The Value Perspective Podcast episode – with Andrew Schemmel

Hi, everyone and welcome back to the TVP podcast. This episode is part of our occasional ‘turnaround’ mini-series, which began with Arc president and CEO Nick Hodler. This time, we are pleased to have as our guest Andrew Schemmel, co-founder and director of Eisvogel Group, a private equity firm that specialises in companies providing software, business services, industrial applications and technical products throughout Europe. Normally, Eisvogel is not a company that seeks to invest in turnaround situations but, with one of their investments – and due to a multitude of factors – they found themselves working with a company that had to apply for bankruptcy protection. In this episode, Juan and Andrew discuss accounting for uncertainty when modelling through scenario analysis; two variables that are difficult to appreciate from the outside as an investor – time and margin for error; good communication with all stakeholders, including employees; and, finally, human capital as the most important variable in any turnaround. On a final note, this episode was actually recorded in the summer of 2022 – which you might gather from some of the weather chat – but we elected to delay release in deference to some negotiations with the case study’s stakeholders. Enjoy!


Juan Torres Rodriguez

Juan Torres Rodriguez

Fund Manager, Equity Value

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Chapter headings for Andrew Schemmel on The Value Perspective Podcast

Please click on the link below to jump straight to a chapter

* Andrew Schemmel, welcome ...

* A case study in uncertainty

* One challenge after another

* Financial models and forecasts

* Applying probabilities to forecasts

* Dealing with a business’s stakeholders

* Communicating uncertainty effectively

JTR: Andrew Schemmel, welcome to The Value Perspective podcast. It is a pleasure to have you here. How are you?

AS: Very well, Juan. Thank you for having me.

JTR: We are recording this on a day that is extremely hot in London – where are you in the UK today?

AS: Today, I am actually in central London – so obviously in the boiling heat too. Record highs are expected today but, if you look back five years ago, probably nobody would have thought the UK would reach 39 degrees in a day.

JTR: That’s true. Still, people complain about the weather all the time in the UK so, in my opinion, we should just embrace these very few days of hot weather!

AS: I would completely agree with you – in the sense of, where I grew up, it always gets very warm. But I do think we have to be conscious of the fact the world is getting warmer. And when you look at a number of folks in the market today talking about climate change and this being the next sort of cycle of opportunities to make significant returns, the climate change phenomenon from an investment sense is definitely going to be real. A number of opportunities will arise out of this.

JTR: You just mentioned ‘where I grew up’ – could you give our listeners a brief introduction of who you are and your journey?

AS: Sure. I grew up in the US. I started my investment career in San Francisco, working with a mid-market private equity firm called Alpine Investors. At the time, the firm was on fund one but they were putting down the foundations of what today is a very much a leading private equity fund in the US. But at the time, it was very small and, as anybody will know, early in your career, if you start small, it is very hard to go big and if you start big, it is much easier to go small. So after a bit of time there, I transitioned and spent some time with GE Capital working between London and New York.

And then I got tired of, I guess, the bureaucratic structure of a large corporate or conglomerate and wanted something a bit more entrepreneurial. So I left GE Capital after two years and moved to Fortress Investment Group in New York, where I spent the better part of five years working on the private equity side of the business within the context of financial services, investing, senior care and transportation. I had about five years of living in New York – from about 2008 to 2012 – which was a very difficult and challenging period in terms of the great financial crisis and from an investment perspective.

I was looking at what steps to take next and that’s when I elected to do my MBA at London Business School. Regarding the MBAs, I looked at a number of different opportunities there but I thought anything in the US –whether that be Wharton, Harvard, Chicago – were basically all pipelines back to New York. I wanted to do something a bit more internationally diversified – a bit more differentiated, in a sense – and LBS fitted the bill as it is a very international school. While at LBS, I focused on private equity and I also met my business partner, Christophe Jungels-Winkler – and we started Eisvogel in 2015.

JTR: I am a bit ignorant about this sector but I would have thought the Fortress Group was a big private equity house but you say you were looking to transition to a smaller ‘shop’?

AS: Yes. Fortress was, at the time, very much a leading private equity fund across the US but, referencing back to when I started, in my early career working at Alpine, I always wanted to go back to that type of investment structure where it’s a bit more entrepreneurial and smaller and you can provide a little bit more ‘value-add’, if I can put it that way. I think, at the level of the market at which Fortress was operating, which is a very large-caps sort of private equity model, it is much more financial engineering-led, as opposed to deep value-add – adding, you know, governance into businesses or operational best practices.

