Private Equity: A New Approach

This article originally appeared in Business Insider

July 20, 2011

By David Johnson, ACM Partners

The markets have opened up enough that deals are getting done, but challenges remain for private equity investors looking down the road and asking the obvious question: how to generate attractive returns in this environment?  Increasingly the answer has been a heightened focus on operations.

This pivot from the traditional (though somewhat dated) view of private equity as being an industry composed of senior deal makers and junior model monkeys has been driven by a number of developments:

  • The diffusion of key deal-making skills has eliminated any competitive advantage based on deal-making / financial engineering acumen (at least in mature private equity markets).
  • As Adley Bowen at Pitch Book has noted, there are currently 4,500 private equity portfolio companies.  Many of those companies are not alone in their niche but find themselves competing against other well-funded private equity portfolio companies.
  • The recession of 2008-9 forced many private equity firms to implement significant operational changes in their portfolio companies.  This trying experience instilled an appreciation for the centrality of an operations focus in an entire generation of private equity professionals.

Private equity firms are managing this dynamic in different ways.  Larger firms such as KKR have developed in-house units, as KKR has done with Capstone.  Across the PE spectrum the role of operating partner has become increasingly common.  And of course advisors are often relied on to either provide this core competency or supplement private equity firms’ in-house resources.

In the face of low-growth in developed economies the impact of boring but impactful initiatives such as book of business analyses, centralized purchasing, increased IT infrastructure, etc. has shown itself to be a significant driver of value.  Growth stories are more exciting, and it is always nice when the blocking and tackling of performance improvement can be combined with a return to growth, but sometimes that is not possible.

At the end of the day, style points matter less in investing than returns, and returns generated from making portfolio companies leaner still count.

The Never-Ending IP Struggle

This article originally appeared in Business Insider

July 14, 2011

By David Johnson, ACM Partners

Disney is releasing another Winnie the Pooh movie, and the occasion made me think of the peculiar intellectual property fight that has been raging over Pooh for some time.  The story of control over Winnie the Pooh and the other lovable characters that populate the Hundred Acre Wood is fascinating in its byzantine complexity.  To summarize:

  • The characters were created in the 1920’s by A.A. Milne.  Copyright protections at the time lasted for an initial period of 28 years and a renewal period of 28 years.
  • In 1930 Milne and Stephen Slesinger entered into a contract granting Slesinger merchandising and other rights in exchange for royalties.  Slesinger created a company, Stephen Slesinger Inc. (“SSI”) and assigned those rights to the new entity.
  • SSI was extraordinarily energetic with their IP, creating the first Pooh doll, board game, puzzle, radio broadcast, animation and motion picture.  By November 1931 Winnie the Pooh was a $50 million business, providing an eye popping return on Slesinger’s $1000 upfront payment to Milne (Milne also received 66% of subsequent income).
  • Milne died in 1956, with rights to Winnie the Pooh transferred to his wife, Dorothy.  Upon Dorothy’s death rights were transferred to the Pooh Properties Trust.
  • Disney acquired the rights to Winnie the Pooh from SSI in 1961.
  • An amendment of the 1976 Copyright Act granted an additional 19 years of protection.
  • Disney negotiated a revised deal with the Pooh Properties Trust in 1983 in order to prevent a feared contract termination.
  • In 1998 the Copyright Act was amended again to provide an additional 20 years of protection.
  • In 2002, with Disney embroiled in litigation with SSI over claims that it had systematically underpaid royalties due SSI for years, Clare Milne sought to terminate the 1930 agreement.
  • In 2006 the U.S. Supreme Court declined to grant a writ of certiorari, leaving the heir of A.A. Milne with no recourse.

It has been a long and winding road for a bear of very little brain.  Something to think about as the new movie helps create and enhance the enthusiasm of another generation of fans.

Bowing to the Inevitable

This article originally appeared in Business Insider and TMA Midwest Blog

January 4, 2011

By David Johnson, ACM Partners

Eastman Kodak (EK), once among the preeminent companies in the U.S., is reportedly preparing to file for chapter 11 bankruptcy.  This is a sad but not entirely unexpected development.  In October I wrote on the evolving situation at Eastman Kodak, noting that in distressed situations there are no optimal outcomes.  Rather, a distressed situation is brought to a successful conclusion when the least bad outcome is pursued and achieved.

It seems that the least bad outcome has been settled on.  With its $900 million of cash being quickly eroded by persistent operating losses, Kodak must sell its prized intellectual property (IP) in order to maximize value.  The prospect of utilizing this IP in order to reinvent its business is gone.  Lazard has been managing the sale of 1,100 patents, and it appears that one of the drivers of the likely bankruptcy filing will be the need to complete that sale with the protections of the U.S. bankruptcy court.

In addition to facilitating asset sales, another benefit of a bankruptcy filing is the increased availability of financing.  For those unfamiliar with the world of restructuring, it may seem counter-intuitive that a bankruptcy filing could result in Kodak having easier access to financing.  However, given the priority assigned to debtor-in-possession loans, it makes sense that lenders would feel more comfortable providing Kodak financing to complete the sale of its most valuable IP.

Things did not need to be this way.  Eastman Chemical, once viewed as the stodgy spin-off to the more dynamic Kodak, is now thriving.  The key difference, unsurprisingly, between success and failure for these two corporate offspring of entrepreneur George Eastman was the willingness of Eastman Chemical to embrace change.

There is some poetry to the art of restructuring and turnaround, and at a moment like this, with one of the “must own” companies of the 70s reduced to contemplating a chapter 11 filing in order to sell off intellectual property that it was never able to sufficiently capitalize on, the bleak words of Shelley’s “Ozymandias” come to mind.  We should all take a moment to look on this wreckage and despair.