If you're interviewing for a job in a private equity firm, then you will almost certainly come across a case study. Be warned: recruiters say this is the hardest part of the private equity interview process.
"The private equity case study is in the recruitment process for a reason – to see if you can think for yourself," says Gail McManus of Private Equity Recruitment. It's purpose is to make you answer one question: 'Would you invest in this company?'
In most cases, you'll be given a 'Confidential Information Memorandum' (CIM) relating to a company the private equity fund could invest in. You'll be expected to a) value the company, and b) put together an investment proposal - or not. Often, you'll be allowed to take the CIM away to prepare your proposal at home.
Sounds easy? Don't be deceived.
"For many candidates, this can be one of the most challenging elements of the interview process," says McManus.
"The end decision [on whether to invest] is not important," says one private equity professional who's been through the process. "The important thing is to show your thinking/logic behind answer."
Preparing for a PE case study has distinctive challenges for consultants and bankers. If you're a consultant, you need to, "make a big effort to mix your strategic toolkit with financial analysis. You need to prove that you can go from a strategic conclusion to a finance conclusion," says one PE professional. Make sure you're totally familiar with the way an LBO model works.
If you're a banker, you need to, "make a big effort to develop your strategic thinking," says the same PE associate. The fund you're interviewing with will want to see that you can think like an investor, not just a financier. "Reaching financial conclusions is not enough. You need to argue why certain industry is good, and why you have a competitive advantage or not. Things can look good on paper, but things can change from a day to another. As a PE investor, hence as a case solver, you need to highlight and discuss risks, and whether you are ready or not to underwrite them."
McManus says private equity funds will often confuse candidates by providing them with CIMs relating to companies the fund's already invested in. She says this makes life difficult for candidates: "How do you respond? Do you give an unequivocal YES – you would invest? Or do you say NO – making it look like you disagree with the judgement of your potential employer?"
In this situation, most candidates end up saying they would invest, but McManus says this is a mistake. "The fund could have changed the numbers in the case study, added or taken away detail. They may be regretting the investment themselves. Make sure that you have your own opinion. That’s what they are looking for. Otherwise, what are you adding to their business?"
McManus says too many people are unwilling to say something definitive when it comes to valuation. If you’d invest – would you do it at any price? And if you wouldn’t invest – if the price was low enough, would the answer still be no?
"You will almost certainly be asked what you would pay for the business included in the case study," she says. "Too many people wimp out at this stage and will start putting caveats around the pricing decision. Don’t. If there’s one thing you can be sure of, it’s that if you dither around on pricing you won’t get the job," she warns. "Don’t make life difficult for yourself, just deduce an Earnings-Before-Income-Taxes, Depreciation and Amoritization (EBITDA) figure, think of a sensible multiple, usually between 5 and 8 and multiply the two together. Be brave: state a specific price. It works."
Another current private equity professional says you shouldn't go out on a limb though, and you should appear cautious: "Keep all assumptions conservative at all times so as not to raise difficult questions. Always highlight risks, downsides as well as upsides."
We spoke to another private equity professional who's helpfully prepared a checklist of points to think about when you're faced with the case study. "It's a cheat sheet for some of my friends," he says.
When you're faced with a case study, he says you need to think in terms of: the industry, the company, the revenues, the costs, the competition, growth prospects, due dliligence, and the transaction itself.
The questions from his checklist are below. There's some overlap, but they're about as thorough as you can get.
When you're considering the industry, you need to think about:
- What the company does. What are its key products and markets? What's the main source of demand for its products?
- What are the key drivers in that industry?
- Who are the market participants? How intense is the competition?
- Is the industry cyclical? Where are we in the cycle?
- Which outside factors might influence the industry (eg. government, climate, terrorism)?
When you're considering the company, you need to think about:
- Its position in the industry
- Its growth profile
- Its operational leverage (cost structure)
- Its margins (are they sustainable/improvable)?
- Its fixed costs from capex and R&D
- Its working capital requirements
- Its management
- The minimum amount of cash needed to run the business
When you're considering the revenues, you need to think about:
- What's driving them
- Where the growth is coming from
- How diverse the revenues are
- How stable the revenues are (are they cyclical?)
- How much of the revenues are coming from associates and joint ventures
- What's the working capital requirement? - How long before revenues are booked and received?
When you're considering the costs, you need to think about:
- The diversity of suppliers
- The operational gearing (What's the fixed cost vs. the variable cost?)
- The exposure to commodity prices
- The capex/R&D requirements
- The pension funding
- The labour force (is it unionized?)
- The ability of the company to pass on price increases to customers
- The selling, general and administrative expenses (SG&A). - Can they be reduced?
When you're considering the competition, you need to think about:
- Industry concentration
- Buyer power
- Supplier power
- Brand power
- Economies of scale/network economies/minimum efficient scale
- Input access
When you're considering the growth prospects, you need to think about:
- Change of asset usage (Leasehold vs. freehold, could manufacturing take place in China?)
- How to achieve efficiencies
- Limitations of current management
- Change of control clauses
- Environmental and legal liabilities
- The power of pension schemes and unions
- The effectiveness of IT and operations systems
- Your LBO model
- The basis for your valuation (have you used a Sum of The Parts (SOTP) valuation or another method - why?)
- The company's ability to raise debt
- The exit opportunities from the investment
- The synergies with other companies in the PE fund's portfolio
- The best timing for the transaction
With all this to consider, you're likely to run out of time. McManus warns that you will never have enough time to complete the case study properly. One private equity insider cautions bankers from going overboard on the modelling element of the analysis: "Nobody actually checks the model, they only look at the printouts/screenshots."
If you get a chance to take the CIM home and to prepare it ahead of time, he says you should get someone who already works in PE to check it over for you. He also advises getting friends who've been through case study interviews before to put you through some mock questions on your presentation.
Lastly, McManus says you need to use your common sense. If something looks and feels wrong, it probably is.
"An interviewee calculated that it would take 35 years to payback some capital investment. This looked completely wrong compared to everything else he knew about the business. He told the interviewer that this was a terrible investment and shouldn’t under any circumstances be taken any further," she says. " It never occurred to him that he may have miscalculated the data and he argued himself into a very big hole. He should have said – this looks really odd – maybe I’ve made a mistake. If he hadn’t made a mistake he had still flagged the inconsistency, if he had made a mistake he was covered by his comment and showed a bit of humility."
Photo credit: Kevin Gilmour