GenNx360's Trapped Asset Play


Two Bites of the Apple to Create Value
By: Chuck Castine
and Art Harper


Executive Summary

Every CEO has one – a business asset in the portfolio that is not strategic. It is acceptable in delivering net income and cash flow – but really not core to the strategic mission of the corporation. It is also difficult to articulate the growth strategy to shareholders and analysts because there isn’t one. It is not desirable to put a significant amount of time and energy into selling the business because it may not attract an acceptable multiple. Moreover, to invest in growing or restructuring the non-core business to achieve an acceptable multiple diverts capital and human resources from the remaining group of strategic businesses within the company’s portfolio.

What should be done? Label it a cash cow and ignore it? Yes, but that only works for as long as you can punt those board questions about the plan for the non-core asset. GenNx360 Capital Partners has developed a better, proactive solution – the "Trapped Asset Play."

Large and mid-market companies have businesses or divisions that over time have moved into the category of becoming non-strategic to the current or long term direction of the company. This happens as a result of either a non-competitive cost structure that has developed over time or a recent acquisition that brought over components that are not critical to the strategic mission of the acquiring company.

Assets labeled as non-strategic or non-core may still be delivering some revenue growth along with net income and positive cash flow, but they are often neglected and generally treated as orphans within the existing corporate structure. They receive little to no investment, operating managers along with the HR team avoid putting the best talent in the orphan, and employee morale suffers due to the neglect from the parent. Over time, product performance and service begins to stagnate and customers begin to move to suppliers they sense are more committed to them and their markets. In time, the orphaned asset loses market value relative to its book carrying value. The asset finally becomes a drag on the parent company’s stock valuation and a diversion to management attempts to focus on the strategic direction of the overall business.

Once the impact of stagnation is realized, efforts to improve the non-core unit "in place" will dilute the capital and human resources that should be available to corporation’s core businesses. Such an activity will create challenges in communications to investors and employees with respect to the true strategic direction of the company. An attempt to sell the business as is, will result in the realization of a lower market value than what would have been achieved had the asset been sold when as it was recognized that there was no longer a strategic fit. In a majority of the cases, this value is below book value. At this point, the parent company has what is commonly referred to as a "trapped asset." It is unable to be sold at a satisfactory price and is very problematic to fix in place.

Traditionally, in dealing with a "trapped asset" management teams have considered the following three options…none of them optimal:

A. Do Nothing…delay and continue to harvest the business but provide no investment. As a result, the business does not attract the best talent and the market value of the business continues to fall. Management convinces itself that the income and cash provided by the business helps it continue to fund the strategic direction of the corporation.

B. Announce A Divestiture…often a major decision for a publically traded company. After such an announcement, the business must be placed in discontinued operations and the divestiture must be completed within one year from the time of announcement or the business must be placed back into continued operations. More often than not, this will result in a significant market discount in order to complete the divestiture.

C. Privately Look For A Buyer…publically announce that strategic alternatives are being evaluated and attract inquiries from potential strategic or private equity buyers. This is the least attractive alternative because it diverts operating management time and raises more questions on when and how the issue around the non-core asset will be finally settled.

A potential solution to this dilemma lies in the "trapped asset" concept. This approach is built on partnering with an industry knowledgeable, operationally skilled, and culturally compatible private equity investor who can execute on a turnaround of the non-core business and generate value: such a partner can buy a majority share of the non-core business. The parent company stays in for the remainder. Without diverting the parent company’s strategic focus, the private equity company does the restructuring, reenergizes the management team, intensifies the industry focus, and increases the value of the business.

When the private equity company finally sells the asset after three to five years, the parent gets "another bite of the apple" in the form of a gain on its minority holdings that compensates for the earlier discount.

The "Trapped Asset" Problem

Parent companies, in general, have serious reservations about the "trapped asset" concept. Public or well established private companies lack confidence in traditional private equity companies to execute operationally and remain in alignment with the interest of parent company’s minority interests.

More specifically, the parent company generally has problems with the short term and financial engineering focus of private equity. In addition, there is concern over the organizational chemistry and comfort (the fit) with private equity partnership managers. There is the perception that private equity managers are not business operating people who speak the business operating language; thus, there is generally a lack of trust between the two cultures. As a result, the public or private company would rather not be bothered with the aggravation of trying to make a fit work and will continue to limit their choices to options A, B or C above.

