Wall Street rarely applauds compassion. In fact, for years Costco was derided by analysts, who felt the company paid its employees far too much money. Its reward for such largesse was a price-to-earnings ratio that traditionally lagged behind Walmart and other retailers who weren’t nearly as generous to their staff. Criticism from the likes of Deutsche Bank analyst Bill Dreher, who told the Wall Street Journal in 2004 that “Public companies need to care for shareholders first,” was not uncommon at the time.
Increasingly, though, investors are starting to come around on the Costcos of the world, recognizing that a company that invests in its employees, clients or even society at large doesn’t necessarily do so at the expense of profits. In fact, in many cases, these decisions create a more sustainable business model and drive value that is ultimately reflected in performance. Costco, it’s worth noting, has a price-to-earnings ratio today that sits above 20, making Walmart’s stock, trading around 13x earnings as of press time, look undervalued by comparison. In investment circles, people will toss around the acronym ESG, which stands for “environmental, social and governance” criteria that may go into an investment decision. It’s different from the SRI strategies, or socially responsible investing, that tend to make value judgments against sectors considered to be sin industries.
Acquirers too are beginning to search for the hidden value that tends to elude recognition on a company’s balance sheet. If you ask Advent International’s David Mussafer about the firm’s investment in lululemon athletica, one of Advent’s biggest wins in recent years, he’ll recount a hike the firm’s partners took with the company founder, which revealed more about the opportunity than any boardroom meeting or dataroom visit could possibly uncover. Meanwhile, the sale of Zappos to Amazon was spurred in part by Amazon’s desire to capture company’s culture. In hindsight, Zappo CEO Tony Hsei, in an excerpt from his recent book, revealed that the sale was also motivated by management’s efforts to preserve the culture from its VC backers, who, amid the downturn, were “only concerned with maximizing profits.”
David Wolfe, a principal at marketing consultancy Wolfe Resources Group, co-authored ‘Firms of Endearment,’ a book that explores the transforming marketplace in which more and more companies are guided by a “stakeholder relationship management” model. The strategy, Wolfe describes, is centered on a company’s ability to deliver social value through recognizing the ‘stakeholder status’ of customers, employees, suppliers and the community at large. Essentially, it’s about recognizing a wider band of constituencies whose fortunes are tied to the company, and creating a true alignment of interests between all of the relevant parties. The end result is often better all-around performance for the company. The catch is that it requires business leaders to trust their guts in terms of good business decisions even if numbers aren’t available that immediately validate a particular strategy. “The business schools have placed too much emphasis on ‘the quantifiable’ to the exclusion of the unquantifiable factors that can make a significant difference,” Wolfe states.
In M&A, that’s why analysts tend to trust cost synergies over revenue synergies.
Wolfe adds that businesses employing the model espoused in his book seem to “intuitively grasp” the idea that it’s the factors not necessarily counted by Wall Street that often add the most value.
Of course, it will always be impossible to quantify karma. Ventura, Calif.-based Patagonia Inc. is an organic outdoor clothing and apparel company that has made it a point to take a lead role around environmental causes. The company has launched initiatives to form a national park; it has provided more than in $35 million in environmental grants to grassroots programs; it co-founded an alliance credited with saving over 34 million acres of wildlands; and helped launch the initiative “1% for the Planet,” in which companies sign on to donate at least one percent of their revenues toward environmental causes. Beyond the philanthropy, Patagonia uses only organic materials in its merchandise, and many of its products provide “footprint” data, disclosing the environmental impact that went into producing each particular item. All this, of course, goes back to the company’s mission statement: “Build the best product, cause no unnecessary harm, use business to inspire and implement solutions to the environmental crisis.”
