Anybody looking for a bad guy in the story of Sun Country Airlines stranding passengers in Mexico as a snowstorm disrupted its operations could quickly find one — now that the ruthless money-grubbers of private-equity firm Apollo Global Management has bought the airline.
That’s how an April blizzard turned into just another bad PR moment for private-equity managers, who can’t even seem to come up with a good word to describe themselves. The term they use is “sponsors,” which seems to better describe a local Dairy Queen franchisee who helped buy youth softball jerseys.
The PE partners ought to call themselves “owners.” They own businesses. And just like business owners anywhere, all the best ones really want is to see the value of what they own increase.
This helpful clarity about the mission of a private-equity firm came out in a meeting billed as a roundtable earlier this week with four partners of Norwest Equity Partners (NEP), a Minneapolis private-equity firm with a history in the region that goes back to the 1960s.
NEP recently bought a controlling stake in three businesses in the region, all of which sell technology and services to business customers.
The latest was Avtex of Bloomington, a 230-employee firm that puts together systems for customer contact centers and other customer management systems.
Last year, NEP acquired Bailiwick Services of Chaska, which started as a cable installer and now sells systems and services to big companies. In 2015, NEP took over St. Cloud-based Marco Technologies, which has been busy since acquiring other companies. Marco now has 1,200 employees, including 350 or so in St. Cloud.
Another thing these three companies shared, although for completely different reasons, is that they really could have used more capital to grow.
Asked if they look for low-hanging fruit in deals like these, an unprofitable product or service line they can quickly jettison or a wasteful practice they could stop right away, the NEP partners had to pause before giving a serious answer.
“That wouldn’t fit the definition of a well-run company,” said Kevin Torgerson, an NEP operating partner. “If they are really good, there probably wouldn’t be low-hanging fruit. It’s more likely there’s low-hanging fruit on the opportunity side” with a new line of business or customer segment that management wanted to go after but lacked the capital to pursue.
One of the first things NEP explains to its new partners running a company is that they should make decisions as if NEP is going to own the business forever.
This is just advice to avoid short-term thinking, as NEP may hang around for only five years or so before selling. That’s typical of the industry. Companies are owned by partnerships that have to be wound down, and that means selling their investments to somebody else.
In addition to asking managers to stay calm and think long-term, NEP fills them in on what partner Tim Kuehl called its “value creation” approach. He said they try to make this message as simple as possible.
The first thing managers have to do is think of ways to make more money, as the yardstick used to establish what a private company is worth is almost always its recent cash earnings, the income before depreciation, interest and taxes. Some multiple of this number determines the value put on a company.
Boosting cash earnings through growth into profitable new market niches certainly works. So do acquisitions, particularly of smaller companies that can be bought and folded into the bigger organization.
Paying back the money borrowed to fund the acquisition also increases the value of the ownership. Any homeowner looking at a mortgage balance decline knows all about this math. A business bought for $10 million can be worth $10 million in a year and still provide a nice gain if the debt got cut from $7 million to $6 million.
The last thing managers are asked to think about, Kuehl said, is a higher multiple of cash earnings. While this might seem beyond anyone’s control — the going price in the market is the same for everybody — there are lots of ways to make the same dollar of earnings more valuable.
In the technology-services industry, for example, $1 million of profit from a series of long-term service contracts is worth more than $1 million in profits earned on some other types of projects. A customer list can be worth a lot more if it is filled with long-term customers on renewable service agreements rather than new names on shorter contracts.
The NEP partners encouraged me to phone their CEO partners, and when Marco Technologies CEO Jeff Gau got on the line he knew he would be asked what the term “value creation” meant to him.
There is good growth and bad growth, he explained, and he’s after only the good, consistently profitable kind.
“You can vend a whole bunch of hardware at a low margin, and you still grow,” he said. “Or you can have less revenue, and sell it in your services category, and you create more value. So what you sell, or how you grow or where you grow, all matters.”
Gau said several years ago, when looking at options for the company, he was unenthusiastic about private-equity owners for the same reason people found it easy to blame Apollo for canceled flights. Now, nearly three years after selling to NEP, he will happily share his experience with other business owners.
“People have a track record,” he added. “Not all PE firms are created equal.”