Description
In this detailed criteria in regard to when targets are missed.
16 | FINDINGS | Summer 2014 Summer 2014 | FINDINGS | 17
WHEN TARGETS
ARE MISSED
I
n February 2000, 3i and Gresham
Private Equity acquired UK parcel-
delivery business Target Express
from its three founders for £220m.
The PE firms had grand ambitions
for the company. Target Express was
a £135m-turnover business with a
focus on the business-to-business (B2B) market
in the UK. Gresham and 3i saw an opportunity to
push Target Express into the rapidly growing
business-to-consumer (B2C) space.
Unfortunately for 3i and Gresham, the
investment did not quite go to plan. The buyout
firms did eventually exit the company, but only
after a resource-intensive turnaround.
Following the exit, Michael G Jacobides,
Sir Donald Gordon Chair of Entrepreneurship &
Innovation at London Business School, prepared
a case study now taught in the school’s popular
“Managing Corporate Turnarounds” elective.
Jacobides says that the purpose of the case
study is to provide guidance on some of the
common errors that buyout firms make when
they do deals and in their responses to any
worrying signals of failing investments.
“Target Express is a good example of a deal
that went awry and required a turnaround,” he
says. “The point of the case study is not to say
that the PE firms screwed up, but to understand
what can go wrong, what can be overlooked in a
deal, and, if things go wrong, how to fix them.”
Revenue is vanity; profit is sanity
One of the first mistakes made by the PE
investors, the case study found, was focusing on
growing revenues at the expense of remaining
profitable. At the time of 3i and Gresham’s
investment, B2C was seen as the major driver of
growth in the industry thanks to the rising
popularity of online shopping. However, as
in many over-hyped sectors, profits were
(and are) elusive.
The two firms wanted to capture this growth
and, after investing in Target Express, focused
on increasing sales – especially by expanding
into B2C. Target Express opened up a new
warehouse in Coventry to support these
ambitions and signed a deal to take on deliveries
for Dell, the leading computer manufacturer.
However, although the B2C market was
growing, it was difficult to make a profit. There
was a higher risk of delivery failure due to
potential problems such as obscure addresses
and recipients being out at the time
of delivery. Target Express also lacked the
infrastructure to deal with the large volumes of
returned products, which led to growing
dissatisfaction with service levels.
Target Express’s focus on growing revenues
in B2C hurt profitability. Salespeople were
incentivised to boost revenues and had great
freedom to set prices. As a result, the company
soon found itself with rapidly eroding margins.
Case study
“Expanding a business into a new area that
promises growth can be deceiving,” says
Jacobides. “Growth does not always correlate
with profitability. The challenge for PE firms is to
develop a more active method for testing growth
assumptions, both in terms of how profitable the
market can be and whether a firm’s capabilities
are well suited to different environments.”
As it turned out, Target Express’s IT systems
were not sophisticated enough to track the costs
of deliveries and determine optimum pricing
levels. The founders of the company held this
knowledge exclusively, and they had left the
business following the buyout. For Jacobides,
this demonstrates the importance of recognising
the value of outgoing owners, as the business
knowledge they possess can be crucial for a
company and difficult to replace. When Target
Express’s founders left, so did the contract-
pricing algorithms. “It’s easy to underestimate
the value of institutional memory,” says
Jacobides. “There is always a risk of overlooking
how much value can be lost if the founders go.”
In 2001, a year after the acquisition, sales at
Target Express had increased by 15%, but there
was a 30% decrease in EBITDA compared with
2000. The company’s net working capital had
also been drained, and stood at a negative
£200,000. In October 2001, Target Express
could not make the interest payments on its debt
due to cash-flow problems, and breached its
banking covenants. 3i had to negotiate a six-
month standstill with Target Express’s banks and
mezzanine lender ICG in order to undertake a
financial restructuring.
