Both during and after a down economic cycle, workout firms and turnaround groups often see a jump in business. Like an umbrella during a rainstorm, their appeal naturally goes up when companies are in trouble. And in the current environment, where more than a few companies are struggling, buyout firms have emerged as new customers.
Howard Brownstein, a principal at NachmanHaysBrownstein Inc. and a director of the Turnaround Management Association (TMA), says he’s seen a spike in cases from private equity funds in the last 18 months. And with the economy still lagging, the industry’s case load isn’t going to lighten anytime soon.
“Between 1995 and 2000, I’m not sure if I did any private equity restructuring work,” says James Sprayregen, the partner in charge of workouts, restructuring and bankruptcy at Chicago-based law firm Kirkland & Ellis. “But from the third or fourth quarter of 2000 until now, I have been involved in many private equity workout situations.”
The buyout firms seeking help range from the tiniest partnerships working on a deal-by-deal basis to large household names, including Bain Capital and Madison Dearborn, lately, with decades of experience. So why can’t they handle these problems themselves? Turnaround pros say buyout firms lack both the time and, in some cases, the skills needed to remedy troubled companies. In addition, most buyout pros would rather spend time searching for the next deal than trying to fix one or two problem companies. “A lot of equity sponsors are recognizing that where they make a lot of money is on the transaction side. If they have a troubled company taking up a lot of their time and effort, that keeps them away from getting the biggest bang for their buck, which is doing deals,” says Randall Eisenber, a partner in the business recovery services practice of PricewaterhouseCoopers and president of the TMA.
Apart from the time commitment to restructure a struggling portfolio company, turnaround pros say many GPs simply lack the skills necessary to achieve a successful resolution, in part because they don’t get much practice with turnaround situations. “Frankly, a lot of buyout firms have a pretty short playbook when a company gets in trouble. Page 1 is fire the CEO…and page 2 is often blank,” says Jay Marshall, a principal at Jay Alix & Associates.
Conversely, turnaround pros have highly developed playbooks for sick companies, says Kevin Dowd, a principal at Nightingale & Associates. “Analytically, many times, the companies and investors don’t really know what they have or where they are. So we come in and perform a disinterested, clear-eyed financial and operating analysis and then in three or four weeks, we can say here is what you got, here is what has changed over time, and here is where the company is going based on what is available,'” Dowd adds.
Clearly, the LBO market’s growing appetite for these services hasn’t gone unnoticed. Jay Alix has been marketing itself aggressively to buyout shops, calling on 80 to 100 buyout firms to showcase the services it can provide, Marshall says. For its part, Nightingale is about to announce a new joint venture with an investment group, in which the investment group will buy promising troubled companies and then use Nightingale to come in and do the heavy lifting to turn the companies around.
This type of advice doesn’t come on the cheap, though, as most turnaround firms charge an hourly or monthly fee, plus a success fee for hitting certain milestones, like increased cash flow or Ebitda. Turnaround firms can’t be bought off with equity, either. While some may take warrants, or equity, as part of their success fee at the end of a completed job, they generally don’t take equity up front, because it can create a conflict of interest, turnaround pros say.
In addition to cost, there’s a cultural resistance to consultants that still persists in the LBO market. “GPs want to have a good relationship with the management teams they back, and bringing in a turnaround firm can be viewed as a criticism, or the management/buyout firm sees an initial set of bad numbers as a temporary decline and they only come for help when a company’s value dramatically declines,” PWC’s Eisenberg says.
To allay those concerns, workout groups say they want to be flexible, in some cases lowering upfront fees and asking for more upside only if certain cost reduction targets are met, for example. “We want to align our economics” with those of the buyout firms, Jay Alix’s Marshall says.
Defining Success
One of the disconnects that often occurs between turnaround groups and their clients is their definitions of success. While many clients come to them with visions of cured companies and fat margins, the reality is a successful outcome can take any number of shapes, depending on the condition of the company from the outset. “I always tell my clients that they need to define what success means to them in this situation,” Kirkland’s Sprayregen says.
“A turnaround success is, given the reality of a certain situation, formulating and implementing the optimal alternative,” Brownstein adds, noting that ultimately finding the best alternative comes down to managing risk. “An alternative may be painful, but it could still be the best option – and this could mean anything from pumping money into an enterprise because a full-scale turnaround seems possible, or totally liquidating a deal or selling it under pressure at a depressed valuation just to get rid of it and the risk and liability associated with it.”
Workout pros say another challenge with LBO firms is they generally come looking for help too late. “The biggest mistake LBO firms make is just waiting too long to act,” says Jay Alix’s Marshall. “Unless you’ve been through this before it can be a shock to you to how quickly an underperforming company can enter a crisis mode.”
The problem with delaying is that the less time turnaround firms are given to work with, the less likely they are to be able to affect a positive change, Nightingale’s Dowd says. “When someone waits to the point of significant deterioration to approach us, then they end up asking us to be miracle workers, because we have less of a company to work with; whereas if they had come to us earlier, we probably could have had a chance for a positive impact,” he adds.
Indeed, Dowd recalls one company that brought Nightingale in for a review and ignored the firm’s advice to replace its CEO. About a year later, the company hit the wall, ditched the CEO and ended up having to bring in Nightingale for a full turnaround effort that resulted in a sale out of bankruptcy. “If they had listened to us earlier, they could have avoided all of that,” he notes.
Brownstein suggests buyout firms should have a yearly checkup of their portfolio for diagnostic purposes. “Rather than pay us a lot of money later, pay us a little up front for a check-up. The best medicine is preventative and, inevitably, some sub-set of their portfolio companies are going to merit a closer look,” he says. “That way, we can look at some companies and set up some guidelines for signs of what could go wrong and what to do. Then when a wire is tripped, the buyout firms can know if a company is moving to address the problem, or if they are not.”
Skeptics Remain
While the theory behind an early detection seems compelling, plenty of LBO firms aren’t sold on the idea yet. T.J. Maloney, president of buyout firm Lincolnshire Management Inc., says it is hard to know just when to engage a turnaround consultant. “When you are looking at bad numbers now, they could be the result of bad strategic decisions two years ago. So when is bad? And how bad is it?” he says. Maloney says Lincolnshire is actively involved with its portfolio companies and tries to manage any problems they encounter in-house. Lincolnshire has used a turnaround consultant just once, about eight years ago, and the experience wasn’t positive. “There was a big bill, and they didn’t really fix anything,” he adds.
Lincolnshire’s experience notwithstanding, Brownstein insists one of the best things a buyout shop can do for itself, especially in the current environment, is engage in a close relationship with a turnaround firm. “We aren’t lawyers, we won’t charge you for a phone call to check on something. We only get paid to do work,” he says. “A good fund should have someone like us in their hip-pocket as a resource to help whenever they have a problem with a company.”
Contact Alistair Christopher at:
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