After a tumultuous year that almost saw the company drowned by its previous strategic investor, German vertical retailer Hallhuber found a financial investor in Robus Capital Management. Management of both firms agrees to invest in brand growth.
The good news came only a year after Jack Wolfskin, another German brand, ended its decade long private equity path in the safe heaven provided by Callaway Golf Company, a strategic US investor. For Jack Wolfskin, the years spent with financial investors had been a roller coaster.
While these two happy endings land in different investor camps (strategic vs financial), both brands share a history of rock-solid business models that were at least partially derailed by investor influence. Both were pushed too hard, both came close to bankruptcy, and both actually had a healthy business model at the time.
Strategic vs. Financial Investor – Who Wins?
Jack Wolfskin and Hallhuber are just two examples of a long list of brands and retailers who had a roller coaster experience with their investors. And the list of failures is about as long as the list of success stories.
A recent study by two US consumer advocate groups blames job losses and the failure of retail chains on the fact that the majority were private equity owned. Critics of the study argue that these companies were already debt-laden after previous strategic investors no longer believed in the future of those chains before financial investors became the last hope (and failed).
The verdict is still out on whether strategic or financial investors are the better investors, as success and failure rates in the retail and brand industry appear similar. Like many studies before, this one too fails to put the argument to rest, and we’re likely to continue this discussion for years to come.
Retail Brand Growth vs. Profits
As much as there is no final proof of which are the better investors, there is no firm guidance on how to manage those investments. But there is a notable difference in how investors measure investment success and performance. While financial investors call for faster growth, strategic investors prefer qualitative growth. And these two different approaches to brand growth come with different sets of KPIs.
Brands that are taken over experience this not only in their strategic planning but also in their regular reporting. The most obvious is the difference in profit focus on EBIT vs. EBITDA. While EBIT is mostly used by strategic investors, financial investors favour EBITDA to manage their investments.
These diverging strategic priorities affect how brands and retailers go about their planning and management. Some good, some bad in either case. Brand Growth Inspiration has asked authors Norbert Steinke and Guido Schild, two seasoned experts on brand growth and private equity, to share their views on EBIT vs. EBITDA.
Norbert favours EBITDA, while Guido defends the use of EBIT. Here’s what they had to say:
Norbert: EBITDA is the strongest KPI to show the operational performance and strength of a company. There is no extra room for any creative fine-tuning of financial results, like stretching depreciation over years. You can stretch a store’s depreciation until its next renovation, until the end of a rental contract (which is prudent) or stretch it as long as 30 years (which I have also witnessed).
Guido: EBITDA is a private equity ‘drug’ that investors like to administer to distract their charges from EBIT so that they grow faster. And once they are dependent on EBITDA and achieve the required speed, the ‘dealer’ moves on and forgets to tell the ‘addict’ that the rest of the world is living on EBIT where you also have to earn the cost of your investments.
Norbert: It’s a question of smart target setting, but a successful growth-based (CAPEX driven) strategy needs EBITDA as its core steering KPI, along with a solid proof of concept as a prerequisite. If you have that, you can only want to invest as fast and much as possible. An EBITDA focus supports speed where negative EBITs are useless investment hurdles. The positive side effect: You don’t pay tax on profits that you can reinvest in more growth.
Guido: The strong focus on investment speed and EBITDA shrinks an organisation’s natural sense of risk control and quality. In the long run the organization puts expansion speed over a profitable store portfolio. To prioritise speed over quality might maximise capital returns, but never leads to healthy and balanced brand growth.
Norbert: EBITDA allows for comparisons across different companies and concepts. Take for example the different distribution models of wholesale and online sales. Both may achieve a similar EBITDA. But with an EBIT focus, wholesale with almost zero CAPEX will likely prove its strong case with a far higher EBIT. But the wholesale market is shrinking, while online continues to grow. This means that an EBIT focus leads to avoiding investment risks and sticking with shrinking markets instead.
Guido: It’s true, the focus on EBITDA shows the true operational results of a business, with all non-core topics removed from the P&L. But then again, there is no operational performance without the independence and strength of financing current and future strategic moves of the company.
Managers who focus on EBITDA and EBIT ensure that profits and investments stay balanced in the company’s own interest. And the company secures its independence and future brand growth. Constantly ignoring the underbelly of how a financial result has evolved (the difference between EBIT & EBITDA) is taking the CFO out of his responsibility.
While expert opinions, including those of our authors Norbert and Guido, continue to differ, one thing is exceedingly clear: managing by EBITDA vs. EBIT is not a black and white affair. Please share your own thoughts and experiences in the comments!
About the Authors:
Norbert Steinke had a successful career as a manager in family-owned as well as in private-equity-owned companies and enjoyed both. He is now an advisor to investors, both financial and strategic. Read more of his work here or connect with him on LinkedIn.
Guido Schild was a banker and controller before he became a consultant in brand growth & retail strategies and worked on 20+ investment due diligence and post-merger integrations. Today he coaches startups. Read more of his work here or connect with him on LinkedIn.