Most of these businesses already had professionalised management teams in them and, therefore, the investment thesis was very different. When you’re talking about the lower mid-market, on the other hand, most of these businesses are much more founder-owned or family-owned. At Eisvogel, we only look at primary transactions and therefore they have never had a professional investor in their cash structure before. So a lot of the investment thesis is taking a business through that journey of instituting best practices, building out a governance structure and financial reporting – but also looking at, you know, how do you really leverage what the business has through inorganic growth and/or international expansion?

JTR: So what sort of private equity do you guys do at Eisvogel Group?

AS: Great question. Eisvogel is a growth-focused investor so we look at the lower end of the market – $1m through $15m of EBITDA and probably more focused towards the earlier part of that. And we look at opportunities in what I would term as software, B2B and B2C business services and industrial or brand- enabled solutions – all sort of within the overarching theme of the ‘silverisation’ of Western Europe, in the sense that the region’s economies are ageing. And that will impact the markets in a multitude of different ways – from consumer discretionary spending through to how Western Europe needs to adopt more technology, whether that be robotics or software, to remain competitive on a global level.

JTR: Do you operate a traditional private equity structure where you look to raise a fund and exit within X amount of time? Or do you focus more on permanent capital and a longer time horizon?

AS: We are definitely a longer-dated investor. We are not in a position to look to, you know, cycle through investments in three to four years, which has become sort of the new norm within the private equity market. The way we think about it is we want to invest across multiple growth cycles – a growth cycle being three to four years. So our investments will typically be two to three growth cycles – somewhere in the range of six to 12 years. But our goal is to take businesses through that journey, where you implement best practices and/or add resources from a management level and then think about how you continue to build on that and develop that business – again, thinking about new product development, geographic expansion and additional acquisitions as well.

JTR: How different is it doing private equity in the US market, which is very deep and very big, versus markets in different countries with different cultures within Western Europe that are not so deep?

AS: It’s very interesting. The US is obviously a much larger market in terms of scale and size and also the capital available. But there are some structural differences in the market that actually make some of the European markets just as competitive. So, in the US, you don’t have certain public disclosures regarding information on private companies that you do in the European markets. In the UK, for example, you have public disclosures that, relatively speaking, make a lot of information on private companies available to anybody through Companies House – whereas, in the US, that information is actually not available.

So if you’re investing in the lower mid-market in the US, it is more challenging to find information on companies that is readily available in the UK in various different databases versus the US where that information is much more opaque. So you have to do a lot more work regarding the information of the markets themselves and trying to understand the market – and trying to understand targets within the market and build that industry knowledge.

A case study in uncertainty

JTR: This is a podcast about decision-making under conditions of uncertainty and, within that, we decided to do a miniseries on corporate turnarounds. The reason for that is, we are value investors and, as such, we find ourselves in many situations where we are investing in a company that is struggling –either because it has suffered an accident of its own making or because it is operating in an environment where it is facing very different challenges. That makes for a lot of decisions made in a very uncertain environment and so we wanted to discuss what it looks like to be invested in a business that is struggling and the sort of process and mindset on a day-to-day basis that are needed to make decisions that will help that business turn around. Now Eisvogel is not a private equity firm that specialises in turnarounds – however, we are going to discuss a situation where you invested in a company that looked very promising but has faced a lot of challenges throughout the last five years and walk through that journey. Obviously, because this is an ongoing situation, you cannot name the company or the country in Europe where it operates but could you give us a bit of context and background? What was the investment thesis, what does the company do and what happened?

AS: Sure – not a problem. To your point, we are not a turnaround-focused investment firm but it’s important to highlight that, obviously, markets turn and are impacted by different factors or variables – and what a successful investor will be able to do is navigate those challenges and, ultimately, find a way through that. Some challenges will be internal within the business and some challenges will be driven by external factors –and I think, when you look at this particular investment, it’s clear we have been hit with both of those.

To provide some context, we went through the change-management process for this business. It was an owner-managed business and we went through the process of bringing in a new CEO. This was in 2018 and, within six months, that individual was diagnosed with an aggressive form of cancer. He asked to be released from his duties as he was undergoing chemotherapy and radiation – which is entirely understandable and yet, from an investment perspective, it’s very challenging. That individual had already begun the process of change management and to hire some key individuals to add depth to the management team.

