PE firm synergies

Private Equity
New answer on Jun 27, 2021
3 Answers
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Anonymous A asked on Jun 26, 2021

Do PE firms contribute to synergies by leveraging their expertise in an area? If not, how do they decide whether to buy a company and why do they buy them?

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Ian
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replied on Jun 27, 2021
MBB | 100% personal interview success rate (8/8) and 95% candidate success rate | Personalized interview prep

Hi there,

Honestly, while this happens it's extremely rare in a case.

PE firms (particularly in a case) will buy a company for any of the following reasons:

  1. The firm is undervalued (we see value that the market doesn't). Translation: Home flipping
  2. The firm has huge potential if we just change a few things. We'll buy it, fix it, and sell it (this is where their expertise may come in).  Translation: The home is a fixer-upper
  3. The firm's parts are greater than it's whole. Well buy it and carve it out (1+1 = 1). Translation. Buy a plot of land and subdivide.
  4. Multiple firm's together are worth more than apart. We'll buy them and combine them (1+1=3). Translation: Buy a few plots of land and build a megadevelopment.
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Asim
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replied on Jun 26, 2021
Strategy& Engagement Manager | Grad & MBA Interviewer| Ex-Investment Banker | Financial Services expert

On your first question - increasingly PE firms focus on value creation by providing operational expertise to improve the companies they have bought (their portfolio companies). If they already own a portfolio company and buy / merge with another company as part of a buy and build strategy (bolt on acquisition), they can add value by providing advice to the management teams on how to structure and execute the deal and provide integration support afterwards. In that way, they could help contribute to cost and revenue synergies but I would say it is relatively indirect.

On your second question -  PE firms will buy firms that:
- meet their stated investment criteria and constraints (e.g. sector, size, business model)
- they believe will achieve at or above their hurdle rate of return (e.g. 20% IRR) over their investment horizon (e.g. 5 years). Assuming the market does not change of the time horizon, then a PE firm's view is that the company will be able to grow profits (EBITDA) driven by revenue growth or cost reduction throughout the period. With the cash generated, the idea is that they will use this to pay down the debt used to fund the deal.

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Henning
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replied on Jun 27, 2021
Bain | passed >15 MBB interviews as a candidate

It happens, but it's the rule rather than the exception. I have done ~15 PE cases so far in my career and only one looked at merging the target with an existing asset. 

When buying a firm, PE funds always plan through what they call a Value Creation Plan to grow the value of the business. This can include growing revenue entering new markets, launching new products, targeting new customers, increasing sales performance, etc. or improving bottom line by increasing operational efficiency, reducing overhead, selling assets, etc.

Especially in very competitive biddings this is a key component of the due dilligence as they need to figure out the future potential and price along this, rather than just pricing current cashflows.

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Ian gave the best answer

Ian

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