Patagonia is a private company, so its financials are not publicly available. However, a visit to any one of Patagonia’s 26 locations makes it clear that the company’s message resonates. At a recent visit to the outlet stores in Freeport, Maine in May, Patagonia had around a dozen or so patrons lined up at the storefront before it opened; across the street, at J. Crew, a line never formed. Patagonia’s approach is in stark contrast to a company like BP, whose response to the biggest oil spill in US history was to threaten clean-up workers with termination for wearing respirators. The oil giant has also reportedly turned away photographers from documenting the damage, all in the name of either protecting its image or limiting its liabilities. The effect, however, has only created more ill will, to the point that someone co-opted BP’s Twitter identity, @BPGlobalPR, and quickly amassed over 100,000 followers with hundreds of tweets that gave a voice to people’s perception of the the company. When BP hired Dick Cheney’s former flak, for instance, a tweet quickly followed from the fake PR team documenting that their boss made them watch an autopsy video “as a team building exercise.”
BP, whose very survival is being questioned, is all of a sudden the poster child for non-sustainability.
But how do buyers looking to acquire the “sustainable” companies manage to carry on the karma and continue to extract value post close? Wolfe notes very bluntly that it’s not easy. At the same time, he points to the Container Store as one example. The retailer, which at one point was ranked as the No. 4 best company to work for by Fortune Magazine, reportedly pays wages 50% to 100% above the industry average to its sales staff. The company, as Fortune pointed out, also has a “family friendly” shift that starts later and ends at 2:00PM, allowing for parents to take their kids to school. When Leonard Green & Partners acquired a control-stake in the company in 2007, it did so with the promise that the co-founders would be able to manage the company in the same way they had been prior to the sale. Even amid the downturn and pronounced consumer pullback, the retailer has maintained a spot on Fortune’s top 100 places to work, a sign that Leonard Green has kept its promise.
Private equity, however, doesn’t always seem like a logical fit for a “sustainable” company. The same way the asset class tends to shy away from biotech or other R&D heavy industries, a sustainable business strategy can take a while to fully gestate, as loyalty from employees, suppliers and clients is measured over years, not quarters. Moreover, as Wolfe points out, exit options may be limited; unique cultures require the right steward to thrive.
Sunny Vanderbeck launched Satori Capital with Q Investments veteran Randy Eisenman last year. A veteran of Microsoft, who founded Data Return, Vanderbeck has seen first hand the value of a sustainable business strategy. Through Satori, he and Eisenman wanted to develop a private equity firm that could provide an outlet for business owners who want to sell, without selling out. On the firm’s website, the strategy is summed up as “conscious capitalism.”
Vanderbeck recognizes that the PE model faces some challenges when it comes to providing an ideal location for these types of companies. PE, for instance, is typically viewed as a temporary destination, a midpoint from where a company is and where it will be five to seven years later when it’s time for the sponsor to show a return to its limited partners. This doesn’t always sit well with family owners who may have a longer-term outlook.
For this reason, Satori has deviated from the traditional fund structure. The firm’s debut vehicle, which is targeting $175 million, has a traditional ten-year fund life, with a couple of extensions. The fund breaks new ground, however, in its ability to carve a company out of its portfolio and designate it as a ‘core’ holding. LPs, following a third-party valuation, would be given the option to cash out completely, achieve partial liquidity, or remain invested in the company following the transition. Satori, at the same time, is given the option of converting its carry to equity. The firm would be able to do this with as much as a third of its portfolio.
Vanderbeck notes that this structure is important when it comes to communicating both to LPs and potential target companies how Satori is different from other private equity firms. “We’re business owners. We’re not buyers and sellers of businesses,” he says. “It allows us to have a credible conversation with management, and show them that we can be a long-term capital partner.”
Meanwhile, Vanderbeck believes the opportunity set is only going to grow. He points to Goldman Sachs’ GS Sustain program, which was established in 2007 by the investment bank to integrate a sustainability framework within their equity research. Also, in 2006, the United Nations instituted the Principles for Responsible Investment after coordinating with leading institutional investors to better align capital with the broader objectives of society. The result was an archetype on how investors can incorporate environmental, social and governance issues into their mandates. Perhaps the biggest motivator for companies toward a more sustainable model are the examples set by those who never thought to consider karma in their business strategy, because nobody wants to run the next BP.