So, we were in a position where we were going down a path of change management and transitioning from an owner-managed business into a more professional management structure and, obviously, being hit with that ‘black swan’ event, if you want to put it that way, was very, very challenging. We had to go back to the market and look to bring a new CEO into the business, which we did. It was over the course of about a four-month period as, obviously, bringing management to a business doesn’t happen overnight. It takes time.

But also, during that time period, obviously the business continues to operate. So it’s a matter of how do you continue operations of the business while, very clearly, the business is going through change – in the sense that you’re undergoing a change management process, which is not easy. If you then layer on the fact you then have to go through another change management process during the same period, that is very difficult.

Nonetheless, we hired a new CEO into the business – in October 2019, I want to say – and, as any CEO would, they wanted to make changes to the management structure and so on. So, in the first couple months, he started making those changes – but then, as you know, in February 2020, Covid hit. So you’re in a situation where you have already had one black swan and then you’re facing a second one in a matter of months, which makes the investment very challenging, as it was already going through a significant amount of change.

JTR: What does the company do?

AS: It is a project-based business producing bespoke machinery – primarily into automated machinery. So anything regarding the application of robotics and/or handling of industrial goods.

One challenge after another

JTR: OK. So, February 2020, Covid hits? How does that impact this company specifically?

AS: Covid was very challenging initially – one, because, a lot of the European countries actually closed their borders. So if you’re supplying services and delivering projects across European borders, in many situations, that became incredibly challenging because they didn’t allow companies or workers to cross borders, geographically speaking. In addition, the business itself was challenged with how to obtain goods across borders. If you are sourcing goods from Asia – and specifically electronic goods – that market then became very challenging as well because, obviously, the global supply chains became very disrupted.

So you had another layer on top of that in the sense there was significant disruption within the global supply chain; your employees were not able to cross borders to complete installation of certain projects; you yourself are fighting Covid within your own employee base – as everybody was, globally speaking – and yet you’re still going through this turnaround phase, if you want to term it that way, where you’re going through that change management and implementing a new management team into the business.

Also, we initially completed the transaction using some financial engineering or financial leverage from banks. So, during this entire process, you’re also going through that process of negotiating with banks and trying to achieve a resolution to move forward in terms of the actual investment structure, which obviously was a very challenging period for everybody. In fact, the more challenging period was that, once you thought you got through the first wave of Covid and you developed a plan going forward, obviously, everybody was then impacted by the second and third waves of Covid.

And every time you had to go through that – when you’re already faced with a challenging situation at day one, entering the Covid period – it became increasingly more challenging through that process because the external factors continued to shift and change. And at that point in time, obviously, conversations with external stakeholders – as in the banks – became very challenging.

JTR: At what point would you say this specific investment case become ‘distressed’? During what we could call the first phase – when you made the initial investment and needed to change management? Or when the new CEO became sick and you need new management again? Or when Covid hit?

AS: Anybody in this situation will tell you there are different levels of stress and distress. When you’re going through that turnaround process, the business will undergo several different types of changes, right? Certainly that first sort of phase – where you going into change management – I wouldn’t call it ‘distress’. That’s an element of investment in a way – you have to introduce change management and it happens.

When you’re talking about external factors and the market simply changing, that can bring around significant distress – and I think Covid really created a situation with this particular business where it became distressed. Everyone will tell you the market creates a lot of stresses in multiple different industries. With this particular business – where it was in its own lifecycle and the industry and the business model it had – that all led it to become more distressed.

JTR: So you’re dealing with Covid, which takes the business to a place where relationships with different stakeholders becomes a bit more strained. And then Russia invades the Ukraine, which creates yet another layer for the business. Is that correct?

AS: Yes. The Russian invasion of Ukraine was certainly the third black swan event for this particular business – the reason being, the leading raw material for this business is steel. I mean, it’s fabricated, but it is steel – and Russia and Ukraine are the largest steel producers for the European economies. But also, one of our customer’s largest raw material products is timber – and, again, some of the largest suppliers of timber into the European economies are Russia and Ukraine. So you had another double-layer effect with this particular business as the market effectively faced another black swan event and this business, again, was put into a situation where it faced essentially more significant challenges yet again.

