The wolves that circled Spotless finally have their prey. As much as Peter Smedley had tried to convince shareholders that the turnaround would deliver future rewards, the figures at the services company just looked too lean to long-suffering shareholders, and too juicy to a bloodthirsty corporate raider.
Spotless was demonstrating some impressive-enough top line growth. As the chart below shows, the company managed to emerge from the 2008 slowdown in relatively good shape, with the exception of its struggling hanger division Braiform. Revenue for its major earner – managed services – is growing nicely, boosted by a 73 per cent rise in sales to resource companies like Rio and BHP. All that fly-in-fly-out infrastructure has to come from somewhere.
Unfortunately, the next chart is what investors will have been looking at when considering the takeover offer from Pacific Equity Partners. The margin Spotless is earning on its divisions is risible, with the exception of laundry services, where presumably, economies of scale in plant and equipment apply.
Spotless knows its margins are below international peers like Compass and Sodexo, who manage to deliver 5 to 6.5 per cent. On an averaged basis, with laundry included, they’re not too far off, but with their biggest contributors languishing with margins around 3 per cent, the company had a lot of work ahead of it.
Private equity firms live for this stuff. It’s classic Gordon Gekko territory when you have a diversified company with standalone divisions that are underperforming their peers. With the laggards dragging the company down, Pacific Equity has managed to snap up Spotless’ predictable, long-term revenue streams at just 5.5 times EBITDA, compared to 8.2 times EBITDA for comparable takeovers (Bloomberg analysis).
PEP will look at each unit as an individual company that can be restructured and spun-off, a likely rapid fate for Braiform. As brilliantly spelled out in a Bloomberg Businessweek article last week (My week at private equity bootcamp), every step in a worker’s day will be mapped out and assessed to determine where and how the company wastes money.
In the US, teams of experts in continuous improvement, or Kaizen, focus on productivity, eliminating unnecessary steps between actions. These can be as simple as repositioning a rubbish bin on the factory floor.
Incremental changes, shaving a minute off here and there, can restore those margins, once delivered across the entire company. And despite their slash and burn reputations, private equity firms can often be a shot in the arm for struggling businesses. Silos can disappear overnight, and rank and file staff often find that new managers are far more receptive to their ideas. Where once division heads had a complicit understanding that "I won’t poke my nose into your business, if you keep out of mine”, now ideas can be replicated and shared.
Spotless knew it had this problem when it engaged on its turnaround in 2007. It was organised in geographic and divisional silos. Its IT infrastructure was antiquated and was being served across 135 different IT systems. It had six different payroll systems, even though labour accounts for 70 per cent of its operating expenditure.
Essentially, Spotless failed to properly measure productivity. It is not alone. As Robert Gottliebsen has warned in his article Australian CEOs don’t measure up (March 20), only a quarter of Australian firms do and those that continue to ignore it are failing their shareholders. Spotless investors who have seen the share price bump along at $2.50 since they fell from over $5 in 2007, will have a testing time to see whether they are witnessing a massive transfer of wealth to the partners at Pacific Equity. With the right metrics properly applied, I suspect PEP will clean up.
To see an example of how firms are removing steps from their processes and delivering huge cost savings as a result, see the latest video from Productivity Spectator here.