Caxton-Iseman Portfolio Co. Struggles To Stave Off Default

By Joyce Pellino Crane

The investment that Caxton-Iseman Capital and Sentinel Capital Partners made in a chain of well-performing buffet-style restaurants seven years ago is pitching under a weight of debt that’s been complicated by a fragile layer of liquidity.

A big part of the problem: A recent acquisition that is proving more costly than anticipated and that led to a downgrading of the company’s credit rating. Financial results have also been hurt by the diminishing appetites of patrons, who appear to be pulling back on their dining-out budgets due to higher gas prices and other factors.

Last month, Standard & Poor’s lowered the Eagan, Minn.-based company’s rating from ‘B-‘ to ‘CCC+,’ mostly due to the transaction costs incurred when Buffets acquired Ryan’s Restaurant Group Inc. in November 2006. (In the last 25 years, more than a quarter of all companies rated ‘CCC+’ or below defaulted on debt within a year of attaining the rating, according to the ratings agency.) Since the acquisition, merger-related synergies have fallen far short of the target, cash flow and EBITDA have plummeted, and the company has edged toward the outer limits of the promises it made to bond holders, according to an S&P report.

The new rating affects about $842 million of debt—nearly double the amount reported during the previous fiscal year.

Buffets isn’t the only buyout-backed company treading on precarious ground. In August, S&P identified nearly 30 portfolio companies holding $17 billion in obligations as prime candidates for defaults in the coming year. Buffets also illustrates another trend—that of buyout firms taking advantage of robust credit markets to reduce their risk. Caxton-Iseman was able to recover its $111 million equity investment in Buffets through dividend recapitalizations in 2002 and 2004, according to David Lilly, a spokesman. “Buffets has been a profitable investment for Caxton-Iseman,” he said.

Lenders may not be able to say the same thing. Operating cash flow spiraled down from $49.3 million in fiscal 2006 to $5.9 million in fiscal 2007 ended June 28, due in part to a $24.1 million increase in cash payments for interest, a $27.7 million increase in cash payments for income taxes, $10.9 million in merger and integration costs that could not be capitalized, and $2.5 million in other costs. EBITDA fell from $182.6 million for the 12 months ending Dec., 13, 2006, to $148.1 million for the 12 months ending June 27. Year-over-year same store sales dropped by 0.7 percent during the fiscal year that ended in June.

Caxton-Iseman’s venture with the self-serve restaurant chain began in 2000 when it joined with Sentinel Capital to buy Buffets Inc., an owner and operator of 403 restaurants in 34 states, for $643 million. Together the two private equity firms agreed to pay $13.85 per share to take the company private later that year. Today Caxton-Iseman, which has more than $2 billion under management, owns 77.4 percent of the company, Sentinel Capital holds an additional seven percent, and Buffets’s vice chairman, Roe Hatlen, holds six percent, according to the company’s 2007 annual report. The remaining stockholders are executive officers and directors of Buffets.

At the time of the deal, Buffets represented the largest investment in Caxton-Iseman’s portfolio, according to the February 2001 edition of Buyouts. In return the firm got a company with solid management, a proven concept, growth potential, and a ten-year history of stable income. After a wave of restaurant openings and closings over the years, Buffets Holdings currently operates 632 restaurants in 42 states under the monikers Old Country Buffet, HomeTown Buffet, Ryan’s and Fire Mountain. The Ryan’s acquisition netted the company 332 restaurants at a price of $834 million, according to a regulatory filing.

Company officials targeted $55.7 million in synergies and cost savings from the Ryan’s acquisition, but have so far realized $13.9 million—just 25 percent of the goal. The company has put into place changes that are expected to produce another $30 million in savings by cutting general administrative, food and purchasing, and labor costs, according to A. Keith Wall, Buffets’s chief financial officer. But speaking during a September conference call, Wall added that it may take a number of months for savings to begin to show up in the company’s financial results.

It’s not the first time Buffets has had trouble digesting an acquisition. Back in 1996, the company acquired HomeTown Buffet in a stock and debt transaction valued at about $190 million. In the aftermath the company experienced higher-than-expected merger costs and lower-than-expected synergy savings, according to the International Directory of Company Histories, published in 2000. Nevertheless, throughout the 1990s the company’s revenue growth and cash flow outpaced industry averages by margins of 33 percent and 57 percent respectively, making it an attractive buyout target, according to a June 2000 story in Buyouts.

Spokesman Lilly acknowledged the challenges ahead for the company. “Present market conditions are challenging for Buffets, as they are for all companies serving its niche in the casual dining segment,” he said. “We have been and will continue to work very hard with management to aggressively address the company’s issues and pursue a strategy to continue to build value at the company.”