JTR: At one point, this company was about to file for bankruptcy – is that correct?

AS: Yes. We underwent a Chapter 11 bankruptcy.

JTR: OK – so it happened. And that creates its own process of dealing with the different stakeholders to try to extract the business from that situation. At any point, though, did you ever think you would have to close the business and liquidate its assets? Or did that not enter your thinking?

AS: Again, we’re not a turnaround investor, right. And I think, when you enter into these situations, certainly you have to approach everything with, in a sense, a fresh outlook. As any investor will tell you, one of the number-one rules of investing is not to put good capital after bad – and so you certainly have to ask yourself: does the investment still have merit? Certainly, the one overarching theme in that is, is the market still viable?

That is because, obviously, a lot of these things we are talking about concern different shifts in the market. And the key question is, have the underlying drivers in the market shifted or are those still intact, which would allow the business to recover? And we made the determination that, even though it had undergone significant shifts because of external factors, the market was still attractive in the sense that Western European economies still need automation.

As a society, we are still not as highly automated as other countries – specifically Japan and South Korea. So there is a lot more automation that the European economy will have to do in the coming years. And therefore we thought, look, there is still merit in this – albeit, we have had some external market shocks. But you know, with the right management team in place, the business has a future.

Financial models and forecasts

JTR: That’s really interesting. When you are thinking about investing into any company, there is always a lot of modelling and forecasting. People usually also think about scenarios and do the typical base, bull and bear cases. How do you think about the process of forecasting? And within that process, do you do scenario analysis – and, if you do, how do you incorporate the various qualitative factors within the context of modelling and forecasting?

AS: As a private equity focused investor, certainly we do a significant amount of modelling and forecasting – and, to your point, we do think about base case, downside case, upside case and so on. But we always also think about it within the context of what a model actually is. You know, a model is significantly precise but highly inaccurate – in the sense that it will determine you a number but the one thing that’s guaranteed is that number is not actually going to be how it will play out.

So you have to think about and understand – OK, what are the various different factors that come to play in this? The largest factor being the market and the second one being management ... so I think there are a multitude of different factors you have to consider and a lot of those are not quantitative but qualitative. And so the question becomes – how do you, through that process, really build your knowledge of the market to ensure you have a fundamental understanding and can further support your investment thesis? And I think that context provides a lot more value-add, in many ways, than the actual numbers in the model itself or the forecast itself. The qualitative factors that provide the context actually are the factors that enable you to deliver the forecast and to adjust or pivot during different market challenges.

JTR: Some of the challenges that made the investment case go into a distressed level and led to the business filing for bankruptcy – such as a global pandemic and a war in Europe – were situations the world had not seen for many decades. Such things are extremely difficult to anticipate and to model – even under a bear-case scenario – so, given this experience, how would you say people can look to incorporate into their base-case the sort of unforeseen events this specific investment has had to deal with over the last five years? Or is the answer that you just cannot do that?

AS: Gee, Juan – that’s a very loaded question! But I think the reality is that the market is adjusting today. If you think back to the global financial crisis, going into it, the market was obviously topping out and getting very frothy – so there was capital readily available in multiple different corners of the market. And I think we are entering a situation now where, when you’re looking at the VC [venture capital] market, there is significant volatility as valuations are coming down.

So I think people are thinking more about risk today – you know, it’s more of a risk-off kind of market than a risk-on one. And therefore valuations are naturally being challenged more today than they were a year ago, as the market is pricing in, if you want to put it that way, the various different black swan events we’ve seen occur over the last couple of years. Whereas, since World War Two, we haven’t had a war in Europe – there has been geopolitical stability on the European continent for more 70 years.

So you’re looking at a situation where a certain amount of uncertainty has occurred over the last three years that’s driving investors to price in some of these risks that probably, historically speaking, they didn’t really consider because the market was more stable. But I think there’s a lot more uncertainty in the market today that we, as investors, need to account for.

Applying probabilities to forecasts

JTR: It is difficult. One of the things we have explored on this podcast – a lot – is how to better think in terms of probabilities, and how to adopt probabilistic thinking. When you are thinking about a new investment, can you apply probabilistic thinking to the different forecasting scenarios? Is that something you would consider doing or, in practice, is it just too difficult?

