Company Profile: Alchemy Partners – The chemistry of Alchemy: While the firm may not have rounded up Rover, the ‘difficult deals

UK independent Alchemy Partners has hit the business headlines almost daily during the past few weeks, thanks to its audacious but ultimately unsuccessful attempt to acquire ailing British carmaker Rover from BMW. Before the Rover bid thrust Alchemy into the limelight, few outside the private equity industry were aware of Alchemy’s existence – despite the fact that the firm, from a standing start three and a half years ago, has deployed more than GBP500 million in 49 deals involving 35 companies.

On the private equity circuit, however, Alchemy famed for its appetite for difficult’ deals and has rapidly emerged as a serious force to be reckoned with both in the UK and in German-speaking Europe, following the opening of the firm’s Frankfurt office two and a half years ago.

Alchemy’s founder and managing partner, Jon Moulton, is renowned as much for his trenchant views as his formidable track record, particularly in the field of turnarounds.

Alchemy opened its doors early in 1997, following Jon Moulton’s departure from Apax. Moulton’s private equity career began with Citicorp Venture Capital in London and New York, before he moved in 1985 to head Schroder Ventures as managing partner on its inception, a role he was to fill for the next nine years. At Alchemy, Moulton was quickly joined by Apax colleague Robert Barnes, who had specialised in pub deals, and Martin Bolland, the former chief executive of Lonrho’s Princess Metropole Hotels – appointments which highlighted Alchemy’s interest in the hospitality sector. Shortly afterwards, Eric Walters, who had already worked with Moulton during much of his ten years as a partner at Schroder Ventures, crossed over to Alchemy. Scott Greenhalgh, formerly director of HSBC’s specialised financing division, who joined Alchemy to head up its German operation, and Paul Bridges, previously an associate director of Lonrho, complete the six-strong partner line-up. The firm currently has a further six investment executives based at its London and Frankfurt offices as well as a finance director, investor relations manager and partnership counsel.

Jon Moulton believes that, with 12 deal doers, Alchemy has reached its optimal size: “We have no intention of getting bigger. The business is extremely effective at its current strength, I think this is the right cell size’ and I would rather replicate Alchemy than expand it”.

Large private equity firms where the CEO no longer takes a hands-on role in executing deals but where politics is rife are clearly anathema to Moulton and it is more or less an open secret that this was one underlying reason for both his and Walters’ decision to move from Schroders. Walters, like Moulton, is famous for never being happier than when in the thick of deal negotiations, as Moulton himself reveals. “You should have seen Eric during the Rover transaction – he was working extremely long hours but was as lively as at any time during the past 20 years”.

While staying small is one critical element of the Alchemy model, the two factors that differentiate the firm most clearly in the crowded UK and German-speaking markets are its funding structure and its preference for difficult’ transactions. Rather than opting to raise conventional LPs, Alchemy devised a rolling structure, where its investors are asked how much they wish to commit over the next 12-month period. From the firm’s point of view, the great advantage of the Alchemy Investment Plan – which is quite closely analogous to certain structures in the quoted arena – is that it circumvents the normal cyclical pressures of fund raising. Among the advantages for investors are the short commitment horizon, the potential for co-investment in larger transactions and highly competitive terms: Alchemy takes a carry of just 10 per cent on a deal-by-deal basis.

In its first year, Alchemy raised GBP100 million for the Investment Plan. In 1998, after the opening of the Frankfurt office, the annual pot was expanded to GBP255 million and has remained at that level ever since. There are currently 35 live participants (with varying start dates) in the Alchemy plan and, investor relations manager Jill Pickering reports, only one investor so far has withdrawn from the plan, although many groups have either raised or lowered their annual commitment levels. Alchemy has raised capital from sources in the US, the UK, continental Europe and the Middle East, including AMIZ, Baltic, British Aerospace Pension Fund, Chase Capital Partners, the Merseyside Pension Fund, Pantheon, UBK and Yale University. US capital still predominates in the Alchemy Investment Plan although the proportion drawn from European sources increased substantially once Alchemy expanded its remit to include German-speaking Europe.

