June 3, 2014
Interviewed by: David Snow
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What Lies Ahead for CD&R?

The head of one of the largest private equity firms in the world gives a wide-ranging interview.

The head of one of the largest private equity firms in the world gives a wide-ranging interview.

What Lies Ahead for CD&R?

With Don Gogel of Clayton, Dubilier & Rice

David Snow, Privcap:

We’re joined today by Don Gogel of Clayton, Dubilier and Rice.  Don, welcome to Privcap, again.  Welcome back, I should say.

Donald Gogel, Clayton, Dubilier & Rice:

Thank you, David.

Snow: Your firm has done quite a few deals.  You’ve just raised a large new fund, so congratulations on that.

Gogel: Thank you.

Snow: Let’s start with fundraising.  These are the interesting times across the board in the economy and certainly, in the private equity fundraising market.  For many firms, it’s been very challenging, if not impossible.  What was it like for Clayton, Dubilier and Rice? How was it that you hit your hard cap? How did the process go?

Gogel: We were fortunate.  We have a very strong team, a strong record and a very, very loyal group of investors that were satisfied with our previous fund, and in many cases, many funds.  We have investors that have been with us for 25 years.

We started with a strong base and we had a lot of momentum.  The actual fundraising process went remarkably well.  It took us, really, just about a year to raise a fund that went up to the hard cap.  That’s always gratifying but the fundraising process always tells you a lot about both your firm as well as your investors as well as about the broader environment.  In many ways, it’s a pretty good measure of peoples’ assessment of the future and the risks that they see in the environment.

I think, notably, for us, for the first time, more than 50 percent of our investors came from outside of North America.  Some of that is sovereign wealth funds, which as you know, are heavily concentrated now, in terms of dollars or whatever the currency is invested in Asia, some in the Middle East.  But obviously, quite different than the first fund that I raised at Clayton, Dubilier and Rice, where less than 20 percent was non-North America.

What you learn in the fundraising environment, which makes it a challenge, but also quite interesting, is how various investors, all smart, all institutional, are trying to determine what the future will bring?

Going out on the road, of course, the instrumental or narrow focus is that we’d like your commitment, but you learn a lot.  You hear from investors of their anxieties about investing in some geographies, about some sectors.  You hear their somewhat changing assessments of different managers.  It’s a wealth of information. I think the best firms learn a lot from the process.  It’s hard. I can’t say I look forward to it but this was the sixth fund that I’ve raised at Clayton, Dubilier and Rice.  Everyone has a long story.  This was no different, but this one went quite well.

Snow: Talk about the operating imperative at your firm.  Your firm integrates financial and operating professionals within the partnership.  What were some recurring themes in an exceptionally weak economy, as you attempted to help your portfolio companies improve?

Gogel: In difficult times, the operating expertise that we have really comes into play.  As a result, we see different opportunities.  We get to make investments that, perhaps, we would not have been able to make in a more robust time.  I say that because in a period like this, even some of the best-positioned companies are going to suffer reverses in performance.  As a result, the valuation of those companies is going to be diminished and of course, not only on a multiple basis, but also, the base of earnings on which you’re being able to buy the company is depressed.

Now, seeing through that and believing that there will be a recovery, both in the broader economy and in the fortunes of the individual companies is what makes private equity pretty exciting.  We don’t worry about next quarter, even next year.  We can afford to put more equity in a deal, expecting that we will actually go through a further downturn.  That, indeed, happened.

We have invested pretty steadily through this last cycle, about a billion a year each year for five years.  That’s what we had hoped to do in our 2009 fund.  But even in these difficult times, we’re able to put money to work if we have an operating executive who can help us recognize what we will do if we own a business.  That’s not an idle question.  There’s a lot of scrutiny on that assessment.  The operating partner has the responsibility and takes it very seriously to deliver the results that he and the management team are committing to us.

Snow: During the downturn, your firm did a large number of deals of a certain type in which the selling corporation retained a significant stake in the business and turned over the keys to your firm.  Why was that format appropriate for the times that you were investing in?

Gogel: In a difficult period, a number of businesses that might have been put out to market in a more typical auction could not really withstand the scrutiny because they didn’t have the results.  It’s very hard to sell a business and get a lot of excitement when a business has declined in both revenue and profitability over a year or two-year period.  While there are some businesses that might be sold in a more traditional format, as you know, the deal flow just slowed down.  Particularly, corporate divestitures dried up almost to a trickle.

You couldn’t borrow much against them.  The corporate seller was struggling with valuation concerns. “ How can this business that I thought was worth X is now only worth 80 percent of X?”