AS: In theory, it is a great exercise to go through – in terms of some sort of regression analysis and so on – but the reality is that you will have one situation or one outcome that is highly unknown at the time you make an investment. And the reality is, there are too many factors that play a role over a period of three to 10 years that you could not deal with from that perspective. This is a great case study, right? Think about it – if you were investing in a business at the end of 2019, how would you think about a global pandemic occurring within two months? There’s no way of modelling that – it’s impossible. It’s literally impossible.

So the question then becomes, today, when is the next global pandemic going to be? How do you factor that? From a modelling perspective, it’s incredibly challenging. I think what investment firms are focusing more on today are markets that are less susceptible to external shocks. So you have seen a lot of investors look at the healthcare market and say, oh, that’s a very attractive market because it’s less susceptible to these type of events. And you’ve seen a lot of capital raised around the healthcare market and opportunities there because, again, it’s less susceptible to these external shocks and demand is going to be there, no matter what,

JTR: That is a great point. In the first few years after the global financial crisis, I remember in the media it was all about mortgage-backed securities and the like and discussing whether or not that sort of risk was building somewhere else in the system. Yet the probability that would be the cause of the next crisis within financial services companies is very low because people are already aware of that risk and they have made contingencies to limit it. Similarly, you are now seeing media reports about possible new pandemics – for example, monkey pox – and yet the probability of having a pandemic that proves as bad as Covid, so soon afterwards, should be relatively low. The point being, whatever is going to hit us, it is something we cannot anticipate or even imagine – that is what makes it so challenging.

AS: Yes – and specifically how it impacts a particular business or opportunity. That is incredibly challenging to understand because, to your point, a monkey pox pandemic would impact one business in one market sector very differently from another one. Think about the Ukraine crisis, for example: the Western European markets that were heavily impacted by Covid – hospitality, leisure and so forth – I would argue they are less susceptible to the conflict in Ukraine. So it also really depends upon how those markets are impacted by those external factors. That is what makes it very challenging from a sheer modelling perspective – thinking about how you understand what a downside case could look like and ascribing any probability to that.

Dealing with a business’s stakeholders

JTR: Two variables that are difficult to appreciate as an outside investor dealing with a turnaround type of situation are time and margin of error. Both tend to be connected because stakeholders tend to provide less slack and the company is more susceptible to external events – both positive and negative. At each turn, it seems like the margin of error gets smaller so could you walk us through the decision-making process at each turn for this company – starting, perhaps, with changing management after your initial choice got sick? How do you prioritise and deal with different stakeholders, especially suppliers, banks and employees?

AS: This is a fantastic question because it really gets to the heart of what makes businesses tick. The most important element of a business, bar none, is its employees – because obviously, at the end of the day, that’s who delivers whatever the business is doing. And when you’re talking about generating some sort of income and developing that into profitability, the employees are driving that process. So, when you are going through these kinds of challenging periods, employee retention is very high on the list – you need to make sure you’re focusing on communicating a clear message to the employee base to ensure there is understanding around what is being done and why.

That is because, in these situations, the one thing you cannot have is uncertainty within the employee base as that creates a scenario where there are a number of different rumours going around and so on, which ultimately can lead to leaks into the external market. So the most important thing is to make sure there is alignment within the management team and the employee base, regarding the steps that are being taken, why they’re being taken and what you expect to occur in the coming months as well.

On top of that – certainly in businesses that are dependent on an external supplier – the supplier base is very important as well: you have to make sure there is continuity there. So you need to be communicating a message to them. And to your question, banks certainly are important as well – but, in many ways, banks are not just recipients of information, they’re also providers of capital.

So if the banks are there to assist you – which hopefully they are – obviously you want to make sure they are well-informed throughout this process, because they can also provide a lot of advantages, if they’re willing to continue to lend to you or provide you with some liquidity through the process. And depending on the amount of stress or distress within the process, that becomes an option or not an option.

JTR: I made the point about suppliers and banks because – and correct me if I’m wrong – when people feel there is trouble, they are less willing to give the whole ecosystem slack so you can deal with the different uncertainties. So when it comes to paying back your suppliers, for example, they might not be willing to provide you with credit and the time you are allowed to pay them back shortens. And banks might be more willing to call on covenants or, as you were saying before, not provide more capital because they will be worrying about throwing good money after bad.

AS: Don’t get me wrong – you are 100% correct? I think the reality is that, from many perspectives, the conversation is really dependent on how quickly the business can recover – and how believable is possibility?

