Company Ch. 11 Caps Tough Year For Cypress

A portfolio company of the Cypress Group filed for bankruptcy a week before Christmas, capping a year the New York-based buyout shop would probably rather forget.

Aside from the Chapter 11 filing of Rhode Island-based Amtrol Inc., Cypress watched the bottom fall out of a publicly traded portfolio company. Two top partners quit the firm, including co-founder James Singleton, who left in early 2006, and former president William Spiegel, who departed in May to join a start-up venture. The firm also appears to have met a tepid response from investors asked whether they’d back a new limited partnership.

That’s not to say there weren’t some bright spots in 2006 for the firm. In March, Cypress sold Meow Mix to Del Monte Foods for $705 million, representing a big gain on the $432 million it paid for the cat food maker in 2003. The firm won a gamble on the company’s decision to introduce wet cat food to Meow Mix’s offerings during a period when agricultural commodity prices were steep. And, in April, Cypress took public portfolio company CPI Inc., returning roughly $170 million on its $100 million investment. In all, Cypress’s last five exits have produced $1.2 billion in returns on $665 million invested.

The most recent bad news came Dec. 19, when Amtrol Inc., a maker of water storage and pressure control devices, filed for bankruptcy protection. The company declared bankruptcy because, simply, it had “too much debt,” Amtrol’s chief executive said in a statement. Cypress paid $219 million for the company in 1996, one of the first acquisitions of its inaugural fund, the $1.05 billion Cypress Merchant Banking Partners LP.

By the time Amtrol sought bankruptcy protection, Cypress no longer had an “economic interest” in the company, according to the firm. More than a year ago, Cypress was able to cash out an undisclosed part of its investment through a recapitalization, returning the proceeds to Fund I investors. Still, according to Amtrol’s bankruptcy filing, Cypress maintains a 91 percent ownership stake in the company’s equity.

At the end of 2005, around the time Cypress said it financially exited Amtrol, the company carried nearly $180 million in debt, according to an Amtrol 10Q, the same document that warned that the company’s debt load threatened its “ability to continue as a going concern.” Amtrol reported EBITDA of $26 million in 2005, implying a leverage multiple of 7.2x. Three auctions supervised by Goldman Sachs didn’t produce a buyer.

Meanwhile, on July 31, Cypress saw its investment in Scottish Re Group Ltd. all but vanish in a few hours. The reinsurance company’s stock lost three-quarters of its value following a quarterly loss and diminished outlook. Scottish Re tried unsuccessfully to sell itself in the fall and was saved only when Cerberus Capital Management and MassMutual pumped $600 million into the company, replacing Cypress as the largest shareholder.

Cypress bought its roughly 15 percent stake in Scottish Re for $180 million—now worth about $42 million—with its second fund. The $2.5 billion Cypress Merchant Banking Partners II closed in 1999 and is 90 percent invested, according to reports.

Now it’s 2007, and Cypress Merchant Banking Partners III has yet to materialize. Disappointing investments such as Amtrol and Scottish Re, along with the bankruptcy of Frank’s Nursery & Crafts Inc. and the closure of online grocer in 2001, have kept an undesirable lid on returns.

According to Washington State Investment Board, a limited partner in both Cypress funds, through June 2006 Cypress had produced a 2.2 percent internal rate of return on Fund I and 4.8 percent IRR on Fund II. (At press time, we were unable to learn if Washington State reports gross or net IRRs.) By comparison, Washington State’s entire portfolio of U.S. LBO funds has generated a 16.5 percent IRR. Washington State also reports that Fund I had generated an investment multiple of 1.17x, while Fund II’s is 1.16x. Both are well below the buyout portfolio’s average of 1.68x.

The low returns—coupled with the bankruptcies—contributed to a “lukewarm” response from investors when the firm went out to raise money for new funds, according to one Cypress investor who passed on the most recent round. In fact, the firm’s management seemed surprised at how “uniformly the market pushed back,” according to the investor. “Based on the lack of interest, (Cypress) went back to work on their portfolio,” the source said, suggesting that Cypress realized it needed to show more results before asking for more money. “I assume they will come back and try again.”

Another investor who decided not to re-up with Cypress said LPs turned the firm aside because so many other LBO shops are now returning to the fundraising market trumpeting much higher returns. Cypress “knows how to deploy capital,” the second investor said, but falls short on assembling a focused portfolio. “When you have a group like that, you’re kind of uncertain what they want to be when they grow up,” the investor said.

A Cypress spokesperson said the firm never officially committed itself to fundraising in 2006.

According to the two investors and published reports, Cypress’s fundraising activities in the last year included trips to Asia and across the country to build a third fund with an estimated target of $2 billion. The firm also sought to amass a bridge fund, according to one investor, and Cypress wanted to assemble a special-purpose or “pledge” fund geared to a specific target, according to the other investor. Cypress has also raised $195 million for a financial real estate investment trust that will operate as a lending vehicle.—J.H.