Taking the helm

A good time for CEOs to take charge of a pandemic-induced turnaround?

The number of portfolio companies whose end markets have been disproportionately impaired by the pandemic has increased the demand for transformational CEOs who can lead such a business through this troubled period and beyond. While the prevailing mindset associated with these roles may be one of trepidation, an executive can feel bullish about such an opportunity under four conditions.

First, an executive must believe the pandemic’s impact will fade over time. Based on our conversations with sponsors, a reasonably full recovery for even the most challenged end markets, such as travel and hospitality, is expected by 2023. While some markets will be permanently altered, opportunities for both organic and inorganic growth should abound.

Second, an executive should expect their equity grant to be struck at the business’s current valuation. Such an equity model will provide fair-minded outcomes for restoration of value, along with significant financial upside for an exit that delivers a real return for the sponsor.

Third, an executive must assess the PE firm’s commitment to the investment and gauge its appetite for future capital infusion. Key diligence items include the sponsor’s relationship with the lender and the specific portfolio company’s importance in the broader context of the portfolio. Most sponsors will fight to the end to avoid turning the keys over to the bank, but a variety of factors may undercut a firm’s commitment to a deal. A telling indicator can be the sponsor’s willingness and ability to hold the asset for another four to five years, if necessary.

Fourth, an executive must evaluate both the appetite and debt covenant flexibility for future M&A activity. While the importance of this factor varies by deal, significant bandwidth for inorganic growth offers a compelling lever for value creation. Several of the platform’s competitors will have likely suffered from comparable end market impairment, presenting add-on opportunities at an attractive price. As the industry consolidates, adjacent acquisitions may be had for pennies on the dollar.

The significant caveat here is that the next 18 to 24 months will undoubtedly be arduous. While sponsors are not blind to the additional obstacles brought on by the pandemic, that fact does not displace their expectation for near-term progress. Prospective CEOs for these roles should ideally have experience in developing new products, tapping new channels, seizing market share and expanding into new markets. Such efforts will likely be necessary to drive near-term growth and position the asset to effectively leverage the impending broader economic recovery.

This is not to underestimate the inherent challenge, as these ailing portfolio companies require transformational leadership. Executives considering such a role should understand the investment thesis is now as much about their own horsepower, ingenuity and resiliency as it is any of the traditional elements that existed when the company was acquired under normalized conditions.

Incremental CEOs who best excel when tasked with simply taking a relatively stable asset a click or two up the quality curve — though a valuable skillset in its own right — need not apply. Even more so than a typical PE-backed role, success in these challenging positions requires a must-win, burn-the-boats mentality.

For transformational CEOs, the right pandemic-induced turnaround provides a chance to prove themselves a powerful force for value creation while procuring access to an exhilarating financial upside.

Rob Huxtable is a partner at FALCON