Americas – May 2003

AmericaMonitor
The operating guys
Buyout firms are going out of their way to prove to investors that they have the necessary operational expertise to improve the businesses they invest in. But investors are skeptical, asking tough questions about which general partners really do know how to grow portfolio companies in a difficult market. By David Snow.

Look who’s the hotshot GP these days – it’s not the ex-Goldman partner with 42 IPOs under his belt. It’s not the financial engineer who works magic with spreadsheets and flipbooks. It’s the guy who spent 20 years working his way up the corporate ladder in the kinds of jobs that make Harvard MBAs cringe. It’s the operating guy.

The private equity “round trip” consists of three parts – buying the company, fixing it up, and selling it. The selling part is often harder than the buying part, especially in today’s market. But depending on how badly impaired the company is, the “fixing it up” part may be the most difficult by far. This is because improving a company’s performance is a day-by-day feat of managerial skill and personal endurance.

In a rising market, the operating partners don’t have as much to do, or get as much credit, because rising earnings are taken for granted. Even mediocre managers seem to perform well when the economy is roaring. Now, GPs and LPs alike have realised the importance of having professionals on the team who know how to run companies other than capital management boutiques. As the market has fallen, the stock of true, nuts-and-bolts operating guys has gone up.

The concept of having a range of skill sets within a private equity firm is not new. On the venture side, firms have long been careful to maintain a good balance between professionals from science and academia (the PhDs) and business (the CEOs). On the buyout side, general partners have long presented their firms as possessing both professionals who excel at transactions (buying and selling companies) and at operations (running and improving companies). Over the past two years, there has been an added emphasis on the latter type of professional for obvious reasons. The many compelling buying opportunities in the market now are of companies that have been battered by deteriorating market conditions. Prices may be low, but an investment in a weakened company without a clear plan for growth and repositioning typically turns out badly.

And don’t forget the people who have to actually carry out these plans. Private equity’s biggest advantage over public market investing is control over the acquired asset and the ability to effect change. As returns come back to earth (and sometimes crater), investors are becoming increasingly aware that the only resource many private equity firms brought to their portfolio companies was money, which, considering the amounts of it raised, was not a very differentiating factor. What portfolio companies need now more than ever is talented human capital – a rare commodity if there ever was one.

The buyside are looking hard
Increasingly, limited partners are basing their new commitment decisions on a private equity firm’s ability to effect change. For many, the focus of due diligence has shifted from deals to operations. “The days of financial engineering are over,” says an investment professional at a major US endowment. “One of our central goals is finding groups that really have an operational focus.”

“A red flag goes up when we come across a private equity firm where no one’s ever run a company”

The task of assessing a firm’s operational focus is not easy – every GP group claims to add value. These groups need only point to a successful deal as proof. See how the value of our portfolio company increased, they say, that’s us adding value.

“We don’t just look at track record,” says the endowment manager. “It’s not enough to know that a deal returned 4x – we want to know where the 4x came from.”

This professional says the quantitative side of his due diligence focuses on growth in EBITDA margins versus top-line growth. His endowment looks for organic growth and strategic improvements. A portfolio company that has grown only through successive add-ons or an expanding market may bode well for the investment, but reflects little glory on the operating skills of the financial sponsor.

A good operating team will work independently of the transaction specialists. Operating partners help evaluate management teams, implement milestones, see that the milestones are being met and, if they are not, will have a Plan B and C in place. “Today a private equity firm needs guys who can change incentive structures, who can bring an equity culture into a company,” says the endowment manager.

However, an understanding of incentives and equity at a financial services firm does not readily translate to, say, an automotive parts manufacturer. “A red flag goes up when we come across a private equity firm where no one’s ever run a company,” says the endowment pro. “Just because you’ve been a direct investor in a bull market doesn’t demonstrate that you know how to add value.”

The manager says that, in his experience, most venture capital firms have a good mix of operating partners, but “over half” of the buyout firms that come calling at the endowment “do not have true, deep operating experience.”

Bankers need not apply
Buyout firms are going out of their way to prove that they are in the true, deep half. At conferences and industry events, GPs have been heard trumpeting the value of hands-on investing. Others have recently bulked up on the operating side. One of these is New York-based middle-market buyout firm Fenway Partners, which added Dale Morrison as an operating partner last July. Morrison is the former CEO of Campbell Soup Co., and his resume does not read like that of most senior partners at top-shelf private equity firms. From 1995 to 2000, Morrison held a number of executive positions at the Campbell. Prior to becoming CEO, he was president of the Pepperidge Farm business and of International and Specialty Foods. Before joining Campbell, Morrison was with PepsiCo for 14 years. He cut his teeth in the food industry by spending 10 years at General Foods.

