A.T. Kearney: GCC Family Businesses: Unlocking Potential Through Active Portfolio Management
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A.T. Kearney: GCC Family Businesses: Unlocking Potential Through Active Portfolio Management

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Since 2008, times have been tough for family businesses. The antidote: tapping into hidden value. ...

Since 2008, times have been tough for family businesses. The antidote: tapping into hidden value.

Like families in general, family businesses seem to function relatively well in troubled times. In fact, many studies show that, in the long run, they perform better than other business models. Key factors for their ongoing success include a management perspective that emphasizes the long term, strong brand and family name recognition, and often a strong focus on the core business.1

But in the Gulf Cooperation Council (GCC), family businesses are trending in the opposite direction.2 During the recent crisis, they have been less resilient than the rest of the economy despite a pre-downturn history of rapid growth and market dominance. Since 2008, the A.T. Kearney GCC Family Conglomerate Index has decreased by 60 points, while the Bloomberg GCC 200 Index has decreased by 40 points, a 20-point performance gap (see figure 1).3 After a tough 2008, GCC family businesses rebounded to some extent (as did the market), but this did not last. As the overall market has trended mostly up, family businesses have trended downward.

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  • 1. GCC Family Businesses: Unlocking Potential Through Active Portfolio Management Since 2008, times have been tough for family businesses. The antidote: tapping into hidden value. GCC Family Businesses: Unlocking Potential Through Active Portfolio Management 1
  • 2. Like families in general, family businesses seem to function relatively well in troubled times. In fact, many studies show that, in the long run, they perform better than other business models. Key factors for their ongoing success include a management perspective that emphasizes the long term, strong brand and family name recognition, and often a strong focus on the core business.1 Family businesses seem to function relatively well in troubled times. In fact, they often perform better than other business models. But in the Gulf Cooperation Council (GCC), family businesses are trending in the opposite direction.2 During the recent crisis, they have been less resilient than the rest of the economy despite a pre-downturn history of rapid growth and market dominance. Since 2008, the A.T. Kearney GCC Family Conglomerate Index has decreased by 60 points, while the Bloomberg GCC 200 Index has decreased by 40 points, a 20-point performance gap (see figure 1).3 After a tough 2008, GCC family businesses rebounded to some extent (as did the market), but this did not last. As the overall market has trended mostly up, family businesses have trended downward. Figure 1 Family businesses in the GCC have struggled since 2008 100 100% 80% –40% 71 61 60 60% –60% 40 40% 20% 2008 2009 2010 2011 2012 A.T. Kearney GCC Family Conglomerate Index Bloomberg GCC 200 Index Note: 100 basis is January 1, 2008. Source: A.T. Kearney analysis Credit Suisse Research Institute, September 2012 1 The GCC includes Bahrain, Kuwait, Oman, Qatar, Saudi Arabia, and the United Arab Emirates. 2 Top 80 listed GCC family-owned conglomerates and top 200 listed GCC companies, respectively 3 GCC Family Businesses: Unlocking Potential Through Active Portfolio Management 2
  • 3. This might come as a surprise to some, considering the advantages GCC family businesses enjoy. The biggest advantage is the ability to capture the region’s significant growth via international partnerships and franchises across multiple sectors, which are reinforced by local regulations, and exceptional leaders with strong entrepreneurial spirit and intimate knowledge of local markets. Given these strengths, the question of what is causing GCC family businesses to underperform deserves a closer look. Families must consider how they can capitalize on their advantages to recover, and then build on this to recapture stronger performance. Sustainability is crucial, after all, as many of these businesses are facing increased competition in local markets, pressure to continue to internationalize their businesses, and challenges associated with generational transition of leadership and business management. Portfolio Management Challenges GCC family businesses are seeing performance recover more slowly than the market for several reasons. One is the way they’re managing their wide-ranging portfolio of businesses and investments. Most GCC family businesses have a highly diversified, fragmented portfolio (see figure 2). This contrasts with family businesses in the more mature European and North American markets, where portfolios tend to be more focused and have clear business platforms. While GCC family businesses have been extremely successful diversifying, few have implemented systematic, active portfolio management (see sidebar: Unlocking the Hidden Value on page 4). Several other issues are creating obstacles to recovery: Low visibility of the true performance of individual assets and the portfolio as a whole. Opportunities exist to increase the systematic tracking and visibility of the contribution each individual business makes to a portfolio’s overall performance. This often goes untracked. Value creators—and destroyers—must be clearly identified. Figure 2 Most GCC family businesses have fragmented portfolios Number of sectors in the portfolio (%) 38% Business sectors in the portfolio (% active in sector) 72% 64% 56% 28% 56% 44% 17% 36% 17% 28% 24% Transportation Media Food and beverage Industrial 66% of family businesses participate in five or more sectors Hotel and leisure 7+ Construction and engineering 5 to 6 Real estate 3 to 4 Financial services 1 to 2 Retail and trading 16% Note: Based on a sample of 40 major family businesses in the GCC; includes investments Sources: Zawya, Bloomberg, public company information; A.T. Kearney analysis GCC Family Businesses: Unlocking Potential Through Active Portfolio Management 3
  • 4. Lack of clear strategic direction and formalized risk appetite. The development of clear strategic direction for the businesses, and therefore the investment portfolio, is often not systematic and inclusive. Discussions around the tradeoff between risk and reward are also not embedded in the culture. Stringent investment guidelines have not been fully developed, which results in conflicts among stakeholders about which investment strategies to follow. This creates a portfolio where assets are accumulated without the structural strength that comes with a clear investment and divestment rationale, which commonly supports large investors. Insufficient anticipation of mid-term and long-term trends. Given the region’s rapid growth in recent history, many family businesses have not felt the pressure to implement processes for monitoring mid- and long-term market trends or to develop contingency planning to deal with a downturn in business. As a result, an internal ability to develop foresight and embed it in strategic planning and risk management is often missing. Without active portfolio management, several undesirable outcomes emerge: Fragmentation of capital with limited platform for competitive advantage. Over recent years, the focus has been on growth, with top-line growth being the priority. Growth in low capitalexpenditure businesses, such as service- or distribution-focused activities (agency arrangements, for example) has limited the establishment of robust barriers to entry. Many family businesses Unlocking the Hidden Value Recent applications of structured portfolio management with diversified family-owned business portfolios in the GCC show just how much latent value can be unlocked. A deep look at regional family business portfolios and the underlying performance at the individual business level is revealing, with players falling into one of three categories. Only about 30 percent of businesses in the portfolio are true value creators. This group contributes the vast majority of profits (often 70 percent) from 55 to 70 percent of the total revenues. However, they use only about 50 percent of the equity deployed, demonstrating a less-than-ideal approach to allocating capital. The largest bucket of companies, usually 30 to 60 percent, is the complexity makers. Often in non-core segments or somehow subscale to the value creators, these businesses tend to be either historical interests that have not been actively managed or new ventures that have yet to reach maturity. At least some of these in the latter category will flounder after a good business opportunity fails to materialize, often because of a lack of continued management focus after the initial investment. Despite their large numbers, complexity makers only deliver 25 to 30 percent of revenues and 25 to 35 percent of profits. While not unprofitable, these businesses can have two negative effects on the portfolio. The first is the need for capital investment, as this group tends to use more capital for smaller returns than the value creators. Second, the level of management attention required to make these ventures successful could deliver more bang for the buck if it focused on continuing to grow and enhance the strongest performers. Complexity makers should be treated with care to select and cultivate the future stars, while regularly cleaning up the others to redeploy financial and business resources for higher returns. The value destroyers must be addressed most aggressively. These businesses, which have fallen out of favor either with the market or management, should not be allowed to destroy the good work of the others in the portfolio. Tackled strongly and exited or restructured, the released capital and resources can provide a quick, valuable uplift to the overall portfolio. The potential for unlocking value is undeniable. Addressing the underperformers, redeploying equity to higher-yielding opportunities, and capturing latent synergies in the portfolio can have a tremendous impact. In fact, applying robust portfolio management can increase profits by 10 to 30 percent. GCC Family Businesses: Unlocking Potential Through Active Portfolio Management 4