JTR: With the suppliers or with the banks?

AS: That’s with the banks – because at the end of the day, banks are investor-stakeholders in the business. So they want to see a return on the capital they have already invested and yet, to your point, they don’t want to invest good capital after bad. And they also want to think about the probability of getting a return on the total investment. So they have to see what you have done, as a manager or as a management team, to correct the issue and what the way forward is – in other words, what does the business plan look like going forward?

So you constantly have to readjust the business plan or develop the business plan. Suppliers are slightly different because their exposure to you, as a client, is significantly less in many ways – but that doesn’t mean you are less dependent on them because, in many cases, you are dependent on the suppliers. Still, it is very hard for them to extend you credit – or it can be difficult – depending on how that relationship has developed through that challenging period.

JTR: I guess they will also have less visibility into what might be happening to the business?

AS: Significant less visibility, right? From a banking perspective, typically speaking, in these kinds of processes, the bank you get financing from is also the banking institution you use on a day-to-day basis – so they have visibility of the movements in and out of the accounts as well. So, from that perspective, they have a lot of visibility regarding the type and quantity of movements in and out of the account on a daily, weekly and monthly basis. And that provides them a lot of comfort – or concern! – depending on the situation.

JTR: How was the decision taken, when you decided to file for bankruptcy?

AS: Obviously, anytime you go through the process, it’s very, very challenging. In this particular situation, though, entering into the Covid period, as we’ve discussed, the business was already going through significant changes. When you’re talking about changing management, that is also communicated to customers and suppliers and so on so they also see those changes and obviously, to a certain extent, that raises concerns. Layer on top of that the first wave of Covid and obviously those concerns get significant higher.

In this particular situation, going into the first wave of Covid, the business became stressed – and the level of stress continued to increase throughout that time. Our biggest problem was that we developed a business plan but the business plan continued to change as the external environment continued to change – because you went through the first wave of Covid, the second wave of Covid, the third wave of Covid ...

Within the first few months of that first wave of Covid, everybody thought, OK, look, the market is stabilising and we’ll return to some amount of normalcy in the coming months. And we had a brief window where we did have some normalcy in the market – but then the second wave of Covid hit and that created further uncertainty in the market. And if you think about the situation we were facing, through those different scenarios or waves of Covid, we were trying to have conversation with the banks – and the problem is that the business plan continued to shift and change and therefore those conversations became more challenging.

I mean, to return to your point around modelling – how do you model that and present your business case going forward? The problem is, it just continued to change. And therefore, to your comment regarding the banks and certainty or comfort around that, it was very challenging from their perspective. So we were in a situation where the business needed liquidity and the only way for us as investors to provide liquidity into the business was to take it through a quasi-Chapter 11 process where you could bring new cash into the business that stayed in the business and didn’t get swept out by the bank.

JTR: I guess that could have strained the relationship with the banks?

AS: I wouldn’t say ‘strained’ – but obviously the relationships were very difficult. Still, if you think back to this period of time, we would not have been the only business confronted with these issues. The banks themselves were inundated with different businesses coming to them in need of credit. We were one of many – put it that way.

Yes, from our perspective, it was obviously a very critical juncture. But from a banking perspective, the banks were inundated with businesses in need – whether that be simple things, such as access to revolvers [revolving credit lines] through to new credit facilities through to full-on restructuring. So, when you look back at it, yes, various different central governments were providing liquidity into the market – but there was also an element of that just not being enough.

JTR: You mention Chapter 11 but that’s just a reference to this business filing for bankruptcy somewhere in Europe. I just want to make that clear for our listeners as you cannot name the actual location or jurisdiction.

AS: Sure – it was just a pre-packed bankruptcy process equivalent to Chapter 11.

Communicating uncertainty effectively

JTR: OK. On the first episode of this miniseries, our guest Nick Hodler – who is CEO of Arc Group, a French glass manufacturer that has been a turnaround situation for seven years now – mentioned something you also highlighted: the importance of human capital in managing the turnaround. That can sometimes be overlooked – especially by people looking at a business from the outside, who can become obsessed with the numbers. Can you elaborate on why this is so important and how you dealt with it in the context of communication in order to build understanding and alleviate uncertainty?

