I had a chance to re-read the great study from INSEAD on the emerging new models of value creation ( VC 2.0). The research contrasts traditional value creation models to a new and more comprehensive framework.
Traditional value creation elements tend to be:
- EBITDA impact – focusing on operational value creation, process improvements, technology improvements which ultimately translate to growth of free cash flow. This cannot separate impact of general industry growth from PE impact on the specific company
- Multiple impact – focuses on basically changes between entry and exit price levels. Mostly ignores economic cycles and industry shifts.
- Net debt impact – shows the overall improvement in cash position and ability to generate free cash flow. Most relevant in LBOs and not growth equity
The report argues that in recent years academic research shows no clear differentiation from industry peers vs PE backed companies in the above value creation strategies.
To measure the real impact of PE outperformance over industry in the businesses they transform, the report proposes a set of new frameworks. The analysis narrows down value attribution to value creation strategies vs general industry movements, i.e. the company-specific alpha.
The report attempts to deconstruct value creation into more drivers than the 3 traditional ones, seperating industry infleunces. Using a sample of 28 investments they found the following conclusions:
– Revenue growth was 68% of the total value creation, confirming the most impactful and most elusive area of repeatable value creation theses
– Margin improvements accounted for 16% of the total value creation. This is notable because most PE operating teams tend to focus on this much more than top line process strategies
– The rest (22%) was multiple expansion due to market conditions and industry cost of capital
The report has a series of case studies and a lot of other insights. Well worth the read.