Feb 27, 2017

PODCAST: Dave Calhoun on Creating Value through Portfolio Operations

Today on the Blackstone podcast, our channel dedicated to the insights, conversations and news from across our firm, we’re sharing an interview with Dave Calhoun, head of Portfolio Operations. Dave recently sat down with Joe Lohrer from Private Wealth Solutions to discuss the ways Blackstone creates value in our portfolio companies.

Listen and subscribe on iTunes.

Joe: Today, we are delighted to have with us the head of private equity portfolio operations and a member of Blackstone’s management committee, Dave Calhoun. Our call today is focused on operational intervention, how we create value within our portfolio companies after acquisition, and we think very much this is an aspect not widely understood by investors and a lot of curiosity generated by advisors about this aspect of what happens at Blackstone. 

We plan to keep today’s discussion at a relatively high level, discussing strategy and tactics broadly, and we will not discuss any funds or performance figures. So, Dave, welcome to today’s program.  Thanks for being with us.

David: Yes, thanks, Joe.  It’s good to be here.

Joe: We always love to start by allowing our advisors to get to know you and the leadership at Blackstone a little bit better.  So, if you can, take us through your career journey, a little bit of how and why you found your way to Blackstone, I think would be very interesting.

David: Yes.  It’s a very large story I’ll try to keep short.  My life in the business world started with General Electric, 1979.  As you probably know, that was the year before Jack Welsh took over, and, as you probably know, GE has had a very long and very steady commitment to leadership development. 

I would say that probably over my 30 years of doing that, I probably practiced at every geography, probably practiced across every industrial part of GE, including the financial services part.  I was privy to leadership style and culture embodied in Jack that was exciting, inspiring, challenging, but each and every day you came to the office sort of not knowing what to expect, but that if you didn’t work to do something a little bigger and a little brighter for the company and for your particular business interests, you were probably not going to survive the next day.

I loved that environment, I truly did.  I got to a late stage where a new CEO was appointed.  I worked closely with that new CEO and the succession and at just about ready to turn 50 years old, I decided I wanted to do something else and try this out on my own. 

I did not choose private equity.  I chose an opportunity that was embodied in a company we now call Nielsen, but was then called VNU.  VNU was a collection of market research companies that had been pulled together by a Dutch publishing company who had no future, but a lot of cash flow, and decided to assemble lots of things in the marketing world. 

I knew that embedded in there were several businesses that I’d seen in my GE life, but the most important one was the Nielsen asset, and the data company that provided market share data to all the major retailers, along with the media ratings company.  At any rate, at first blush, not unlike the private equity interest that ultimately bought the company from the public markets, I believed it had been undermanaged and undermanaged a lot.  Its lack of courage in trying to create that new vision and integrate the company truly with a simpler and broader purpose, I thought, was a big opportunity.

I give you that background because that is the nature of private equity.  That’s sort of what it starts with.  You have to believe when you underwrite a company, when you make that investment, that you can do important operating things differently and that you can create value in that process. 

Honestly, my first and biggest concern with taking this task of running VNU, was private equity itself.  I had been trained for all those years to believe that private equity was sort of a one trick pony.  They go in, they starve a company down, and then they maximize profits and sell it off into the markets and so forth and so on.  That scared me a bit, gave me some anxiety.  Nevertheless, I decided to go do this. 

I had five major private equity sponsors behind me, including Blackstone, so I learned a lot in the process of working with them, but to be totally honest with you, the biggest surprise of all for me was that as an operator, somebody running a business, and wanting to have all the flexibility that you can muster to operate it better.  And what does flexibility mean?  It means having an investment availability when you need it.  To make the bets you want to make, to make them in a disciplined but in a very steady state no matter what the world around them looks like—all of those things became available to me. 

This was 2006 when I started, and two years into it we had 2008 and 2009, which, of course, was one of the more tumultuous times in everyone’s lives.  But, interestingly, in those two years, we put more distance between ourselves and our competitors than I could ever have imagined.  Why?  Because my model allowed me to stay disciplined, continue to invest, expand globally and build a bigger product set, while my competitors rocked and reeled in the public markets and all the drawbacks and began to vacate territory.  For me, that moment was everything and it taught me everything I needed to know about the advantages of private equity.

