Brian Gallagher Hits The Road For His Fund of Funds

Name: Brian Gallagher
Company: Twin Bridge Capital Partners
Title: Managing Partner
Last Book Read: Titan: The Life of John D. Rockefeller, Sr., by Ron Chernow
Hometown: Matteson, Ill.
Residence: Glen Ellyn, Ill.
Education: BA in accounting from the University of Notre Dame; MBA from Northwestern University’s Kellogg Graduate School of Management

The era of the sedentary funds-of-funds manager is over. And no one knows that better than Brian Gallagher.

The way he sees it, gone are the days when a funds-of-funds professional could spend the bulk of his time in the office, working the Rolodex, relying on old contacts, placement agents, and even cold calls to keep the fund pipeline stocked. Now, the skyrocketing interest in private equity among institutional investors and the proliferation of middle-market buyout firms has changed the market dynamics. “You have to get out and get in front of these sponsors long before they are launching their next fund,” Gallagher said. “To a very large extent you have to sell yourself on the sponsors as much as they’re selling you on their performance.”

What Gallagher is selling is Twin Bridge Capital Partners, his funds-of-funds firm that has a laser-like focus on the North American middle market and an active co-investment program. “We don’t have designs on being a typical fund of funds,” he said. While many of Twin Bridge’s peers mingle capital commitments from limited partners into one vintage fund, Gallagher wants to manage a stable of separate accounts, one for each investor. Since many large institutional investors lack the staff to research mid-market buyout vehicles, he aims to position Twin Bridge as providing a customized solution.

Gallagher likes the middle market primarily because there’s a bigger universe of companies to buy. “Generally, you can get better returns because there’s a lower purchase price and you can have a greater impact on company performance,” he said. And while Gallagher defines mid-market buyout funds as those with $1.5 billion or less, Twin Bridge has a particular affinity for vehicles between $200 million and $500 million. The firm is looking at several funds that all are slated to hold first closes in the second quarter.

Gallagher looks to back mainly generalist funds, sprinkling in specialists where he can. The idea is to find today’s top fund managers in the lower middle market and stick with them as they become tomorrow’s rock stars in the larger end of the middle market. Energy, financial services firms, health care and branded consumer products are among the industries Twin Bridge has focused on. Health care and branded consumer goods are somewhat resistant to recession, Gallagher said, and the sluggish economy may yield opportunities in the financial services sector. Energy funds often provide high returns, Gallagher said, and the firm is actively searching to commit to an energy fund of $1.5 billion or less. “We came close on one and it wound up being way oversubscribed, so that’s another thorn in our side,” and another reason it’s crucial to hit the road and meet GPs early, Gallagher said.

In late March, he and members of his team were tooling around New York City, Westchester County and Connecticut. He dropped in on a buyout shop he’s had his eye on and learned that the firm plans to close on a $300 million fund in a few weeks. During the same trip, Gallagher visited a lender who clued him in on a chance to buy a secondary position in another fund he’d been targeting for some time. It’s still uncertain if Twin Bridge will lock up either opportunity, but “if we hadn’t had those meetings we’d never have the chance to pursue it further,” Gallagher said.

Debut Fund: $500M

While his funds-of-funds shop is relatively new, Gallagher has been a buyout professional for 18 years, working first at PPM America Capital Partners, the private equity arm of investment adviser PPM America Inc., and then UIB Capital Inc., a lower middle-market LBO firm. He and business partner Debbie Ackerman, a private equity professional who worked with Gallagher at PPM America Capital Partners, launched Chicago-based Twin Bridge in 2005, and much of their time is spent telling their story to prospective general and limited partners.

The maiden fund got its start thanks to a $500 million commitment from one large U.S. institution, along with minor sums from wealthy investors. Gallagher would not name the LP, but a source familiar with Twin Bridge identified it as Thrivent Financial for Lutherans, a financial services firm for Lutheran congregations and institutions. Come fall, the firm will likely be looking to raise more capital. Twin Bridge hopes to raise another $500 million from existing investors, and an additional $500 million from new backers. The funds-of-funds manager is selectively targeting U.S., international and corporate pension plans, as well as sovereign wealth funds. Twin Bridge invests on a discretionary basis, takes a management fee, and earns carried interest tied to its performance.

Twin Bridge, which has five investment professionals, is close to emptying out its first fund, Pacific Street Fund I LP. The firm has committed roughly $400 million of the $500 million vehicle across 15 buyout funds and 12 co-investments. The firm typically deploys between $20 million and $30 million to buyout funds and makes co-investments anywhere from $5 million to $25 million.

While Gallagher would not name specific funds and co-investments, some of Twin Bridge’s investments have been reported. In 2005, the firm backed and invested alongside New York-based Centre Partners Management LLC, which specializes in North American mid-market companies, when it bought Diversified Specialty Institutes Inc. The company acquires and develops hospitals, medical imaging facilities and dialysis centers. Twin Bridge also committed capital to Minneapolis-based Goldner Hawn Johnson & Morrison Inc., which focuses on consumer and industrial companies in the upper Midwest, and in July 2006 co-invested in the LBO shop’s $100 million acquisition of Allen-Edmonds Shoe Corp., a men’s footwear retailer. And last spring, the funds-of-funds manager backed Jefferies Capital Partners, the New York-based buyout arm of Jefferies & Co. investment bank, in its $695 million recapitalization of Edgen Murray LP, a global distributor of industrial steel products.

Roughly 25 percent of all the capital Twin Bridge deploys goes to co-investments, which the firm prefers to make alongside general partners whose funds it has already backed. “My partners and I have committed over $750 million across 70 different [co-investment] transactions over the last 11 years,” Gallagher said. “You get a sense for what works.”

Generally, Twin Bridge avoids investing in a company with a capital structure that feels “over-levered,” which Gallagher defined as less than one-third equity, more than two-thirds debt. And it seeks out lending syndicates that will work with the GP to restructure the debt if the acquired company winds up in distress. To that end, Twin Bridge tends to avoid deals where hedge funds are the lenders. “That would scare us, because it’s not always a consensual restructuring,” he said. The co-investment pipeline is “definitely quiet” right now, Gallagher said, but he predicts a bevy of opportunities down the road resulting from the credit crunch, albeit with less leverage. “Where you could previously get 5x senior leverage, now it’s closer to 4x. That extra capital is probably going to have to come from equity or co-investment dollars,” he said.

Co-investing, like primary fund commitments, takes Gallagher and his team out of the office to dig in with co-investment GPs. “We spend a lot of time with our sponsors working downside cases and draconian scenarios, meaning if [the portfolio company] suffered the loss of several key customers, and sales and EBITDA dropped appreciably, you still can service your debt and fight through the tough times,” he said.

A substantial benefit of co-investing is the window it provides on how a sponsor sources, researches, manages and exits a deal. That insight is invaluable in deciding whether to back the GP’s next fund. While Gallagher has been impressed by the majority of LBO shops he’s co-invested with, in some cases being up close and personal costs the GP a future fund commitment. In particular, GPs that are timid about dropping the hammer on ho-hum management teams will lose Gallagher’s support. “It’s not an easy decision, but sometimes you’ve got to change out management. If we feel that a change is in order and the sponsor’s unwilling to make the change then that often leads to pretty poor results,” he said.

Gallagher considers Twin Bridge to be an asset to its co-investments partners, acting as an extension of their fund. He also stressed the firm’s flexibility in looking at deals. “If someone calls us saying, ‘This only has four weeks before it closes. Can you be in New York on Wednesday to look at it?’ We’ll be there,” Gallagher said.