Media Coverage
Private Equity: A Force For Constructive
Corporate Change And Value Creation


Astoria Private Equity Investment Forum,
a Speech by Donald J. Gogel

November 2006

Good morning.
I would like to focus my remarks this morning on why private equity continues to be a dynamic force in the global economy – acting as a catalyst for constructive corporate change.

Private equity has played an important role in global restructuring over the past 20 years and has been a rich source of creative corporate innovation – finding novel solutions to critical problems faced by many types of businesses in North America, Europe and more recently in Asia.

Private equity by nature is flexible. It's transitional. It's entrepreneurial. It's risk taking. It can fill spots in the global restructuring environment that public company capital cannot.

Private equity is a highly creative mechanism that allows large struggling corporations to remain competitive in response to the rapid changes in the global economy. Many of Clayton, Dubilier & Rice's investments over the years certainly reinforce this point.

The sheer scale of global private equity today carries with it, if not the actual seeds of excess, at least the perception of excess. After the notorious $30 billion buyout of RJR Nabisco in the late 1980's, buyouts earned the wrath of the U.S. public and Congress, a telling reminder that private equity can polarize, even in countries where the principles of liberal capitalism run deepest.

To the average person, private equity can appear threatening and mysterious – even more so to political leaders. Only last year a German minister created considerable controversy by famously branding private equity investors and hedge fund managers as "swarms of locusts" descending on the country and stripping it bare. At least three countries have launched inquiries into private equity in the last few months, wanting to better understand how the new high-profile industry is affecting their economies.

Given some of the misperceptions about the asset class, it is appropriate to step back and ask ourselves why private equity has proven to be so successful and why it should continue to act as a catalyst for constructive corporate change and operational excellence globally.

I am not suggesting that the largest public companies around the world will all be private in a few years. Rather it is to suggest that there is real substance and economic value underlying the "private equity" equation – an equation that cannot and will not be thwarted in societies that prize improvements in productivity and asset utilization and that care deeply about the prosperity of their citizens.

So – what is that real substance and economic value and, importantly, why do I predict that private equity will play an even more important role in the global economy for many years to come in transforming ownership, assets, management practices, business strategies and capital markets in a productive fashion?

Let me start with a case study.

The story of Lexmark's metamorphosis began in 1990, when IBM was planning its first ever divestiture. The sale involved IBM's office products division, which sold typewriters, dot matrix printers and related supplies. Instead of shopping the complicated transaction to many potential buyers, IBM decided to hold exclusive talks with CD&R primarily because of our reputation for building the businesses that we own. The then IBM chairman John Akers put it another way when we first met with him. Holding up the bestselling book, later a movie, about the takeover of RJR Nabisco called Barbarians At the Gate he said: "The reason I am talking with you is because you are not mentioned in this book."

It was a challenging divestiture by any standard:

  • IBM's office products division, as such, did not exist. It had no corporate center, no sales force and no audited financials. The units that produced the various office products were embedded deep within the IBM structure.

  • IBM's typewriter business may have struck some as an attractive cash cow, but given the rapid proliferation of the PC, its days were numbered.

  • The division had excess inventory and technology that paled next to its competitors.

  • Product development took an average of 30 months, which may have been acceptable for the typewriter business but was not sufficient if Lexmark were to become an effective competitor in the world of high technology.

Our vision was to create a stand-alone company from a collection of product lines and then transform Lexmark from a typewriter manufacturer into the industry's most dynamic developer of computer printers.

After the investment was completed, we moved quickly to build a strong foundation for the company. Aided by an innovative equity ownership plan that we devised, which included all of the employees, we create an entrepreneurial, market-driven culture. To help fund expanded research and development on laser printers, as well as a new marketing effort, we helped Lexmark secure financing, despite the lack of conventional financial statements for the company and the extremely weak capital markets at the time.

