Why a Digital Mindset needs to be centre stage with Distressed Asset Management
Updated: Aug 25, 2020
3 lenses to add to your valuation model
Venture capital thrives in overall positive economic conditions, but hedge funds tend to benefit from the exact opposite. The current market downturn represents a big opportunity for distressed asset managers to get their hands on potentially extremely undervalued businesses and turn them around for a profit. The approach employed tends to be either a high yield bond investment or a more involved turnaround strategy, based on the underlying conditions for the business and the assumptions made about the future of the company and the overall economy.
Your valuation model is only as good as your assumptions
Normally, the financial models employed for this assessment based on EBITDA, debt leverage covenants and revenue assumptions would be enough to make an investment decision, and the turnaround strategies centred mainly around margin improvements and cost cutting would usually result in a successful turnaround.
But we are not in a traditional recession, because Covid19 is accelerating shifts in underlying consumer behaviours and business feasibility that will potentially become permanent. The world was already on the way to embracing digitalisation, but what would have normally taken decades is being compressed into a matter of months.
According to the June report released by Adevinta & Dealroom, in the small space of one month, online share of retail sales grew 31% in the UK compared with the 20% growth it experienced over the past 7 years combined. Similarly, app downloads in education and groceries have increased 1–2X just in March 2020 compared to January 2020. Notable increases belong to Preply, an online educational platform that pairs students with private tutors, with 284% growth, and Ocado with 99%. These behavioural changes in digital adoption are unlikely to be temporary.
3 Lenses of a Digital Mindset
Amidst this backdrop, the valuation and turnaround strategies of distressed businesses need to include the impact of rapid adoption of digitalisation to be financially astute. If you don’t take digitalisation into consideration for your assumptions, your model might be far from reality, making your best case scenario worse than your worst case scenario. Conversely, if digitalisation is incorporated into the assumptions and the ensuing turnaround strategy, the future valuation of the distressed business might be higher than what your traditional model predicts.
We suggest a digital-native scope with three lenses to be applied on top of the financial and business acumen that hedge funds bring to maximise multiples.
1. What assets and/or processes can be partially or fully digitised? As our favourite tech business journalist and podcast host, Kara Swisher, says “Everything that can be digitised will be digitised.” Therefore, when reviewing a business’ assets during the identification phase, a thorough evaluation of the digitisation potential needs to take place.
2. How can they be digitalised? This is the lens that’s obsessed with the application of the above digitisation potential, and this is where you really need to flex your expansive thinking. While certain information has precedence on how it can be digitalised (i.e. purchase histories informing recommendations), others may not have previous case studies. It is important to understand cloud and machine learning capabilities so that you can build the applications relevant for your data. Ideally, you generate a long list of potentials before you dwindle it down by asking questions on feasibility, affordability, ecosystem potential, etc.
3. Who is best placed to spearhead digitalisation within the organisation? Every change that is corporate-wide needs to have a leader with authority and enough seniority to actually follow through. This mindset shift is no different from executing other kinds of corporate culture change. Ideally, the leader would come from within the organisation, who has established relationships, respect and trust that enables them to guide the business, but they also have to have a leading role in forming how the product shifts based on customers’ real needs and a large market in sight. Interestingly, this step is where most transformations stumble as without these leaders, the stamina and endurance required for the full mindset shift dwindles. Without leadership and authority backing the transformation, nothing really happens.
The aim with this three lens approach is to avoid the so-called halfway house that many firms fall prey to. Just establishing an e-commerce site but leaving your marketing and sales teams set in their previous processes does not make a business ‘digital’. There needs to be a holistic mindset shift to digital-first in all aspects of the business permanently.
What we can learn from startups
Building a business model and executing towards profitability in a digitally native way within an environment of extreme ambiguity is where startups shine. It is what they’re made of as they excel in imagining all possible scenarios that might play out and then leading with the one they believe in. We call it the Dream-Lead-Adapt model, which you can read more about here.
But all of this valuable digital knowhow is trapped in the startup ecosystem. Many corporations aim to tap into this vast knowledge through their own startup accelerator programs or CVCs, but these rarely change the company hosting them as they are seen as a foreign entity by the rest of the profit-building machinery. It is not in their DNA.
Even more worrying is that no one takes the role of translator to apply this knowhow to mature companies, especially distressed businesses, who need to transform more than just their operating efficiencies. A complete mindset shift needs to accompany the transformation for it to take root in the post Covid19 world and blossom.
We’re living through a great upheaval of traditional business models, which also require the disruption of traditional responses to such distressed assets. There is a lot of capital in the world, and with it, a lot of value can be generated for the future, if distressed asset management modifies its approach from cost-cutting margin improvements to long-lasting turnaround strategies that have digital at their core.
To find out more about our services on transforming your distressed business restructuring in a digital native way, please visit our dedicated page.