Arsenal Seeks Mezz To Finance Portfolio Expansion

Arsenal Capital Partners financed its most recent acquisition—its fourth this year after buying nothing in 2007—with an asset-based lending facility the target already had in place. But the firm is talking with a mezzanine fund to procure more financing to help expand the company, Diversified Global Graphics Group.

The Jersey City, N.J.-based company, known as DG3, prints regulatory documents, brochures and other products for companies in the financial services, pharmaceutical and education sectors. Arsenal Capital and DG3 CEO Michael Cunningham acquired the commercial printer earlier this month from Peter Furlonge, the majority shareholder and former chairman who is retiring. Arsenal Capital, which didn’t divulge the deal’s price, acquires companies with enterprise values between $50 million and $400 million. The debt-to-equity ratio of this deal was about 50-50.

To help with DG3’s expansion strategy, Arsenal Capital is in talks with a lower mid-market mezzanine provider for as much as $25 million of additional funding, said Terry Mullen, a managing director. Mezzanine providers are more active in today’s market, largely because the second-lien market has evaporated and because senior loans are scarce. Mullen said that all-in prices on mezzanine loans have risen 250 to 500 basis points since the first half of 2007, depending on the deal, and he’s seeing mezzanine coupons in the 14 percent to 15 percent range. That’s a healthy increase compared to the 11 percent to 12 percent interest rates mezzanine lenders were getting late last year, according to a December story in Buyouts.

The availability of mezzanine financing is providing a silver lining of sorts in the gloomy financing markets, helping to get deals done, albeit at lower leverage levels and with costlier debt. But Mullen noted that less debt at a higher price also tends to cap purchase prices for companies. “Now that the senior market has dried up, they’re the prettiest girls at the dance,” Mullen said of mezzanine providers.

Mullen declined to discuss specifics of DG3’s existing asset-based facility, which is underwritten by Bank of America. That credit package can grow larger to accommodate add-on acquisitions.

Because printing is seen by many as a cyclical industry, Arsenal Capital’s investment is somewhat of a contrarian play. But the sector’s potential for a roll-up strategy lured the firm. Commercial printing is a $75 billion industry in North America, Mullen said. More importantly, there are 35,000 commercial printers, including many mom-and-pop outifts struggling to keep pace with increased competition from larger companies. For Arsenal Capital, that presents a large menu from which to choose add-ons. “There has been a long-term trend of consolidation in this industry,” Mullen said.

DG3 has operations in North America, the United Kingdom and Asia, including Hong Kong, Japan, Sydney and Manila. Aside from extending the company’s footprint beyond the East Coast in the United States and into Continental Europe, Arsenal Capital also plans to tap the resources of its newly opened office in Shanghai to help the company expand into mainland China.

Larry Bloch, a publishing industry veteran who had worked under Mullen in the past, brought the deal to Arsenal Capital in November. Cunningham, the CEO, was contemplating seeking a partner to help him buy DG3 and approached Bloch through a mutual friend for guidance. Bloch had been chairman of TransWestern Holdings, a telephone directory publisher formerly owned by Thomas H. Lee Partners, where Mullen cut his teeth before co-founding Arsenal Capital in 2000. Thomas H. Lee scored a huge win with that company, acquiring it in 1997 for $300 million and selling it in 2005 for $1.6 billion.

Arsenal Capital and Cunningham met Furlonge shortly after Thanksgiving and inked a deal soon thereafter; Arsenal Capital then conducted its due diligence through the first quarter. Furlonge did not shop the deal to any other potential buyers, Mullen said.

This is Arsenal Capital’s fourth deal in 2008. In 2007, the firm sold several companies but bought none. The firm expects to close its fifth deal in the next month or two. On completion of that fifth deal, Arsenal Capital’s $500 million second fund, closed in 2006, will be about 45 percent invested. At this deal pace, the firm may start raising its next fund in the second half of 2009. Mullen said it was premature to speculate on what the target may be.—B.V.