July 2008 Private Equity Firms: Value Creation through ...

1 July 2008. Private Equity Firms: Value Creation through Services Globalization Private Equity firms (PE) have started to look beyond their roles as mere providers of capital. Companies are looking for true business partners, who can contribute significantly to business growth, operational excellence and providing management guidance. PE firms are investing billions of dollars in emerging markets. This is an opportunity for PE firms to provide capital infusion and help their portfolio firms to generate substantial Value by leveraging services globalization. In this paper, we look at various options available to PE.

2 Firms and the key success factors and risks that need to be managed in pursuing these options. In particular, we will look at the Shared Services model for Value generation. This publication contains copyrighted material. Please do not re-use or reprint anything within this document without written consent from Tholons, Inc. PE Firms: Value Creation through Services Globalization Introduction PE firms have transformed their roles over the years from being mere providers of capital to active participants in the Value Creation process of the portfolio companies. Many of the PE firms now take very active interest in the running of their portfolio companies, understand the businesses very well and bring significant management and operations experience to the table.

3 PE firms are taking active steps to enable their portfolio companies to achieve two key objectives: Growth and expansion Operational Excellence. The key areas of support that they provide the portfolio companies are - Develop and implement growth and expansion strategies Enter or expand into new services and geographies Provide networking opportunities to top management to gain access to a wider set of customers, suppliers and alliance partners Assist with the inorganic growth (M&A) strategies for the company Access to latest knowledge and industry best practices to improve operations Strengthening management team and corporate governance by bringing in external experts and consultants.

4 Background An integral part of PE firms' current focus in helping portfolio companies has been in the area of increasing adoption of global outsourcing. PE firms realize the potential benefits that could accrue by leveraging global outsourcing. We look at some of the strategies that PE firms are exploring to leverage the power of services globalization; both from a top line expansion and a bottom line optimization perspective. PE firms traditionally have the following strategies in order to gain economies of scale or reduce cost: - Strategy 1: Leveraging synergistic business opportunities across the portfolio companies - Strategy 2: Consolidation / Roll-up among the portfolio companies However, there is a potential third strategy that is increasingly being tested by the leading PE firms.

5 This involves pooling the strategic outsourcing initiatives of the portfolio companies into a common initiative that has substantially better chance at succeeding where individual efforts may not make sense. We will look at this third strategy in more detail later in the paper. 2008 Tholons 2 of 10. Strategy 1: Leveraging business opportunities across the portfolio Leveraging synergies across portfolio companies has been a fairly old concept. PE firms actively urge their portfolio companies to consider working with each other. For example, Intelenet, a Mumbai based BPO and a portfolio company of Blackstone, is believed to be in dialogue with over two dozen portfolio companies to carry out some of their back-office tasks from various offshore locations.

6 Similarly few of Sequoia Capital (the leading US venture capital firm) funded companies are also working together to carry out product development from offshore markets like India. However, these have been one to one relationships between individual companies. IT & BPO. Services Cross-Leverage Business Opportunities between Portfolio Companies Key Execution Risks 1. Mis-aligned Goals and Objectives: In case of services globalization, it is important to align the objectives of the outsourcer (client) to the service provider. In such a scenario, the client and service providers might pursue their own agendas and not enter into a fair client-supplier relationship.

7 This could influence the engagement right at the beginning and affect the final outcome. It is critical for the PE firm to ensure that they work with all the stakeholders to ascertain that the objectives are aligned and hence maximize Value generated for the portfolio companies and as a result for themselves. This is a challenging task given that the companies have different interests and goals. 2008 Tholons 3 of 10. 2. Sub-optimal solution discovery: If the PE firm pressurizes its portfolio companies to work with a particular service provider, an open solution discovery might not be possible. One of the key tenets of an effective sourcing process is the fair discovery of the solution from various suppliers and hence selecting the best solution for the client, which could also mean a customized solution based on inputs from two or more providers.

8 In such a case buyers, would not be able to get access to the best solution and hence diminish the returns. This will have a huge impact on the companies' goals of achieving the stated targets. 3. Sub-optimal price discovery A managed sourcing program could again hamper a fair price discovery. The client would not be able to gain access to the fair and transparent pricing and various pricing models. In such a scenario, the initiative would be sub-optimal for the client and as a result for the PE firm. Risk Impact on Client Impact on Supplier Impact on PE firm Mis-aligned goals and High High High objectives Sub-optimal solution High Low Moderate discovery Sub-optimal price High Low Moderate discovery A sourcing program gone wrong can cause serious issues for the management team of the client.

9 It can de-focus them from certain key growth and expansion initiatives at hand and utilize crucial bandwidth at correcting the outsourcing relationship. When the portfolio companies have reached critical size and scale, they usually are competent to carry out the sourcing initiatives on their own. However, such a model could work better for VC firms;. given that majority of their holding companies are early stage, small size companies. They lack the necessary expertise and sufficient scale to run and effectively manage global outsourcing programs. Add to this, they usually face challenges of skilled labor constraint and are under pressure to generate returns as quickly as possible for their share holders.

10 In such a scenario, if VC firms are able to provide a collaborative environment wherein an offshore product development company could provide necessary support and help launch products faster, it could be a win-win scenario for stakeholders. Strategy 2: Consolidation among portfolio companies Another trend that has been seen in recent times is the PE firms' focus on promoting consolidation among businesses of a similar nature among their portfolio. This helps businesses to gain credible size and scale enabling them to compete effectively in the global marketplace. From a PE firm's standpoint it helps them to increase the valuation of the businesses thus maximizing their returns.