GenNx360 Capital Partners represents a new generation of private equity, or as we like to refer to this generation, Private Equity 3.0. GenNx360 is a private equity company with an operations DNA. Many of its partners have spent their entire careers in major corporations, running P&L businesses. GenNx360 believes that it can and will get around the problem of "fit" with major public or private corporations and focus a serious conversation around the parent company taking a minority interest in the non-core business they currently own.

Dealing with "Trapped Assets"

For many companies, dealing with "trapped assets" is a tough challenge, especially given the need to consistently deliver EPS targets on a quarterly basis. In addition, for most of these "trapped assets," there will be little, if any, capital available to allocate for required restructuring. The answer for many companies in this situation is to assign their best operating talent to these businesses and ask them to take on the challenge of fixing the "trapped asset" or "treading water" while preparing the asset for sale.

There’s never a long line of volunteers for these assignments!

Because several of the GenNx360 partners have had 30+ year careers at GE, retiring at levels of Vice-Chairman, EVP, VP and equivalent, they have, on a number of occasions, been that assigned volunteer! Experience has taught them that these "trapped assets" can be transformed and prepared for divestiture much faster and with less pain in the organization if they were not under the pressure of quarterly EPS performance.

Many of them in this situation would have loved to have had a private equity firm acquire a majority equity share of these "trapped assets" allowing them to maintain a minority equity share. In this arrangement, they would have allowed the private equity firm to restructure these businesses. While they may have had to take a financial write-down on the initial transaction, they would have a second chance, or as we like to say "a second bite of the apple" in the sale of the business to recover any losses and break even or, better yet, to make a gain.

So why didn’t they ever execute this strategy? The answer to this question is simple.

During the time that GenNx360 partners spent working in large corporations, they simply never saw a private equity firm that they believed had the right team with enough global and industrial operating experience to run and restructure businesses and at the same time be an easy fit within the corporate culture. So, even though they knew that private equity’s non-public structure would allow them to accomplish this task faster and with less pain than they could, they would never execute on a "trapped asset" strategy.

The Solution

This is where GenNx360 is different from other legacy private equity firms. Given their strong industrial operating experience inside Fortune 100 companies, its partners have the proven experience in restructuring, fixing, and growing businesses that they had always hoped they could have seen done in the private equity framework.

Based on this experience, GenNx360 developed the Self Funded Reinvestment (SFR) process which allows for this type of restructuring work on a self-funded basis – without any restructuring dollars from the parent company! SFR is a process for first aligning costs and revenues of a business and then investing in the business to drive core revenue and EBITDA growth.

The operating partners within GenNx360 have a proven track record of successfully improving, restructuring, and fixing "trapped assets."


Implementation…Executing the "Trapped Asset Play"

Just having the experience and proven track record of transforming "trapped assets" to create value alone is not enough to successfully execute the "trapped asset play."

Because the "trapped asset play" will result in having two owners for the "trapped asset" until exit, it will require the two owners to work closely together. Therefore, in addition to execution capability, cultural fit between the two parties will be extremely important.

As a result, GenNx360 works hard to assess and get comfortable with this cultural fit before entering into each of these deals.

While GenNx360 will always prefer to keep the current management in place in each "Trapped Asset Play," the firm is not uncomfortable with putting in new management, if necessary.

Once it becomes the majority owner, GenNx360 will become very involved in executing the SFR process to transform the business and create true enterprise value. Its partners will leverage their significant network to assist the business in securing new business. Finally, to ensure alignment of interests, they will remain engaged with the parent company’s CEO and Board of Directors at a level acceptable to all parties.

Their approach will always be to roll up their sleeves and get involved to successfully execute their SFR approach without micromanaging the business.

Appendix

Bios of the Authors:

Charles Castine
Partner
Operations

Chuck is a partner of GenNx360 Capital Partners. He brings over 30 years of experience in sales, business operations, and competitive strategy, specializing in leading businesses through market changes while improving both profitability and customer service.

