Carve-outs have always offered significant value for investors willing to put in the work. Yet, as Bain’s latest Private Equity report highlights, their success depends now more than ever on operational transformation rather than financial engineering.

AURELIUS has been building businesses by transforming their operations for 20 years. So we read with interest Bain’s latest Private Equity report, which puts data behind our strategic approach. Some of its findings were positive – for example that the reduction in inflation and thus interest rates in 2024 supported an uptick of over a third (37%) in deal activity. Others put numbers to what people were talking about – namely protracted fundraising periods, with a staggering 38% of buyout funds now taking two or more years to close, up from just 9% in 2019. Their report, which contains numerous additional interesting insights, can be found here.

We were particularly interested in the finding that traditional buyouts now outperform carve-outs, with average MoIC now 1.7x vs 1.5x respectively. This is a stark about-face from pre-2012, when carve-outs were undertaken by a brave few and generated handsome returns (3.0x, vs. 1.8x for traditional buyouts).

As carve-outs are our bread-and-butter, we were delighted to see the report focus on this part of the market. The reality is that returns prior to the global financial crisis – across all leveraged deals, not just carve-outs – were propped up by debt and multiple arbitrage. To the first point, erstwhile frothy leverage markets have all but dried up, with financing now trickier and more expensive to secure, and this impacts returns. To the latter point, arbitrage potential has been diminishing for some time as markets became more competitive and drove up entry pricing. This had been less the case for carve-outs, which have been traditionally less expensive to secure given the relatively low number of bidders able to manage the complexity of executing successfully.

This may be changing. Our own recent Carve-Out Survey revealed 59% of respondents felt the number of buyers pursuing carve-outs is on the rise, possibly because it helps would-be buyers to cast origination nets wider. Andthis heightened competition seems to be driving up acquisition multiples, which in turn will necessitate additional enhancements in efficiency and profitability. It will mean focusing on operational improvements to effect meaningful value creation, rather than relying on multiple arbitrage and financial engineering.

This is hinted at in the Bain report, which highlights a correlation between a weakening in carve-out performance and achieved operational enhancements: prior to 2012, companies involved in carve-outs experienced substantial growth, with revenue and margins increasing by 31% and 29%, respectively. In contrast, post-2012 figures indicate more modest gains of 17% in revenue and a mere two percentage points in margin improvement. This decline in operational advancements has, in turn, led to a decrease in multiple expansions during exits. Unsurprising, really.

“We have long believed that private equity’s toughest deals hold the greatest potential. But we know that you have to work incredibly thoughtfully and collaboratively, combining an ability to execute complex carve-outs and make operational improvements, to fully unlock their potential,” says Tristan Nagler, Partner and Head of AURELIUS’ Investment Advisory.

Unlocking potential with operational transformation: Distrelec
Our focus on carve-outs means we truly understand what it takes to help businesses reach their potential. Take for instance our work with Distrelec. Our carve-out and holistic operational transformation over the course of just three years saw profits grow ten-fold at the company. The transformation involved end-to-end digitalisation to become a leading pan-European multi-channel platform for B2B customers in the MRO business for electronic components. With our support, it grew to serve 180,000 customers across 19 countries, with two-thirds of its revenue derived from digital channels at the time of exit in 2023.

Pre-investment challenges: This wasn’t a case of buy cheap, leverage it, and watch it fly. On the eve of lockdown in 2020, our conviction meant we travelled into and out of Switzerland in under 24 hours to close the deal, the day before restrictions. The journey started out with a comprehensive IT carve-out and building out the talent team to drive growth.

Transformation: Ultimately, we moved the headquarters to the UK, developed a scalable and customer-centric omnichannel platform with data-driven decision-making, and doubled the offering through a webshop – growing from c. 168k products in 2021 to an estimated 500k in 2025, over half of which is virtual. Outcome: All of this helped boost gross margins, with a vastly improved Distrelec sold to a trade buyer for just shy of 11x adjusted EBIT. Read more here.

The success was achieved through application of our proven playbook, developed in the course of executing more than 100 carve-outs globally since our inception 20 years ago.

We are working with a number of businesses to great effect now, including Hallo Healthcare Group, Minova and LSG Group. All of them have been carved out with our support and are being transformed operationally and thriving as independent entities. LSG, which we carved out of Deutsche Lufthansa, is off to a ‘flying’ start as an independent entity. Our work together thus far has included transitioning the entire global IT landscape to an independent framework to achieve full standalone capabilities. We achieved this by the end of 2024 – 12 months ahead of schedule. We have also relocated headquarters to Dallas, Texas to better reflect its customer footprint.

With carve-outs, remaining passive as an investor is pointless. It takes energy, tenacity and graft to get them to their full potential.