AS: I think when you’re investing into the lower mid-market – or indeed any market, even large-cap – it really comes down to human capital and the quality of the management team, as well as the employee base. Certainly, it’s incredibly important in these situations where there is a significant amount of stress that there is also a consistent and clear line of communication. So, from that perspective, it’s incredibly important that a plan is built, is supported by the management team and is communicated within the organisation.

When you think about any investment, generally speaking – and I think you can say this about the public markets as well; certainly, when you’re looking at large corporate turnarounds – a lot of investors focus on who’s leading the turnaround itself. Who are those individuals? Because, when you’re talking about the lower mid-market or large cap – turnaround or not – I think a lot of this is really dependent upon the individuals who are leading the business because, ultimately, that is who you are supporting and backing.

That is really the heart of this and, when you’re thinking about the management team of a business of this nature – so a relatively small business going through a turnaround – it really comes down to the individuals who are leading that and their ability to execute, given those constraints in the market. So their ability to navigate that and deliver some sort of upside and/or develop the business to enable it to grow out of this phase. You know, with lots of these businesses, the big question is, really, how quickly can you get them out of this turnaround phase? And certainly access to credit or access to capital is a big part of that.

JTR: A recurring theme on this podcast is how best to communicate probability and uncertainty. You have mentioned how part of the success with this situation, which is still ongoing, is communicating well with your employee base in order to try to reduce the uncertainty. So how do you go about doing that?

AS: I mean, reducing uncertainty is not necessarily that easy! What you try to do is build a significant amount of best practices into the businesses themselves, as well as governance, to ensure there is oversight regarding how the business operates day-to-day and, more specifically, how the management team are spending time. What are they thinking about? The most critical element of this is to ensure you are building a structure within the business that can sustain or would sustain external shocks.

Now, if you’re thinking about, say, a war in Ukraine breaking out – you know, things will happen that are obviously impossible to anticipate. The question is, how well can you develop an internal structure within the business to be able to overcome those kinds of challenges? And, again, a lot of this comes down to people – because those are the individuals who actually have to build the structure.

But also – how do you ensure the business is not dependent on just one or two key individuals, which is a different layer of challenge? In small businesses, that’s another challenge you need to overcome – how do you build in enough best practices and/or technology to ensure that, should a change in management team be required or occur, how do you continue to push forward that ongoing process?

JTR: As you mentioned, the world is facing an environment that has not been seen for many decades, yet the private equity model was born in the late 1970s and early 1980s, when there was high inflation and high interest rates. It has always been predicated on using leverage to acquire the target company and relying on the IRR [internal rate of return] to turn around – the risk, of course, being too much leverage might not allow a business enough time to complete that process. Given your current experience, then, do you believe a leaner balance sheet could have helped the company to turn around or navigate through the very challenging environment it has had to endure over the last two years?

AS: I mean, if the balance sheet was not levered, certainly it would have provided a lot more opportunities to get capital into the business. Still, if it was merely less levered – if there was still some leverage on the business – I think we would have faced the same issues in some ways. Because ultimately, if you have a counterparty that is a banking institution, they have a certain objective as well and they will ask the equity holders to take a certain amount of risk before they take risk themselves – certainly in uncertain times.

So I do agree with you in the sense that, if the business was not levered at all, additional capital would have been available – there’s no question about that. But if there’s any financing on the business, with this particular situation, I don’t think the outcome would have changed – because, again, you’re in a situation where the business became over-levered because of external factors that significantly impacted the performance of the market, not of the business.

So the market became very challenging and therefore anybody in that market faced similar issues, in a way. You know, if you had any financial engineering or financial leverage on your business – something substantial in the range of 20% or thereabouts – I think you would have been facing a very similar situation.

JTR: That’s very interesting. Andrew Schemmel, thank you very much for coming onto The Value Perspective podcast. It was fascinating and best of luck with your investment case – I really hope everything goes well.

AS: Juan, thank you very much for your time.


Juan Torres Rodriguez

Juan Torres Rodriguez

Fund Manager, Equity Value

I joined Schroders in January 2017 as a member of the Global Value Investment team and manage Emerging Market Value. Prior to joining Schroders I worked for the Global Emerging Markets value and income funds at Pictet Asset Management with responsibility over different sectors, among those Consumer, Telecoms and Utilities. Before joining Pictet, I was a member of the Customs Solution Group at HOLT Credit Suisse.  

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