  • 5. face having to build a differentiating industrial platform to compete against new market entrants and expand into new markets. Organizational complexity and potentially distracted management. Diversification on such a large scale often leads to complex organizations, overstretched span of control at the CEO or chairman level, fragmented management focus, and protracted decision-making processes—particularly in companies where all strategic decisions are taken by one person, who is typically the family head. Erosion of asset value. Unstructured and reactive portfolio management makes it difficult to effectively review capital expenditures to remain competitive. Hesitating to make decisions about divestments from value-destroying assets also contributes to sometimes hidden erosion of portfolio asset value. Any one of these elements can undermine a portfolio’s potential value and robust performance. In some cases, portfolio growth is slowed to the point that revenue expansion can no longer compensate for eroding portfolio profitability. This puts family businesses at great risk, especially in tough economic times. Building on Three Pillars Although many have yet to fully embrace the change, some GCC family businesses are seizing the opportunity to build sustainable, robust, protected investment portfolios—and they’re doing it by building on the three pillars of effective portfolio management: performance transparency, investment strategy, and active investment management (see figure 3). Following is a close look at each: Performance transparency. Portfolios are comprised of assets that deliver widely varied performances, from outstanding to abysmal. The latter category, however, can go unnoticed if the portfolio is performing decently as a whole. This happens when portfolio performance Figure 3 Three pillars can help fortify GCC family business portfolios Effective portfolio management Performance transparency • Four sets of indicators to assess the portfolio’s overall performance: economic, financial, operational, and strategic • Comprehensive appreciation of performance, including competitive strengths and weaknesses Investment strategy • Clear vision and strategy for the portfolio with identified, targeted industrial platforms • Prioritization of sectors for focus to support strategy Active investment management • Investment review • Active investment value capture • Investment performance monitoring • Investment approach Source: A.T. Kearney analysis GCC Family Businesses: Unlocking Potential Through Active Portfolio Management 5
  • 6. is not effectively monitored. Too often, there’s a focus on aggregate growth, either revenue or assets, which can obscure a portfolio’s real performance. This is particularly true for GCC family businesses, which tend to be complex and wide ranging. A clear understanding of overall portfolio performance—and effective asset management—requires monitoring four elements: Economic. Provides clarity on investment returns, value creation, and efficiency of resource allocation. Tracking share price, internal rate of return, return on equity, return on capital employed, and economic value-added or risk-adjusted returns will help answer questions such as these: What is the return on investment? How does the added value compare with the cost of funding? Is there optimum allocation of financial resources for maximum portfolio return? What is the real return given the level of risk being taken? Financial. Provides a sense of business potential and financial sustainability. Track growth in revenue, profit, and earnings before interest, taxes, depreciation, and amortization as well as margins (both gross and operating), working capital, cash flow, and gearing (debt related to equity capital). This will generate insights into an asset’s financial viability and potential contribution to portfolio performance. Operational. Provides data on an asset’s efficiency. Tracking indicators such as the cost of goods sold, operational expenditure, employee productivity, and asset productivity can shed light on the performance and competitiveness of the combined assets. Strategic. Provides an indication of the robustness of the market positioning and likely long-term economic and financial contributions. The focus is on private equity investors’ value-creating activities, including the number of interactions and initiatives, and on investee companies’ market share and performance in key areas of business. Some GCC family businesses are seizing the opportunity to build sustainable, robust, protected investment portfolios. In short, performance transparency provides the information needed to assess portfolio strengths and weaknesses, develop investment strategies, and effectively manage assets. Investment strategy. Historically, many GCC family businesses started and developed as commercial agents to international companies or as contractors to government projects. As competition increases, they