Keeping up appearances
Following the breach, 3i dismissed Target
Express’s finance director, sales director and
operations manager. The chief executive was
retained and a new finance director appointed.
Strategy was left unchanged at this point.
The banks and ICG, however, were unhappy
with the management changes and did not
believe that the company could meet its targets.
ICG approached David Hoare, who invested in
ailing companies with a view to turning them
around, to conduct a management review of
Target Express on its behalf.
One of Hoare’s key concerns was that,
although both an investigative accountant and
the company’s new finance director were
adamant that Target Express would miss its
budget for the financial year and breach
covenants again, the chief executive disagreed
and was convinced that hitting targets would not
be a problem; he felt that, despite the business
being behind schedule, it would catch up
because the necessary changes had been made.
Indeed, Hoare would later find out that the
chief executive had been worried all along about
making the budget, but had been reluctant to
relay this to the PE investors as it could have
placed his position at risk.
This is another key lesson from the Target
Express case from which other firms can
benefit. “The information that flows to a PE firm
can be garbled by stakeholders who want to
support the new strategy,” says Jacobides.
“If someone is determined to deliver on a
certain strategy, there is a risk that they won’t
relay bad news. That makes it difficult to keep
things on course.”
Top turnaround tips
What 3i did next is an example of what
PE firms should do when a portfolio company
has run into difficulties. Hoare took on the
chairmanship of the company and
immediately communicated to the banks,
ICG and PE investors that Target Express
would not hit profit targets. His philosophy
was to communicate bad news early – and,
at the same time, put forward a plan to
address the problems.
Hoare also shifted the focus of the
business away from B2C and back to its
core, profitable, B2B operations. He brought in
a new chief operating officer and made cash
flow a priority, but also focused on service
quality and cost. The company set a target of
reducing debtor days from 60 to 30 and cutting
working capital from £14m, while ensuring that
service – a key driver of customer loyalty and
margins – was preserved.
“In a distressed situation, a firm should
refocus on its core business, make cash a
priority, identify a clear and simple set of
priorities and have the patience to sit it out and
wait for the company to turn,” says Jacobides.
3i moved quickly to support Hoare’s
turnaround plan. It took a £50m write-off and
injected an additional £10m into Target Express
to fund the turnaround.
“When 3i saw that the original strategy
wasn’t going to work, it took the bold decision
to support the restructuring, and put in
£10m of fresh money,” says Jacobides. “It
made an excellent return on that money and
recovered a reasonable amount of its initial
outlay. This shows how firms can turn a
challenge into an opportunity and make
money from a distressed situation. It is so
important for PE firms to act quickly, while
they can still influence a situation. Investors
need to make changes happen. Waiting
erodes the upside from any recovery.”
In November 2006, Target Express was sold
to Rentokil for £210m. The firm’s working
capital had been reduced from £14m in 2003
to £1m in 2006 and debtor days were down to
30 days from 60. Sales, having remained flat
initially, reached £140m in 2006 – 10% up on
the previous year. The turnaround strategy had
worked, and investors were duly rewarded.
Sadly, though, the new buyer arrogantly
assumed it “knew better”, and managed to run
both Target Express and CityLink, its own
parcel delivery business, into the ground.
A year ago, Better Capital bought the
combined firms for £1, and the effort to
stabilise and grow the business is ongoing –
a potent reminder that hubris and managerial
challenges are part and parcel of business life.
All the more reason for PE investors to
keep an eye out for problems in their portfolio
– before it’s too late.
“There is always
a risk of
overlooking
how much value
can be lost
if a business’s
founders go”
“It is so important
for private-
equity ?rms
to act quickly,
while they can
still in?uence a
situation”
“In a distressed
situation, a ?rm
should refocus
on its core
business and
identify a clear
and simple set of
priorities”
When delivery company Target
Express started running into
trouble, its backers had much
to lose. What were the lessons
for private equity from what
went wrong?
