PE Harnessing Synergies

For years the very idea of a synergy premium has been confined to corporate buyers. However, as private equity groups grow in stature and their sprawling portfolios evoke comparisons to the large conglomerates, many groups have started to harness the power of their portfolios when working with third party vendors.

The concept is not necessarily new. Investors will pool their portfolio companies into a single buying entity in order to gain leverage when negotiating for healthcare plans, air freight contracts, IT services or other business needs. The evolution of this practice is inevitable with the maturation of the industry.


Blackstone Group, for example, is actively instituting such a program for its companies, which combined generate $60 billion plus in revenues. The savings aren’t necessarily reflected in higher purchase prices, yet, but as private equity firms rely less on financial engineering, there is a need for groups to get creative when it comes to instituting positive change.

One of the more recent success stories comes from Bear Stearns Merchant Banking Partners (BSMB), which over the last 18 months has instituted a program it calls Merchant Banking Strategic Services (MBSS). BSMB’s master contracts include everything from insurance to plastic bags and when it approaches a company for an investment, the firm now provides a menu of savings plans for prospective targets.

BSMB Partner Gwyneth Ketterer, who spearheaded the program, said there are a few key hurdles that BSMB had to get over in the program’s creation. First, the firm had to convince vendors to see the contracts as a relationship not with the portfolio companies themselves, but with BSMB alone. While the portfolio companies shift underneath BSMB as they are bought and sold, BSMB’s revenue base stays intact or grows. Ketterer adds that once BSMB convinces a single vendor in a category, all the others have to follow suit to remain competitive.

A second major obstacle was putting long tails on the ends of the contracts, so that when the portfolio company is sold, it holds onto the contract for up to three years. After that period BSMB has the option to decide whether it will remain in the family of contracts.

One aspect that makes the BSMB situation unique and gives it an advantage is its relationship with parent Bear Stearns, which has greater spending power for services like IT and healthcare. “We piggy back on Bear where we can,” says Ketterer.

To set up the program Ketterer recruited David Knoch of Alaris Consulting. Ketterer presumed ahead of time that most consulting firms would have experience in the area, but she discovered that actually few did. Knoch, who came on in October 2004, told Buyouts that big consulting firms are priced for Fortune 1000 companies, so cost cutting strategies at middle market companies that can’t afford their services aren’t typically a priority.

In December 2004, BSMB identified 10 portfolio companies and 10 major areas of spending. Bear tackled $200 million in total spending and found that roughly $100 million could be addressed by master contracts. The first year of the program the participating companies generated close to $15 million savings. Now in full swing, the program cuts between 10% and 20% off of those costs at each company.

While the savings are apparent, some groups worry that such oversight could negatively impact a firm’s relationship with management. Linsalata Capital Partners Senior Managing Director Eric Bacon said he leans heavily towards keeping his companies separate and letting the operators make their own choices. “We feel that such forcing [into a buying program] undermines our relationship and often sets up the buying function to fail,” says Bacon.

Bacon further notes that his experience as an operator taught him that managers don’t necessarily want to be viewed as being beholden to anything. “They don’t want anything forced on them,” he says, adding, “And I also don’t want them to have that excuse.”

Ketterer, though, insists that Bear’s management teams are not only on board, but are in fact enthusiastic about the program. She describes that most managements presume, when being bought by a private equity firm, that improvements are going to come in the form of leverage, and won’t be “tangible to improving the day-to-day business.”

She adds, “We’re talking to a management team on a real level. When we tell them about it, most management teams look up and say, ‘Now you are speaking our language.’”

One of BSMB’s portfolio companies is 4 Wheel Parts Wholesalers. The company’s CFO Tim Mongi said that when the firm came in promising cost savings in so many areas, he was “a little skeptical.”

“I was thinking… we were good negotiators and could continue to do a good job on our own,” he added.

In working with 4-Wheel Parts, Bear targeted eight categories for savings, among them printed materials, an area where the company spends about $3 million per year. Across all categories, the program has saved the company between $1.5 million to $2 million, with more than $700,000 coming out of the company’s outlays for printed materials.

Why not?

At this point, there isn’t an overwhelming number of firms that have followed suit. Ketterer speculates that one reason is that a private equity firm needs to function collectively to have such a program. At many firms, different partners are individually in charge of a few deals each, without much overlap.

In talking to a number of groups in recent weeks, however, Buyouts discovered that a number are thinking about instituting similar polices in the future and most already have a form of a master contract for their portfolio’s insurance needs.

One hurdle many new firms face is scale. “It’s a good idea but harder to implement on a level that makes a big difference that would be readily apparent,” said Paul Levy, senior managing director at JLL Partners.

Kevin Prokop, meanwhile, a director with Questor Management Co., agreed, saying that the areas where the cost savings can be generated aren’t big line items that can move the needle. He leaves health insurance as an exception, and notes that Questor does pool its portfolio when negotiating for healthcare. “We do it as much to ensure consistency of service as cost reductions,” he says.

Toronto-based Onex Corp. is one firm considering the launch of such a program. Onex VP of Finance Don Lewtas said the growing size of Onex’s portfolio can now get the attention of vendors as a major opportunity. But he does see challenges, and cites in particular similar issues voiced by Linsalata’s Bacon. “To be successful you’re going to be breaking some existing relationships. That [decision] comes at the top,” he says.

Bear, meanwhile, is taking its program to the next level, and is working to create a more formalized network of communication between portfolio companies. In one case, a BSMB retail portfolio company wanted to know the correct legal language to put on the back of gift cards. An email blast was sent out to BSMB’s stable of retail companies and a half dozen responses quickly poured in. BSMB also gives discount perks among portfolio companies and seeks out cross-selling opportunities. In the future, Bear’s MBSS program could expand to IT outsourcing in India or Chinese manufacturing, said Knoch.

It’s only a matter of time before synergy premiums start finding their way into private equity purchase prices. Strategics beware.