need to rethink their value proposition. Key to any business’s success and sustainability is the ability to focus and have a clear value proposition. This is challenging with just one business, let alone a diverse conglomerate or business portfolio. But this is precisely where family businesses must develop strong capabilities for long-term success. Developing a strong investment portfolio, defining the areas of focus, and building a platform for competitive advantage require a strong investment strategy. A four-step process can be used to create such a strategy: First, assess the current positioning and outlook of the business. Honestly articulate the competitive positioning of the core business. Note the sustainable advantages along with the weaker elements. In addition to this internal view, analyze the market environment, moving GCC Family Businesses: Unlocking Potential Through Active Portfolio Management 6
  • 7. beyond the immediate atmosphere. Garnering an understanding of the long-term trends and how they might affect the business positioning and market environment is essential. Once this is clear, it is possible to identify the next set of opportunities. These could be in the current business and markets or in new areas as a result of changing local market dynamics, new industrial trends and consumer patterns, or opening and closing of various geographies. After understanding the playing field and identifying where opportunities may arise, the third phase of strategy development is to identify which opportunities are worth pursuing. Several elements need to be considered: • What are the conditions for success, and how can internal strengths be capitalized on to create competitive advantage? • What long-term value would the opportunity bring to the overall portfolio? Given current business, which opportunities would strengthen the core for the future? Alternatively, how would exploring other opportunities that might not be directly complementary provide value by capturing adjacent emerging trends (or protect against potential negative impacts in the core)? • What are the funding requirements for this expansion to both protect the current business and capture the new opportunities? (For example, which assets would need to be divested or restructured?) With this potential portfolio expansion, how can the risk be managed effectively? Answering these questions requires reviewing and prioritizing industry-related sectors to build relevant platforms. It’s important to note, however, that there is no clear-cut answer to the question of whether to focus or diversify a family business portfolio. The benefits of focus are as clear for family business portfolios as they are for any other portfolio. However, given that families in the GCC are often highly exposed to very cyclical businesses such as construction, a systematic diversification of the business portfolio can reap rewards, for example in the form of countercyclical revenue streams or as a pillar of effective risk management, spreading market and credit risk. After deciding on a strategy, the last step is to determine a targeted investment approach. Again, answer a few important questions: • What investment capital is available? • What is the tradeoff between investing in current businesses versus in new ventures? What are the risks and rewards? • What is the best entry mode—organic, acquisition, or partnership, for example—for target investment opportunities, both for portfolio growth and protection? An objective assessment of what is needed to be successful in the investment venture and what current portfolio and management can bring to it is crucial. As the region’s markets become competitive, family businesses must be able to see the true value of their contribution from the perspectives of the market and also external partners, particularly international leaders that bring the core expertise and intellectual property to any partnership. This will enable them to reap the full rewards of their positioning and lay the foundation for long-term success. The process must be systematic, consistent, and integrated with portfolio management, with an objective of being proactive about future portfolio-building opportunities. This also helps mitigate risk and set the stage for organizational changes that might have to be made. GCC Family Businesses: Unlocking Potential Through Active Portfolio Management 7