At the new Lexmark, product development was completely overhauled. If HP had an 18-month product development cycle, Lexmark would have to be even faster. Lexmark's new approach mandated that if a product could not be brought to market in 15 months, it should not be developed at all. To "make this happen," we instituted multi-disciplinary teams with sales, manufacturing, purchasing, R&D and operations leaders all tackling technical problems as a team. Lexmark became the industry leader in innovation, introducing families of products built to address the customer's and the market's needs. We were bringing new products, such as laser printers, to market in 15 months, and at price/performance levels that many considered the best in the business.

We also created a new distribution system for the company's products. And that also required some revolutionary thinking. Knowing that it would be easier to make inroads against HP in niche markets, Lexmark created a direct sales force to focus on crucial industry segments such as banking, insurance and retail pharmacies. Until that time, no printer company had ever had a direct sales force of any kind. And unlike HP, Lexmark manufactured its own, thus gaining control over a key technology and creating an ongoing "razor blade" revenue stream.

After just one year, Lexmark profits were 30% ahead of plan and loan repayments were ahead of schedule. As the company's new products succeeded, Lexmark managers became more ambitious. The company invested substantial amounts in new software capabilities – without expecting a short-term payback. As it happened, the payoff took several years, but it was a big one permitting Lexmark to emerge as the leader in many portions of the market for networked laser printers, doubling its share of this market. Increased research spending also led to the creation of Lexmark's proprietary inkjet technology.

Under our ownership, Lexmark's sales and profits grew every year and so did employment. Today, with a market capitalization in excess of $7 billion, Lexmark continues to be a powerful force in the printer business, and it still gets products to market faster than most rivals do.

Lexmark makes a very good case for private equity. But I would argue that it is not a singular case. It is not an exception. Rather, I would argue that private equity has a number of structural advantages that can be used to create value in many business settings, in many industries, and, with appropriate modification for local practices and culture, in many parts of the world, and certainly in Japan.

I would rest the case for the value of private equity on seven points:

  1. First, private equity thrives where there is demand for change. In the world of competitive business, change and adaptation is critical to sustaining success. Shifts in technology, culture, fashion, labor markets, economic cycles and customer needs demand a responsiveness that is difficult to achieve for large corporate enterprises built primarily on the logic of economies of scale and functional prowess in engineering, manufacturing, marketing and sales. Even if 90 percent of global corporations adapt to the demands for change, 10 percent do not – and that is where private equity will come in to play.

  2. Second, private equity succeeds in part by shifting ownership to more focused committed owners.

    Why should ownership matter? More than anything else, leveraged buyouts are opportunistic responses to the difficulties encountered by current owners and managers to sustain or improve performance of their "old" or "non-core businesses" while they are building new capabilities for the future. Buyout groups ("private equity sponsors" in the more polished vernacular of the late 1990s) seek investments where current owners find themselves unwilling to undertake the next generation of changes required to fix businesses and make them more profitable. Often, and with good reason, these businesses are "orphans" that have been unable to attract or warrant the management talent or capital needed to continue their growth.

    This may not be a failure on the part of the current corporate owner. On the contrary, it can be an extremely studied and appropriate response to changed conditions. The decision by IBM to sell its Office Products Division reflected an assessment that IBM had more attractive opportunities than those presented by the low price/low margin typewriter and printer business which was increasingly coming to resemble the consumer electronics market. The decision by Westinghouse in 1994 to sell its Wesco distribution business reflected a strategic assessment that captive distributors were an ineffective channel to customers. The decision by the Gillette Corporation to sell its direct sales cosmetic business, Jafra, in 1998 reflected a considered judgment that a direct sales channel was never going to be compatible with Gillette's massive investment and franchise in the retail channel. Certainly the sale of Hertz by Ford was an appropriate response to Ford's worsening financial condition – Hertz just was not a strategic asset. All of these decisions rested on a calculus that concluded the target business would not contribute to shareholder value.

    Certainly many European conglomerates today find themselves in similar positions. PPR, the French luxury goods conglomerate sold us Rexel, an electrical supply distribution business. Veolia Environment, reeling under a mountain of debt and stymied by terrible franchisee relations, sold us Culligan, the water treatment business. And we are seeing more examples of this in Asia as well.

