Cautionary Tales From Worst Fund Blow-Ups

It doesn’t seem suitable to write just one feature on 10 of the worst performing funds of modern private equity.

Each one seems deserving of its own tragic novel. Their stories suggest how a desire to move up-market (Exxel Capital Partners V, vintage 1997; Heritage Fund III, vintage 1999), changes in investment strategy (Heritage Fund III), federal investigations (Heartland Industrial Partners, vintage 2001) and the Olympian forces of global economic catastrophes can destroy even the most promising funds (Exxel Capital Partners V, Exxel Capital Partners VI, vintage 2000).

At the root of this story is data, specifically investment returns on more than 400 buyout funds from 10 public pension funds going back to 1981. Altogether, 10 of the worst-performing of these funds by investment multiple cost investors such as the Oregon Public Employees Retirement Fund and the Washington State Investment Board almost $3.7 billion (see adjoining table).

To learn the stories behind these funds, Buyouts relied on a combination of press archives, interviews, Web sites and other sources. Only one limited partner would speak for this story, and even then not for attribution. An executive with Argentine buyout shop The Exxel Group was the only general partner to speak openly about the difficulties his firm faced. Another executive provided a lengthy e-mail explaining why his fund made the list. A third GP spoke with Buyouts, but didn’t want to be named.

Often it was hard to track down executives in these funds, while others did not return requests for comment. This was particularly the case for the Beacon Group III-Focus Value Fund LP and BCI Growth V, which both targeted growth equity and buyouts, and Texas Growth Fund-1995 Trust, a state-sanctioned buyout fund.

The brief profiles that follow offer hard lessons at a time when the buyout market is rebounding and emerging markets funds are once again in vogue. For LPs, these are a reminder to stay attuned to early red flags in prior funds when asked to support follow-up efforts: Two firms accounted for two funds each in the bottom 10 list. For the opportunistic buyer, of course, the vestiges of these funds could present deal opportunities, such as TriMas Corp., a publicly traded company backed by Heartland Industrial Partners, or OneSource Distributors, distributor of electrical products backed by Heritage Partners.

For Exxel Group, Lightning Strikes Twice

Exxel Group’s funds testify to the devastating effects that macroeconomic forces can have on fund performance. They also offer a lesson to LPs on the risks of backing emerging markets funds.

Juan Navarro, a former executive at Citicorp, was a trailblazer of leveraged buyouts in Latin America. In 1991, he founded Exxel Group in Buenos Aires and soon raised $47 million for one of the first buyout funds targeting the region.

By the late 1990s, Exxel Group controlled 38 companies with combined annual sales of $3 billion, according to a 1998 article published in Business Week. The firm had created such a successful franchise—achieving a gross internal rate of return 30.2 percent and an investment multiple of 2.4x, according to the firm—that it could raise $867 million for its fifth fund in 1998, with backers including General Motors Investment Management and AlpInvest. “At the time, they were probably the most experienced investor down in that area,” said one Fund V investor.

Exxel Group’s companies were able to obtain financing from international capital markets, which provided cheaper, more long-term financing than what was then available from the capital markets in Argentina. The loans were denominated in U.S. dollars. However, the companies mostly did business in Argentine pesos, a factor that would later prove near-fatal to the firm.

In 1999, when Argentina entered a severe recession and the value of its peso plummeted, it became increasingly difficult for Exxel Group’s companies to pay back the loans denominated in U.S. dollars. In the meantime, in early 2000, the firm had begun raising Fund VI, ultimately closing it at $511 million in 2001.

Net revenues of Fund V companies on average fell 39 percent from 1998 through 2001, while borrowing costs climbed on average to 27 percent per year, according to the firm. Worse yet, 40 percent of Fund VI had been invested before the crisis unfolded. Marcelo Aubone, an executive who helped establish the firm, told Buyouts that Fund VI essentially “started under water.”

Aubone said the firm could have been more prudent in its use of debt, though by U.S. standards it was fairly conservative. The firm kept about 8 to 10 percent of its funds in reserve for challenges at its companies, and it typically financed its deals with about 50 percent debt and equity. “That could have helped us survive the massacre,” he said.

The Fund V LP said his firm is now more cautious with emerging markets funds. “You have to have confidence that there is going to be overall economic stability and that the kind of macro characteristics you see are high GDP growth, benign inflationary pressures and government surpluses,” he said.

Navarro continues to lead Exxel Group, which manages nine investments from Fund VI, including the clothing brands Lacoste and Penguin, and Desarrollos Patagonicos, a tourism development company.

Exxel Group has not raised another fund, but has done some one-off deals funded by firm executives and co-investors. That’s a pretty steep fall for a firm that had raised more than $2 billion. “That’s still a big number even 10 years after we raised the money,” Aubone said. “But we hit the wall.”

Altogether, Exxel Group lost an estimated $968 million on Funds V and VI as of Sept. 30, 2010, according to Oregon Public Employees Retirement Fund.

Heartland Debut Debacle

A risky old-economy strategy, a highly concentrated portfolio and a crippling legal battle devoured Heartland Industrial Partners, the once-promising firm founded in 1999 by David Stockman, a former managing director at the Blackstone Group and, before that, President Ronald Reagan‘s budget director.