  • 8. Active investment management. With a clear assessment of the portfolio performance and investment strategy, active investment management becomes the core engine to generate value and superior returns. Investments in the portfolio should be managed through three consistent and systematic processes (see figure 4): Investment review. Thoroughly assess investment opportunities—whether startups or existing businesses—to support internal decision making. Active value capture. Review portfolio performance, develop plans for creating value, and follow up on turnaround performance. Identify and review other opportunities, including acquisitions, mergers, and divestments. Follow up on execution and post-deal performance. Investment performance monitoring. Map current investment activities, and create an integrated database of relevant investments. Implement key performance indicators, and employ a mechanism for quantifying and reporting value created and its contribution to portfolio performance. This is essential to effective management and decision making. Active investment management requires internal governance and organizational support. Clear investment guidelines and an investment committee can help ensure the structured application of investment strategy, portfolio management, and assessment of potential opportunities. Large family businesses can benefit from forming a dedicated, in-house team with the authority to do the following: • Manage processes and undertake portfolio analysis • Execute investment processes, either through its own resources or by retaining external advisors • Investigate performance of the underlying investments to assist decision making by the investment or management committee Figure 4 Three processes will help maximize a GCC family business portfolio • Review new opportunities (investments and acquisitions) 2. Active value capture Ac ti • Develop action plan and ways to engage business owners • Mobilize investment or operations teams for value capture, and provide required resources • Execute action plan (investment in new business, acquisition, turnaround, merger, and divestment) Po • Design and contribute to portfolio strategy sector (sector investment strategy, acquisition, merger, and divestment strategies) ws vie re capture lue va ve • Assess existing investments (for example, as-is performance and expansion opportunities), revisit investment thesis, and refresh value creation Inves tm en t 1. Investment reviews r tf o m li o p o n e r fo r m a n c e it o rin g 3. Portfolio performance monitoring • Track at entity, sector performance, and portfolio levels • Track operational achievements and value creation versus action plans • Report information for portfolio management decisions Source: A.T. Kearney analysis GCC Family Businesses: Unlocking Potential Through Active Portfolio Management 8
  • 9. An Indispensable Tool Entrepreneurial approaches to investment and portfolio management have given family businesses a competitive advantage for many generations. The experience and maturity built and transferred through family history have resulted in distinctive management approaches and superior performance. But while some GCC family businesses have initiated the kind of active portfolio management described here, many have yet to do so. If the region’s family businesses are to return to their historically high level of performance, they must not only grow and sustain their current business, but develop beyond the GCC. Active portfolio management is an indispensable tool for accomplishing that goal. This transformation will be scrutinized by many stakeholders, especially governments, as the long-term sustainability and success of these conglomerates are often inextricably linked with entire economic segments and considerable employment of the local population. Authors Cyril Garbois, partner, Middle East cyril.garbois@atkearney.com Cyril Gourp, principal, Middle East cyril.gourp@atkearney.com Rebecca Hall, principal, Middle East rebecca.hall@atkearney.com The authors would like to thank Dr. Abdulrahman Al-Tuwaijri for his valuable contributions to this paper. GCC Family Businesses: Unlocking Potential Through Active Portfolio Management 9
  • 10. A.T. Kearney is a global team of forward-thinking partners that delivers immediate impact and growing advantage for its clients. We are passionate problem solvers who excel in collaborating across borders to co-create and realize elegantly simple, practical, and sustainable results. Since 1926, we have been trusted advisors on the most mission-critical issues to the world’s leading organizations across all major industries and service sectors. A.T. Kearney has 58 offices located in major business centers across 40 countries. Americas Atlanta Bogotá Calgary Chicago Dallas Detroit Houston Mexico City New York San Francisco São Paulo Toronto Washington, D.C. Asia Pacific Bangkok Beijing Hong Kong Jakarta Kuala Lumpur Melbourne Mumbai New Delhi Seoul Shanghai Singapore Sydney Tokyo Europe Amsterdam Berlin Brussels Bucharest Budapest Copenhagen Düsseldorf Frankfurt Helsinki Istanbul Kiev Lisbon Ljubljana London Madrid Milan Moscow Munich Oslo Paris Prague Rome Stockholm Stuttgart Vienna Warsaw Zurich Middle East and Africa Abu Dhabi Dubai Johannesburg Manama Riyadh For more information, permission to reprint or translate this work, and all other correspondence, please email: insight@atkearney.com. A.T. Kearney Korea LLC is a separate and independent legal entity operating under the A.T. Kearney name in Korea. © 2014, A.T. Kearney, Inc. All rights reserved. The signature of our namesake and founder, Andrew Thomas Kearney, on the cover of this document represents our pledge to live the values he instilled in our firm and uphold his commitment to ensuring “essential rightness” in all that we do.