The building that houses the London office of Sun European Partners, the European arm of US firm Sun Capital Partners, is not much to look at (although for a firm that has made its name buying troubled companies, it is appropriately positioned: right at the end of a very long road).
But this is no brass-plate satellite office or marketing outpost. In the last two years, almost two-thirds of the capital put to work by Sun globally has been spent in Europe, via this very office. In 2010 it completed 12 deals; another 11 followed last year. 2012 looks set to be even bigger: at the time of our conversation in early March, Sun had already completed four deals, with another four pending. From an office that used to do one or two small turnarounds a year before the crisis, that’s a huge ramp-up of activity in a relatively short space of time. To put it bluntly: Sun is going large in Europe.
The office is run by senior managing director Michael Kalb, a straight-talking, high-energy American ex-banker with machine-gun delivery. One of the first people hired by Sun founders Marc Leder and Rodger Krouse in the 1990s, Kalb has been based in London permanently since last year, although he’s been involved with Sun’s European business since way back in 2004, when he started coming over from New York to work on the firm’s earliest deals.
“I landed on the red-eye in Dusseldorf, took a shower, and went straight to meet with [ThyssenKrupp, whose business, the Huennebeck Group, Sun ended up buying]. I walked in by myself, and there was a team of about 20 massive Germans staring at me. I thought: Wow, this is kind of cool! Afterwards I called Marc and Roger and said: ‘Guys, Europe can be a real opportunity, let’s go open an office there’. They said: ‘Fine, go’. And I was like: ‘No you don’t understand, I meant hire someone – not me, my wife will divorce me!’” (laughs uproariously).
Instead, when Sun did open a London office the following year, Philip Dougall (another long-time associate of the founders) was appointed as chief executive. In the next few years, the European team typically did a couple of deals a year, mostly turnarounds. Says Kalb: “For those first three years, it was very much a case of: ‘Let’s get our name out and build a reputation, because nobody knows who we are’.”
And then came the financial crisis.
FLYING TOO CLOSE TO THE SUN
Before the crisis started to bite in 2008, Sun’s rise had been suitably stellar. Founded in 1995, it was still only a handful of people by the end of the decade. Yet by 2007, it was closing the $6 billion Fund V, taking its total assets under management to about $8 billion. Sun was able to raise a full $2 billion more than it had originally targeted for that fifth fund, as LPs clamoured for a piece of the action.
However, its business – and its reputation – took a hit as the markets went south. No fewer than 16 of its portfolio companies were forced to file for bankruptcy, mostly in the US. The firm itself shed a number of staff, closing down its Asian offices and exiting from a securities fund it had raised to buy non-control positions.
Inevitably, this resulted in some pretty unfavourable coverage. But Kalb insists Sun’s woes were exaggerated. “Our business is restructuring. Oftentimes, we have to put our own companies into bankruptcy to fix them.” He cites the example of Big 10 Tires in the US, which had a number of unfavourable leases that it needed to get out of, and the controversial pre-pack administration of Homeform in Europe, where Sun bought the healthy bedroom business from the administrator after allowing the kitchen and bathroom businesses to go bust.
“There was a lot of noise in the US because I don’t think the market really appreciated what we do,” he argues. “We’re operational. We roll up our sleeves and get involved in very hairy situations.” It’s certainly true that Sun is operating in one of the riskiest areas of private equity, where the dividing line between success and failure is often a fine one.
Sun also ended up scaling its fund back from $6 billion to $5 billion – partly to help out LPs who were suffering from liquidity issues, but also because it didn’t have the dealflow to support a fund of that size. Sceptics will tell you that it never did; that a mid-market firm with an average equity cheque of about $40-50 million was never going to need a $6 billion fund. Kalb’s argument is that the firm typically spends about $750 million a year, so over the course of a 10-year fund, it wasn’t a ridiculous sum. But when it only managed to put £200 million to work in the year of the crisis, downsizing was the obvious option.
Kalb admits, with admirable frankness, that the firm over-reached itself in two specific areas: the non-control fund, and the Asian office. “What did we do to stretch ourselves? We opened offices in China and Tokyo. That was too far afield. We did one deal in Japan that was actually a very successful transaction for us. But for every deal that we looked at in Asia, we had a team in the US or Europe shadowing the team on the deal; it was very inefficient. Plus the way of doing business in Asia was very different. So we decided we had to retrench from that.”
During this period, Sun was, in essence, taking its own medicine. “We did to ourselves what we tell our portfolio companies to do: get core, focus on your market; be as efficient as you can at what you know best.”