Alchemy is defined as the pursuit of the transmutation of base metals into gold. With its connotations of transformation, the name neatly encapsulates the firm’s approach to investment; here, it is perhaps worth remembering that Moulton once pointed out that other metals could indeed be turned into gold – provided only that one has a nuclear reactor at one’s disposal. When Alchemy kicked off in 1997, the UK buyout market was bedevilled by auction frenzy. The firm made it clear from the start that it would avoid the mainstream where auctions (and therefore inflated pricing) were most prevalent, choosing instead to fish in murkier waters.

Jon Moulton at the time said the typical Alchemy deal was liable to have an incomplete story’ – in other words, to have either poor financials or poor management (or both) or be operating in an unfashionable or difficult sector. Within the UK, Alchemy has stuck closely to this brief. Among the turnaround investments undertaken to date are AG Stanley, Ashbury Confectionery, Moore Paragon and Sunley Turriff Group. When it comes to unfashionable sector’ credentials, these could scarcely have been more firmly established than they were by Alchemy’s GBP3.1 million investment in ATH Resources, a company extracting and marketing coal from an opencast site in Scotland (Alchemy acquired rights to the site from an insolvent public company in 1998; ATH is now thriving and has just enjoyed a record month.)

Where Alchemy has really come to the fore in the UK, however, is in the public-to-private arena, having completed 13 such transactions to date. Former public companies in the portfolio include Instem, Newmall/Wellman, Goldsmiths, Avonside, Four Seasons Healthcare and Radius. Jon Moulton attributes Alchemy’s prolific success in the public-to-private arena – so far, the firm has completed every such bid launched – in part to the small size and flat hierarchy of the firm, which enables it to make rapid decisions and move forward fast. By contrast, says Moulton, some of Alchemy’s competitors “tend to go into high church’ mode when dealing with public companies”. Moulton adds that even the worst’ of Alchemy’s going private deals has been decent’ – unfortunately, without specifying the company involved.

The profile of deals done out of Alchemy’s Frankfurt office is rather different – partly because public-to-privates have yet to become a feature of the continental private equity landscape and partly because, Moulton explains, Alchemy “has exposed itself to a different strand of deal flow”.

So far, Alchemy GmbH has advised on eight transactions – four in Germany, three in Switzerland and one in Austria – two of which, Steudle GmbH and GMG Holding have been substantial consolidation plays in, respectively, precision engineering sectors and the PC peripherals and services . (Incidentally, one of the acquisitions made as part of the GMG deal resulted in Alchemy being able to boast an 100 per cent share of the Liechtenstein MBO market last year.)

So far, Moulton says, deal flow in German-speaking Europe has been adequate but not luxurious’. The likelihood is that the flow of acquisition opportunities in Germany in the current year will be somewhat sluggish, as potential vendors hold fire until the abolition of capital gains tax comes into effect in 2001. Thereafter, Alchemy – and many other private equity houses – anticipate a spectacular increase in activity.

Although the average age of Alchemy’s portfolio is only 18 months, the firm has already achieved three full exits. The first was apparently nothing to shout about, returning only a little over cost. AG Stanley and SMATcom, however, have been spectacular successes.

AG Stanley, a UK decorating and soft furnishings retailer, was losing around GBP1 million a month on annual sales of GBP110 million by the summer of 1997 when Alchemy paid Boots GBP2 for the business and took on its freehold properties as part of a GBP3 million investment.

The turnaround was, Moulton recalls, virtually instant. Moulton himself went into the company as chief executive for a short and painful period during the early stages of the deal. Alchemy’s first actions were to take a wall of cost’ out of the business and to replace the entire senior management team. The next priority was to institute a more appropriate incentive scheme. Before the Alchemy acquisition branch staff performance incentives were determined by overall group performance; Alchemy tied them instead to sales at individual stores. In parallel with the new incentive scheme, Alchemy and management reversed the company’s earlier policy of offering the same product range across all its stores irrespective of location, instead tailoring the product offering in each outlet to reflect the economic status of the local customer base. In the first month, AG Stanley showed a 15 per cent like-for-like growth in gross margins and, at the end of its second month in the Alchemy stable, was trading profitably again.

