The Last Great Arbitrage – Management Process Excellence

Excess liquidity has flooded private markets and reduced the number of easy targets in private equity. Investors are now competing for ever smaller arbitrage opportunities on the long tail of value creation opportunities. However, there is still huge opportunity sitting right under their nose, which some sponsors like HVD Partners are starting to address. They focus on improving management processes, entrepreneurial governance and organizational behaviour to realize superior returns.

Ironically, even financially strong businesses with great market power in high-growth and high-profit sectors often have dysfunctional organizational behaviours and poor management processes. They succeed despite the way they are run. But how much more value could be created by running them much better? These firms offer great arbitrage opportunities if sponsors look at them through the organizational performance lens.

Stanford University’s Nicholas Bloom and LSE’s John Van Reenen empirically linked revenue growth and profitability to management practices in their study of 10,000 organizations in 20 countries. Their results confirm a vast spread of performance as they note, “We find substantial variation in management practices across organizations in every country and every sector, mirroring the wide spread of productivity and profitability within industries.” They also confirm astounding arbitrage potential with a small improvement in management practices resulting in a 25% increase in labor productivity, 3.5x higher organic sales growth, 3x higher return on capital employed, and a dramatically lower risk of bankruptcy.

But without hard facts, it’s difficult for sponsors and management teams to identify specific organizational gaps and bottlenecks, much less to initiate organizational changes that enable improved portfolio company performance. There has been a lack of broadly accepted management process standards and codified governance best practices to date.

By applying proven methodologies from system analysis, signal processing and control theory, together with big-data analytics, Humatica has codified the behaviours and management processes which drive the collective ability to make good decisions and implement them at all levels. These methods enable rapid identification of the required organizational structure, process- and competency changes needed to increase workforce agility and grow value. Remedies for agreed organizational issues and bottlenecks are developed together with management to ensure buy-in and ownership. As a result, the value creation plan can be implemented faster and financial gains realized sooner.

Over 30 international funds across the deal spectrum have already embraced these kinds of specialized tools and services to address the new organizational source of value creation and realize outstanding returns. Sponsors like HVD Partners leverage Humatica’s methods with under-managed cases to generate an over 9x return in little more than two years. That’s an arbitrage opportunity you can bank on.

This article was originally published as the Humatica Corner in Real Deals magazine.