Weigh the opportunity
Unfortunately, the best-case scenarios don’t always come true. You also need to assess potential risks. Bleyzer spends 70 to 80 percent of his time on this stage, considering it not just an evaluation but risk protection.
Start with a macro assessment of the economy. The benefit of the recent recession is that now you can envision the effects of a downturn and what it takes to be prepared. Bleyzer thinks people are “slowly, painfully” starting to recover, but that doesn’t stop him from asking, “What if?”
“What if it is worse than that?” he asks. “What if, in fact, there is a double dip? Can you still survive in that environment?”
Each step of the due diligence process builds on itself. As you evaluate risks, you’re weighing them against rewards. If the market flops or strategies don’t go as planned and you have to pour in additional funds as a fix, consider what happens to the overall profitability equation. If, instead of five times the initial value, you only end up with twice as much, the opportunity might lose its appeal.
“If the overall balance looks like the upside is clearly there and it’s exciting and it’s big, No.1; No. 2, if you also see that risks are there — they’re always there — but they’re manageable, it may take slightly longer, but we can get there,” he says.
Then it comes down to forecasting how well the company can handle risks. Bleyzer looks at three measurements to determine sustainability.
“We ask ourselves three questions: Can this business become quickly cash-flow positive if it isn’t already?” he says. “Can this business survive without getting additional debt, really, having no debt? And can this business build some kind of cash reserve?”
SigmaBleyzer specializes in unleveraged buyouts, because it traditionally worked in emerging markets where credit was either unavailable or outrageously expensive. But the norm in this country, at least before the financial crisis, was using leverage to pump funds into companies that you purchased.
But now, with the post-crisis mature market acting more like emerging markets, credit isn’t readily available. And it’s a good thing, if you ask Bleyzer, because now you have to look beyond leverage.
“In this environment, how do we create value?” he asks. “Well, the old-fashioned way: fundamentals. You need to have a business that is cash-flow positive, that is not relying on debt or using no debt and has some cash reserves. If those are the three elements that a business has, then you can survive the worst possible scenario.
“No matter what business you’re in, you need to ask yourself, ‘Are you going to be the last man standing if worse comes to worse, and what will it take to get there?’ In my book, it’s pretty simple: cash-flow positive, cash reserves, no reliance on leverage.”
Those three factors play into the overall financial modeling. Bleyzer goes back further than that, though, looking at the company’s infrastructure.
“The business needs to be properly capitalized to start with, which means you need to have the right capital structure,” he says. “You need to have made the right investments, so you need to be in the position, from the infrastructural point of view, to deliver products to customers that will produce good margin. That requires certain initial investments in people, technology, systems, facilities and so on. You need to assess all of that.”
Then you move into the present, plugging the company’s current numbers into your financial model to play out different scenarios.
“There are financial models that show that, by executing those strategies, you can get to certain results,” he says. “Then you either confirm or you don’t confirm your going-in assumption that it can be a ‘5x’ or ‘10x’ idea.
“In the end, it all boils down to financial modeling. Financial modeling is a pretty technical and, therefore, mechanical thing, but the assumptions are the key.”
That’s why the entire process — from setting focused parameters up front through the due diligence of analyzing risk and reward to the final financial steps — is so crucial. That’s also why Bleyzer has been so successful managing assets valued at approximately $1 billion.
“If you have the wrong assumptions, then they will lead you to the wrong conclusions,” he says. “But if you’ve got your assumptions right, then the rest is basically mechanics.”
How to reach: SigmaBleyzer Investment Group LLC, (713) 621-3111 or www.sigmableyzer.com