Moving into mainstream private equity

?Why should a manufacturer own offices? That's not efficient at all

As investment companies go, Patron Capital is an unusual breed. Set up in 1999 by Keith Breslauer, it is half private equity firm, half real estate investor. It differs from conventional real estate opportunity funds in that it isn't interested in buying property assets only, but also to invest in companies and help them grow. Unlike private equity houses on the other hand, extracting value from the real estate assets that these companies own is indeed an important part of the Patron proposition.

Selling the concept to institutional investors was not easy. When Patron went fundraising for the first time in 2000, institutions had a hard time understanding the model. But a number of successful transactions early on in the company's life helped convince the buyside that Patron was indeed worth looking at. To date Patron has raised some $130m from institutions, university endowments, families and individuals in the US and Europe.

Including leverage, Patron has access to funds in excess of €1bn at present. Five per cent of the firm's capital under management comes from Patron personnel: every member of the firm, including the support staff, has an interest in the fund as well as the opportunity to co-invest in deals. The fund is looking to return between 2x and 3x times equity to investors, starting with base return of 10 per cent from capital yield and then growing investee companies to generate an overall IRR of 20 to 25 per cent.

Freeing up assets
So what is so special about Patron's approach? Breslauer says Patron is in the business of making equity-led entity level investments in businesses where the purchase price is supported by the underlying assets, not the business itself. He explains: ?The big real estate funds are typically chasing single assets. That's not us. We're as much about investing in assets as we're looking to back companies and help them grow. Technically we're buying teams of people, taking decisions about liability and employee risks.?

Breslauer is also excited about the idea of bringing corporate finance skills to bear on real estate assets across Europe. ?I enjoy identifying assets that are tied up in complex, screwed up structures. Why should a manufacturer own offices? That's not efficient at all.?

Patron will invest between £7m and £20m in transactions, targeting deals that may be too small or too leftfield for larger investors. At the same time, it has a number of close relationships with large financial institutions including Royal Bank of Scotland, Commerzbank and General Motors Acceptance Corporation that it can bring into play as co-investors in bigger transactions.

Patron also has close ties to a handful of private equity firms including PPM Ventures, Royal London Private Equity and Royal Bank Private Equity, alongside which in 1999 it invested in the management buyout of igroup, a mortgage lender. The deal was highly profitable, putting Patron's name on the European private equity map for the first time. An even more high-profile private equity transaction that the firm came very close to recently was NCP. Had Cinven not clinched the deal at the last minute, rumor has it that Patron would have been working with Dawnay, Day and Co., the property partner to another leading competitor, on the real estate side of the £820m car park transaction.

Breslauer says Patron got to know the private equity mainstream almost ?by default,? as befits its founder's roots in opportunistic property investment.

Speed, not brilliance
Breslauer honed his investment approach during ten years at Lehman Brothers, where he started out investing in banks and savings & loans before moving into buying distressed mortgages, real estate and LBO portfolios in the US in the late 1980s and early 1990s. In 1993 he moved to Europe to trade in property and non-performing mortgages in the UK before spending the second half of the decade mostly focusing on distressed real estate opportunities in France. In 1997, Lehman Brothers asked Breslauer, then a senior executive at the bank's principal finance arm, to return to New York and manage a division. Breslauer turned the bank down.

This probably wasn't a surprise to those close to him. Breslauer comes across as a hard-charging, deeply commercial individualist, used to doing things his way. Raised in New York City, Breslauer grew up in what he describes as the ?rough and tumble world of real estate development,? watching his father, a developer, suffer serious losses. He left school and set up his first business, a promotion company, at the age of 16. Later, while at college, he ran a computer consultancy to pay for his studies. After graduating he was ?hungry as hell? and joined Lehman Brothers to start making money.

Breslauer enjoyed Wall Street. ?Lehman's was a great place. Nobody ever told me to stop working, and I had a bed in my office and slept there twice a week. I took on more and more, had great bosses and because I could handle it, I rose quickly.?

However, by the late 1990s, Breslauer must have been itching to get back to being his own boss and running his own business, where decisions could be taken however quickly and flexibly he and a small cast of senior colleagues would want to move. Today, at Patron, speed and flexibility are indeed seen as key strengths of the business. ?We're our own sponsor, there's no major external investor, or any committees unrelated to our European activities to go through. There is no brilliance to what we do, we're just more focused and a bit quicker than others.?