If you know you have them and you believe strongly in your vision and you have some operating experience and some confidence around what you can do, it’s a perfect marriage.  It’s a big advantage.  So, my love of the industry was really cultivated over the eight years I spent at Nielsen, in good times and bad times and all of the operating flexibility that I enjoyed vis-à-vis my public competitors.

I remind every CEO we have in our world that those same opportunities exist for them.  I don’t care if their training was in the public markets or where it was, but in our world, if you are committed to that vision and committed to that competitive advantage, we will stand by you, we will invest with you, we will get you the resources necessary to make that work, but you have to have the courage to want to do it.

Joe: So, let’s talk a little bit more about that.  Coming out of a background where private equity was feared, potentially perceived as a one trick pony, as a senior leader and now providing advice and guidance to senior leaders and counsel CEOs that you’re now facing off with as partners, what’s the counsel and the direction that you try to impart on those CEOs today?

David: It is that.  Most CEOs—some when we make an investment in a company we inherit, some may have come from the public world or most, I would suggest, have been trained in the public world, for sure.  So the first counsel I give them is not to miss the point.  That we are privately owned.  We are long equity.  We are going to be around for a long time, right alongside of you.

And the quarters—we like to make operating progress, but the quarters as reference points about whether we are doing well or doing bad are sort of silly.  Because we are going to hold this investment anywhere from 5 to maybe 10 years, we want to make the investments and the bets and create the disciplines and operating rhythms that are good for that 10-year outcome.  I have to remind them of that every day.  They live amongst the public world.  Everybody has the public benchmark for them.  Everybody wants to talk about it, but we enjoy this advantage and I have to remind them of that.  Again, we do it all the time.

The only other comment I would make is that, particularly at Blackstone, I believe very strongly that you learn most important things, most things that you can bring to your company and create value and benefit, from industries outside your own.  It is very rare that you grab a practice from the competitor down the street who looks just like you and you’re trying to eat each other’s lunch.  It’s rare that you find something big and differentiating from them and implement it in your world, but a lot of CEOs fall victim to only looking at their life and the way they operate against their nearest competitor.  My GE life taught me different. 

Well, at Blackstone we have 100 companies, 100 experiences, 100 environments that people are having to deal with and contend with.  The things that you learn the most from are the ones where it’s a survival question, where you’re up against a survival issue in a tough environment.  Almost always they create practices that are best in class, almost always.  Why?  Because it’s survival, right?

I can’t migrate every best practice from every company to one another.  It doesn’t work.  But, I can create an environment where the CEOs who I counsel know that if they’re not hunting and if they can’t import at least one practice a year, they’re probably not going to survive in our world, because I believe so strongly in that as an improvement philosophy.

Joe: That’s a good transition to go right into describing your team.  I don’t think people are familiar with the resources and the structure of the portfolio operations team here at Blackstone, so if you could take us through the organization and what you consider to be mission critical.  You know, when your team steps in, is it different for each company?  Is there a set playbook that you look to implement?  What’s mission critical once the transaction is underway?

David: We come at it in two angles.  I’ll start with the resource base that I have at the Blackstone level that we send in to each of our companies to support operating improvements. 

That group is a team of specialists.  They do one thing really well.  I have an individual who knows as much about health care in the US system as anybody I’ve ever run into, and who can help all of our companies design and implement the most appropriate health care practice in their business.  Well, that may sound trivial, but it’s not.  It’s millions of dollars for all of our companies and we can achieve improvement in less than a year.  Why?  Because we have an expert, somebody who has done this across many, many, many companies and at very large scale, and he can do it for these smaller mid-cap kinds of companies who would not every attract a resource like that. 

Why did he come to Blackstone?  Well, because he gets to do this for 100 companies.  He practices his specialty and extends his reach in such a way that it’s fulfilling in every way and I get, really, an outsized resource for each of the companies that we have. 

