Investment Bankers vs. Capital Projects: Which Creates Value?

I was recently at an industry conference where there was a panel discussing consolidation in the process and industrial market. Among the topics covered was the value that investment bankers create during the merger and acquisition process. As I listened to the conversation go on, I struggled to bite my tongue. Finally, during the Q&A session, I decided to speak my mind. I stood up and said that while investment bankers are skilled deal negotiators, the value of the merging companies is still based primarily on the years of work that each of those companies has put into building a viable business. To me, real value creation is built through research and development, making risky capital allocation decisions and spending long hard days in the field building assets that pull resources from the ground and turn it into products that improve the human condition. That is value creation. These investment bankers aren’t creating value for their clients, they’re harvesting the value that has been built on the backs of others. Bankers have specialized skills that help accentuate a company’s assets. But the assets are what the assets are.

The great irony of this conversation is that one decision that can truly create value is also one of the first areas where investment bankers often advise cutting to improve short-term return on invested capital. Successful capital projects undeniably create long-term value. The keyword is “successful.” We know that a majority of capital projects fail to meet budget and scheduling goals. At the same time, neglecting to invest in capital projects altogether is a recipe for failure. If manufacturing and processing companies aren’t able to expand production capabilities over time, they can’t grow. If they do not deliver capital projects effectively, they destroy shareholder value. There is a huge difference between efficient capital project delivery and effective capital project delivery. Let's pause here and let that sink in. We all want to be efficient, but even if we are efficient on an ill-conceived capital project, the result will not effectively increase shareholder value.

For small and mid-sized organizations, committing to capital projects can carry more weight than it does for large companies. The risks are greater and the stakes are higher. In challenging economic climates, many companies tend to pull back on capital expenditures. However, an interesting study from Boston Consulting Group sheds some light on why basing capital expenditure decisions on the near-term performance of the economy might be a bad decision.

BCG analyzed the capital expenditure performance of 175 industrial companies from 2005 to 2015. According to their findings, companies that spent consistently on capital projects over time had a 13 percent better return on gross investment than companies that spent more in boom periods and pulled back during recessions. Yet unsurprisingly, only 22 percent of the companies analyzed actually followed the steadier investment approach. The lesson for owners and operators is that capital projects create value, but only when they are undertaken consistently and with a clear business strategy.

I believe consistently committing to capital projects is also likely to equate to consistency in project execution. Creating processes for capital projects and repeating them regularly will help ensure that fewer projects end in failure. In short, practice makes perfect. I’m not one that typically recommends business books, but “Great by Choice” describes the traits of “10X companies,” and hard research for the book reinforces BCG’s point (or maybe BCG read the book). We’ll leave it at that for now.