Has Spend Management Saved KKR and Other PE Firms From Disaster?

Earlier today, it became known that Kohlberg Kravis & Roberts Co (KKR) ran into additional difficulty listing their shares on the NYSE, according to the Wall Street Journal and other sources. Perhaps this is no surprise given that KKR lost over $1 billion in 2008 as several of their investments declined in value. In this regard, the Journal notes that KKR is "currently valuing several of its largest buyouts, including utility TXU and payment processor First Data, at steep discounts to where it acquired them." But might these new valuations -- and KKR's overall value -- be even less if they did not take on a key role in driving operational cost reduction initiatives within their portfolio companies?

Having spoken to a number of advisers and consultants serving the PE market in recent years (KKR included), I can say with near certainty that these firms are taking an aggressive stance at driving cost reduction programs within their portfolio companies, in some cases even building internal strategic sourcing and lean teams to drive these efforts (besides simply relying on consultants). While many of these efforts have been kept hush-hush behind the scenes, there's no doubt that funds of all sizes -- and serving all segments of the market -- are getting serious about helping their portfolio companies to reduce their operating costs.

In an earlier column on private equity and Spend Management I wrote that "it's sometimes possible to have a huge EBITDA impact merely by targeting a handful of category sourcing or lean initiatives, increasing valuations by as much as 1.5x-3x depending on given industry multiples. Even though many investors are not lean or direct materials sourcing experts, they get it. And they're increasingly bringing in operational experts -- often ahead of new sales and marketing staff -- to help create new value." What are other techniques PE firms are using? Indirect spend aggregation and supplier rationalization have both been tried.

One of the great ironies of private equity involvement in Spend Management is that many of the working capital management problems faced by their portfolio companies were entirely self-inflicted by saddling their investments with debt (either to consummate initial transactions or to provide for cash payouts to the PE firms as in the case of Blackstone's shenanigans with Orbitz). But at least by instilling a good sense of cost reduction and working capital management religion in their portfolio companies, they'll reduce the need for additional borrowing -- while possibly magnifying their fund's potential returns by an order of magnitude. Who ever thought that a procurement or operations expert with a Michigan or Arizona State MBA would be more valuable to a PE firm's portfolio than a Wharton or HBS stuffed shirt? Well, in this market they certainly are.

Jason Busch

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