  3. Third private equity is successful by creating a very public expectation for change.

    In a famous 1940s study of industrial organization at the Western Electric plant in Hawthorne, New Jersey, researchers found that productivity at the factory increased when the lights were turned up to brighter levels. However, in a subsequent stage of the study, the researchers found that productivity increased again when the lighting levels were turned down.

    The conclusion of the study was that workers like to have people pay attention to them. The Hawthorne effect has since been used to describe changes in behavior that are induced by management "paying attention."

    In many ways, buyout firms and management teams have the benefit of the Hawthorne effect as they negotiate, finance and close a leveraged transaction. First and foremost, a management buyout involves a change of control, an event that is by definition a transformation. The buyout unleashes a number of powerful forces that enable firms like CD&R to initiate a broad range of changes. The buyout process subjects management plans in every geographic, product and functional area to critical review, not only by the buyer, but also by the buyer's banks, and, often, the broader capital markets. Such a review typically challenges old ways of conducting business and forces consideration (and sometimes adoption) of new business practices.

    Although not necessarily part of the buyout process, buyouts are also associated with a host of attention-getting changes: a change in corporate name and logo, articles in the local newspapers, a new boss. Everyone is paying attention and, in such a setting, management teams are typically more successful in bringing about change.

    When CD&R acquired VWR from Merck AG, there were widespread and well-founded expectations that with new ownership the company would be changing its European organization, its sourcing strategy, its sales force compensation system, and much, much more. Similarly, when we acquired Brakes, customers, suppliers and employees all expected that life would be different as ownership shifted from a family-controlled enterprise to a CD&R-controlled business.

  4. Fourth, private equity spurs new business strategies.

    Buyouts are also typically an occasion for thinking about business strategy, an opportunity to reconsider assumptions about how a business tries to sustain (or regain) its competitive advantage. Elements of strategic thinking typically help shape the investment rational put forth by the buyout sponsor: low cost position, product positioning along price/performance parameters, target markets and customers, breadth of distribution channel.

    The impetus for re-thinking strategy starts with resource allocation. The very act of financing a buyout requires a host of assumptions about how capital will be allocated as well as the timing and level of return on investment.

    In Kinko's, a leading business services company, we realized that the historical target market of small commercial customers – the average Kinko's transaction was $11 when we made our investment – was being eroded by new technology that allowed for in-office reproduction. So we were able to shape new strategy to attract large corporations that today routinely spend millions of dollars with Kinko's.

  5. Fifth, private equity works because it attracts new management talent.

    Many, if not most, management buyouts include the existing management team. Typically, with the help of the buyout firm professionals, a few new managers are recruited to the team. This usually occurs as part of a systematic process to assess the quality of managers in key jobs. At a minimum, this discipline forces an evaluation of management capabilities that is extremely difficult in most steady-state organizations where weaknesses are much more readily tolerated.

    Since experienced professionals in most buyout firms have the experience to assess management talent, most buyouts lead to the addition of new managers in several "skill positions" such as purchasing, and finance and information technology.

    Occasionally, there are circumstances where an almost all-new management team must be recruited. This can occur when division managers are expected to return to the parent company at the closing of the transaction, or in certain special circumstances.

  6. Sixth, private equity is effective because it creates new capital markets which in turn support new transactions.

    It is impossible to speak of the rise of private equity without noting the parallel rise of the market for high yield securities. Originally developed as a financing source for public takeovers, it has grown dramatically to include financing for a variety of high growth industries such as cable TV, wireless telephones and casinos. High yield debt raised in the U.S. and Europe each year is measured in hundreds of billions of dollars.

  7. And seventh, private equity is compelling because it creates a sense of urgency.

    Perhaps the greatest leverage of all in a leveraged buyout is the leverage of time. Although a long-term perspective can be important in developing strategy, it is often an obstacle and an excuse for not moving quickly to implement required changes in a business.

At some level, a buyout creates a sense of urgency to get things done. The discipline imposed by a leveraged capital structure certainly plays a role in creating that urgency. Monthly interest payments that often chew up half or more of a company's cash flow tend to get the attention of every executive and, sometimes, all employees. The burden of annual amortization payments is a major spur to action.