Heartland Industrial raised $1.4 billion from top institutional investors including CPP Investment Board for acquisitions of manufacturing companies in downtrodden sectors like auto parts and textiles. Joining Stockman was Timothy Leuliette, the former president of manufacturing conglomerate Pensky Corp., and Dan Tredwell, a former managing director from Chase Securities. By 2001, the firm had 30 employees spread across three offices, and had $5 billion in deal value closed.

But the firm soon struggled with two auto parts companies: Metaldyne, which was eventually sold to a subsidiary of Ripplewood Holdings at a loss, and Collins & Aikman, which went bankrupt in 2005.

In 2007, prosecutors charged Stockman with fraud for allegedly inflating Collins & Aikman’s performance in an attempt to keep it alive. The charges were dropped in 2009. Stockman, in an e-mail, blamed the bitter legal battle for Heartland Industrial’s demise. “Since Collins & Aikman constituted one-third of the Heartland’s portfolio, it could not recover from this body-blow nor from all of the disruption that attended my unwarranted prosecution,” Stockman wrote (his full reply regarding Heartland’s performance can be found at and sister Web site

The firm’s remaining portfolio includes a stake in TriMas Corp., a publicly traded company that provides engineered and applied products in the packaging, energy and aerospace and defense industries. The company is trading at about $20 a share, up from a low of around $5 a share in late 2009. Stockman said it and a stake Heartland Industrial also holds in a home furnishings manufacturer will provide some recovery for investors.

Heartland lost an estimated $966 million on its fund as of June 30, 2010, according to CPP Investment Board.

Heritage Betrays Its Past

The failure of Heritage Fund III offers a classic lesson in the perils of abandoning your core strategy.

For almost 20 years, Boston-based Heritage Partners specialized in taking significant minority stakes in family-owned businesses. But Heritage departed from that in 1999, when it raised $843 million for its third fund, which was more than double the size of its $380 million Fund II, closed in 1997. HerItage, perhaps lured by the outsized returns some of its peers generated in bigger deals, delved into large LBOs.

Two of the firm’s co-founders—Michel Reichert and Michael Gilligan—led the shift, believing that the firm’s investment sizes should grow proportionally to its fund sizes. But the strategy’s failure prompted Reichert and other senior executives to leave the firm in 2007, leaving Peter Hermann and Mark Jrolf to try to rehabilitate Heritage’s image. The firm continues to hold at least two Fund II companies: OneSource Distributors, a company that distributes electrical products in Southern California; and Saunders & Associates Inc., a manufacturer of test measurement and production equipment used in electronic products.

Hermann, like Gilligan, has since transitioned to a senior advisory role, while Jrolf is managing general partner. Jrolf did not return calls seeking comment.

Heritage lost an estimated $438 million with Fund III as of June 30, 2010, according to the Washington State Investment Board.

The Lure Of The New Economy

Its faith in unproven technology companies appears to have led to the ruin of Thomas Weisel Capital Partners, the buyout arm of San Francisco-based investment bank Thomas Weisel Partners.

In 2000, the firm raised $1.3 billion fund with backing from the California Public Employees’ Retirement System and other investors for LBOs of later-stage start-up technology companies just before they were ready to go public.

Then, in early 2002, three senior executives—Alan Menkes, Dan Dross and Keith Oster—left, ostensibly to start their own firm. But it appears the fund had been having problems. By late 2002, the firm had already invested around $900 million in about 36 investments, mostly minority stakes in communications and Internet-related businesses. A typical example was a $25 million investment in optical switch maker Tellium Inc., whose stock fell to almost $3 in 2002 from a 52-week high of $29.73. “There were a lot of people at the time who thought this was a transformative moment in history and it was almost like a land grab,” said one source, who said the fund was invested too quickly.

In 2003, Thomas Weisel recruited a new team, which spent the next two years salvaging what they could and investing in a handful of deals with what was left of the fund. They were led by Larry Sorrel, a former general partner at Welsh Carson Anderson & Stowe, and Douglas Karp, a former partner at Warburg Pincus. The new group based itself in New York, abandoning its predecessor’s San Francisco headquarters.

This group had anticipated raising another Thomas Weisel fund, but ultimately spun out as Tailwind Capital in 2006. In 2007, the firm raised $775 million for its fund, which it is still investing. In January, the firm sold Trover Solutions, an outsourcer of insurance claims services, which had originally been bought via the Thomas Weisel Capital Partners fund. The deal generated a 4.1x investment multiple and a 50 percent IRR for Tailwind, according to the source.

In 2010, Stifel Financial Corp. bought Thomas Weisel Partners for more than $300 million.

Thomas Weisel Capital lost an estimated $520 million on its fund as of Sept. 30, 2010, according to Oregon Public Employees Retirement Fund.

If there’s any hope for those involved with these funds, it’s that, at the very least, most were able to continue or revive their careers. Navarro and Aubone continue to lead Exxel Group. Stockman is a regular contributor for Minyanville Media and a widely sought pundit on economic issues.

Even the original Thomas Weisel Capital Partners team has landed elsewhere, though they never did raise a fund together. Menkes is a managing partner with G2 Investment Group, a financial advisory and management firm. Dross is a partner with Trinity Hunt Partners, a Dallas-based buyout firm. Oster is a managing partner at Global Leveraged Capital LLC, a San Francisco-based mid-market firm. They could not be reached for comment.