Case

PE Portfolio Strategy

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Problem Definition

We are a private equity firm operating primarily in the automotive industry. We would like you to figure out whether we should increase our portfolio in the sensor market or not.

We would like you to do a profit/margin growth potential analysis and tell us how we can add value to this company given the other companies in our portfolio.


Comments

The case is designed to be presented to the candidate by an interviewer, who plays the role of a major stakeholder in an Private Equity firm operating primarily in the automotive industry.


Short Solution

Key question 1: Profit growth potential of the company

Present Value estimation reveals a positive return of $1.25M.

Key question 2: How can we add value to this company given the companies in our portfolio?

  • Expand beyond automotive industry
  • Access technologies which could be used by other companies
  • Enlarge size of entities

Detailed Solution

Paragraphs highlighted in green indicate diagrams or tables that can be shared in the “Case exhibits” section.

Paragraphs highlighted in blue can be verbally communicated to the interviewee.

Paragraphs highlighted in orange indicate hints for you how to guide the interviewee through the case.

The interviewee should perform a back-of-envelope calculation which answers two key questions:

  • Profit growth potential of the company
  • How can we add value to this company given the companies in our portfolio?

I. Background

Wait for the interviewee to ask questions regarding the background of the case. A few sample questions are shown below. You could use them to help the interviewee with information, if he's stuck.

1. Could you offer some insights on the market potential?

Interviewer’s answer: It is expected to keep growing. Electronics content in an average vehicle is expected to represent 17% of total purchased materials by 2006. As per a previous study conducted by us, approximately $150 on average per vehicle will be represented by sensors by the year 2005.

2. Is there any growth potential beyond automotive industry?

Yes, in aerospace, medical devices, semiconductors and consumer electronics. Automotive and aerospace are the biggest growth areas.

3. Do we have any data on the investments required to operate a company in sensor market?

A recurring investment of $10M, $11M and $12.1M respectively starting year 0, 1, 2. We also expect a cash flow of $12M after the first year growing at a rate of 5%. Following our internal investment rules, we usually do a three year outlook to decide whether we should go ahead with an investment or not. In the past we assumed cost of capital as 10%.

4. Do we have any idea about the key demand drivers?

Increasing consumer demand; government regulation for safety, environmental, and comfort in automotive.

The customers of sensor manufacturers are OEMs. Since electronic systems are seen as a source of differentiation, they place high value on leading-edge technology.

5. How does the competition look like?

Fragmented. Leading sensor companies are growing by using acquisitions and partnerships to expand their product, industry, geography and/or new technologies.

II. Analysis

Key question 1: Profit growth potential of the company

Assumptions:

  • Growth rate = 5%
  • Cost of capital = 10%

Calculation and Conclusion

Present Value estimation reveals a positive return of $1.25M taking a time horizon of three years into account.

Although the exact value of PV of cash-flow is $31.25M, a value between $31-31.5M should be accepted. So a final answer between $1-1.5M is good.

Key question 2: How can we add value to this company given the companies in our portfolio?

Discussion and Conclusion:

Advantages

  • New technologies that can be used by our portfolio companies could be accessed
  • Expansion in other growing industries (beyond automotive industry)
  • Since the market is currently fragmented, the firm could aim to be the industry leader
  • Size of entities dealing with OEM customers could be enlarged

Disadvantages

  • Good chance that a significant investment will be required to stay competitive as the OEMs place high value on leading-edge technology
  • Acquisition could also be expensive
  • Risks are high as there is a long lead time from R&D to market

III. Concluding Observations

The present value estimation reveals a positive return of $1.25M at the end of three years.

To add value to this company given the companies in the firm's portfolio, the firm should expand beyond automotive industry, access technologies which could be used by other companies and enlarge the size of entities.

Difficult Questions

If the interviewee solves the case very quickly, you can come up with more challenging questions.

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Case exhibits