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Behrman Capital Uncovers Diamond In the Rough With TMNG –

Roman Statesman Marcus Tullius Cicero once said that reason should direct and appetite obey. Well, when Behrman Capital, a buyout firm with offices in New York and San Francisco, decided that it was hungry for The Management Network Group (TMNG), a telecommunications focused consulting firm, many investors might not have understood the reason directing them. But the partners of Behrman Capital have dedicated years to understanding their investment areas and are confident that they know a gem when they see one. As it turns out, the reasoning that led Behrman to TMNG was not only sound, but it also convinced quite a few others to join the feast.

It all started in 1997 when the partners at Behrman Capital began brainstorming about the best ways to add and create value in the New Economy. The verdict: stick to what you know. So Behrman Capital, which focuses on businesses in information technology, telecommunication services and business-to-business outsourcing, put together their special interest and expertise in telecommunications and decided the market was ripe for a play in infrastructure that could exploit the boom in telecom.

Following the Telecommunications Reform Act of 1996, the market changed rapidly. “There was sweeping deregulation. There were rapid technological advances,” says Darryl Behrman, co-founder and managing partner at Behrman Capital.

Indeed the telecom and media industries were rocketing in the late nineties. A Gartner Group study indicated that total market for telecom, media and e-business would surge to $99.3 billion by 2003 from its 1999 market of $19.2 billion.

“There was a major trend toward globalization and, of course, there was the explosion of e-business,” he adds, noting “that complexity actually is leading to chaos in the boardrooms across America. People simply don’t know what to do, how to respond to this environment. And a natural function of that is there’s the trend toward outsourcing, i.e. people couldn’t solve the problems internally, they had to go out and find the expertise.”

A Virtual Reality

After identifying some companies and management teams with potential, Behrman Capital contacted some intermediaries in pursuit of an acquisition and eventually hired Broadview Associates. Knowing that Richard Nespola, TMNG’s chief executive, was interested in looking for ways to grow the company, Broadview recommended that Behrman Capital contact him. Bill Matthes, a Behrman Capital managing partner, did just that and after “romancing” Nespola for about four months, TMNG and Behrman Capital had an agreement.

Sounds reasonable enough, right? Well, here’s the catch. When Behrman Capital acquired TMNG in February 1998, the company did not have a headquarters, not even an office. The company also did not have a chief financial officer and had never had an audited financial statement. But Behrman Capital still saw a great opportunity.

“What we really saw was a business model that in our judgement was as revolutionary for the consulting industry as Michael Dell‘s model was for the PC industry,” says Behrman.

Behrman Capital was confident that TMNG was a good investment, but when it came to securing debt financing – thank goodness for well-established relationships with Chase Capital Partners and IBJ Whitehall Financial Group.

Following protocol, Chase inquired about visiting the company’s offices only to find out that its address was simply www.tmng.com. Behrman was told that for the first time in Chase’s 150 year history, it provided a senior credit for a company whose offices it could not visit. But due to Behrman Capital’s domain expertise in telecommunications and a trusted relationship with the debt providers, the firm received the necessary financing. “At the time the credit markets were a lot more friendly than they are today, but even back then the idea of lending money to a company that didn’t have an office was somewhat of an anathema,” Behrman says. “And I think it was through the relationship that we’ve had with Chase – which goes back to 1989 – and the very strong relationship with IBJ Whitehall that allowed them to pierce the veil of what was a virtual company, to understand that we actually knew what we were talking about.”

Competition for the acquisition was mild, enabling Behrman Capital to negotiate a price of 8.7 times trailing 12 months earnings before interest, taxes, depreciation and amortization (EBITDA), which Behrman says is not a steal, but a fair price. “That’s 8.7 times for a company whose revenues are growing at 50% a year, has 30% margins and who is a very scaleable business. So I think that what we looked at was a fair price but for a company that was growing rapidly and in which we clearly were able to identify hidden value,” he says.

In February 1998, Behrman Capital acquired approximately 65% of TMNG with $21.7 million in equity from Behrman Capital II LP, approximately $30 million in senior credit from Chase Capital Partners and IBJ Whitehall, and the remaining balance in stock rolled over by management.

