered thermoplastics supplanting metals), secular tailwinds (e.g., aerospace or medical device) or cyclical rebounds (e.g., housing or automotive). Buying right also means being a disciplined investor and having a strong understanding of the value drivers which can be brought to bear during the investment horizon. In this context, due diligence of an operating nature (evaluating growth prospects, identifying potential pitfalls, assessing product and process advantages and evaluating the incumbent managerial talent) as well as financial due diligence is key in putting together an achievable business model upon which to base our financial offer.

“Run right” is critical to achieving value creation and encompasses the core responsibility of MCM’s Operating Partners. Our attraction to the Microcap market is predicated on the advantages smaller companies have over their larger brethren including the ability to be more agile, effect change easier and require less investment to grow. However, they generally possess disadvantages as well, such as limited organizational “bench strength”, customer and vendor concentration, and relatively narrow product lines. Our focus in creating shareholder value is to optimize the former while mitigating the latter. Post-acquisition, we expect the company to go through three stages: initial positioning, performance management, and upside identification. During the first stage, an MCM Operating Partner will typically work closely with the new management team (occasionally as the CEO) in developing an appropriate organization and operational strategy aimed at achieving long term sales & profitability targets. While making budget is important in this phase, maximizing profitability is not. That comes in stage two – performance management, where we expect the company to deliver on its promise. Stage three, upside identification, is the operating lead-in to “sell right”. This stage involves putting together a creditable “blue sky” scenario through the development of new product, process, or customer initiatives for a future buyer to act upon.

“Sell right” is the last and most obvious tenet of MCM’s approach. Building upon tenet two, creating an enterprise with bench strength, solid growth prospects and sustainable profit margins are key drivers in creating intrinsic value. Just as the competition in private equity has forced more industry specialization amongst PE shops, selecting a sell side advisor with deep sector knowledge has become more important to achieving outsized returns and multiple arbitrage. Moreover, exiting in an environment characterized by liquidity and an upward trend in the business cycle is likely to produce more favorable outcomes.

As the industry has matured and become more competitive, MCM has responded by strengthening its operating expertise and sector knowledge and applying that expertise to the Microcap market place. Moving forward, we believe by remaining consistent in our traditional focus of investing in smaller niche manufacturing and distribution related business our expertise combined with the knowledge of our Operating Partners will continue to allow us to generate superior risk adjusted returns.


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