In a non-leveraged company, an increase of inventory levels is likely to engender a response measured in months. The inventory builds up during the last month of a quarter, but, since it is only a month, will not draw attention. It is discussed in a quarterly operating review at the end of the next quarter. The responsible executive promises to address the problem and report on progress at the next quarterly review.

In a buyout, a good CFO and line executive will have identified the build-up in the first month, and by the end of that month, in the first quarterly review, will report on actions being taken to address the issue. Follow-up will be weekly, if not daily.

Again, I do not want to overstate my case. I am not predicting that private equity will own the world. But I am looking ahead to a period where private equity will continue to play a leadership role in corporate restructuring. In the past, over 40% of global private equity transactions involved corporate divestitures – CD&R's number one target. The second largest source of deals involves private company sales – our number two target. In fact we've had situations like Brake Brothers – one of the largest food distributors in Europe – that are a mix. Prior to our acquisition, Brakes was 58% owned by the Brake family; even though it was public, it really operated more as a private company.

We also expect to see more public to private transactions in the U.S. as beleaguered public company boards and management teams try to escape activist, pirate hedge funds and the unrelenting demands of post-Enron regulation.

Let me close by taking a risk to suggest that everything in the CD&R strategy can, should and will apply in Japan.

For 30 years CDR has worked closely with large corporations to shed divisions that no longer fit with their core activities. In highly complex carve-outs of corporate orphans, we are often the private equity firm of choice. In just the past the past two and a half years, CD&R has led transactions involving five non-core corporate divisions, including, our purchase of Hertz from Ford. We understand the complex employee, customer and supplier issues that arise in cases where offices, plants and personnel are being carved out as stand-alone businesses. Is there any one in this room that does not know of a dozen Japanese corporations that should divest one or more non-core divisions?

We typically acquire businesses that are underperforming relative to their potential. Improving the profitability of these businesses provides superior investment returns. More than 90% of the returns generated in our last three funds have come from operating improvement, measured by EBITDA growth. We view this capability – and its translation into increased enterprise value – as our key competitive advantage. Is there any one here that does not come across underperforming businesses in Japan every week?

To execute our strategy, we are the only private equity firm in the world whose partnership is evenly divided between financial partners and operating partners – like Jack Welch – who are experienced leaders from global companies. Another example is Ned Lautenbach, who spoke at this conference last year. Prior to joining us, Ned was in charge of IBM's worldwide sales and services business and he also served as President of IBM Asia Pacific. He currently serves on the board of The Sony Corporation.

Our operating partners lead our transformation efforts in the portfolio – and bring the talent and experience necessary to make it happen. Working very closely with our operating partners, CD&R's financial professionals assume responsibility for sourcing new investment opportunities, structuring and financing transactions, working on portfolio company acquisitions and establishing strong financial controls at portfolio companies.

Would you all agree that operating expertise is an essential element in transforming and improving businesses?

Operating capabilities are a necessary condition to undertake Lexmark and Hertz-type corporate transformations. They also require something more. They must be undertaken with great integrity and care. Corporate transformations must add clear and demonstrable value. They must be undertaken with sensitivity. Employees must be treated fairly…intellectual property protected…the environment respected. If we ignore these important principles, we run the risk of losing public and political support for the enormous economic benefits that private equity can produce.

So I would conclude by saying that I am upbeat for the long-term prospects for private equity globally and here in Japan.

Private equity is a force of constructive corporate change. Even in this country where corporations historically had a hard time letting go of divisions, no matter how non-core, Japan is today one of the world's fastest-growing markets for management buyouts.

Private equity is an engine to drive needed restructuring anywhere companies are looking to shed operations that don't generate much cash and to focus on businesses that do.

Private equity is a powerful form of governance for changing the way people behave and businesses perform, transforming mediocre operations into top tier performers.

And finally, private equity has proven to be a very flexible source of value creation to deliver superior results in a variety of economic and capital markets climates, particularly for the firms with investment models grounded in generating returns from operating performance improvements and profitable growth initiatives at their portfolio companies.

Thank you.


