Private Equity : Operational Due Dilligence

Operational due diligence in the acquisition of a specialized retailer by an investment fund
Case study
07/17/2015

Context and objectives

Our customer is an investment fund specialized in the acquisition and operational improvement of companies in the retail and consumer goods sectors.
In the pre-closing phase, our customer was seeking to identify the major levers of improvement of the target’s operational performance in order to refine its price proposal.

As is often the case, the fund decided to call on a general agency (in this case a strategic consulting agency) for the “market” due diligence, but preferred to task an agency like Argon Consulting, which is far more specialized in operational aspects, with the operational due diligence.

The following targets were set for the team from Argon Consulting :
1. Assess the current performance of the target in comparison with the benchmarks in the sector
2. Challenge the management’s business plan
3. Identify additional levers for improvement
4. Analyze the impact of these levers on the future economic performance of the target

As is usually the case in this type of operation, the analysis was conducted in a highly restricted context :

  • A very tight 3-week deadline, in view of the scope to be analyzed
  • Limited access to information and management of the target (there were several possible buyers at this point of the operation)

Approach and methodology

A three-step approach was adopted, with deliverables agreed upon with our customer in advance:

  • Mapping of the target’s supply chain, from the suppliers to the shops (sourcing, logistics circuit, distribution network, stock levels and costs on the chain, etc.)
  • Performance benchmark, covering in particular :
    • Stock levels (warehouses and stores)
    • Costs (warehouses and transport)

The analysis highlighted a cash flow risk caused the ambitions to reduce stocks, which did not appear to be justified in view of the planned actions.

  • Identification of additional levers, with two priorities :
    • Sourcing, with a level of lcc sourcing that appeared to be very low in view of the type of products, resulting in a high potential upside in terms of purchasing with significant impacts on the business plan (product design, stock levels)

In addition to the analysis of the value and an estimate of the issues at stake by major product family, we also acquired quotes for a few products from china, in record time with our local partner, in order to confirm our estimate of the benefits

  • The re-definition of the supplier logistics circuits. The level of integration of the suppliers is relatively low, which explains why the stocks in the stores are high than average in the sector. The overhaul of the logistics circuits is seen to be an important lever, but with impacts in terms of stocks (less stock in the stores, more stock in the warehouses) and logistics costs (gains in purchasing vs. Logistics costs)

Results

The approach adopted by Argon Consulting :

  • Identified an operational risk (not included in management’s business) that could Impact costs by €8m per year and the wcr by €20m
  • Identified annual gains of €25m and a €40m reduction in the wcr in addition to the Business plan