Given Sun was still predominantly a US-focused firm at the time, was there not a temptation to pull back from Europe too? Kalb acknowledges that the firm did “shrink down” as activity dropped off, with headcount falling from about 24 to about 16. “But what that meant was that we gained massive momentum coming out of that period.” These days, headcount is back up to around 30 people in Europe (which given the respective levels of deal activity, suggests it may have been a bit over-staffed before the crisis).
Since 2007, Kalb had been spending a much greater proportion of his time in Europe. After getting involved with a complicated deal with German business Neckerman during a trip that year, Leder had asked him to stay on for an extra year to keep an eye on the deal. Reading between the lines, there’s a sense that his remit was actually a little broader. “Like most private equity firms, we turned 100 percent of our attention on our existing portfolio – stabilising the businesses, making sure they were capitalised properly, going out and negotiating with the banks… It was really good I was there throughout that process.”
In 2009, Dougall quit (to do smaller deals – he’s since reappeared as a partner at turnaround specialist Kelso Place) and it was decided Kalb would take charge full-time. He didn’t move to London officially until 2011, when his family came over, but he’s clearly been pulling the strings for a lot longer than that. And while circumstance dictated the change, he says he was excited by the challenge on offer in Europe. He cites, approvingly, the verdict of a Sun associate on secondment from the US: that working in Europe is ‘like drinking water out of a firehose’. “That’s why I love it,” he grins.
Sun had been finding it hard to get deals done in the immediate aftermath of the crisis – but around the time of Dougall’s departure, it started to see light at the end of the tunnel. “In mid-2009, we were seeing the clouds move away. There were still some issues; we were still blocking and tackling. But we had the opportunity to go out and start doing deals again.”
As for Kalb, he was busy “trying to figure out what we should be doing, and what sort of deals we should be looking at… We made a real effort to expand the type of deals we were doing. People knew we had operating experience, but we need to communicate that better and get involved in more situations.” As well as turnarounds, it started looking for under-performers (companies that were fundamentally good but in need of some operational support) and special situations (mostly complicated carve-outs).
In order to find deals, Sun started by targeting the banks – reasoning that they’d been lumbered with a number of companies that they’d want to lose. But this proved unfruitful. So too did the next plan: to target private equity firms, in search of over-leveraged companies with operating problems. Here, says Kalb, the problem was that “pride and ego would get in the way of getting something done” – as a result of which, firms were unwilling to sell at the kind of prices Sun thought were reasonable.
So his third port of call was corporates. “We started to proactively target corporate divestments in a big way.” It paid off. About a quarter of the deals done by the European office have fallen into this category, including acquisitions from the likes of mining giant Rio Tinto and packaging firm Huhtamaki. This strategic focus was a key factor in Sun gaining “significant traction”, as Kalb puts it, coming out of the crisis.
But the focus wasn’t just on who the firm was buying from; it was also on how it was buying. Sun clearly prides itself on its ability to execute a deal faster and more efficiently than any of its competitors – and it tried to use these early corporate deals as a way to let the market know that. “It got out the message: ‘We’re decisive. We do what we say we’re going to do. We bridge our own transactions. And we don’t over-negotiate’. A lot of private equity firms say that, but we actually live by it.”
This last principle stems from an unsuccessful bid he and Leder worked on together in 2001. “We were doing the typical private equity things – negotiating every single economic point – and we lost the deal. Marc and I looked at each other and said: ‘This is ridiculous, we shouldn’t have lost that deal’. When you add up all the petty stuff we’d negotiated, it didn’t amount to a hill of beans. So we evolved our approach.”
Does that mean it’s less fussy on terms than other financial buyers? “I can’t tell you all our secret sauce,” he says, with a broad grin. “But when we negotiate contracts we only focus on the five or six or seven big issues. And we will bend over backwards to be accommodating. I think it’s a competitive advantage for us.” Kalb cites the example of the Albéa business (formerly Alcan) that Sun bought from Rio Tinto. Apparently, Rio had previously tried to sell two other divisions to private equity, but “they couldn’t get the deals done – they were nickel and dimed to death.” But by “holding their hand through the entire process”, Sun was able to do the deal – and according to Kalb, this gave Rio the confidence to do additional deals elsewhere (Rio didn’t return calls for comment).
High-profile deals like this, along with the likes of Maxeda (where Sun apparently agreed a contract over a 72-hour period) or Hewden (where a deal was completed within three weeks to forestall an auction process) “did a tremendous amount in terms of our reputation”, he says.
But there’s another important reason why Sun has managed to win so many deals in the last few years.