Media Coverage
Private Equity: A Force For Constructive
Corporate Change And Value Creation


Astoria Private Equity Investment Forum,
a Speech by Donald J. Gogel

November 2006

Good morning.
I would like to focus my remarks this morning on why private equity continues to be a dynamic force in the global economy – acting as a catalyst for constructive corporate change.

Private equity has played an important role in global restructuring over the past 20 years and has been a rich source of creative corporate innovation – finding novel solutions to critical problems faced by many types of businesses in North America, Europe and more recently in Asia.

Private equity by nature is flexible. It's transitional. It's entrepreneurial. It's risk taking. It can fill spots in the global restructuring environment that public company capital cannot.

Private equity is a highly creative mechanism that allows large struggling corporations to remain competitive in response to the rapid changes in the global economy. Many of Clayton, Dubilier & Rice's investments over the years certainly reinforce this point.

The sheer scale of global private equity today carries with it, if not the actual seeds of excess, at least the perception of excess. After the notorious $30 billion buyout of RJR Nabisco in the late 1980's, buyouts earned the wrath of the U.S. public and Congress, a telling reminder that private equity can polarize, even in countries where the principles of liberal capitalism run deepest.

To the average person, private equity can appear threatening and mysterious – even more so to political leaders. Only last year a German minister created considerable controversy by famously branding private equity investors and hedge fund managers as "swarms of locusts" descending on the country and stripping it bare. At least three countries have launched inquiries into private equity in the last few months, wanting to better understand how the new high-profile industry is affecting their economies.

Given some of the misperceptions about the asset class, it is appropriate to step back and ask ourselves why private equity has proven to be so successful and why it should continue to act as a catalyst for constructive corporate change and operational excellence globally.

I am not suggesting that the largest public companies around the world will all be private in a few years. Rather it is to suggest that there is real substance and economic value underlying the "private equity" equation – an equation that cannot and will not be thwarted in societies that prize improvements in productivity and asset utilization and that care deeply about the prosperity of their citizens.

So – what is that real substance and economic value and, importantly, why do I predict that private equity will play an even more important role in the global economy for many years to come in transforming ownership, assets, management practices, business strategies and capital markets in a productive fashion?

Let me start with a case study.

The story of Lexmark's metamorphosis began in 1990, when IBM was planning its first ever divestiture. The sale involved IBM's office products division, which sold typewriters, dot matrix printers and related supplies. Instead of shopping the complicated transaction to many potential buyers, IBM decided to hold exclusive talks with CD&R primarily because of our reputation for building the businesses that we own. The then IBM chairman John Akers put it another way when we first met with him. Holding up the bestselling book, later a movie, about the takeover of RJR Nabisco called Barbarians At the Gate he said: "The reason I am talking with you is because you are not mentioned in this book."

It was a challenging divestiture by any standard:

  • IBM's office products division, as such, did not exist. It had no corporate center, no sales force and no audited financials. The units that produced the various office products were embedded deep within the IBM structure.

  • IBM's typewriter business may have struck some as an attractive cash cow, but given the rapid proliferation of the PC, its days were numbered.

  • The division had excess inventory and technology that paled next to its competitors.

  • Product development took an average of 30 months, which may have been acceptable for the typewriter business but was not sufficient if Lexmark were to become an effective competitor in the world of high technology.

Our vision was to create a stand-alone company from a collection of product lines and then transform Lexmark from a typewriter manufacturer into the industry's most dynamic developer of computer printers.

After the investment was completed, we moved quickly to build a strong foundation for the company. Aided by an innovative equity ownership plan that we devised, which included all of the employees, we create an entrepreneurial, market-driven culture. To help fund expanded research and development on laser printers, as well as a new marketing effort, we helped Lexmark secure financing, despite the lack of conventional financial statements for the company and the extremely weak capital markets at the time.

