Some companies are astounding successes, such as Apple. Other companies succeed initially only to fail spectacularly, like Lehman Brothers. Between these extremes lie the majority of companies that just bob along behind their competitors with a brand that is, frankly, a little bit tired. Stock markets reward successful companies with a rising share price but the also-rans tend to trade sideways or fall.
What these straggling companies need is the corporate equivalent of a makeover. This is where private equity companies step in. As the name suggests private equity companies are usually privately owned, which is to say they do not trade on a stock exchange but are funded by capital from a fairly small set of extremely wealthy investors. What is not immediately obvious from their name is that private equity companies buy entire companies that are trading cheaply, turn them around, then sell them at a profit.
Just like individual investors private equity companies have varying appetites for risk. The highest risk investments are start-ups which are likely to fail, but occasionally pay off handsomely, and these come under the label venture capital. For example KPCB paid USD 20 million for 20% of Google in 1999, an investment now worth about USD 31 billion. A lower risk strategy is to invest in established companies that need some form of reorganization.
The reorganization could be a matter of tweaking the balance sheet. The company may be sound but simply have too much debt in which case the private equity company can either take over some of the debt and reduce the coupon in return for a share of the company, or delever the balance sheet by injecting more equity capital. Often the changes are more fundamental. When Apax Partners bought Tommy Hilfiger in 2006 for USD 1.6 billion the brand was losing favour in the United States. Apax Partners enhanced the online business, entered an exclusive distribution deal with Macy’s and revitalized the image. They sold the company in 2010 for USD 3.2 billion.
To give an example of a private equity deal, Wendy’s / Arby’s Group recently sold Arby’s to Roark Capital Group. Roark specialize in turning around restaurant companies and so are particularly suited to purchase Arby’s, a sandwich restaurant in the United States with 3,600 restaurants. Roark will pay USD 130 million in cash and take on USD 190 million of Arby’s debt in return for 82% of the company.
Roark will help to fund Arby’s growth and their experience in turning around food franchises will hopefully revitalize their business. The deal is beneficial to Wendy’s, as it allows them to focus on their core Wendy’s franchise and frees up capital. If Roark’s management makeover succeeds in re-vamping the Arby’s brand this deal will produce a good return for Roark and an improved client experience for Arby’s diners.