I have somebody who does procurement.  This is usually the easiest one for people to understand.  The first thing you do is we create contracts that accumulate the volumes of indirect purchases that all of our companies make.  We have a pretty simple and automated way to quickly understand what it is they buy in the indirect space.  These are all of the papers and scissors for offices or benches and other things for production facilities, etc.  So, we accumulate that data very quickly.  We go out and we compete for big contracts at significantly reduced prices and higher service levels, and so we get the benefits of scale that you wouldn’t get if you were a single mid-cap company or the scale of the individual companies that we have.  That’s one purchasing dimension. 

The other purchasing dimension is just better practices.  We’ve created what we call—it’s really an e-procurement operation based in Singapore and in effect, what it does is, it uses the internet to create auction environments for as many possible line items as we can run through it.  The beauty of it is it creates high-frequency contracting on the part of our businesses.  Rather than buy into something or enter into a contract for three years, we can auction every three months.  We create enormous competition and it happens real time.  We get a bigger set of competitors wanting the volume, and, of course, we get a more aggressive set of competitors knowing that winner takes all for the next three months.  We run this very effectively and almost all of our companies take full advantage of it.  We create significant savings right out of the chute when we introduce them to this practice.

The beauty for us is many of our companies have not done that previously.  We can get them started on that, up, running and saving money within six months, and then we just keep running that clock.  We keep trying to run more and more of their procurement needs through it.  That’s sort of easy.

We have a specialist in the Lean Six Sigma arena who is practiced in the automotive industry and practiced in many other big industrial settings and in service delivery settings.  What we do is simply create the vision around Lean Six Sigma, a better way of delivering these products and services, and then we stand up to the capability in each company with specialists who do a lot of what he does.  We stand up that capability inside the company so that they can continuously improve to achieve the vision around Lean Six Sigma. 

That sounds like an old-school thought, but most of the companies we invest in are in the first inning of that movement.  So, our job is to get them there much faster, create the improving capabilities much faster, and then everything takes care of itself.

We have a number of these other specialists who do these things.  Enterprise systems is another one.  We can buy systems and information technology services at scale to help our IT organizations across the company.  We can attract more capable and bigger resources to our IT team because they get to implement their world’s best thinking across 100 companies as opposed to doing it in a single company.  That is very appealing to that kind of talent.  So, again, you get an outsized talent relative to the companies you’re supporting and you get volume metric scale where you need it.  These are the things we try to implement. 

Now, one last comment I would make about these specialists.  I view all improvements as having to go through the eyes and go through the ears and be implemented by the CEOs of our companies.  If the CEO says to me, that specialist is not going to do it better than I’d do it, I say, fine, I get it.  That hardly ever happens because the advantages are so obvious.  Our scale does give us discounts, our scale does give us access to better practices, and so usually it is a yes, let’s go do it, let’s run it.  I’m not there to challenge their strategic thinking or who’s in operational control, I’m simply giving them a set of tools that saves them money right out of the chute.  I have hardly ever run into a CEO who’s not willing and wanting to do that and do that quickly.

We try not to second guess our leadership teams.  We simply try to provide them with tools that give them scale access and other things and then ask them to implement it. 

Now, if there are CEOs who are not capable of doing that or, for some reason, decide that their way is the only way even in the stark presence of better ways of thinking about it, it won’t take us long to encourage change in that leadership team.  I don’t want to avoid that discussion.  It doesn’t happen that often on subjects like this, but if it needs to, it will.  We need to have an open culture.  We need to have CEOs and leadership teams who are always looking for a better way to do something.


Regarding results, how do you think about—is it company by company?  How do you think about results?  What are some of the key measurements you’re driving on and are there check points to those measurements whereby you know, there’s a path that we initially underwrote for, we need to shift gears, guys, or not?  So, really driving toward results now, what gets measured?  How do you think about the impact of your team on the overall equation of investor results?