Morrison’s background was exactly what Peter Lamm, the chairman and CEO of Fenway Partners, was looking for. “We like operating partners who were trained early in their career at companies that are known for teaching the basics,” Lamm says. “We’d been looking for someone with good food experience and brand experience. We spent four months courting Dale and during that time developed a very high level of comfort and trust.”

partners at Fenway are charged with overseeing the work of the individual portfolio company CEOs. “The operating executives are there to help other capable CEOs, not to be the CEOs residing in New York,” he says.

That said, when crises occur, or when the management originally selected does not work out, operating partners are called on to temporarily sit in the driver’s seat, as it were. Lamm estimates that management must be changed at Fenway portfolio companies from one-half to two-thirds of the time. With a market recovery still a distant light on the horizon, many other private equity firms are spending much more time strolling the proverbial factory floor, but, lacking a real understanding of how to run their own portfolio companies, are not necessarily equipped to know how to make improvements. “You don’t walk in from Goldman Sachs or Salomon Smith Barney and immediately become a good private equity operating guy,” says Lamm.

“The operating executives are there to help other wonderful CEOs, not to be the CEOs residing in New York”

He adds: “In the world today it is increasingly difficult to buy companies inexpensively and sell them expensively. You need to bring value to the proposition.”

AmericasDeals & Exits
Madison, Carlyle partner in $1.1bn energy buyout
Madison Dearborn Partners and The Carlyle Group’s Carlyle/Riverstone Global Energy and Power Fund II, have jointly acquired natural gas company Williams Cos.’ 54.6 per cent stake in publicly-traded energy investment subsidiary Williams Energy Partners in a buyout valued at $1.1bn.

The two partners are committing equal amounts of capital to an acquisition vehicle that will take control of Williams Energy Partners. The partners have agreed to pay approximately $512m in cash to Williams, in addition to assuming $570m of the company’s debt.

Williams Energy Partners is a publicly traded partnership formed to own, operate and acquire a diversified portfolio of energy assets. The firm primarily transports, stores and distributes refined petroleum products and ammonia.

The company’s assets include a 6,700-mile refined products pipeline system and 39 related storage terminals, an ammonia pipeline system, five marine terminal facilities located along waterways such as the Houston Ship Channel, and 25 inland terminal facilities connected to thirdparty pipelines.

For the year ended 2002, Williams Energy Partners had total revenues of $435m and total expenses of $219m, for an operating margin of $216m.

JP Morgan exits automotive investment
Castle Harlan has invested in the buyout of automotive accessories company Advanced Accessory Systems, a manufacturer of automotive roof racks and towing systems in North America and Europe, from JP Morgan Partners, the private equity arm of J.P. Morgan Chase. The deal is valued at approximately $260m.

Advanced Accessory, based in Sterling Heights, Michigan, has 18 manufacturing facilities throughout North America and Europe. Two-thirds of the company’s sales are to original equipment manufacturers in North America and Europe and one-third to the aftermarket. The company had revenues of $328m last year and net earnings of $46.6m.

Behrman, Blackstone fund defense deal
Behrman Capital has bought defense, aerospace and industrial products provider ILC Industries in a $303m MBO. Behrman partnered with ILC chief executive officer Clifford Lane to complete the transaction. Senior debt financing was provided by UBS. A subordinated debt package was led by the Blackstone Group.

ILC Industries, which is based in Bohemia, New York, operates Data Device Corp., a manufacturer of microelectronic components for the aerospace and defence industries, and ILC Dover, a manufacturer of advanced softgood materials for unique space, military and commercial applications.

Behrman Capital also acquired kitchen and bath cabinet component manufacturer Woodcraft Industries in a transaction valued at $145m. Woodcraft manufactures assembled solid wood doors for kitchen and bath cabinets.

One Equity in $1.7bn pharma PTP
One Equity Partners, the private equity arm of Bank One Corp., agreed to acquire pharmaceutical trial outsourcing company Quintiles Transnational Corp. for $14.50 per share, meaning the total acquisition price for the company’s 118m outstanding shares amounts to more than $1.7bn.

