Intuition to Insight : Developing Risk Analysis Tools for Special Situations Investing

This thesis was conducted in collaboration with Lazarus Industrif¨orvaltning AB, a Swedish investment firm focusing on acquiring distressed companies. Lazarus conducts their own due diligence and utilizes internal tools to analyze risk and return for potential investments. However, the firm’s four partners perceived their previous tools as both unclear and unreliable. Through interviews this perception was found to be due to the risk tools giving similar risk scores across different cases, performance metrics not matching the firm’s needs and an overall lack of user-friendliness. The purpose of this thesis was to develop improved risk tools to better support Lazarus’ investment analysis process. For this, two main research questions guided the work. First, how can Lazarus improve its company-specific risk analysis tool for evaluating potential investments in a way that aligns with its operations? Second, how can a risk-adjusted return measure be calculated while accounting for risks associated with different financing structures? Through a qualitative and abductive method, interviews were held with Lazarus’ four partners. Existing theory was used as a basis for the development decisions suggested during the interviews and the tools were developed iteratively with continuous feedback. This process resulted in two new risk analysis tools. First, a new company specific risk tool based on 19 predefined risk factors with probability × impact scoring and aggregation through a weighted mean model. Second, a redesigned tool for calculating risk-adjusted return based on cash flows through different financing structures and their inherent risk, illustrated by this thesis’ new performance metric MORAC (Multiple On Risk Adjusted Capital). The tools improve clarity, usability and alignment with Lazarus’ needs. While tailored for their needs, isolated components of the risk tools could potentially be of use for other investors. Limitations to this thesis include dependence on subjective and qualitative input, and future research could benefit from long-term testing of the tools’ consistency between users, and evaluating whether scores correlate with investment outcomes over time.