When Alchemy sold AG Stanley to Rosebys in a cash and shares deal last autumn, the group returned GBP37.4 million to its investors, representing a 12.3 cost multiple and a transaction IRR of more than 500 per cent.

SMATcom was Alchemy’s third exit and the first from its continental portfolio. A holding company established by Alchemy to acquire cable TV operating companies in Germany, Switzerland and Austria, it made its first acquisition, of Frankfurt-based KVG, in the summer of 1998, adding Eastern German operator MKM a few months later and buying Kabelcom Essen in May 1999. These acquisitions positioned SMATcom as the sixth largest German cable TV operator. Deutsche Bank’s DB Investor AG subsidiary acquired the group this spring. The Alchemy plan, which had invested DM26.4 million in total into SMATcom, was able to return DM117 million to its investors on the sale, corresponding to a transaction IRR of 157 per cent.

Taking 22 distributions as well as the three complete exits into account, Alchemy has to date distributed GBP121.5 million to Plan investors.

Interestingly, particularly in the context of the image of Alchemy that supporters of the Phoenix consortium sought to foster during the war of words for Rover, AG Stanley is the only instance in which Alchemy has replaced the entire senior management team and put in one of the partners as chief executive for an interval. In the course of its 49 individual investments, Alchemy has made 37 senior management changes – most of them, Moulton says, very close to the time of the deal; 40 per cent of the current portfolio is run by individuals Alchemy or its partners have backed before, several more than once, and the firm is now working in conjunction with one manager to find what would be his fifth Alchemy partners-backed transaction.

In the aftermath of the BMW/Rover/Phoenix palaver, more attention has been focused on the one that got away’ than on the firm’s actual portfolio. This is to an extent understandable given the size and nature of the proposed MG Car Company project.

Indeed, having lost Rover at such a late stage after around six months of negotiations, it is easy to imagine the Alchemy team returning home to kick the corporate cat. But Moulton seems unperturbed, noting “It’s the first deal I’ve missed by GBP1 billion”.

An alternative buyer for Rover having emerged at the eleventh hour, it is not hard to divine BMW’s motivation in selling to the Phoenix consortium, whatever smokescreens may have been thrown up by various parties over what actually broke the deal with Alchemy. Alchemy was to receive a gift’ of some GBP800 million to take the English patient’ off BMW’s hands. The Phoenix consortium is getting by with a GBP500 million loan. Even if that loan is never repaid – and a lot of smart money believes that will indeed be the outcome – the Phoenix option is the lesser of two evils for BMW shareholders.

Since April, when news of Alchemy’s bid for Rover first emerged, the firm has received an unprecedented level of publicity for a European private equity house. Is Alchemy concerned that the widespread exposure, and the ultimate failure of the Rover bid, will have and adverse effect on the business? Not a bit of it, judging from Moulton’s comments. “I haven’t a clue why, but when the Rover deal was public, it suppressed virtually all other forms of phone call to our offices: contacts from investors, portfolio companies and new deals, were all rare. But, now it’s over, we’ve seen rapidly increasing volumes of new deal calls”.

Another unexpected side effect of the Rover brouhaha has been the feedback from existing portfolio companies. “They tell us that reactions have been very good and that increased awareness of Alchemy, and of what it does, makes them look part of something substantial”.

For a start-up still less than four years old, Alchemy is indeed something substantial, employing around 28,000 people across its portfolio – a portfolio that looks set to expand substantially in the immediate future. Moulton reports that six public-to-privates are on the cards at present; Alchemy hopes to announce at least two of these before a month is out. The firm’s willingness to tackle difficult deals clearly remains undiminished. The real question is, what will be the next surprise up Alchemy’s sleeve. Its competitors would love to know but, post-Rover, will scarcely dare to guess.