Understanding Private Company Fundamentals during COVID-19 (part 2)
Estimating how GPs will react during a crisis requires an understanding of positions held, profitability metrics, cash burn, and forces within the sector.
Grinding the world economy to a halt, COVID-19 has demonstrated an urgent need for better visibility into investment portfolios. Especially when it comes to the complexities of multi-asset class portfolios. Our goal with this series is to demonstrate the strategies that modern-day investors can use to make the most of opportunities, and respond productively to challenges. Today is the second of four parts:
- Assessing Liquid Portfolio Corrections
- Understanding Private Company Fundamentals
- Modeling Private Portfolio Impact
- Quantifying Cashflow Requirements
Understanding Private Company Fundamentals
You feel a bubble of envy growing at the fact that Eva only lost 17.7% during the COVID-19 downturn. You’re also envious that she can quantify her losses in the first place, regardless of how much, especially since you have no clue what yours are. As she takes a moment to pat her sleepy golden retriever on its head, Eva begins switching to the Novus private equity dashboard.
Eva explains that her approach to estimate how GPs will most likely react during a crisis of COVID-19’s proportions hinges upon her thinking like them. This requires a deep, fundamental understanding of two things:
- The positions held in the fund, along with their profitability and cash-burn;
- The head- or tail-winds these companies are facing based on the sectors they belong to.
As the tables and numbers appear on the screen, something in the dashboard smells familiar. But of course! This is the master template that Eva had you develop when she was still desk head and you were a young intern. Against the common wisdom of the time, Eva had advocated for position-level transparency, even for private market portfolios. (While others were happy with just returns.) She had also pushed everyone on the desk—driving a few people mad—to harmonize net income statements across different GPs in order to facilitate comparisons among companies. Figure 1 depicts Eva’s dashboard on Novus, where each company is listed, on a look-through basis across all her GPs, with their own sets of fundamentals.
“Wait a moment Eva, did Novus seriously come up with the exact dashboard we developed a few years back—did they read you mind or something?” you ask.
“Oh no, this is a standard Novus feature. They let you pull the data you want, and organize it how you want in custom dashboards; you can specify columns, labels, order, aggregation methods, and a few other things…their team was extremely patient in showing me how to do it, and after a few clumsy attempts I got the gist. I pretty quickly replicated that entire private markets dashboard we made back when we were working together,” Eva responds.
“I get it, they just gave you the flexibility on the front end,” you reply a bit dismissively.
As Eva sorts portfolio companies by increasing EBIT Margin, she says, “Actually, not only that. They also took care of the harmonization needed to arrive at these comparisons, mapping GP-provided statements and metrics into a standard net income statement syntax, thus allowing for aggregation.”
Your heart skips a few beats. Your memory goes back to that hot, humid summer in New York when Eva had asked you and the other interns to harmonize net income and balance sheet statements from 56 GPs across 3 years. With each GP holding about 30 portfolio companies, and 7 fields to harmonize (she had spared you the full list of 39), you and your team had to manually copy-paste (and map) 141,120 fields. (56 GPs reporting 7 fields quarterly, for 30 companies each, 3 years in a row.) The boundless ambition of youth had made you volunteer to do it all over the weekend. Clearly you had not done the math before speaking, and found yourself finishing at 5:45am on Monday morning, a few hours before Eva needed the figures. You had also forgotten that the air conditioning was shut off during the weekend in an effort to "go green." You delivered the project exhausted, dehydrated, and depressed. You remember Eva taking pity of you and sending you home after complimenting you for a job well done. And now everything seems to have been taken care of by machines. You wish you were born 20 years later, this feature would have saved you from that grueling, sweat-drenched weekend.
Eva has moved on, and quickly applies simple math in front of you: “We have a few companies with EBIT<0 in the portfolio, and profitability will be key to determine cash requirements. In speaking with GPs, I reckon they’ll simply pull the plug from Health Care holdings and not re-up their investments. Moreover, companies with an EBIT margin not lower than -5% should still have enough cash from the latest recapitalization round. This leaves us with the five holdings in Information Technology and the one in Communication Services. Those are the ones that GPs will call capital for.”
You know that Eva typically looks at the amount of profit made by GPs in their portfolio companies up until that point in order to validate her assumptions. GPs are less likely to inject into unprofitable companies unless their valuation has increased during the period.
But Eva moves faster than you, and fiddles with an additional Novus dashboard on the fly to contrast position-level profitability via company valuations (from the perspective of the GP) with some of the company fundamentals she showed you in Figure 1, pulling up the aggregated dashboard in Figure 2.
“So, by combining realized and unrealized P&L by portfolio company," continues Eva, "we can see that none of these companies are underwater from the perspective of the GP, which makes me think they’ll want to call capital to keep them afloat. By eye-balling revenues and average EBIT margin among those (Eva flips to the dashboard in Figure 1 again), in a normal situation these companies would need around USD 60m of additional cash. Also, revenues will drop by 15% at a minimum this year. Assuming that it will take us twelve months to get back to normal, and given our share in the fund, we should expect additional capital calls for USD 30m in the next twelve months. Given that the first quarter’s capital calls are 3x any of the subsequent quarters, we need to prepare USD 15m of cash.”
You’re stunned at the speed of her reasoning, and at the breadth and depth of data she can access at her fingertips. And you’re getting jealous of the tools she has to put it all together. Eva gives you a moment to digest what she just went through and gives a few pats to her golden retriever, whose sleep remains unperturbed by Eva’s caresses and the drama affecting institutional investor portfolios.
After a few moments, Eva looks back at you, “Shall we see how this will further impact private portfolios down the line?” You nod in silence and straighten up in your chair.