One Equity Partners, through a company it set up with Quintiles’ founder and chairman Dennis Gillings, has committed $415.7m to Gillings’ new company, Pharma Services. Pharma Services also received debt commitments of $875m from Citicorp North America and Citigroup Global Markets. Pharma Services will also use $586m in existing Quintiles cash to finance the transaction.

Quintiles, which specialises in outsourced Phase II and Phase III clinical trials, had 2002 revenues of $1.99 bn. The $14.50 per share price is approximately $8.31 more than the share price of the company on October 11, 2002, the day before Pharma Services originally proposed an offer for the company.

Silver Lake buys WorldCom bonds
invested in $175m in bonds of bankrupt telecom company WorldCom. Silver Lake is the third private equity investor to buy its way into WorldCom, alongside New York-based distressed debt investor Matlin Patterson Global Opportunities Fund and Boston-based Bain Capital.

WorldCom has approximately $30bn of face value in bonds outstanding, and Silver Lake’s $175m, based on current market prices, would give the firm $625m in face value of debt.

Thomas H. Lee makes $150m rescue loan
Thomas H. Lee has committed to a $150m term loan from its Thomas H. Lee Equity Fund IV, in a bid to keep troubled portfolio company Metris afloat. Minnesota-based Metris specialises in issuing credit cards to low-income individuals with poor credit histories. The backup facility would carry annual interest of 12 per cent plus an option to earn an additional economic return based on the performance of Metris’ managed receivables through Dec. 31, 2004.

The loan, if drawn, would be repayable in full on March 1, 2004. Thomas H. Lee invested $300m to acquire a 29 per cent stake in Metris in November 1998. The firm’s president, Thomas H. Lee, joined Metris’ board of directors.

Advent teams with Johns Hopkins
Advent International has completed a $115m recapitalisation of American Radiology Services in partnership with the company’s existing physician shareholders and Johns Hopkins University.

Advent invested $35m in equity from its $1.9bn Global Private Equity IV Fund to acquire 60 per cent of American Radiology. Bank of America led a syndicate including Merrill Lynch Capital, General Electric Capital and BNP Paribas that provided the debt financing to consummate the transaction.

American Radiology provides diagnostic imaging services including MRI, CT, PET, ultrasound, x-ray, and mammography through outpatient centers and in-patient hospital contracts throughout the mid-Atlantic region.

North Castle invests in drug treatment
North Castle Partners has funded for-profit drug and alcohol treatment services provider portfolio company CRC Health Corp.’s $110m acquisition of Comprehensive Addiction Programs (CAPS).

The CAPS acquisition was completed with financing of $40m in an equity syndicate including Credit Suisse First Boston, in addition to a $70m senior debt financing led by BNP Paribas and Madison Capital. CAPS owns and operates sixteen residential and outpatient addiction treatment facilities that are now part of CRC, making the company the nation’s largest network of privately held addiction and recovery facilities.

Leonard Green has school spirit
Leonard Green & Partners has purchased Varsity Brands, a provider of goods and services to the school spirit industry, in a goingprivate MBO that values the company at $130.9m, including the assumption of debt.

Varsity’s stockholders will receive $6.57 per share in cash upon the closing of the deal, which represents a 39.8 per cent premium over the company’s closing price of $4.70 per share and a 43.7 per cent premium over the average closing price of its common stock for the preceding twenty trading days. Based in Memphis, Tennessee, Varsity Brands designs, markets and manufactures cheerleading and dance team uniforms and accessories, as well as dance and recital apparel for the studio dance market; operates cheerleading and dance team instruction camps throughout the US; produces nationally televised cheerleading and dance team championships and other special events; and operates studio dance competitions and conventions.

Kohlberg & Co buys Thousand Trails
New York-based private equity firm Kohlberg & Co is to acquire membership-based campground owner and operator Thousand Trails in a privatisation valued at approximately $113m. Kohlberg has agreed to pay $14.50 per common share for the company, a 55 per cent premium on the company’s recent trading price of $9.35.

Thousand Trails owns 59 membership-based campsites for 112,000 members. The campsites are located in 17 states and British Columbia, Canada. The company also manages 240 public campgrounds for the US Forest Service and has a reciprocal use program for its members to access approximately 280 other facilities.

Kohlberg & Co typically makes investments in middle-market companies with enterprise values between $50m and $500m. The firm was co-founded in 1987 by James Kohlberg, one of the founders of private equity giant Kohlberg Kravis Roberts.

