The Adventure of the Technology-Skeptic Investor

Tim must convince a potential, and skeptical, lender that his investment will return more than 12%/yr.

Tim’s Problem

Tim is a partner in a private equity firm. His firm uses leveraged buyout to buy and restructure companies. The amount Tim’s firm puts up in the buyout is 20%. Debt financing provides the rest.

Tim’s firm must convince his potential lender of the buyout’s competitive advantages. The lender is a financial whiz, but not a techie. He is skeptical of investments that involve technology advantages.

The prospective buyout by Tim’s firm is a Tier 2 supplier in a complicated value chain. Finding the buyout’s place in the chain’s profit pool1 depends on understanding its competitive advantages.

Tim’s Solution

Tim was familiar with my Market-Technology intelligence work. He engaged me to understand the buyout’s competitive advantages.

Understanding the Competitive Advantages of the Target Investment: Executive Summary


The target produces a polypropylene Tier 2 product using these integrated steps:

  1. Purifies a regrind polypropylene stream obtained from recyclers of a polypropylene-containing consumer product.
  2. Produces a consistent, low cost polypropylene using trade-secret technology .
  3. Makes the Tier 2 product by “deep draw” injection molding of polypropylene. Injection molders at target have high skill at “deep draw.” Some have 15 years experience at this work.

First I built a list of 230 knowledgable individuals in the target’s value chain. Then for statistical significance, I followed the Rule of 30 method2 and called people on the list. Each heard that the client had a process for making low cost, recycled polypropylene.

Conversations with 30 knowledgable individuals helped place the buyout target in the profit pool’s sweet spot.

First Competitive Advantage

Buyout target balances science and artisan knowledge to achieve a consistent, low cost product.

“The 300+ “Mom & Pop” shops who buy used injection molding machines can’t compete in this arena. To succeed you need to produce a consistent product.
An experienced machine operator knows “stuff happens.” He is familiar with his machine and the polypropylene source and the mold and what the part should be. He’ll do work-arounds so he can produce the part and keep all costs low.
That said, it’s the polypropylene cost that covers whether you make a profit on the job. It’s not the labor cost. It’s not the cycle time.”
     VP Engineering … Imperial Tool and Manufacturing Co. Inc.

Second Competitive Advantage

Long distance supply chains are not common in injection molding. Delivery performance is king. A preferred Tier 2 supplier is within 500 miles of its customers.

Two-thirds of the buyout target’s plants are within 500 miles of its Tier 1 customers.

Outcome

The prospective investor accepted Tim’s understanding of the competitive advantages. He financed the leveraged buyout.

Tim’s firm within:

  • Six months replaced the Owner-CEO with an experienced turnaround CEO
  • Two years purchased the competitor whose plants served most of the remaining 1/3 of Tier 2 customers.
  • Six years sold the buyout target. The investor’s return was 15%/yr. on his investment. Tim’s firm’s return was 25%/yr. on their investment.

Endnotes

  1. Profit Pools: A Fresh Look at Strategy Gadiesh, G. and Gilbert, J. L. Harvard Business Review https://hbr.org/1998/05/profit-pools-a-fresh-look-at-strategy
  2. My work followed the Rule of 30 method 
  • Blind study
    In a blind study the respondent does not know who commissioned the study.
  • Gathered intelligence through 30 conversations with experts in the buyout target’s industry. They were from a random sample of 250 knowledgeable individuals.
  • Analyzed data gathered in the conversations, using the Central Limit Theorem, for statistical significance.