David: I’ll give you two angles.  One is in aggregate.  Our objective—you can debate whether it’s aggressive enough to be honest with you—is to grow our operating earnings at twice the rate of the S&P.  Our view is now simply, if I were an institutional investor allocating money and I had that choice, which one would I go to?

To be totally honest with you, in my history here and the long history of our operating team, we kill that measure.  We beat that by a mile.  So, if the S&P grows operating earnings—this is not after share buybacks, but operating earnings—if they grow it at 4%, we’ll grow it at 12%.  If they grow it at 1%, we’re usually at 8%.  So, beating that metric has not been the hardest thing in the world, but we want to pay attention to the overall portfolio performance.  It needs to be at least twice their rate.  That’s aggregate.

Individually, it’s one business at a time.  We have an underwriting case.  It’s very detailed.  Then, we usually have a management case that is significantly more aggressive than the underwriting case.  The underwriting case protects investors, the management case is sort of the upside for investors.  So, we render that management case and we’re disappointed every time we miss a number and we try to beat numbers more than we miss them.  But, that is a quarterly exercise for every company. 

Joe: It would be terrific to follow on that.  You’ve been here now about three years, I believe.  A case study or two even, whether you can mention the company or not I’ll leave that to you, but if you can kind of take us through an example of when operational intervention, anything unique about that that you thought was memorable.  Then secondly, one where it did require course correction and exactly how that was handled.  The more case study oriented, our advisors and their clients love stories so if we can give them a little of that, it would be terrific.

David:   Today we invested in a company, about two-and-a-half years ago, in a company called Gates.  Gates is a big industrial company.  It’s a company with an enormously powerful brand.  It is a global franchise.  It produces transmission belts and hydraulic hoses, devices for high-end industrial applications where the specs are tough and the value is important.  Resilient business, global in nature. 

When we looked at it, we saw that it had not yet committed itself to the Lean and sort of Six Sigma production culture that exists in a lot of other industries.  Maybe it never had to.  Maybe it got along just fine without ever having to do that.  But for those of us who have been through that exercise, it was pretty obvious on the first day that this opportunity was ahead of us. 

A lot of what we did, a lot of the reason we underwrote that business and we invested in that case was because of our notion that if we did this, we could create more operating leverage in a business that’s already got some good operating leverage.  We could create more.  We would significantly reduce the working capital environment, appetite, of the business because we would shorten production cycles and we’d do all the things that we know Lean does and increase our service levels to customers. 

Then the last thing I would say is that we recommitted ourselves because I think this business during some downturns took its eye off some of the big emerging markets and we decided that we’d commit ourselves to those. 

Joe: So when you think about Blackstone’s approach to operational intervention, portfolio operation, can you contrast it to other pools of private equity and the approach that they take in let’s call it the fix-it stage of a company.  What do you think are the defining aspects of the approach taken by you and your team versus maybe what the common practice, industry private equity?

David: My experience and again I’ll repeat we — I’ve dealt directly with a large number of our PE firms out there because of my role at Nielsen and the fact that we were owned by five PE firms.  I’m going to repeat my notion that the biggest benefit of operating in the private equity world is that the ten-year hold or the five-year hold compared to the quarter hold in a public shelter [ph].  I don’t want to gloss over that. 

Now with respect to the assistance provided by the private equity firm on improvements in the operations, I do think our model is unique.  I’m not aware of any of the other firms that have the specialist model.  The notion that you’re going to bring in one person that knows a subject matter probably better than anyone else and then is commissioned to implement that across the portfolio of companies and because we have such a wide variety of companies and scale, that also adds to the value that we bring.  If I had one company that I’m working with and I have the scale of Blackstone compared to many of our competitors who have a third that scale, it’s got obvious advantages.  I do think our model is advantaged in that way. 

The other part of the model that I haven’t discussed is worth discussing.  As I mentioned, we have two major ways we do this is our philosophy is to staff the board of a private investment on the first day with operators who can help the operating team, the CO and their teams, perform better.  Oftentimes in our industry, the board development doesn’t happen until just prior to an IPO for governance reasons.  They do it well and I’m not — there’s no debates about that.  Everybody knows what they’re after.  Usually they meet the governance requirements. 