Back in 1998, another reason for deciding against the bank was that a career in management didn't appeal at all. ?I wanted to carry on doing deals, not manage people.? And he didn't want to leave Europe either. ?Europe is a great place to do business, because you can work through one small market after another replicating financial technology that has already been tested in the US. You don't have to learn anything new. Obviously you have to have a great deal of cultural sensitivity though, otherwise there's no deal.?

So Breslauer left Lehman but stayed in London, first helping Lone Star, the US real estate fund manager, to set up a European operation, then launching Patron a year later together with partners Tad Shay and Kendall Langford.

Multiple deal channels
Even though in the early days Patron may not have any great expectations about private equity, today

Breslauer is in no doubt as to how attractive an opportunity it offers: ?Building our franchise in the private equity community is extremely important to us.?

He believes Patron's real estate focus is well suited to assist private equity investors in their pursuit of value. ?We're not trying to compete with private equity firms, and we're not looking to go into a deal with them for some kind of arbitrage. We'll go in to help effect the transaction, reduce their potential downside and help them extract value in ways that might otherwise not be open to them.? Sale and lease back of a company's real estate portfolio is one instrument Patron may use, securitisation another.

The attraction for Patron is private equity deal flow. ?What we would get from them is access to a big pipeline. It can bring us into deals that we wouldn't get close to otherwise.?

Nevertheless private equity is only one of several areas in which Patron has an active interest. Although Breslauer says the business is unlikely to ever get into raising billion dollar funds, his vision for Patron is to manage a series of funds including a generalist private equity fund, a private equity fund focussed on financial institutions and a core-plus real estate fund, each with up to $300m in investor commitments and vested with a number of co-investing partners with deep pockets to go after large transactions.

?We're buying teams of people, taking decisions about liability and employee risks?

Patron has already opened up what he calls ?multiple deal channels,? thanks again in part to that network of partnerships, be it with private equity houses, property specialists or banks.

?Building our franchise in the private equity community is extremely important to us?

There is no shortage of examples as to what these channels can generate. In the UK, Patron is believed to be one of the last remaining bidders for Simon Group, a port and logistics company that is currently valued at around £150m.

In Germany, where Commerzbank Securities is a partner, Breslauer wants to invest in companies that are left without access to credit as the prospect of Basle II forces banks to stop lending. He also has been talking to the same banks about helping them hive off certain subsidiaries and their bad loans.

Elsewhere in Europe, dislocated real estate markets are expected to yield attractive assets in Italy and Switzerland, where Patron has already bought hotels in Interlaken and Leukerbad. Corporate restructuring in Switzerland generally is another theme. In order to track suitable targets across European markets, Patron works with a network of local origination affiliates.

The company also remains open to buying mortgages, and Breslauer says he wouldn't be at all surprised to see Patron become active in the secondary market as well, acquiring discounted limited partnership interests in the big real estate opportunity funds. Given such a broad range of interests, it's clear why he is keen to stay flexible and move fast.

Building a business
To the lay person, some of the successes that Patron has had to date may appear curiously simple. Take Patron's €12.5m acquisition in 2001 of Santa Maria Milan for instance, a small lending bank with a six-floor office building in central Milan and a portfolio of non-performing loans. Patron had planned to hold the property for three years and run the bank in the meantime, ready to see the loans deteriorate further. But then the office building was sold for €16.3m after only five months, giving Patron a 700 per cent IRR and an equity multiple of 2.2x. Meanwhile the firm continues to operate the bank, and today the loans are doing considerably better than expected.

Easy? Breslauer is adamant that there is nothing straightforward about his line of work. First you've got to find the deals, and then there is the transaction risk. In March this year, Patron won a deal of the year award for Hotel Arts at the International Hotel

Investment Forum, which the jury selected ?due to the complexity of the transaction combined with the high quality and value [?] for a bargain basement price.? The complex was sold for €285m, less than its breakup value, but to Breslauer that doesn't mean there is anything straightforward about the deal: ?I don't care what anyone says: it's still a hairy transaction. With Deutsche Bank, we own a 485-room 5-star hotel, there are about four guys in the world that we can sell it too, and there may be a war on with Iraq. It's not exactly a liquid asset.?

Despite these occupational hazards, Breslauer says doing deals is actually the easy bit compared to what really matters, which is to consistently deliver to investors what they have been promised. ?We operate under the theory that our investors are gods. I think we've won their respect because they know we're making every pound sweat. It's why you won't find a £40,000 conference table here. Flush offices are no good to our clients. What we've invested in instead is reporting technology, because that's crucial to what we're doing – we're building a business.?

Breslauer makes the point so emphatically that there can be no doubt this is indeed the project he is fully committed to. He's building a business, and he's determined to make it reach deeper into the private equity community.