Warburg Pincus launches Targa Resources
Seeking to take advantage of the glut of opportunities emerging in the energy sector, New York-based Warburg Pincus has committed an undisclosed amount of seed funding to midstream energy sector acquisition vehicle Targa Resources.

Houston, Texas-based Targa will target opportunities including gas pipelines, storage, gathering and processing facilities in the Gulf Coast, Mid-Continent and Rocky Mountain regions, where management has extensive experience. Warburg Pincus has also negotiated the terms under which it would invest additional equity in Targa to fund specific acquisition or growth opportunities.

Warburg Pincus has appointed Rene Joyce and Roy Johnson as managers of Targa. Previously, Joyce was president of the operating companies of gas pipeline, processing plant and storage facility company Tejas Gas Corp, sold to Shell Oil in 1998 for $2.4bn. Johnson worked with Joyce at Tejas Gas in senior management and business development roles and both have held other senior positions with major midstream energy companies.

Blue Point Capital sells Pleasants
Ohio-based private equity firm Blue Point Capital Partners, which is affiliated with KeyCorp, has sold its commercial door, frame, and architectural hardware distributor portfolio company Pleasants Hardware to strategic buyer WW Holdings. Terms of the deal were not disclosed.

Pleasants Hardware makes doors, frames, finish hardware, partition systems, fabrication and specialty products for commercial and institutional building projects. Blue Point originally invested in the company in 1999, when it was Key Equity Capital.

AmericasFunds & Buyside
Bain, Tenaska sponsor $550m power fund
Bain Capital has forged a partnership with Tenaska, the largest private independent power producer in the US, to jointly sponsor a $550m investment partnership that will target US power generation asset acquisition opportunities. The partnership will target emerging power generation opportunities, in addition to established power generation assets.

UTIMCO records must be made public
Texas Attorney General Greg Abbott has ruled that the University of Texas Investment Management Co. (UTIMCO) must release its investment records, including the performance of private equity funds in which it is a limited partner. In making his decision Abbott rejected arguments from fund managers, including Atlas Venture, Austin Ventures, Crescendo Ventures, KKR Associates, The Carlyle Group, and Warburg Pincus, that such disclosure was exempt from the Texas Public Information Act for competitive reasons because it would leave affected funds at a competitive disadvantage.

The ruling was forced by the decision that UTIMCO, which manages roughly $14bn on behalf of the University of Texas System, made last month to withhold the latest quarterly return data for about half of its private equity investments.

Accel cuts fund again
Accel Partners has reduced the size of its most recent fund for the second time. Accel plans to reduce the size of its $1.4bn Accel VIII fund, which closed in 2000, by an additional 29 per cent to $680m. Accel also has reduced a strategic $275m side fund, Accel Internet Fund 4, by the same proportions.

Last May, Accel reduced the size of Accel VIII by 32 per cent to $952m after investors balked at the firm’s decision to cut the fund in half but keep the remaining $700m for a future fund.

Since its first fund reduction, Accel has invested in only six deals. Limited partners in Accel VIII include CalTech, General Motors, Harvard University,

Hewlett-Packard, Illinois State Teachers’ Retirement System, MIT, Northwestern University, the Washington State Investment Board, and the University of Michigan, which recently revealed that the fund’s internal rate of return through the second quarter of 2002 was a negative 22 per cent.

Global Asset Capital wins Viventures battle
After several months of negotiations, French media group Vivendi Universal has ceded control of its global venture capital investment unit Viventures to a consortium of US investors.

California-based Global Asset Capital, backed by US private equity group Hamilton Lane Advisors, has acquired Viventures Partners, the firm responsible for managing the Viventures I and II funds. Global Asset Capital’s bid is worth €9m and enables LPs in Viventures II to abandon 25 per cent of their future commitments. GAC intends to raise a €100m fund to co-invest alongside Viventures II.

Reports of a takeover of the Viventures management company emerged early this year when a group of the firm’s limited partners, led by Compagnie Nationale à Portefeuille, the investment company of Belgian investor Albert Frère, SGAM and several Singapore-based investors, called for a change in ownership following Vivendi’s decision last year to cease making commitments to Viventures II.

AmericasPeople
Merrill sues placement defectors
Merrill Lynch has filed suit against Lazard Freres & Co. and a group of former placement agents who left en masse to form a new placement business at the financial services boutique, charging the defectors with collusion and misappropriation of confidential information, according to sources.

