Investment firms that seek to deploy a new fund every two to three years can find that an economically fulfilling proposition, says Frontenac Managing Director Ronald W. Kuehl. But that potential comes with a risk.
“As you’d anticipate, that strategy can be highly lucrative,” Kuehl says. “You can also end up with a number of assets that you’ve spent less time with in diligence and you've had to make an investment decision more quickly. We pride ourselves on finding the right business and then the right risk/return opportunity.”
In December, Frontenac sold Chino, California-based Liquid Technologies, a contract formulator and manufacturer of personal care products, to Pritzker Private Capital-owned PLZ Aeroscience Corp. The deal wrapped up an investment relationship that began in 2016.
“We were able to grow EBITDA margins 700 basis points as a result of automation efficiencies and operating leverage,” Kuehl says, reflecting on his firm’s ownership of the company. “Partnering with growth-focused, founder-owned businesses is a core pillar of our strategy, and we are delighted by the successful partnership we forged with Liquid Technologies.”
Smart Business Dealmakers spoke with Kuehl to learn more about the Liquid Tech deal and the role Frontenac’s investment strategy played in its success.
Find the margin
Kuehl focuses on investments in the commercial, industrial and business service sectors, using a mix of patience and urgency to find good deal opportunities.
“We’re rarely buying businesses that have been polished up and have optimal operations and particularly strong back offices,” Kuehl says. “We focus on identifying what the value creation levers are and then, with a sense of urgency, pursuing and executing on a strategic growth plan, as well as a tactical plan, shortly after closing, that is specific to the business and the opportunity.”
There are several things Frontenac likes about the personal care products sector.
“The industry is not recession-proof by any stretch,” Kuehl says, “but generally speaking, you’re going to use the same amount of personal care products whether GDP is up 2 percent or down 2 percent. And then the final piece — and this is the worst-kept secret in the consumer world — is that these products don’t cost a tremendous amount to manufacture, but ultimately get sold at some heady prices.”
Good margins are typically achievable in this space for the companies up and down the value chain: ingredients suppliers, contract formulators and manufacturers and the brand owners, which often earn the best margins, Kuehl says.
“This is not a situation where everyone is scrapping for a penny or two in the total cost,” Kuehl says.
Additionally, it’s a highly fragmented market, with a number of players in the $5 million to $25 million revenue range, he says.
“They tend to be regional and have some concentration — either product or customer,” Kuehl says. “There’s also not a significant number of potential buyers for those businesses at that size range.”
Always have a plan
Yet another factor that was appealing to Frontenac about the personal care products sector is the stickiness with both manufacturers and brands.
“There is a reluctance to change in this business because of more risk than upside,” Kuehl says. “There’s so much margin that everyone will keep doing what they’re doing with their current suppliers. The only real motivation to change is if product quality or service is really substandard. Otherwise, it’s not a segment, at least with our strategy, where there’s a tremendous amount of price sensitivity.”
That’s not to say the nearly four years of ownership of Liquid Technologies were free of challenges, Kuehl says.
“The company did not have a sales force when we invested,” Kuehl says. “We built out a full salesforce and business development team, which fueled organic growth. On the margin side, we invested in automation and added a second shift. Our journey to a successful outcome was different than we would have anticipated. It stresses, at least for us, that you have to have a couple of different paths to success to ensure you’re not reliant on any one singular strategy or component of value creation.”
The key is to always have a plan, as well as credible alternatives to execute on if your plan doesn’t work out exactly as you had hoped.
“From the moment that you own the business, you need to have a real operational angle and a clear path toward value creation,” Kuehl says. “You need those things to manifest themselves in a sense of urgency to build value, get off to a strong start and begin the avalanche of success.”