By Nicholas Neveling.
doc_619222007.pdf
In this detailed criteria in regard to when targets are missed.
16 | FINDINGS | Summer 2014 Summer 2014 | FINDINGS | 17
WHEN TARGETS
ARE MISSED
I
n February 2000, 3i and Gresham
Private Equity acquired UK parcel-
delivery business Target Express
from its three founders for £220m.
The PE firms had grand ambitions
for the company. Target Express was
a £135m-turnover business with a
focus on the business-to-business (B2B) market
in the UK. Gresham and 3i saw an opportunity to
push Target Express into the rapidly growing
business-to-consumer (B2C) space.
Unfortunately for 3i and Gresham, the
investment did not quite go to plan. The buyout
firms did eventually exit the company, but only
after a resource-intensive turnaround.
Following the exit, Michael G Jacobides,
Sir Donald Gordon Chair of Entrepreneurship &
Innovation at London Business School, prepared
a case study now taught in the school’s popular
“Managing Corporate Turnarounds” elective.
Jacobides says that the purpose of the case
study is to provide guidance on some of the
common errors that buyout firms make when
they do deals and in their responses to any
worrying signals of failing investments.
“Target Express is a good example of a deal
that went awry and required a turnaround,” he
says. “The point of the case study is not to say
that the PE firms screwed up, but to understand
what can go wrong, what can be overlooked in a
deal, and, if things go wrong, how to fix them.”
Revenue is vanity; profit is sanity
One of the first mistakes made by the PE
investors, the case study found, was focusing on
growing revenues at the expense of remaining
profitable. At the time of 3i and Gresham’s
investment, B2C was seen as the major driver of
growth in the industry thanks to the rising
popularity of online shopping. However, as
in many over-hyped sectors, profits were
(and are) elusive.
The two firms wanted to capture this growth
and, after investing in Target Express, focused
on increasing sales – especially by expanding
into B2C. Target Express opened up a new
warehouse in Coventry to support these
ambitions and signed a deal to take on deliveries
for Dell, the leading computer manufacturer.
However, although the B2C market was
growing, it was difficult to make a profit. There
was a higher risk of delivery failure due to
potential problems such as obscure addresses
and recipients being out at the time
of delivery. Target Express also lacked the
infrastructure to deal with the large volumes of
returned products, which led to growing
dissatisfaction with service levels.
Target Express’s focus on growing revenues
in B2C hurt profitability. Salespeople were
incentivised to boost revenues and had great
freedom to set prices. As a result, the company
soon found itself with rapidly eroding margins.
Case study
“Expanding a business into a new area that
promises growth can be deceiving,” says
Jacobides. “Growth does not always correlate
with profitability. The challenge for PE firms is to
develop a more active method for testing growth
assumptions, both in terms of how profitable the
market can be and whether a firm’s capabilities
are well suited to different environments.”
As it turned out, Target Express’s IT systems
were not sophisticated enough to track the costs
of deliveries and determine optimum pricing
levels. The founders of the company held this
knowledge exclusively, and they had left the
business following the buyout. For Jacobides,
this demonstrates the importance of recognising
the value of outgoing owners, as the business
knowledge they possess can be crucial for a
company and difficult to replace. When Target
Express’s founders left, so did the contract-
pricing algorithms. “It’s easy to underestimate
the value of institutional memory,” says
Jacobides. “There is always a risk of overlooking
how much value can be lost if the founders go.”
In 2001, a year after the acquisition, sales at
Target Express had increased by 15%, but there
was a 30% decrease in EBITDA compared with
2000. The company’s net working capital had
also been drained, and stood at a negative
£200,000. In October 2001, Target Express
could not make the interest payments on its debt
due to cash-flow problems, and breached its
banking covenants. 3i had to negotiate a six-
month standstill with Target Express’s banks and
mezzanine lender ICG in order to undertake a
financial restructuring.