At the new Lexmark, product development was completely overhauled. If HP had an 18-month product development cycle, Lexmark would have to be even faster. Lexmark's new approach mandated that if a product could not be brought to market in 15 months, it should not be developed at all. To "make this happen," we instituted multi-disciplinary teams with sales, manufacturing, purchasing, R&D and operations leaders all tackling technical problems as a team. Lexmark became the industry leader in innovation, introducing families of products built to address the customer's and the market's needs. We were bringing new products, such as laser printers, to market in 15 months, and at price/performance levels that many considered the best in the business.

We also created a new distribution system for the company's products. And that also required some revolutionary thinking. Knowing that it would be easier to make inroads against HP in niche markets, Lexmark created a direct sales force to focus on crucial industry segments such as banking, insurance and retail pharmacies. Until that time, no printer company had ever had a direct sales force of any kind. And unlike HP, Lexmark manufactured its own, thus gaining control over a key technology and creating an ongoing "razor blade" revenue stream.

After just one year, Lexmark profits were 30% ahead of plan and loan repayments were ahead of schedule. As the company's new products succeeded, Lexmark managers became more ambitious. The company invested substantial amounts in new software capabilities – without expecting a short-term payback. As it happened, the payoff took several years, but it was a big one permitting Lexmark to emerge as the leader in many portions of the market for networked laser printers, doubling its share of this market. Increased research spending also led to the creation of Lexmark's proprietary inkjet technology.

Under our ownership, Lexmark's sales and profits grew every year and so did employment. Today, with a market capitalization in excess of $7 billion, Lexmark continues to be a powerful force in the printer business, and it still gets products to market faster than most rivals do.

Lexmark makes a very good case for private equity. But I would argue that it is not a singular case. It is not an exception. Rather, I would argue that private equity has a number of structural advantages that can be used to create value in many business settings, in many industries, and, with appropriate modification for local practices and culture, in many parts of the world, and certainly in Japan.

I would rest the case for the value of private equity on seven points:

  1. First, private equity thrives where there is demand for change. In the world of competitive business, change and adaptation is critical to sustaining success. Shifts in technology, culture, fashion, labor markets, economic cycles and customer needs demand a responsiveness that is difficult to achieve for large corporate enterprises built primarily on the logic of economies of scale and functional prowess in engineering, manufacturing, marketing and sales. Even if 90 percent of global corporations adapt to the demands for change, 10 percent do not – and that is where private equity will come in to play.

  2. Second, private equity succeeds in part by shifting ownership to more focused committed owners.

    Why should ownership matter? More than anything else, leveraged buyouts are opportunistic responses to the difficulties encountered by current owners and managers to sustain or improve performance of their "old" or "non-core businesses" while they are building new capabilities for the future. Buyout groups ("private equity sponsors" in the more polished vernacular of the late 1990s) seek investments where current owners find themselves unwilling to undertake the next generation of changes required to fix businesses and make them more profitable. Often, and with good reason, these businesses are "orphans" that have been unable to attract or warrant the management talent or capital needed to continue their growth.

    This may not be a failure on the part of the current corporate owner. On the contrary, it can be an extremely studied and appropriate response to changed conditions. The decision by IBM to sell its Office Products Division reflected an assessment that IBM had more attractive opportunities than those presented by the low price/low margin typewriter and printer business which was increasingly coming to resemble the consumer electronics market. The decision by Westinghouse in 1994 to sell its Wesco distribution business reflected a strategic assessment that captive distributors were an ineffective channel to customers. The decision by the Gillette Corporation to sell its direct sales cosmetic business, Jafra, in 1998 reflected a considered judgment that a direct sales channel was never going to be compatible with Gillette's massive investment and franchise in the retail channel. Certainly the sale of Hertz by Ford was an appropriate response to Ford's worsening financial condition – Hertz just was not a strategic asset. All of these decisions rested on a calculus that concluded the target business would not contribute to shareholder value.

    Certainly many European conglomerates today find themselves in similar positions. PPR, the French luxury goods conglomerate sold us Rexel, an electrical supply distribution business. Veolia Environment, reeling under a mountain of debt and stymied by terrible franchisee relations, sold us Culligan, the water treatment business. And we are seeing more examples of this in Asia as well.

