I was eating in a pizzeria the other day, run by a family of Greeks, when I spotted my opportunity.
The people who don’t understand private equity think it’s just a matter of finding and buying X Corp*, levering up X Corp, doing a recapitalization to take a dividend 6 months later, underperforming, doing another dividend recap 6 months later, canceling your sponsor fees while doing a third dividend recap, then taking X Corp public while paying for Czech models to be taught how to count your money in French. But it’s about that and so much more. It’s about VALUE, and looking for value everywhere.
I perused the menu and listed the normal core competencies of a towny Greek pizzeria. Large Cheese pizza $9.95. Pepperoni pizza $10.95. Baklava $3.95. But then it struck me, buried under layers of sub-offerings, their calzones were horribly underpriced at $4.50. The basic cheese calzone was not dissimilar in caloric content, cheese density or sauce metrics from a small cheese pizza, yet it was priced at a 20% discount and placed in a non-strategic location on the menu. The spinach and cheese calzone was a higher margin product with tangible value-add to the end consumer through its superior health content.
I could see that it would be a slam dunk to realize value if I could get Nikos to spin off his non-core calzone assets; I would only have to properly structure the deal and wait. Unfortunately, I could also tell from the look in his eye that he wanted me to take on his spanikopita assets as well. This was obviously a dicey proposition. Spanikopita were difficult to market and historically a more labor intensive product that had little pricing power. But they were, in fact, tasty.
I decided I could take on the spanikopita assets, but only if he offered me an exclusive negotiating window. I was not going to let another investor swoop in and eat my pie after I had gotten this far, both in terms of my time and due diligence. Nikos consulted Constantin and had no problem granting this. I started putting out feeler offers of 4.5-5x EBITDA, and could sense that these Greeks were not financially savvy enough to understand fully how to extract value from their calzone assets and how much smarter I was than they were. A quick call to Bank of America and I had already gotten backing for 2.5 turns of senior secured leverage, and 2 turns of subordinated debt; I could practically smell triple digit levels of IRR. They accepted on the spot.
Another succesful day in the delicious life of private equity.
*X can be any noun, verb, conjunction, article or random combination of letters that may or may not be an entity which produces anything or even exists. It just doesn’t matter.