transactions. Your sector knowledge will enable you to empathize with management teams on key industry issues and position yourself as a value-added partner of choice to them. Professional advisers working on deals in the sector that you know well will appreciate the fact that they do not have to spend time educating you about the industry and will be enthusiastic about engaging with you on potential transactions.
It sounds like there are only positives in a thematic deal sourcing process, right? Unfortunately, not. It is a time-consuming and resource-intensive task. It requires such an overwhelming effort on your part that it might be very tempting to return to your day-to-day reactive activities and abandon your goal of becoming an industry expert altogether. I have certainly experienced this feeling on more than one occasion, especially when working on sectors that I was less excited about. I felt like I certainly had enough to fill my days without taking a “deep dive” into a new sector.
What can make thematic deal sourcing less daunting? What I have found is that this task seems far less intimidating when thematic research is broken down into small, digestible pieces that form a checklist-like framework. It is much easier to check small items off your list than deal with one mammoth chore. Since I could not find such a detailed checklist aimed at a thematic private equity deal sourcing process anywhere, I put together this 7-step thematic deal sourcing framework myself. Here it goes.
Thematic Deal Sourcing: ICEBERG Roadmap™1
My framework is called the Thematic Deal Sourcing ICEBERG Roadmap™. Broadly speaking, the thematic deal sourcing process consists of the following steps:
1 Identify a sector theme and build an investment thesis.
2 Conduct an in-depth analysis of the selected industry.
3 Elaborate on your knowledge by mapping out key players operating in the industry.
4 Build a network of experts and company executives to fill knowledge gaps.
5 Establish a long list of potential deal targets and initiate coverage of these companies.
6 Rank the companies by attractiveness and approach two or three potential deal targets at a time.
7 Go visit companies to convert deal ideas into real transactions.
Let's go through these steps in greater detail so that you can understand how I developed this checklist and modify it as needed to create a framework that works for you.
1. Identify a sector theme and build aninvestment thesis
How do you come up with a good investment idea? It might seem easier said than done, but let us look in detail at some of the resources you can use to find a promising investment theme.
Knowledge you already have. Is there an industry that your firm already knows well and in which your fund has already completed transactions? Provided that doing an additional deal in this sector is not going to produce an overly concentrated portfolio, consider capitalizing on the industry knowledge your fund has already acquired through owning this business.
Knowledge you can easily extend. Are there any deals that your fund recently lost to your competition? Are there any valuable industry insights that your fund gained in these aborted deal processes? Are you able to take advantage of this knowledge, identify any second or third-order effects present in this sector's value chain and perhaps even seek to exploit the same investment thesis in a different geography?
Business press. Ask yourself more broadly about what is going on in the world. Where are the pockets of “economic turbulence” I wrote about earlier? Have you recently seen any inspiring articles or interviews in the business press discussing emerging trends, interesting products, or fast-growing and under-capitalized industries?
Top-down sector analysis. Choose a big sector to look at and go through its supply chain to identify interesting subsectors. Where is a good place to invest? Consider the example of aerospace and defense as a large industry. Instead of imagining large aircraft and helicopter manufacturers, think of this sector's smaller segments: Who produces passenger seats, lavatories, three-dimensional real-time maps and in-flight entertainment? What about runway lighting, airport equipment, avionics and aircraft simulators for pilot training?
Industry classification codes. This strategy is for a slow and rainy day. It works well for obscure sectors, especially if you are not sure how to break down a big industry into smaller sub-segments. You simply look for a publicly available source of standard industry classification codes and learn how that database breaks down a large industry of your choice into subsegments. For example, if you focus on the medical laboratory equipment sector and identify manufacturers of spectrofluorometers and turbidimeters through this analysis, then consider yourself to be on the right track.
2. Conduct an in-depth analysis of the selected industry
The objective of this step is to evaluate the attractiveness of the sector, learn about its structural features and identify profitability drivers. It is a dynamic exercise: even the most comprehensive attempt at answering all major questions about the industry will leave you with some information gaps. As you talk to sector experts and company executives, you will be able to fill these gaps and generate your own insights that will help you to come up with an actionable investment thesis.
I describe my own approach to industry analysis in broad terms below.
Sector scope. I find that an appropriate sector definition is key before beginning this analysis. This should generally focus on a relevant geography and include all companies producing the same product or service, as well as those companies offering viable substitutes.
External environment. What broad macro factors2 are likely to have an influence on this industry? Take note of any political considerations, economic trends, cultural influences, legal or environmental concerns that are important to this sector.
Sector performance. What is the total market size and historic growth rate? Is the industry new, mature or declining? What are the key drivers of projected growth? Is there a cycle and, if so, where are we now?
Demand factors. What secular trends are influencing demand? Who buys the product and how are purchasing decisions made? Is this a discretionary spend? What are the key determinants of demand as well as its historic and projected growth rates?
Supply factors. Understand sector capacity: historic, current and projected. What does the supply look like when broken down by product or service? Map out the industry's supply chain.
Competitive landscape. What is the market structure: fragmented or fairly consolidated? What are the market shares of top players? How attractive is the industry? To provide a comprehensive answer to this question, you may find it helpful to refer to the works of Porter (1985) and Grant (2002). In short, any industry analysis should aim to examine key sector forces
