The harsh reality today is that in order to buy quality assets, buyout shops are forced to participate in an auction. Because of this, it’s understood that valuations may go higher than expected, and that means buyout pros must put aside their finance faculties in favor of an operations aptitude.
In an environment where seemingly no private equity firm wants to be pigeon-holed as simply a financial engineer, Blum Capital Partners makes no qualms about being just that. As the private equity universe has changed its face more than once since the firm was founded 20 years ago, Blum Capital has been able keep its strategy the same without yielding anything on returns.
“I think you can still be a financial engineer and succeed today,” says Colin Lind, a managing partner with Blum Capital. “But we do it through first investing in the public markets. Flat out buying companies and putting leverage on them is a dangerous game. The auction process is very efficient. The reason financial engineering worked years ago is because they were buying those companies dirt cheap, but if you’re paying top dollar it can be very difficult.”
The very idea of buying stakes in public companies prior to an eventual buyout or as method to induce change, brings to mind the vulture characterizations that plagued the LBO world back in the 1980s. But for Blum Capital, the firm won’t proceed without an espousal from the management team or board of directors. And while investor activism has taken on an increasingly prominent role in the wake of Disney’s board shuffle, Blum Capital will not look to rally other investors against management.
“We’ve been doing this a long time. We’ve built up experience, or scar tissue, whatever you want to call it,” Lind says. “When we execute an investment, we’ll go up to 4.9% and we won’t exceed 5% [the ownership level where an SEC filing is required] until we’ve gotten confirmation that we will be able to work with management… We want to be collaborative partners. It’s important to us that management doesn’t view us as pariahs.”
He adds that these investments differ from PIPEs in that they are not negotiated deals with the management team, but the deal still requires an open dialogue back in forth between the two parties. “Our purchases are purely open market investments. Everything we do is to develop a trust with management. Before we have to make any filings, we’ll call management and let them know our intentions… If they’re not interested, then we’ll just back out and leave quietly.”
Once Blum Capital decides to go forward and exceed a 5% stake in a given company, the firm from that point starts to accumulate a larger block, and in most cases becomes the largest investor. Rarely, though, will Blum Capital exceed a 20% ownership in a company while public. This strategy, according to Lind, allows the firm to invest in undervalued companies without paying a premium to gain control, and since Blum Capital generally acquires the stake over a 12- month period, the firm feels it allows them a “real-world get-to-know-you period, rather than a thirty day due diligence phase.”
Over the stock accumulation period, Blum Capital works to strengthen its relationship with management and the board. As soon as a comfort level is established, the firm will then put on its financial engineering hard hat and get to work. “We really just try to optimize the capital structure. Sometimes that means a stock buyback, other times it means divesting non core assets, and sometimes we’ll help take a company private but that’s just one of our strategies, and represents more of a continuation of applying financial leverage,” Lind syas
Seeing the Plan In Action
An example of this strategy can be found in the recent floatation of Kinetic Concepts (see story on previous page), which crystallized Blum Capital’s successful investment in the healthcare company. The firm started investing in the business in 1996, eventually building a 10% stake over time. Working with management, Blum Capital helped institute a share buyback program in which the company bought back 9% of its stock. Soon after, the firm helped the company lever its balance sheet, which at the time had no debt and $80 million of cash. When the company’s stock continued to sit still, neglected by the public market, Blum Capital decided to take the company private.
“We approached the founder with a proposal to take the company private,” Lind says. “It was more a plan designed to affect that capital structure, and provided an opportunity to put in the right framework in one fell swoop. To do that we invited Fremont Partners in to invest.”
Lind adds that Blum Capital’s role as either a significant or the largest shareholder in the companies it takes private generally discourages other bidders from lining up, but if others do come out with an offer, they have the benefit of walking away with some upside when the prices get too high. “Our strategy positions us extraordinarily well. As the largest shareholder, when your stake is that large, the other financial sponsors usually don’t bother to show at the auction,” Lind says. “It won’t necessarily stop a strategic buyer from showing, but that’s okay too, since our position gives us the potential upside of a rival bid.”
“When you’re investing private equity, you can either do it through an auction, like most firms do, or you can do it through the public market, with strategic block investments,” Lind adds. “For us, it’s a no-brainer. When you see these stock prices implode on the public markets, and you accumulate stakes at the right price, financial engineering is a strategy that can still deliver attractive returns…For the last 20 years we’ve been right around 20% per annum.”