Alex J. Stockham
Turnaround situations have always been and will always be with us.
As the economy stagnates and more companies become distressed, the opportunity for turnarounds only grows. But the opportunities are more complex now compared to the late 1980s. Back then, financial engineering could lead to quality returns. Now, say turnaround specialists, companies need more than simple financial restructuring – they need operational overhauls.
Private equity firms that specialize in turnarounds may be seeing more opportunity because of the weak economy, but that doesn’t mean they are rushing headlong into deals. Now more than ever, these firms say it is important to stick to their strategy to avoid deals they don’t understand. Most of the opportunity today lies in struggling technology and telecommunications companies. The decision turnaround firms are now faced with, as opposed to the solid but struggling companies of 10 years ago, is if these types of businesses worth saving at all.
Steven Liff, a vice president at Boca Raton-based turnaround specialist Sun Capital Partners, said his firm is seeing many opportunities in the telecommunications and technology sector – unsurprising considering the chaos in those industries. While his firm does look at companies in those sectors, Sun Capital tends to invest in manufacturing, consumer products and services, and other “old economy” companies.
“We’re pretty well diversified in what we’re buying,” Liff says. “Our plan of action is that if it’s a good deal and we can buy it right and execute, it’s something we’ll pursue no matter the sector.”
Sun Capital has been busy this year. In August, the firm acquired forklift manufacturer Clark Material Handling Co., which declared bankruptcy in April 2000, listing $349 million in assets and $374 million in debt. In July, Sun Capital acquired the assets of ACT Manufacturing, which provides electronics manufacturing services to original equipment manufacturers in the networking and telecommunications, high-end computer and industrial and medical equipment sectors. All told, the firm has done six other deals this year.
Other turnaround deals this year include the Retirement System of Alabama’s $240 million commitment to bankrupt US Airways, besting a Texas Pacific offer of $200 million. Philadelphia-based TenX Capital Partners acquired the assets of network infrastructure designer International FiberCom for $30 million. New York-based KPS Special Situations Fund acquired distressed Canadian bus manufacturer New Flyer Industries for $44 million.
A “plan of action” is something Liff says is more important today than it was a few years ago when the economy was good. A firm needs to have a very good idea of how the operations at a prospective company can be fixed because the shaky economy doesn’t allow for slip-ups. A private equity firm needs to get costs in line and prioritize which operations are necessary going forward.
“Today, you have to be much more strategic and thoughtful in how you turn a company around,” Liff says. “If you could turn around an operation and get costs in line and upgrade the management team, in addition to having a strong economy, that would support the topline. It’s a lot easier than today where companies are struggling with the topline.”
The plan of action is well thought out early in the turnaround process, according to Marvin Davis, a managing partner of Atlanta-based turnaround consultancy Grisanti, Galef & Goldress. He adds that experience is one of the most valued assets in a turnaround specialist.
“To be in this business, you need gray hair or no hair,” Davis says. “You need experience. You don’t have to be a technical expert, but you need business experience.”
Grisanti, Galef & Goldress focuses on businesses with enterprise values between $50 million and $500 million. Recent deals for the firm include the turnarounds of wireless company Pinnacle Holdings, financial services company First Plus Financial Group, and Hi-Rise Recycling Systems. His firm comes into the situation when things have already deteriorated, making a battle plan much more important. He says that a financial, strategic, and operational solution all need to be considered, and usually a combination of all three are needed for an effective turnaround.
“We evaluate the options in the first week,” Davis says. “We come with a plan that shows what we can do in the short term.”
Part of that plan involves the business’ operations. Turnarounds that seek to change a business’ operations are becoming more common today, especially when compared to how the turnaround business was started, according to Ross Gatlin, a managing director of newly formed Dallas-based turnaround firm Insight Equity.
“In the mid- to late-1980s and the recession of the late 1980s and early 1990s, you saw a lot more financial engineering,” Gatlin says. “In more recent periods of distress, [they’ve been] based more on operational turnarounds. You’re not counting on financial engineering to get a return.”
Gatlin got his start at Bain & Co., where he worked on that firm’s turnaround of Continental Airlines with Texas Pacific Group. Gatlin was also a founding principal of Carlyle Management Group – Washington, D.C.-based private equity powerhouse The Carlyle Group’s turnaround and special situations division.
Gatlin adds that the industries spawning turnaround opportunities have changed during his tenure in the business as well. In the late 1980s and early 1990s, companies in solid, but cyclical, industries were the preferred flavor. Today, many of the opportunities are in telecommunications and technology as well. This has added a new challenge for turnaround specialists because they are accustomed to knowing the industry inside and out, Gatlin says. What used to be a simple matter of cleaning up a balance sheet has transformed into answering questions about a company’s ability to compete in the market.
“In this latest wave, things have become trickier,” Gatlin says. “There are a lot of companies that may not be strategically viable. It used to be a matter of banks over-leveraging, but in this case, you have whole segments with gigantic questions [about viability.]”
Now, the first thing a turnaround firm needs to do is make sure the enterprise is worth saving, Davis says.
“We’re in the turnaround business, not the resurrection business,” he says. “ We make that call up front.”
Insight Equity’s Gatlin stressed that part of an operational turnaround is knowing “what products are earning the right to grow.” Turnaround firms should have systems in place to determine which product lines or divisions should be kept in place and which ones should be let go, he adds. Gatlin says taking a hard look at how much each division of the company spends and brings in is the starting point of any successful turnaround. Often private equity firms are more capable of doing this than the company’s current management.
“Existing management teams may not get a chance to do it,” Gatlin says. “There might not be time or resources. They might not believe in the tools. It’s hard for CEOs to finally throw in the towel.”
Convincing management that they are actually in need of a turnaround specialist is the hardest part of the process, Davis says. After all, a management team that founded a company does not want to see it fall apart, even if the debt holders are clamoring for change.
“Convincing people to take the first step is the toughest part,” Davis says. “That usually doesn’t happen until the pain becomes unbearable. The difference between a turnaround guy and a manager is realism.”
While any private equity investment is risky, turnaround investments tend to be riskier, especially in a tight economy, according to Liff. The risk can be mitigated by thorough due diligence processes, though. The first thing he looks for in a solid turnaround opportunity is cash.
“There’s always a liquidity crisis [in a turnaround],” Liff says. “When we get involved, sales, run rate and EBITDA are not as relevant, cash is. We have to ensure that there’s enough cash to spark a turnaround. Cash is king.”
Of course, the lack of cash is what gets a company in trouble. Gatlin says his firm is seeing a lot more deals out of bankruptcy. He says that buying a company out of bankruptcy is similar to investing at a company’s inception because those times are when the balance sheet is most clean – and attractive.
“Companies are most clean of liabilities at inception and coming out of bankruptcy approval,” Gatlin says. “Rather than being afraid, you would think that people would recognize the value of the process.”
Bankruptcy is not a process to be taken lightly, though, Liff says. The process can cause problems with customers and vendors.
“Customers and vendors view it negatively,” Liff says. “All parties need to stick by your side.”
Increasingly, Management is beginning to see the value having a firm lead the turnaround process, Gatlin says. Not only does a firm bring in capital, it brings in its contacts, relationships, and the priceless experience of having successfully turned companies around in the past.
“It’s most rational to partner with someone who can give a voice to outside perspectives,” Gatlin says. “It’s better to take corrective action now and reinvigorate a company to save the destruction of value.”
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