Keeping up appearances
Following the breach, 3i dismissed Target
Express’s finance director, sales director and
operations manager. The chief executive was
retained and a new finance director appointed.
Strategy was left unchanged at this point.
The banks and ICG, however, were unhappy
with the management changes and did not
believe that the company could meet its targets.
ICG approached David Hoare, who invested in
ailing companies with a view to turning them
around, to conduct a management review of
Target Express on its behalf.
One of Hoare’s key concerns was that,
although both an investigative accountant and
the company’s new finance director were
adamant that Target Express would miss its
budget for the financial year and breach
covenants again, the chief executive disagreed
and was convinced that hitting targets would not
be a problem; he felt that, despite the business
being behind schedule, it would catch up
because the necessary changes had been made.
Indeed, Hoare would later find out that the
chief executive had been worried all along about
making the budget, but had been reluctant to
relay this to the PE investors as it could have
placed his position at risk.
This is another key lesson from the Target
Express case from which other firms can
benefit. “The information that flows to a PE firm
can be garbled by stakeholders who want to
support the new strategy,” says Jacobides.
“If someone is determined to deliver on a
certain strategy, there is a risk that they won’t
relay bad news. That makes it difficult to keep
things on course.”
Top turnaround tips
What 3i did next is an example of what
PE firms should do when a portfolio company
has run into difficulties. Hoare took on the
chairmanship of the company and
immediately communicated to the banks,
ICG and PE investors that Target Express
would not hit profit targets. His philosophy
was to communicate bad news early – and,
at the same time, put forward a plan to
address the problems.
Hoare also shifted the focus of the
business away from B2C and back to its
core, profitable, B2B operations. He brought in
a new chief operating officer and made cash
flow a priority, but also focused on service
quality and cost. The company set a target of
reducing debtor days from 60 to 30 and cutting
working capital from £14m, while ensuring that
service – a key driver of customer loyalty and
margins – was preserved.
“In a distressed situation, a firm should
refocus on its core business, make cash a
priority, identify a clear and simple set of
priorities and have the patience to sit it out and
wait for the company to turn,” says Jacobides.
3i moved quickly to support Hoare’s
turnaround plan. It took a £50m write-off and
injected an additional £10m into Target Express
to fund the turnaround.
“When 3i saw that the original strategy
wasn’t going to work, it took the bold decision
to support the restructuring, and put in
£10m of fresh money,” says Jacobides. “It
made an excellent return on that money and
recovered a reasonable amount of its initial
outlay. This shows how firms can turn a
challenge into an opportunity and make
money from a distressed situation. It is so
important for PE firms to act quickly, while
they can still influence a situation. Investors
need to make changes happen. Waiting
erodes the upside from any recovery.”
In November 2006, Target Express was sold
to Rentokil for £210m. The firm’s working
capital had been reduced from £14m in 2003
to £1m in 2006 and debtor days were down to
30 days from 60. Sales, having remained flat
initially, reached £140m in 2006 – 10% up on
the previous year. The turnaround strategy had
worked, and investors were duly rewarded.
Sadly, though, the new buyer arrogantly
assumed it “knew better”, and managed to run
both Target Express and CityLink, its own
parcel delivery business, into the ground.
A year ago, Better Capital bought the
combined firms for £1, and the effort to
stabilise and grow the business is ongoing –
a potent reminder that hubris and managerial
challenges are part and parcel of business life.
All the more reason for PE investors to
keep an eye out for problems in their portfolio
– before it’s too late.
“There is always
a risk of
overlooking
how much value
can be lost
if a business’s
founders go”
“It is so important
for private-
equity ?rms
to act quickly,
while they can
still in?uence a
situation”
“In a distressed
situation, a ?rm
should refocus
on its core
business and
identify a clear
and simple set of
priorities”
When delivery company Target
Express started running into
trouble, its backers had much
to lose. What were the lessons
for private equity from what
went wrong?
By Nicholas Neveling.
doc_619222007.pdf