Lionbridge has recently been in the news as the story of their “agreement” to be acquired by H.I.G. Capital spread. I thought it would be useful to examine more closely what Private Equity is, and what they do since I found much of the commentary on the Lionbridge deal unclear, unsatisfying and quite unlikely to be accurate as they seem to overlook why PE gets involved at all. I thought that while I am at it, let me also add Luigi’s opinion which is also not a translation industry mainstream opinion, to provide alternate perspectives to the ones we have been hearing.
From my early business career when I worked close to Wall St. and institutional investment, private equity meant firms like Kohlberg Kravis Roberts, The Blackstone Group, and Apollo Global Management. They were often called corporate raiders, and, in fact, they made a movie about a PE raider, called Wall Street, where Hollywood made PE rock stars like Gordon Gekko, look bad, and suggested he/they lived by an ethos that “greed is good”, destroying companies to extract a few million dollars to buy a private yacht. Maybe that was an exaggeration, but it is true, that PE generally went into companies that they felt were undervalued or under-performing and went in and “cleaned up and improved the situation”. They showed them “how to do it right” as Frank Zappa would say. In fact, there is research that suggests that private equity investors are corporate doctors. Perhaps things have changed since the 90’s, and now Private Equity is a much more friendly and fluffy experience, but my ample gut tells me that generally investors want to make money, and they don’t acquire assets to get a board seat and hang out with the management. They generally want change that results in them making MORE money.
An informative Harvard Business School draft paper provides some insight on the whole Private Equity view of the world. Given that they base their observations on a study of 79 PEGs (Private Equity Groups) with $750B under management suggests to me that there could be some truth here. Top Private Equity Companies are listed here HIG Capital who acquired LIOX is #70 in this list.
What do Private Equity firms do?
PE firms typically buy controlling shares of private or public firms, often funded by debt, with the hope of later taking them public or selling them to another company in order to turn a profit. Private equity is generally considered to be buyout or growth equity investments in mature companies.
What do PE firms do after they invest?
PE firms typically take three types of value increasing actions — financial engineering, governance engineering, and operational engineering. These value-increasing actions are not necessarily mutually exclusive, but it is likely that certain firms emphasize some of the actions more than others.
In financial engineering, PE investors provide strong equity incentives to the management teams of their portfolio companies. At the same time, debt puts pressure on managers not to waste money. In governance engineering, PE investors control the boards of their portfolio companies and are more actively involved in governance than public company directors and public shareholders. In operational engineering, PE firms develop industry and operating expertise that they bring to bear to add value to their portfolio companies.
In fact, because PE firms often fund investments with debt, they are usually very concerned that these investments can service the debt organically i.e. without injecting in more money. So they are often all about cash flow and look for companies that can service the debt while they do their restructuring magic. It is said that they have a pretty strict requirement on return and look for internal rates of return that are in the 20–25% range. The Harvard paper suggests that there is often evidence of both financial and governance engineering. PE investors say they provide strong equity incentives to their management teams and believe those incentives are very important. They regularly replace top management, both before and after they invest. And they structure smaller boards of directors with a mix of insiders, PE investors, and outsiders. These boards are much more concerned about real progress and have much more clout and impactful involvement than in a “normal” public company setting where a board may allow a non-performing CEO to sit for 17 years without asking any probing questions.
There is evidence that the sweet spot for private equity is a company doing okay in an industry whose fortunes are about to improve dramatically.
Several characteristics of the PE business model directly impact the operations of their portfolio companies:
- First, private equity investments are illiquid and more highly leveraged than investments in publicly traded companies–hence, riskier. They need to yield high returns to be worth undertaking.
- Second, the high debt that portfolio companies must service means they must quickly achieve an increased and predictable cash flow. Cutting costs by squeezing labor is the surest way to accomplish this.
- Third, the PE model is the opposite of “patient capital.” While limited partners make a long-term commitment to the PE fund, portfolio companies have only a short time to show results to the general partners.
- Finally, PE will not undertake long-term investments in its portfolio companies unless capital markets are efficient and reward such investments with a higher price when the company is sold. There are definite incentives to turnaround investments as quickly as possible to maximize internal rates of return.
So the research definitely seems to suggest that HIG is not here to just be in the wonderful language loving translation business. They want returns, and they probably want returns soon. As they say on their website: Flexibility, speed of execution, and delivering on commitments are our hallmarks.
Private equity firms typically excel at putting strong, highly motivated executive teams together. Good private equity firms also excel at identifying the one or two critical strategic levers that drive improved performance. They are renowned for excellent financial controls and for a relentless focus on enhancing the performance basics: revenue, operating margins, and cash flow. Plus, a governance structure that cuts out a layer of management — private equity partners play the role of both corporate management and the corporate board of directors — allows them to make big decisions fast.
The following data certainly suggests that Lionbridge (LIOX) was a lackluster if not a failing public company. At no point in the last 10 years did the company market valuation ever reach it’s revenue levels. This is usually a sign that something is not quite right. But the LIOX board sat with this for over a decade. Its market value is terrible even relative to other peer translation companies as the table below shows. In October 2008 the $500M revenue company had a market value of about $70M! It is surprising that HIG is apparently, making no real management and strategy changes, and from all reports will continue with the same management and the same strategy. Some additional things to note:
- The company is being sold for close to the highest value it has had in 10 years and investors in LIOX must be sighing in relief that they did not use an average of the stock price of a longer time period to establish the acquisition price.
- The management team has been mostly the very same for the last 17 years and is said will remain in office.
- The CTO, Eric Blassin, very suddenly left and joined TransPerfect as Luigi has pointed out in his comments below.
- Lionbridge has made less than $50 million net income in total from 2011–2015. This is less than 2% of revenue which I suppose is better than losing money.
Perhaps HIG does not really want to discuss their real plans at this point. As a Limited Partner, I would certainly be concerned about the rationale behind this investment, if no changes are planned, and you are simply expecting to ride the coming translation industry wave of growth. But stranger things have happened, and we do live in a world where the #americanbuffoon Don Trump is the next President of the US.
Interestingly, we now have an attempted action by some investors who think the price is too low and want more cash! Luckily for them a 10-year average was not used as the takings would be a lot slimmer. The odds of this class action suit leading to any changes are pretty slim, since the data overwhelmingly suggests that the investors were lucky to get $360M.
Private Equity investing regularly in an industry is usually a sign that they think that things can be done better (more efficiently, effectively, profitably) and that they can expedite this. We shall have to wait and see if big changes are indeed made, or wait and see if we suddenly start seeing really savvy and skillful execution, and market-leading strategy coming from Lionbridge. That is rare enough that we would all notice. ;-)
I think it is also pretty safe to say that when a private equity firm gets involved with a translation company, it is a clear signal that the PE firm thinks that the company in question can be run more efficiently, and they believe strongly enough in this possibility that they would be willing to put some money on it and prove it.
You can see more analysis and Luigi’s take on this at: Private Equity, The Translation Industry & Lionbridge