What Lies Beneath

Private-equity firms know how to make companies look good. But this buyer knows how to look more closely.

Like lots of active acquirers,
Leggett & Platt Inc. often deals with private-equity
sellers as it seeks targets in its “sweet spot”
between $20 million and $40 million in revenues.
But despite an abundance of candidates
in private-equity (PE) portfolios, finding a good
opportunity is far from easy for this manufacturer
of components for bedding, furniture, and
consumer products.

“By the time the PE firms are ready to sell a
portfolio company, they’ve deleveraged the balance
sheet somewhat by milking cash flow, and
often neglected the necessary long-term investments
to keep it competitive,” says Leggett CFO
Matt Flanigan. Not only that, but the private
owners are adept at hiding the weaknesses of
the outfits they offer for sale. “We work hard to
be sensitive to the fact that some PE sellers are putting
lipstick on a pig,” he says.

Based in Carthage, Missouri, Leggett displays a
decided “show me” mentality when it comes to picking
and choosing among available deals — especially with
financial sellers. When studying PE-owned candidates,
the company, which has become a $6 billion powerhouse
on the heels of 160 acquisitions over the past decade,
focuses on the implications of higher leverage. Specifically,
it examines to what degree managers are geared to
short-term results, thereby alienating the company’s customer
base. Only if Leggett is confident that the private
owners have done well by customers will it consider
making an offer.

Checking the Plumbing

With private equity such a huge factor in mergers and
acquisitions — it now accounts for about a quarter of
overall U.S. deal values as they approach 1998′s record
$1.63 trillion, according to Thomson Financial and
Robert W. Baird & Co. — questions about the quality of
the companies being shopped are more relevant than
ever. On one hand, executives like Flanigan often find
operational flaws beneath the surface. Yet PE firms and
the academics who study them tend to view the assets
being sold as relatively healthy, especially as measured
by cash flow and other financial measures.

In a recent study of one particular type of private-equity
exit strategy — initial public offerings — Harvard
Business School professor Josh Lerner and Jerry Cao of
Boston College found that such IPOs outperform the
market generally in “economically and statistically meaningful” ways. Higher leverage among IPO
companies coming out of private equity,
the study found, did not lead to poorer
performance but, rather, just the opposite.

“That was the big surprise,” says Lerner,
who acknowledges that “there are a lot
of reverse LBO companies that have gone
public over the years, and some people fixate
on certain cases.” In actuality, however,
he believes buyers often prepare themselves
for hefty debt and related shortcomings
stemming from a target’s PE roots, and
somehow overcome the disadvantages.

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