Aaron Sack is head of Morgan Stanley Capital Partners where he also leads the consumer investing group. Sack told Buyouts in a recent interview about how the firm approaches the market.
1. How does deal-making in 2019 differ from previous years? Do you see any new dynamics around auction processes?
I think there is somewhat of a recalibration by the markets for what is acceptable and we will see whether sellers rethink the timing of their exits, and whether they are forced to remove some of the excessive adjustments to their earnings… Lenders are beginning to push back on heavily adjusted definitions of financing Ebitda. People are starting to say ‘no more on fake, low-quality Ebitda, because some of the banks and some of the sponsors have been too aggressive.
I think buyers are willing to pay high multiples for good businesses, but they are not willing anymore to pay high multiples for good businesses on really flimsy earnings, earnings that have too many adjustments, that have too much add-back activity. I think over the next quarter or two if the market starts to push back on those kinds of adjustments and the macro starts to weaken because of trade imbalance — because of China or whatever it is — I think that might start to make the market weaken from what we’ve seen in the past couple quarters.
2. What’s your competitive strategy for middle-market assets?
The middle market is expensive right now. You have to justify to yourself — to your LPs and to your management teams that you actually have a plan in place to drive underlying portfolio-company value. We do compete in the middle market with a lot of firms that are named after rocks, and rivers, and creeks – and that’s fine with us, because very few people in the middle market actually come with a brand name like we have and can actually bring the resources that we do.
We stick to middle-market investing. We don’t go through bigger and bigger companies. Our companies are often little companies off the beaten track and across geographies.
3. How are you navigating the high-price deal environment?
Anybody who is buying things right now and assuming that they are going to hold them and that multiples are going to increase and the world would just get better over the next four years or five years — we view it as a disastrous strategy. And so everything we invest in is predicated on a prescribed value-creation plan relying on operational improvements as well as strategic M&A to drive value creation. We focus on add-on acquisitions very early on in our investments because we think that this lowers our creation value. But more importantly than that, everything we underwrite, by the time it gets to our investment committee and is approved, has a material amount of the value creation during our hold coming from specific operational initiatives that we will work with management on.
4. Talk a bit about the team’s operational initiatives and how they contribute to value creation.
An operational perspective is integrated in everything we do. We’ve been focused on this for a long time. Back in 2007, we incorporated full-time, fully integrated operational partners who had the exact same economics as any other partner.
We did this before many of our peers, and we did it because they were central to our approach. About halfway through Fund VI, we wanted to focus even more on that operational perspective. Our approach evolved — we formalized the value-creation playbooks and built out our in-house operations team beyond just the partners.
Approximately a third of our partners are specific operating partners. We also have functional experts, industry executives and operational accelerators supporting the portfolio companies. So, our operating partners have dedicated staff under them.
We’re a $1.5 billion fund. We clearly can’t be someone who brings in an entire consulting firm. We just can’t do that with our fee and carry structure. But around the edges we are building a quasi-operating department. But the way that we leverage that is as follows.
Every deal is co-chaired by our operating partners. Every deal then has what we call an accelerator [an operationally focused executive]. We just added our sixth. So not only do our portfolio companies have constant time, attention and help through the value creation plan, we’ve now recruited from outside, someone typically from a strategic or project-consulting background. And they have been at a place like Bain or McKinsey or BCG for five or six years, they’ve gone to a business school, and they’ve managed complex projects for large companies or mid-market companies. We are giving them that career path, but first they have to spend three to five years at one of our portfolio companies advising management teams on the collective value creation plan.
5. How involved are operational accelerators with management teams of your portfolio companies?
We like to have an accelerator advising at each portfolio company. For portfolio companies that don’t need an on-site accelerator, we dedicate one of our operational VPs to one or two portfolio companies at a given time. So we would cover them in a hybrid model, either in person in a place like Illinois or Kansas (wherever this portfolio company is), or we would cover it from New York on site as needed and probably spend a day or two a week at those businesses. We plan to add three to four operational accelerators in the next three months as well as a second operating VP to assist companies in New York.
People often ask somewhat skeptically, “How do your management teams in the middle market react to having those consultants on the team?”… Ultimately the management team has to own that person, because [the consultant] is going to be there advising their company. We don’t want it to feel like a resource we are forcing on them. We want it to feel like management hears that and gets excited and says, “Wow, can we actually do the hiring?” We say yes and we think this is what the recipe for success is.
In addition, almost each of our portfolio companies has a value-added board member, which we call an operating adviser or board-plus. We have found that within the middle market, it is not always the most impressive name that will have the most impact. We use the vast Morgan Stanley network and strong brand to attract board members that we believe are the best-fit — [people] willing to roll up their sleeves and play an active role alongside management and our team in the value-creation process.
Correction: An earlier version of this report misspelled McKinsey. The report has been updated.
Edited for clarity by Milana Vinn
Action Item: Contact Aaron Sack and his team at firstname.lastname@example.org.