Private Equity Deal Flow in the Covid-Era: What We Have Learned and Where We Are Going
Private Equity Deal Flow in the Covid-Era: What We Have Learned and Where We Are Going - Treya Partners
Private Equity deal-flow has declined significantly in Q1 and Q2 of 2023. Economic uncertainty, driven by factors such as geopolitical events, and global market volatility, are making an already challenging deal-making environment even more difficult. Further, rising interest rates are making it tougher to secure appropriate debt financing to support deal values. There is also a valuation gap that still exists between sellers and PE buyers. In this challenging environment identifying untapped procurement opportunities can provide an additional source of value to getting a challenging deal over the finish line.
To uncover these opportunities, we recommend that a systematic approach be utilized during due diligence to analyze the target company's procurement processes, supplier relationships, and cost structures:
- Direct expenses (COGS): Utilize the good old fashioned 80/20 pareto rule and identify key suppliers/categories that make up 80% of the direct spend. Gain a detailed understanding of recent sourcing activity and the competence and strength of the target company’s in-house procurement team. Look for payment terms and key pricing structures/indices in materials contracts. Typically, COGS expenditures can be lowered by 4-8% using improved data and benchmark based negotiations, supplier/volume consolidation, specifications optimization, and indexing based on key underlying commodity price trends
- Indirect expenses: Generally speaking, indirect expenses can be reduced by 10-15% for a mid-market company. Look to segment indirect expenses into key spend areas and also look for “hidden” procurement spend in areas such as p-cards. Areas like employee benefits can also provide meaningful cost savings. Transportation (if a meaningful expense) can also be easily optimized to create value
- If the target company is a platform, potentially wait till additional M&A is conducted to gain improved volume-based pricing leverage. If the target company is an add-on, the potential opportunity can be larger depending on the spend overlap with the purchasing company
By utilizing the approach above as part of their due diligence, PE firms can uncover margin improvement opportunities within the target company's procurement function. Detailed analyses can also be conducted to estimate the opportunity and potentially underwrite a portion of that in the deal investment thesis.