  3. Third private equity is successful by creating a very public expectation for change.

    In a famous 1940s study of industrial organization at the Western Electric plant in Hawthorne, New Jersey, researchers found that productivity at the factory increased when the lights were turned up to brighter levels. However, in a subsequent stage of the study, the researchers found that productivity increased again when the lighting levels were turned down.

    The conclusion of the study was that workers like to have people pay attention to them. The Hawthorne effect has since been used to describe changes in behavior that are induced by management "paying attention."

    In many ways, buyout firms and management teams have the benefit of the Hawthorne effect as they negotiate, finance and close a leveraged transaction. First and foremost, a management buyout involves a change of control, an event that is by definition a transformation. The buyout unleashes a number of powerful forces that enable firms like CD&R to initiate a broad range of changes. The buyout process subjects management plans in every geographic, product and functional area to critical review, not only by the buyer, but also by the buyer's banks, and, often, the broader capital markets. Such a review typically challenges old ways of conducting business and forces consideration (and sometimes adoption) of new business practices.

    Although not necessarily part of the buyout process, buyouts are also associated with a host of attention-getting changes: a change in corporate name and logo, articles in the local newspapers, a new boss. Everyone is paying attention and, in such a setting, management teams are typically more successful in bringing about change.

    When CD&R acquired VWR from Merck AG, there were widespread and well-founded expectations that with new ownership the company would be changing its European organization, its sourcing strategy, its sales force compensation system, and much, much more. Similarly, when we acquired Brakes, customers, suppliers and employees all expected that life would be different as ownership shifted from a family-controlled enterprise to a CD&R-controlled business.

  4. Fourth, private equity spurs new business strategies.

    Buyouts are also typically an occasion for thinking about business strategy, an opportunity to reconsider assumptions about how a business tries to sustain (or regain) its competitive advantage. Elements of strategic thinking typically help shape the investment rational put forth by the buyout sponsor: low cost position, product positioning along price/performance parameters, target markets and customers, breadth of distribution channel.

    The impetus for re-thinking strategy starts with resource allocation. The very act of financing a buyout requires a host of assumptions about how capital will be allocated as well as the timing and level of return on investment.

    In Kinko's, a leading business services company, we realized that the historical target market of small commercial customers – the average Kinko's transaction was $11 when we made our investment – was being eroded by new technology that allowed for in-office reproduction. So we were able to shape new strategy to attract large corporations that today routinely spend millions of dollars with Kinko's.

  5. Fifth, private equity works because it attracts new management talent.

    Many, if not most, management buyouts include the existing management team. Typically, with the help of the buyout firm professionals, a few new managers are recruited to the team. This usually occurs as part of a systematic process to assess the quality of managers in key jobs. At a minimum, this discipline forces an evaluation of management capabilities that is extremely difficult in most steady-state organizations where weaknesses are much more readily tolerated.

    Since experienced professionals in most buyout firms have the experience to assess management talent, most buyouts lead to the addition of new managers in several "skill positions" such as purchasing, and finance and information technology.

    Occasionally, there are circumstances where an almost all-new management team must be recruited. This can occur when division managers are expected to return to the parent company at the closing of the transaction, or in certain special circumstances.

  6. Sixth, private equity is effective because it creates new capital markets which in turn support new transactions.

    It is impossible to speak of the rise of private equity without noting the parallel rise of the market for high yield securities. Originally developed as a financing source for public takeovers, it has grown dramatically to include financing for a variety of high growth industries such as cable TV, wireless telephones and casinos. High yield debt raised in the U.S. and Europe each year is measured in hundreds of billions of dollars.

  7. And seventh, private equity is compelling because it creates a sense of urgency.

    Perhaps the greatest leverage of all in a leveraged buyout is the leverage of time. Although a long-term perspective can be important in developing strategy, it is often an obstacle and an excuse for not moving quickly to implement required changes in a business.

At some level, a buyout creates a sense of urgency to get things done. The discipline imposed by a leveraged capital structure certainly plays a role in creating that urgency. Monthly interest payments that often chew up half or more of a company's cash flow tend to get the attention of every executive and, sometimes, all employees. The burden of annual amortization payments is a major spur to action.

