Operational value creation may not be very exciting, but it is the only way to consistently beat the market, build good businesses and generate good returns, according to Terra Firma’s chairman and chief investment officer Guy Hands.
Hands was speaking to delegates at Private Equity International’s Operating Partners Forum in London on Tuesday, his first speech in London for five years.
“A lot of this stuff is not very glamorous, it is not very exciting, it doesn’t make the headlines,” he said. “But our view – and it is a very strong view – is that if you do this consistently, you create added value.”
“Focusing on [operational excellence], figuring this out, is very very different from the general view of private equity,” Hands added. “Private equity is often seen as about being big deal makers. But actually, a lot of studies have shown that the value added by the financial dealmakers to a private equity firm in the long term, is actually very minimal. You can hire and fire them and it really doesn’t make that much of a difference. What does make a difference is the operational side.”
Good operating partners are scarce, he added. “There are a lot of very bright deal makers out there, but there are very few really good operational managers. And we have tried to do at Terra Firma in the last 20 years is get people to understand that you have to have a culture of trying to achieve operational excellence.”
Another key element of creating value-add is being bold about changing management teams, Hands said. “We change CEOs; we have done that 29 out of 33 times. For CFOs, we have done it 31 out of 33 times. And we haven’t been afraid to do this once or twice in a company. Everybody in this business wants to hire a top-quartile management. How many people can get that right more than 50 percent of the time? You have to have the courage to realise that you got it wrong and then have the guts to get rid of them in the first three months.”
According to Hands, a study of 12 Terra Firma deals by consultancy McKinsey & Company on how the firm had made its money yielded some interesting conclusions. “The good news [was], we were very good in grinding out operational improvements through our selected strategy.” The bad news was that the firm had been less consistently successful in predicting where the market would go, he admitted.
Hands also argued that criticism of the industry as asset-strippers was misplaced. “I have to tell you: that is a really tough way of making money. Thirty years ago, maybe [this could be done]. Then you could strip money out of a pension fund and wouldn’t go to jail. Today, you would go to jail.”
He also claimed that Terra Firma had invested as much on capital expenditure, as it did on new deals across its last two buyout funds. “That is an interesting number our there for the politicians. I don’t think this is exactly the norm for the FTSE 100.”