Carving out the “Trapped Asset”
My colleagues and friends at GenNx360 Capital Partners, get most of the credit for this weeks blog entry which looks at how a corporate owner can deal with a non-core business in a way that maximizes value for the shareholders and preserves long-term viability of the business for employees, management and other stakeholders.
In a recent white paper, Art Harper, Founding Partner and Chuck Castine, Operating partner at GenNx360 put forward a method for corporate owners of non-core businesses to work with an operations oriented private equity firm in freeing up the value of “trapped assets” as they term them. The white paper can be read directly from the home page at the GenNx website.
In summary, many businesses have one or more trapped assets, although they almost certainly will not refer to them as such. The trapped asset is a business that perhaps was once core to the strategy of the parent, but is no longer. It is delivering cash to the bottom line, so is not causing particular pain to anyone in the organization. However, as it is not core it is not receiving management attention and is getting maintenance levels of investment at best. As a result the business is losing ground to competition and not participating in the growth technologies or geographies that the market leaders are. There is, however, no great rush to sell the business as it is still cash positive and there is a concern that an adequate value will not be realized for the business, but neither capital not nor management time is going to be invested in “sprucing up the non-core business for sale”.
In the trapped asset play, a private equity investor will buy a majority share, 50% +, of the non-core business and then work with the units management to restructure the business, putting in additional capital as necessary to bring the unit up to a point where it becomes a much more attractive acquisition target for the other competitors in the market. At this point, the asset is off the parent’s balance sheet. After the restructuring period, the business is sold and both owners (i.e. The PE firm and the original parent) cash out together. In this way, the owner gets two bites at the apple and the business is preserved and grown to a much stronger position. Of course, not any PE firm is capable of doing this. Operational skills and experience are essential and much more important than the financial skills associated with the carveout itself.
Some of our work in identifying such trapped assets has found situations such as that described in the charts below. The trapped asset started life as the core business of the company. Gradually, over a period, often of decades, but sometimes as little as 5 years, the focus of the parent changes and the once core business finds itself less and less important from an earnings perspective to the parent.
EBITDA Contribution to Parent:
As a result, the investment in the business slacks off and the performance of the business lags relative to the market in which stronger players are dominating. The chart below shows how a recent “trapped asset” failed to keep up with a market growth that its competitors were enjoying.
Trapped Asset “Growth”:
In light the of the above situation, the parent faces a dilemma, keep the asset (i.e. “do nothing”) or sell it. Neither option is appetizing for the reasons outlined above. Now, there is a third option which is made possible by working with an operationally adept private equity investor.
In summary, the trapped asset play is not for every parent and certainly not for every PE company. We encourage our readers to go to the original GenNx white paper and consider whether this may be of interest to them.
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