Francesco Castellaneta Ph.D. Candidate Bocconi University

1. value creation levers in private equity: the impact of pre-acquisition and post-acquisition competences on performance Francesco Castellaneta Ph.D. Candidate Bocconi University

2. Evolutionary theory: research questions How do firms change? CHANGE How do firms develop an ability to adapt to external changes? LEARNING How is it that firms are generally heterogeneous in the ways they accomplish functionally similar tasks? ADAPTATION

3. Evolutionary theory assumptions

4. Dimensions of change WHAT? HOW? WHY? ASPIRATIONS INTENTIONALITY ROUTINES HEURISTICS & STRATEGIES CONSCIOUSNESS MOTIVATION STRUCTURE CULTURE

5. Organizations evolution: the combination of different factors

6. Acquisition Research in Strategy • Same research questions • Do some firms perform consistently better on acquisitions than others? • Why is this the case? • What should a specific firm do to increase its acquisition performance? • General perception that… • …acquirers (bidders) lose value in acquisitions and that the targets capture most of the value created

7. The impact of experience on performance Effect No effect HP.: The more acquisitions you do the better you should get at acquisitions

8. Recent theory: the acquisition competence

9. Type of competences in the M&A

10. Pre-acquisition versus post-acquisition competence: the impact on acquisition performance Pre-acquisition competence + Acquisition Performance + + Post-acquisition competence

11. Buy-and-build in Private Equity Private Equity Fund Portfolio Company 1 Portfolio Company 2 Portfolio Company 3 Add-on 1 Add-on 2 Add-on 1 Add-on 2 Add-on 3 Restructuring: company without add-ons Buy-and-Build: company with more than one add-on

12. The model Number of add-ons Acquisition Performance + (Hp.1) Timing of add-ons (Hp. 2: +/-) Holding period (Hp. 3: +/-) Number of co-investors (Hp. 4: +/-) A comparison between pre-acquisition competence vs. post-acquisition competence

13. Private Equity as an empirical context • Pros • Cleaned environment • simple • pure • measurability (IRR and money multiples per transaction) that is much more difficult in M&A • Different levels of analyses (fund, companies, individuals) • Cons • Less known in the strategy field • Difficulty in collecting data

14. Data (1) • The information contained in the PPEs are: • detailed “Track Record” of the PE Fund and of the PE team • “investment strategy” for the future Dynamic View • Information collected by the PE fund: • legal and economic issues (ex. Terms and conditions, market and competition) • allocation considerations • supplement analysis (ex. Case studies, interviews, reference calls) • Detailed analyses about each deals: • financial data (ex. • strategic choices (ex. Alliances, acquisitions, top management replacement) • analysis of the market and competition

15. Data (2)

16. Is value creation strategywhat really matters in acquisitions (1)? • “The team’s strong investment track record has in large part been driven by consistent use of a hand-ons value creation approach (organic growth and strategic acquisitions)”. • “Most of the value created was achieved by the team through growing the portfolio companies and improving their profitability. Multiple arbitrage and leverage accounted only for a small share of total value creation”.

17. Is value creation strategywhat really matters in acquisition (2)? • “…private equity is an art that requires a great deal of creativity, initiative and intuition. The weight of the three main sources of value (leverage, multiple arbitrages and the operational value creation) has changed. In contrast to the past, when most value was created through leverage, now most of the value is generated through the gaining of operational efficiencies, accounting for more than 50% of the total value created. The reason: today’s market is much more competitive. The private equity business model now has to be more involved in the operation of a company’s strategy” (Neumann International).

18. Private Equity as an empirical context: definitions

19. Definition of Holding period Entry: the fund buys the company Exit: the fund sells the company Holding Period: the length of time an investment remains in a portfolio of a Private Equity fund (ex: 4 years)

20. The model Number of add-ons Acquisition Performance + (Hp.1) Timing of add-ons (Hp. 2: +/-) Holding period (Hp. 3: +/-) Number of co-investors (Hp. 4: +/-) A comparison between pre-acquisition competence vs. post-acquisition competence

21. Measures

22. Synergies between the portfolio company and the add-ons Hp. 1: The higher the number of add-ons, the higher the acquisition performance.

23. Timing of add-ons: a test for pre-acquisition and post-acquisition competences Add-ons contiguity to the exit = Time (of the add-on) to exit / Holding period

24. Timing of the add-ons First case: Post-acquisition competence > Pre-acquisition competence Exit: the fund sells the company Exit: the fund sells the company Entry: the fund buys the company Entry: the fund buys the company Add-on 1 Add-on 1 Add-on 2 Add-on 2 1998 2002 Second case: Pre-acquisition competence > Post-acquisition competence 1998 2002

25. Holding period: a test for pre-acquisition and post-acquisition competences

26. Holding period First case: Post-acquisition competence > Pre-acquisition competence Exit: the fund sells the company Exit: the fund sells the company Entry: the fund buys the company Entry: the fund buys the company Add-on 1 Add-on 1 Add-on 2 Add-on 2 1998 2002 Second case: Pre-acquisition competence > Post-acquisition competence 1998 2000

27. Different Private Equity funds in Buy-and-build strategy: an example Asian Fund International Fund European Fund Private Equity Fund 1 Private Equity Fund 2 Private Equity Fund 3 60% 25% 15% Company 1 Add-on 1 Add-on 2 Add-on 3 Ownership of the company Competence in the acquisition process

28. Different co-investors: a test for pre-acquisition and post-acquisition competences

29. A summary of the findings To be tested

30. Smit and Maeseneire (2005) • The competitive landscape for private equity investors has changed over the last years as they encounter heavier competition, further driving their returns downwards. In addition, a large part of their once unique resources, such as their creative financial engineering skills and their privileged access to deals, have become commodities. Over time, the traditional idiosyncratic capabilities and sources of value creation have lost their uniqueness. It has become increasingly difficult to appropriate value with a traditional buyout. Only when rival private investors are unable to duplicate the value creation that derives from non-imitable assets or skills controlled by the buyout firm, bidding away the full value creation can be avoided. Examples of such idiosyncratic assets or capabilities include the private investor’s organisation, culture, image and reputation, the firm’s unique history, its experience in deal making and managing portfolio companies, and its network.

31. Theoretical contributions We wanted to analyze how buy-and-build works in the Private Equity empirical setting. What we have fund is that what creates value is: Buy but not build

32. Theoretical contribution: detecting pre and post-acquisition competence

33. Valuable Competences only partially used: why does it happen? Value creation through financial arbitrage (buy low – sell high) Buy-and-build competences > • The potential competitive advantage deriving from the availability of superior and valuable capabilities does not always translates entirely in actual performance • There are two alternative explanation: • they know how to create value through financial arbitrage but not through synergies  firms have only a part of the entire capability • they know how to create value through financial arbitrage and through synergies. Nevertheless, they do not create value through synergies because it is riskier. This risk is apparent when we consider the fact that the long-term effects of mergers on the firm’s value and performance are frequently somewhat negative  firms put aside the competence they have Value creation through synergies

34. Limitations • We do not see the strategic choices implemented in the post-acquisition stage.

35. Future contributions • Next step: analyze the different post-acquisition events in the buy-and-build deals • Propose a measure of pre and post-acquisition competences