In February, nine private equity placement professionals left Merrill Lynch to create a New York-based placement business for Lazard. The professionals, led by Ben Sullivan and William Riddle, also include managing directors Mike Sutka, Scott Church and Tim O’Gara. The nine joined Lazard Private Fund Advisory Group.

According to a source close to the situation, Merrill Lynch has filed suit against Lazard and the group of former employees, claiming they unfairly colluded to create a competing business while still working at Merrill Lynch.

Senior management at Merrill Lynch is arguing that the former employees should have ceased working at the firm once they decided to join Lazard, the source said. “The theory is that raiding Merrill Lynch’s employees under this set of circumstances constitutes unfair competition,” he said. In the suit, Merrill Lynch is claiming its business was damaged by the alleged collusion.

In addition, Merrill has accused at least one member of the group with misappropriating “confidential information” before leaving the firm.

A separate source said the information in question was all or part of Merrill’s investor database – essentially a list of contact and other details regarding people and institutions who commit to private equity funds.

Merrill has obtained a temporary retraining order preventing the Lazard placement team from using allegedly misappropriated information, a source said.

One placement industry source close described the lawsuit as “sour grapes” and “harassment.”

A placement agent source said the line between proprietary investor information and information in the public domain is often hard to discern. “A lot of the names on Merrill’s list are probably in publicly available directories,” he said. “But probably 50 per cent of the names are not in published directories because of staff turnover.”

Perle resigns as Pentagon advisor over VC ties
Defence policy advisor Richard Perle resigned his position as chairman of the Defense Policy Board, a collection of civilians and former military officials who advise US Secretary of Defense Donald Rumsfeld on military issues, because of ties to a venture capital fund that presented a potential conflict of interest.

Perle is a principal at Trireme Venture Partners, a venture capital firm created in 2001 to invest in technology goods and services related to homeland security and defense. Former US Secretary of State Henry Kissinger is also a principle for the firm.

Carlyle names telecoms advisor
US private equity firm Carlyle Group has hired Duncan Lewis, former chief executive officer and president of pan-European data communications and hosting company GTS/Ebone. Lewis will join the firm as senior advisor to its global telecommunications and media group.

“Duncan Lewis has a tremendously broad and varied background, and is a skilled operating executive,” Jim Attwood, Carlyle managing director and head of telecommunications and media, said. Lewis served at GTS from January 2001 to March 2002 when the company was sold to KPNQwest. At the time, GTS ran Europe’s largest optical and IP network carrying more than 25 per cent of Europe’s internet traffic.

Capital Z hires John Crocker
New York-based private equity and hedge fund manager Capital Z Investment Partners, the alternative investment arm of Zurich Financial Services, hired John Crocker as senior vice president and partner. He is Capital Z’s fifth professional hire in the past four months.

Crocker, who will be responsible for identifying and evaluating new private equity sponsorship opportunities and providing guidance to Capital Z portfolio fund managers, becomes the fifth Capital Z partner, joining Laurence Cheng, Scott Delman and Sharissa Jones in New York and Vincent Fan in Hong Kong.

Crocker joins Capital Z from Credit Suisse First Boston’s private equity fund of funds vehicle, where he was a partner. Previously, Crocker was responsible for building the alternative investments business at Donaldson, Lufkin & Jenrette.

Former Microsoft, ICG pro joins Mohr Davidow as GP
Menlo Park, California-based early stage venture capital firm Mohr, Davidow Ventures named Sam Jadallah a general partner.

Jadallah joins Mohr Davidow from Internet Capital Group, where he led the west coast and Asian operations and served as a member of ICG’s senior management team and acquisition committee.

Prior to ICG, Jadallah spent 12 years at Microsoft, where his final position was vice president, worldwide enterprise sales. In that role he led worldwide marketing and sales efforts to commercial and academic customers. Additionally, Jadallah led Microsoft’s efforts in distribution, anti-piracy, TechNet, and training and certification.

Accel’s Alan Austin jumps ship to Silver Lake
Alan Austin has joined technology sector buyout specialist Silver Lake Partners as a managing director and chief operating officer. Austin served as general partner and chief operating officer at Accel Partners for nearly three years. Previously, he spent 13 years at Wilson Sonsini Goodrich & Rosati, including five years as a managing partner. Austin also spent 12 years at Orrick, Herrington & Sutcliffe, where he was a partner and chaired the corporate department.

Lehman’s Newman president
Atlantic-Pacific Capital, founded in 1995 by James Manley, has named Kevin Newman, the lead marketing professional for Lehman