Prior to joining GenNx in 2006, Chuck was the president of the Integrated Services Business for Alliant Energy Corp, a $3 billion electric & gas utility. Tasked with turning around and improving a deregulated business, Chuck achieved both profitability for his unit and an increase of over 25% in overall revenue growth.

Chuck spent almost 3 decades with General Electric serving in various sales, technology, and operating roles with increasing responsibility culminating in his promotion to corporate officer and the Vice President of the Consumer Service Division for the GE Appliance Business where Chuck led a global business of more than 3,000 employees with over $500 million in parts manufacturing and distribution and yearly service revenue and warranty support for its worldwide operations. By completing a $30 million restructuring program, he restored the service business delivery processes to compete profitably in highly competitive markets and revamped the overall appliance business focus from a manufacturing/complaint management culture to being driven by customer satisfaction. Chuck was able to drive over $25 million in annualized cost savings while at the same time increasing both margins, sales growth, and customer satisfaction.

In his other roles, such as New Product Development & Introduction, Sales Force Management and Program Development, running a national engineering and construction business focused on building power plants, new power generation equipment installation, and maintenance of existing plants, Chuck was able to drive revenue, income, and productivity growth.

Chuck earned his B.S. in mechanical engineering from Texas A&M University, where he was later inducted in its Academy of Distinguished Graduates in Mechanical Engineering and served on the University's Engineering Advisory board.

Arthur H. Harper
Founder
Managing Partner

After a successful 27 year corporate career with the last 21 years at GE, Art founded GenNx360 Capital Partners in January 2006.

In his last corporate role, Art was a senior vice president in GE and President & CEO of GE Equipment Services – a $6.5B global business. In this capacity, Art was responsible for a portfolio of 7 global businesses with operations in over 19 countries. He was also a member of the GE Capital board and a member of GE’s Corporate Executive Council.

Earlier at GE, Art did two successive P&L expatriate assignments including first living in Hong Kong and running GE Plastics Greater China and then moving to Belgium as Vice President of Global Manufacturing for GE Plastics and then being promoted to run GE Plastics Europe, India, and Africa.

Before joining GE in 1984, Art spent the first 6 years of his career with Conoco, Inc. and DuPont in various sales and marketing roles.

Art earned a B.S. in chemical engineering in 1978 from Stevens Institute of Technology in Hoboken, New Jersey – his home state.

Art is recognized as a proven leader and has been honored with a number of awards including the 2004 GE Chairman’s "Turn Around of the Year Award," the 2005 Black Enterprise Magazine honor as one of the "75 Most Powerful African Americans in Corporate America" and the 2005 Award for Professional Achievement by the 100 Black Men of Stamford, CT.

As part of his strong belief in giving back, Art is involved with and sits on several non-profit boards, all focused on improving the future lives of minority kids. In his spare time, Art is an avid reader and jazz collector known by his friends for his "Jazz Forever" signature signoff.

Profile of GenNx360 Capital Partners

Our management firm and its $600 million first fund launched in 2006.

As a Private Equity 3.0 firm, we invest in proven, industrial B2B companies in the middle market sector, then assist in their operational transformation into great performers, as the best way to generate and sustain superior investor value in today's environment.

Unlike firms that are generalist investors, deal shops, and money managers who are somewhat hands-off, we are operating managers and industry insiders who are hands-on and specialized. We apply leading operational insights, strategies, skills and connections across the board to successfully buy, guide, grow and sell these industrial B2B companies.

GenNx360 Capital Partners has a global team and presence of 25 professionals in the U.S. and India. Coupled with a global relationship network of top financial and operating executives, the firm is a thought leader on building core enterprise value.

Investment Criteria*

Company Size:
Revenue: $75- $500 million
EBITDA: $10-$40 million

Transaction Size:
$50-$400million

Equity Investment Size:
$25-$100 million

Industry Focus:
• Specialty Chemicals & Engineered Materials
• Business Services
--BPO; Asset-light Logistics
• Industrial Machinery & Equipment Components
--Products & Services
• Global Transportation Component Parts & Services
--Aero, Auto, Rail
• Industrial Water Treatment
--Equipment & Services

* Add-on parameters may be smaller