Separating the Men from the Boys

Besides the fact that the company looked good on paper, Behrman Capital was also attracted to the business model set forth by Nespola. “Rich Nespola was a visionary,” says Behrman. “He had recognized that in consulting, utilization drives profitability.” Using a network of independent contractors, Nespola maintained 100% utilization, and thereby created a virtual company.

When Behrman Capital made its initial investment, TMNG had sales of $20 million and earnings of $7 million. Additionally, the company had a “referenceable” client base, which included companies like Lucent Technologies, AT&T and Cisco, generating high recurring revenue for TMNG. The breadth of their staple clients also created an opportunity for TMNG to grow internationally.

But the real secret weapon behind TMNG is the expertise of its consultants. The company’s consulting is focused on functional implementation and therefore, the best person to provide solutions is the one who has done it for themselves. “If you were going to solve a problem for the back office of AT&T, you couldn’t pull up the school bus and unload some newly-minted MBAs to solve the problem,” says Behrman. So, TMNG’s recruiting model where Nespola hired only consultants with 10 to 15 years of industry experience behind them as opposed to the fresh faces that his competitors were staffing impressed the firm. Behrman explains that hiring these seasoned consultants created a gray area for most companies about where exactly they fit in the hierarchy, leaving a rich pool of candidates and little competition for TMNG. The company has maintained an attrition rate well below the industry average at about 4%.

The Golden Egg

With the acquisition completed – executed by Grant Behrman, Darryl’s brother, and a co-founder and managing partner of the firm, Matthes and Dennis Sisco, a partner – Behrman Capital went to work. A headquarters was established for TMNG in Overland Park, Kan. They hired Donald Klumb as the company’s chief financial officer and 100 of the independent consultants as full time employees. Grant Behrman serves as TMNG’s chairman and Matthes is a director of the company.

As planned, Behrman Capital grew the company’s international reach – TMNG’s international business grew from 6% of the company in 1998 to 26% by the third quarter of 2000 and is expected to reach nearly 40% by next year. Finally, Behrman Capital began preparation for taking TMNG public.

Recognizing that the public markets were not yet ready for a virtual company, Behrman Capital grew TMNG for a year before launching an initial public offering of 4.615 million shares, a 15% stake, in September 1999.

“Just to give you an idea of just how universally acceptable the story was . . . when Rich Nespola went on the road, he had 56 one-on-one meetings with portfolio managers, he ended up getting 56 orders,” says Behrman. “Usually there is at least one skeptic in the group.”

The underwriters for the offering were Chase H&Q, Salomon Smith Barney Inc., BancBoston Robertson Stephens and Jefferies & Co. TMNG began trading on the Nasdaq with an offering price of $17. In the first day the price reached $32.50 before closing at $29.94. The offering raised $78 million, which was used to pay off $23 million in debt and to continue the company’s growth. In July TMNG announced it was filing for a secondary offering and in August the company offered approximately four million shares at $22.88 per share – underwritten by Salomon Smith Barney, Chase H&Q and Lehman Brothers – with approximately 1.8 million shares coming from Behrman Capital II, reducing its stake to 53%, approximately 12.5 million shares.

With the state of the public markets lately, telecommunications stocks have been suffering. At press time TMNG was trading at $10.13. However, prior to August of this year the company traded mainly above the telecommunications industry index.

Today TMNG is still experiencing significant growth. In August of this year, the company acquired The Weatherby Group, its first and only add-on to date. In the third quarter, TMNG announced its revenues had increased 53% and the pro forma earnings per share had increased 67% from the third quarter 1999, says Behrman. As of June 2000, the $21.7 million in equity that Behrman Capital invested back in February 1998 was worth $451.1 million, and even in the strained markets of today, it’s still worth about $300 million. And the firm’s limited partners are in pretty good shape too. Behrman says, after the secondary offering, from a cost-basis of $3.3 million, the firm returned $45 million to their LPs.

When asked if Behrman Capital has any regrets in how they have managed TMNG, Behrman says only that the company can’t be cloned. But all good things must come to an end. Behrman Capital generally has a four- to six-year time horizon for liquidity and TMNG is approaching three years in the firm’s portfolio. Investors, get your money ready.