It was a time that required some innovative deal structures.  Fortunately, we had the reputation of being corporate-friendly, of being operating executives that could work closely with good-selling corporations.

We proposed transactions in which the selling corporation would retain anywhere from 41 to 49 percent of the total equity.  We’d pay what we thought was a fair price on the earnings of the company that day.  But both we and the selling company recognized that if we fixed this business, and really ride a bigger steep curve up to profitability, they’d be a total valuation return several years down the road that would meet the seller’s expectations.

The key to it is we needed an operating partner who could convince the selling company and its CEO and its board that we could do better with this business than they would be able to do alone.  How could that be possible? Well, it’s simply a matter of focus. That’s the magic of private equity.  We bought some of these businesses from parent corporations that have a hundred strategic business units.  We put all of our intention into making three investments a year and we have very talented people to do that.

Snow: Let’s talk about one of the sectors in which your firm invests, the healthcare sector.  Probably no other area of the economy is going through a more gut-wrenching change.  Where do you see opportunity within healthcare today?

Gogel: Well, change can be both friend or foe of a private equity investor.  It’s a tricky area.  I don’t think many people want to wade deeply into healthcare investments that are deeply affected by reimbursement risk, simply because it’s an unknowable future of where some of the Medicare or Medicaid reimbursement levels are going to be.

Of course, the government, which plays a dramatic role in all of healthcare, is always a factor.  But for us, we’re looking for discontinuities in the value creation chain in healthcare.  We’re just trying to figure out what companies are going to be well positioned.  Why would a company be well positioned? Well, they have a better business model.  They can provide something to a hospital or to a patient at a lower cost that’s more effective, that’s faster, that’s better than what’s being done today.   That has led us, in the last few years, to invest in companies in sectors as diverse as disposable medical products distribution.  It doesn’t sound like it’s a very exciting field, but it’s one in which there’s a lot of disruption.  A good operator can make a big difference.  We’re able to do that.

As well as in outsourcing a variety of services.  That’s a common theme in many of our investments because an outsource provider can be focused, effective, efficient and can provide value to a hospital, to a clinic, to a doctor in a way that perhaps, traditional providers cannot.

Snow: Your firm has largely invested in first, North America, and then, Western Europe.  You now are getting more active or thinking more about growth markets.  Talk about what your intentions are in markets beyond North America and Europe.

Gogel: Well, at one level, we’re always interested in growth market opportunities for our portfolio companies.  Today, we have 20 different companies and probably, ten of them have some meaningful exposure, either in the supply chain of sourcing products or the increasingly important exporting of products to Asia or other high-growth markets.

We have not yet crossed the bridge to say we want to invest directly in choose one of those areas, Asia or another African-based companies.  That’s simply because we’re not yet convinced that our style of investing and our hands-on operating management, which requires control, is easily available in other parts of the developing markets.

What have we done just to have a window on it? We have been an anchor investor to a fund that was started by a handful of very experienced investors in India.  The fund is called Kedaara.  It was one of the largest first-time funds ever in India.  We raised $600 million.  We have a partner.  They’re all local.  We get insight into the Indian market.  We can provide a lot of support to them, operating expertise and the like and we get a window on India.  If they find a large transaction that may be of interest to us, which is likely to be not one that is India-centric, but an Indian corporate that happens to have global expansion interests, and maybe even a global footprint, we could make that investment.

Snow: In your experience, what does a team look like when it is succeeding? What does a team look like when it’s not succeeding in business?

Gogel: As you know, there are probably several hundred books written on teams.  One of my favorites is written by a friend, Doug Smith, a gentleman who was then the managing partner of McKinsey’s New York office.  This book was probably published more than 20 years ago.  It’s called The Wisdom of Teams.  It illustrates, I think, one of the most important aspects of working as part of a team.  That is teams actually reach different conclusions, make different judgments – I’d argue better ones – than individuals can do alone.  The magic, I think, in private equity is to put together those diverse perspectives of true partners that will be willing to work as teams, not in a hierarchy, but at some level of collaboration, just to explore opportunities, to think deeply, to work back and forth. I think we make better decisions that way.

The second part of it, which is very important to talented people, is if you have a good team, people are probably going to have a pretty good time.  Having fun may not rank as highly on the scale of business leaders as you might think, but to attract the quality of people we’ve been able to attract who, themselves, have worked very hard for 30 years someplace else, they’re not coming unless they think they’re going to be part of a team that is successful, that they’re going to play a good role and that they’re going to have some fun.

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