When you start on the first day of an investment instead of in preparation for a public offering, you get to staff it with real operators because in those first bunch of years when you’re running the business, that’s what you’re focused on.  And you want people who really do know something about either the industry or can contribute something to that CEO.  Most of what they contribute is confidence because CEOs, like it or not, need confidence.  Where do they get it from?  They get it from operators who have been there, done that and give them that kind of confidence. 

Every CEO that has an ounce more confidence than their competitive one, wins.  That’s just usually the way it works.  I’m not talking about arrogance.  I’m talking about confidence.  And we try to surround that CEO with people who will instill that in them.  We’re not looking to second guess them and I’m not looking for supervisors to sit on that board.  What we’re looking for are people who know how to make the CEO better.  And yes, if it ever came to the question of do I have the right CEO, to be able to answer that question. 

Joe: So you touched on it a little bit but leadership, CEO level, important, the critical factor?  How would you weigh the leadership position in translating to success?   As a follow-up to that, what do you look for in identifying that CEO, that leader that you think is right?  Having worked with Jack, now with Steve, I mean, you’ve gotten a pretty good representation of some pretty strong, successful leaders so what do you look for in portfolio companies, how do you attack the leadership question?

David: I wouldn’t use the word attack when it comes to that question.  I’m a student of the subject to this day. 

To answer your first question, it’s critical.  It’s by far the most important lever any of us have to create operating momentum in a business.  By far.  And we all know it.  Finding the right CEO is the most important thing in the world. 

There are a couple of things that I think — everyone’s got their own probably spec on every individual business, but here are a couple of things that for me are not negotiable.  Every CEO in our world has to want to find a better way of doing things.  If they are closed to my team, if they’re closed to our deal partners, if they’re closed to searching for better ways of doing things and practicing things, they’ll last about 18 months.  Because that’s an impossible situation.  Nobody’s that good.  They can’t be.  You can’t invent the best way of doing things in every arena of your business without help, without some notion.

Now, I don’t want people to get carried away with that notion.  I don’t want them out there hunting all day long and not doing their job, so there’s a little bit of balance.  But you can tell when somebody wants to do it from somebody who doesn’t want to do it.  So my ears are up, my eyes are open and I’m always looking for that. 

By the way, if Jack Welch ever thought for one second that when I was running the locomotive business I wouldn’t learn something from one of the other businesses or import a practice from one of the other businesses or from a customer, he’d shoot me.  I’d want to be shot. 

CEOs get in trouble when they start teaching all day long all the things they’ve learned all their life.  They teach all day long and forget that they’re still in learning mode.  What happens then is that everybody around you, the body language suggests to everybody around you that they can do the same thing.  What you really want is a culture that’s just dying for a better way to do a thing. 

Then the only other thing I will — the advice Jack Welch gave to me, the advice A.G. Lafley, who was on our board at GE and who I have a very high regard for on the subject of leadership gave to me when I first became a CEO: Don’t forget values. 

Values and the instillation of values, the belief in values across a wide organization, I don’t care if it’s a big one, a small one, it’s more important than organization structure.  It’s more important than the lines in the sand that you draw.  It’s more important than the procedures that you put in place because it overcomes all of those things.  It overcomes boundaries.  It creates teamwork and it creates a camaraderie and a belief system that reinforces everything. 

Without it, the bigger the companies get, the more clumsy they look.  Because everyone is looking for things to get solved on org charts and they hardly ever do.

Joe: Great.  I’m going to ask you a final question and then we’d love to give you an opportunity for a summary thought for the group to take with you when they think particularly about private companies versus public companies.  We’re often asked about the exit and what happens to the intervention phase after that company is no longer a Blackstone company.  How do you think about that?  How should investors think about that? 

David:   It’s actually a pretty simple answer.  And the two dovetail each other perfectly. 

