Is value creation more abundant in the middle market?

Leverage is becoming a smaller part of value creation for private equity investors, while interest rate increases are making multiple expansion more difficult. This means the best general partners (GPs) are increasingly focused on operational improvements as they aim to boost returns and performance. The private equity (PE) middle market is, says Titanbay, offering a fertile hunting ground for investors to create value.

MORE ROOM TO MANOEUVRE

The middle market (companies with enterprise values of between $100 million and $2 billion) can offer greater opportunity for value creation, as it consists mainly of businesses that are innovative and growing. Often, they are more agile than larger private or public companies. While they are usually relatively well-established, stable and profitable compared to smaller companies, mid-market firms are often relatively early in their corporate lifecycle, so may still be operationally less sophisticated. They may also be led by smaller, less-experienced management teams that lack the expertise to make changes that could take their companies to the next level.

For mid-market GPs, such characteristics can be attractive. Using their own skills and deep industry knowledge, they may be able to put in place strategic initiatives and make efficiencies in businesses that have greater scope for operational improvements. For example, an experienced GP can provide management guidance and mentorship to help firms hone their business offerings. Particularly for mid-market companies with already established products or services, PE investment can finance quicker growth and expansion than companies might achieve by waiting for it to happen organically. For businesses operating in competitive markets, this can be especially helpful, as agility and speed can provide an advantage.

THE VALUE OF DEDICATED TEAMS

With more managers spotting opportunities in the middle market, the number of teams devoted to operational value creation has risen in recent years.

Usually, these comprise professionals with deep strategic and operational expertise. They are solely focused on operational value creation, during both the due diligence and investment hold periods. The companies that emerge from this high-touch operating approach are often professionalised and well-structured business-category leaders with higher multiple expansion. In combination with value creation that has already taken place, this can make them attractive targets for larger buyout managers.

OPERATIONAL DRIVERS OF VALUE

As mentioned, GPs can use several levers to professionalise businesses. For example, they can drive organic growth by:

• Enhancing a firm’s sales and marketing

• Optimising product pricing

• Refocusing a company’s research and development

• Enhancing its management

• And controlling costs.

Of course, GPs can employ all these strategies in larger companies, but mid-market businesses are typically more agile and less complex. As such, they can make these types of strategic shifts more rapidly.

Mergers and acquisitions (M&A) is another common way for GPs to drive growth and improve margins in portfolio companies and, again, they can undertake this type of activity more quickly and easily in mid-market companies. Transformational M&A is much easier to execute in this area, while the fragmented nature of the middle market provides a broader universe of smaller target companies for add-on M&A.

IN SUMMARY

As part of a well-balanced private market portfolio, exposure to mid-market private equity can bring many benefits, some of which derive from GPs’ potential  to create value more quickly and easily than in other spheres. 

To find out more, read the full report.

Important disclosures
This material has been prepared by Titanbay Ltd and its affiliates (together, “Titanbay”) and is provided for information purposes only. This document is directed at professional investors and qualified investors who have sufficient knowledge and experience to understand the risks of investing in private market investments.

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