In a non-leveraged company, an increase of inventory levels is likely to engender a response measured in months. The inventory builds up during the last month of a quarter, but, since it is only a month, will not draw attention. It is discussed in a quarterly operating review at the end of the next quarter. The responsible executive promises to address the problem and report on progress at the next quarterly review.

In a buyout, a good CFO and line executive will have identified the build-up in the first month, and by the end of that month, in the first quarterly review, will report on actions being taken to address the issue. Follow-up will be weekly, if not daily.

Again, I do not want to overstate my case. I am not predicting that private equity will own the world. But I am looking ahead to a period where private equity will continue to play a leadership role in corporate restructuring. In the past, over 40% of global private equity transactions involved corporate divestitures – CD&R's number one target. The second largest source of deals involves private company sales – our number two target. In fact we've had situations like Brake Brothers – one of the largest food distributors in Europe – that are a mix. Prior to our acquisition, Brakes was 58% owned by the Brake family; even though it was public, it really operated more as a private company.

We also expect to see more public to private transactions in the U.S. as beleaguered public company boards and management teams try to escape activist, pirate hedge funds and the unrelenting demands of post-Enron regulation.

Let me close by taking a risk to suggest that everything in the CD&R strategy can, should and will apply in Japan.

For 30 years CDR has worked closely with large corporations to shed divisions that no longer fit with their core activities. In highly complex carve-outs of corporate orphans, we are often the private equity firm of choice. In just the past the past two and a half years, CD&R has led transactions involving five non-core corporate divisions, including, our purchase of Hertz from Ford. We understand the complex employee, customer and supplier issues that arise in cases where offices, plants and personnel are being carved out as stand-alone businesses. Is there any one in this room that does not know of a dozen Japanese corporations that should divest one or more non-core divisions?

We typically acquire businesses that are underperforming relative to their potential. Improving the profitability of these businesses provides superior investment returns. More than 90% of the returns generated in our last three funds have come from operating improvement, measured by EBITDA growth. We view this capability – and its translation into increased enterprise value – as our key competitive advantage. Is there any one here that does not come across underperforming businesses in Japan every week?

To execute our strategy, we are the only private equity firm in the world whose partnership is evenly divided between financial partners and operating partners – like Jack Welch – who are experienced leaders from global companies. Another example is Ned Lautenbach, who spoke at this conference last year. Prior to joining us, Ned was in charge of IBM's worldwide sales and services business and he also served as President of IBM Asia Pacific. He currently serves on the board of The Sony Corporation.

Our operating partners lead our transformation efforts in the portfolio – and bring the talent and experience necessary to make it happen. Working very closely with our operating partners, CD&R's financial professionals assume responsibility for sourcing new investment opportunities, structuring and financing transactions, working on portfolio company acquisitions and establishing strong financial controls at portfolio companies.

Would you all agree that operating expertise is an essential element in transforming and improving businesses?

Operating capabilities are a necessary condition to undertake Lexmark and Hertz-type corporate transformations. They also require something more. They must be undertaken with great integrity and care. Corporate transformations must add clear and demonstrable value. They must be undertaken with sensitivity. Employees must be treated fairly…intellectual property protected…the environment respected. If we ignore these important principles, we run the risk of losing public and political support for the enormous economic benefits that private equity can produce.

So I would conclude by saying that I am upbeat for the long-term prospects for private equity globally and here in Japan.

Private equity is a force of constructive corporate change. Even in this country where corporations historically had a hard time letting go of divisions, no matter how non-core, Japan is today one of the world's fastest-growing markets for management buyouts.

Private equity is an engine to drive needed restructuring anywhere companies are looking to shed operations that don't generate much cash and to focus on businesses that do.

Private equity is a powerful form of governance for changing the way people behave and businesses perform, transforming mediocre operations into top tier performers.

And finally, private equity has proven to be a very flexible source of value creation to deliver superior results in a variety of economic and capital markets climates, particularly for the firms with investment models grounded in generating returns from operating performance improvements and profitable growth initiatives at their portfolio companies.

Thank you.