I never plan for divestment.  As I said to you, as an operator my greatest wish for every one of our operators is that they never go public because that straightjacket they’re putting it on and they don’t even know it.  And they are going to lace it up.  It’s the way it’s going to work.  But what we do on our watch and it’s important because when we do do the IPO we have to sell that IPO that company into the public market.  That public market has to believe it has sustained improvement capability.  It has to believe that for us to get full value.

There’s nothing we do that doesn’t carry into the public world and ultimately benefit the company itself and its sustained performance vis-à-vis its competitors.  That’s what we’re after.  It’s not really a — everybody wants the same thing.  They dovetail nicely and it works.

As I said, I will fight every day all day with my entire team here at Blackstone to try to keep things private for as long as I can. 

Joe: So continued access, for example, to procurement, the e-auction capability, how do you think – does that maintain itself?

David: That door is open forever.  In other words, we don’t exclude them from that.  Oftentimes we can migrate them maybe off our contract, but sustain the same price as long as we’re working with that same supplier, whatever, but we do not shut the door on that stuff.  And if any of our companies call me, post our involvement and say can I get a little advice from so-and-so, can I get some help here, we are more than open to doing so. 

Joe: It was a fast hour.  I certainly want to say thank you to you and your team. As we let you go, just a general and a summary thought about lessons learned in your current role and actually expanded throughout your career.  You gave us a number of nuggets but as you think about advisors who are guiding investors every day, just a general thought about lessons learned and something to live by in terms of seeking value on your investments and analyzing company investments.

David: I’ll give you two things and we’ve talked about them the whole time so it won’t surprise you. When I say that as an operator I’m enormously advantaged in my private equity world, what am I really saying?  I’m saying I know my investor, that’s what I’m saying.  I know who they’re going to be a year from now.  I’m hoping they’re going to be that one two years from now, three years from now, four years from now, five years from now.  I experience what that feels like as an operator. 

Oftentimes the investment community is caught up in the trade environment — when to trade, how to trade, what to trade — when long-term value creation is this wonderful blend of long-term investor and operator.  I think Warren Buffet probably somehow, some way, how he’s done it all by himself I’ll never quite understand, has solved that one because he’s the investor that never gives up and he hangs in there.  The compound returns by his operators in a bunch of [indiscernible] industries exceed what goes on anywhere else and there’s a reason for it. 

More than ever I try to just convince people the reason this — I hate the term alternative long-term investment thing.  It shouldn’t be alternative.  It should be preferable.  Because that marriage of operator and investor it’s purer here, it’s simpler to understand and nobody really fully appreciates the value that’s created when they’re on the same page for a long period of time.  I do.  I’ve lived it.  I’m only talking through my operator eyes and not through anything else. 

So, that’s a lesson I’ll just keep on learning and there’s probably other ways to do that but right now I like the way we’re doing it. 

The only other subject is I learn something about leadership every day.  The world’s changing.  Young people are motivated differently than they’ve ever been.  Tried and true leaders have to figure out how to use all the new communication vehicles and how to be contemporary around how to manage and yet hold on to some of the fundamentals they’ve always known. 

My only point around leadership is no one ever gets it all.  No one ever will.  This is just one of those continuous learning things and trying to keep up with the youth in our world to make sure that youth is adequately represented in all of our companies is a really important, really important part of company health and performance. 

Anyway, those are probably the two subjects I think about the most.

Joe: Tremendous, Dave, thank you.  Our thanks to all our participants and listeners today and we look forward to the next chapter of the Blackstone experience and the Blackstone educational journey.  Thanks again for being with us today.  Have a good afternoon, everyone.

The views expressed in this commentary are the personal views of David Calhoun and Joseph Lohrer and do not necessarily reflect the views of Blackstone itself. The views expressed reflect the current views of Mr. Calhoun and Mr. Lohrer as of the date hereof and neither Mr. Calhoun, Mr. Lohrer nor Blackstone undertakes to advise you of any changes in the views expressed herein. Neither this podcast nor any of the information contained herein constitutes an offer of any Blackstone fund.