How PE Investors Are Overcoming the "Winner's Curse"

How PE Investors Are Overcoming the "Winner's Curse"

It’s known as the “winner’s curse.” In private equity investing, it’s when a winning bid to acquire a company exceeds its intrinsic value or worth. It’s a problem that’s been on a dramatic rise in recent years. In fact, 61% of U.S. PE transactions in the most recent year exceeded 10 times EBITDA.

In the world of PE, where investors typically look to get a return on their investment and exit their stake within three to five years, this is a major concern. The number of quality deals is limited, so competition is fierce, and resulting higher purchase prices make it difficult to achieve desired returns during an investment hold period.

In fact, according to a recent survey by Pitchbook, 42% of PE investors believe that current pricing is not conducive to typical PE returns. And financial engineering isn’t enough to overcome the challenge in many cases.

As 3G Capital discovered the hard way with its acquisition of Kraft Heinz several years ago, cost cutting only goes so far, and an inability to grow brands, accelerate new growth and find new value can be catastrophic in an era of rising acquisition prices.

PE investors are now looking beyond the standard playbook of debt, new management and cost cutting in an effort to create incremental value.One way they’re doing this is by developing services and functional expertise that can be shared across their portfolio.

Breaking from Traditional Cost Management and Cash Flow Generation

As Jim Howland, a Managing Director and Operating Partner atMorgan Stanley Capital Partners told Forbes recently, PE firms are focusing increasingly on top line organic growth as opposed to reliance on cash flow generation and cost management.

“Over the past 10 years, most private equity funds have built some form of internal operating capability to drive incremental value in their portfolio companies,” Howland said. “This is vital in today’s competitive deal world, where prices are bid up but the value you are able to generate over your ownership period is absolutely in your control and can still drive very attractive investor returns.

“At MSCP, we bring a very prescriptive approach to how we will partner with portfolio company leadership to seek to create value over our hold period, which informs how much we are willing to pay for an investment.”

That prescriptive approach involves sharing and bringing inexperts and services in key areas of leverage, including marketing. As Howland puts it, “Increasingly our value creation plans focus on working to accelerate top-line growth by adopting a more sophisticated marketing strategy and making material investments in the function.”

Stephen Diorlo, director of the Forbes Marketing Accountability initiative, says that smart investors are now using the operating partner role to build up shared capabilities and expertise. Then they’re “using marketing, branding and growth platforms to generate superior returns.”

Diorlo points to several underlying reasons for this:

  • Most of a firm’s value is intangible, and the majority of its intangible assets are marketing and customer-related.
  • Brands can make up over half of a firm’s value, but they’re poorly priced and understood by financial analysts and CFOs.
  • Over two-thirds of PE firms are pushing their portfolio companies to grow at faster than 10% per year to justify price premiums.
  • An ability to quickly and effectively analyze, leverage and exploit customer insights and data can increase tactical marketing returns and generate long-term enterprise value.
  • Organizations across many industries are creating new value by building direct-to-customer (DTC) models. They engage customers directly via mobile, digital and call-center channels to develop deeper customer relationships and behavioral insights as well as identify unmet needs.

According to Diorlo, it’s still relatively rare for PE firms to have found repeatable and scalable ways to leverage these marketing and demand-generation capabilities across their portfolios. But market leaders have mastered the science of marketing and growth to find high multiple returns and create new value where others aren’t looking. Diorla highlights three key strategies that are driving this:

1. Brand Building

Strong brands drive predictable future cash flows, higher margins and create options to quickly and cost-effectively expand into new products, channels and markets. As Bill Sweedler, founder of Tengram CapitalPartners told Diorlo, “What I have learned over the past 20 years of investing is that capital is a commodity, marketing ‘know how’ is valuable, and intellectual property (IP) is priceless.”

Particularly in consumer companies, brands can represent the majority of value, and if you understand them as IP and leverage them to create new value, you may be able to achieve an outsized return at minimal downside risk. Brands often have latent and untapped value, whereas operations create the real risk.

2. Organic Growth

Fast growth is a key to commanding price premiums, as we’ve seen with recent acquisitions of firms such as, Quicken Loans and Marketo. At Rockbridge, the PE arm of Quicken Loans founded by Dan Gilbert, investors have created growth cultures, operating models and demand generation across their portfolio by leveraging the highly sophisticated marketing capabilities and insights that were used to accelerate Quicken Loans’ growth.

Rockbridge operating partner Matthew Kearney recently told Forbes, “We’ve learned that investment in growth drives revenue, profit and exit multiples. We have a big advantage over Wall Street, where there’s a constant temptation to defer investment to hit the numbers next quarter.”

Rockbridge is able to drive rapid organic growth by applying the latest direct-to-customer techniques across an ever-broadening range of products, and digital platforms allow the firm to target the right audiences and measure how they respond to messaging across search, social and paid advertising products. Operating partners are now demanding the same from traditional media as well.

It’s an approach that is increasingly seen in tech-focused PE funds too, where there is a focus on growing organically via evolving technology, go-to-market initiatives and product improvements across portfolio companies.

3. Big Data and Marketing Insights

A key component of direct-to-customer marketing strategies is big data. By using data analytics, companies can better target their customers, set optimal product prices, measure the return on marketing investments, and ultimately maximize their profits.

But big data is moving beyond traditional marketing analytics to artificial intelligence and machine learning, with platforms that allow investors and portfolio companies to get a highly granular understanding of firms and be more informed, precise, and accurately predictive in their marketing investments.

A Strategy for Improving and Sharing Marketing Capabilities

One strategy that many PE operational partners are using to bring in and build up marketing capabilities at their firms and portfolio companies is hiring specialized experts. At Graphite, we’ve seen this trend first-hand, by helping PE firms find talented CMOs, brand building experts and big data analysts through our network of over 5,000 independent consultants.

By tapping into the growing global marketplace for on-demand expertise, PE firms can hire executive-level consultants and pre-vetted experts who can help their portfolio companies drive organic and incremental growth. At Graphite, our independent consultants are seasoned professionals who all have backgrounds at a major firm such as McKinsey, BCG or Bain, and they average over 10 years of experience.

Through our service, firms can engage these top-tier consultants quickly and discreetly, with flexible arrangements that allow firms to add marketing talent to their firm or any portfolio company. It’s also a great way to fill roles in other key areas, such as corporate strategy, finance, product development, sales and IT.

To learn more about our on-demand experts and how to leverage their skills and experience to create portfolio company value, visit us now at or contact our team directly to explore your needs and find out if hiring through Graphite is right for your firm.

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