One of the firm’s key selling points is that it has the ability to bridge all its transactions; in other words, it can write the full cheque on the day the deal signs, without having to go back to lenders. Kalb is coy about the specifics of how this works. But it’s clear from talking to people in the market that the firm basically has a credit facility that allows it to underwrite the financing. Particularly at the moment, that’s a huge execution advantage. As Kalb says: “At the end of the day, if someone is going up against us, and then we say ‘Well we’ll write the cheque’, and they say ‘Oh I gotta get financing’ – we become the de facto winner.”
Once the deal is done, Sun then syndicates the debt out to the market via two dedicated in-house professionals – who will have worked out in advance of the deal how much the market can handle. Does this not leave the firm rather exposed to the vicissitudes of the debt market? “So far we’ve been successful in just about every instance.What I would say is that it’s taking longer; there’s a lot more hand holding and creativity required.”
A REAL OPERATING APPROACH
In Kalb’s view, however, Sun’s main differentiator is what it does with these companies afterwards. Of course, he realises that he’s by no means the only person in private equity to put this forward as a unique selling point. But he argues that Sun can actually back this up with hard facts.
“We have 40 operating professionals. They are part of Sun. They’re not sitting on the bench waiting for a deal to happen; they’re working with multiple portfolio companies at any given point in time.” Twenty-three of these are generalists – usually former CEOs and CFOs (often from Sun portfolio companies) who work with management to help them see the bigger picture and deliver on Sun’s investment thesis. “Maybe it’s about doing business differently, or attacking the customer differently, or shrinking the business down to a core of profitable customers.”
In addition, Sun also has specialists who can bring in sector specific expertise, and a 30-strong sourcing team based out in Asia that helps portfolio companies cut their sourcing costs. And for the really hairy situations, there’s a performance improvement team, who can be parachuted in quickly when there’s an “acute crisis”. Often Sun buys businesses without management teams – or parts company with management very soon after – and in this case, a performance improvement person will come in and actually run the business on a temporary basis.
Does it work? Well, Sun has a nifty chart showing EBITDA growth at its portfolio companies since inception (see p. 31). This shows that the combined profits of its exited investments climbed from $241.5 million pre-acquisition to $661.6 billion at exit – a rise of 174 percent. Since its inception, it has added over a billion dollars in earnings to its portfolio companies.
Kalb is, to say the least, rather sceptical about the industry’s sudden obsession with the idea of operational value creation. “You do roll your eyes sometimes. We’ve been doing this for 17 years. The first deal I did with Marc and Roger, I bought the business, and they said: ‘Congratulations, you’re the CFO of the company’. The operating focus has always been core to what we do. There are some other firms that do a very good job of it as well, and it tends to be those that are truly integrating the operating approach into their business model. The guys who go out and hire an operating partner and say ‘He’s going to work with us on operations’ and then go out to raise money off that – that’s not a real operating approach.”
But if competitors are indeed trying to mimic Sun’s approach, it hasn’t affected his optimism about the months ahead – particularly when it comes to Europe.
“In the US today, there’s plenty of liquidity in the market – so values are increasing, and there’s a lot of competition on transactions. In Europe, we’re seeing a situation where the banks are not lending so there’s less liquidity, and other private equity firms are sitting on the sidelines. So while we still see some competition, there’s not a tremendous amount. At the same time, this lack of liquidity is filtering down to companies and affecting their ability to execute their business plans. So that’s [also] presenting opportunities.”
Banks are also more willing to do deals, he says. “The banks are reluctant to take write-offs, but they’re also reluctant to put more capital in. So that’s triggering more dealflow.”
Does it matter if the economy in Europe fails to improve? “There are always opportunities, in good times and bad.. If we do a deal, we have to comfortable that it will be successful regardless of the economic conditions. So the first and most important decision we make is: are we buying the right company? Does it have a reason to exist? Does it have a good market position? Does it have a good customer base? We want to buy good businesses that have a problem. We’re not looking to buy a business so we can throw it against a wall and see if it sticks.”
Of course, the proof of the pudding in Europe will come when it sells all the businesses it has bought in the last couple of years – but he is certainly bullish about the portfolio.
Indeed, Kalb is clearly not a man racked with self-doubt. So is there anything that he loses sleep over? “There are outside factors that can clearly impact how we do. We’re going to control all the things we can control. But it’s those outside factors that keep me up at night.” The creeping cost of compliance, as per Sun’s recent SEC filing, is one concern (“The amount of time that takes away from us being able to do our jobs is massive”).
But the biggest worry, he says, is the macro situation in Europe. “What happens if the crisis does erupt and the euro disappears? Will we see another crisis like we did in 2008?” If that does happen, Sun will hope there’s no need to retrench this time around.