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CSFB Lets LBO Group Go Free

Credit Suisse First Boston has spun out its leveraged buyout group, citing conflicts with investment banking clients. The move will occur early next year, with the new group serving in a sub-advisory role to the three existing DLJ Merchant Banking Partners funds, including a $5.4 billion vehicle that is approximately 90% invested. It also will manage a new fund, which currently is being raised with a $3.5 billion target capitalization.

Thompson Dean, current head of leveraged corporate private equity for CSFB, will lead the spinout, although no other managers have yet been named. Some existing DLJ Merchant Banking members will remain to manage real estate, mezzanine and secondary private equity practices, while others conceivably could take this opportunity to switch firms.

Certain not to sign on, however, are five DLJ Merchant Banking pros who left earlier this year because of the very inter-bank conflicts now cited for the spinout. The quintet, which includes former CSFB Private Equity chief Larry Schloss, formed a new Park Avenue firm named Diamond Castle Holdings, and bashed their former employer in a Wall Street Journal interview. “We were held hostage to [CSFB’s] financial sponsors group,” said Diamond Castle Holdings partner Mike Ranger in the Wall Street Journal article, published in September. “It was all about supporting the mother ship. We wanted to prove ourselves in a non-investment bank model.”

More surprising than the attack, however, was the response. In that article, Dean dismissed Ranger’s claims, saying that his group had “successfully managed the conflict situation.” He added, “We are big believers in the investment-banking model, which has generated huge returns.”

Last week, Dean did not back off despite the discrepancy between his comments and the spinout rationale. But he did provide some context. “CSFB has never told me what to do, even when what we were doing caused us to come into competition with some of their larger clients,” he explained. “But as they did a strategic review of the entire business, they came to me and said that they wanted to focus on building up the [financial sponsors] business, and that it would become increasingly difficult for them to let us maintain our independence.”

As for Dean’s praise of the I-banking model, it could be argued that the spinout is not so much abandonment as it is a compromise. DLJ Merchant Banking Partners – or whatever the new firm will be named – will maintain some significant vestiges of its legacy, but without being subjected to certain inherent conflicts, manageable or not.

The most obvious example is that CSFB will honor its agreement to serve as a limited partner in the new fund, albeit at a reduced amount than originally anticipated. It also will continue to provide deal-flow. This latter point is of particular importance, as DLJ Merchant Banking Partners has invested about $5 billion over the past four years, with 40% of that deal-flow coming from the CSFB platform. Another 40% came from within the DLJ Merchant Banking group itself, and the remainder can be traced back to Wall Street.

Dean stressed the maintenance of the CSFB relationship in a letter sent last week to existing DLJ Merchant Banking LPs. It is unclear how LPs will react.

DLJ Merchant Banking IV began fund-raising at around the same time as Providence Equity Partners, with each group essentially looking for between $3.5 billion and $4 billion. While Providence hit the $4 billion mark in relatively short order, DLJ Merchant Banking is still looking to hold a first close. The original plan was to hold a $2 billion interim close this month, and a final close in February, but the spinout and reduced CSFB commitment has altered plans. New fund-raising documents are expected to be drawn up soon, with that interim close now scheduled for February, and the final close to occur at a still-unspecified time. Dean and a CSFB spokeswoman declined to comment on any aspect of fund-raising, citing Securities and Exchange Commission restrictions.

According to a publicly available report from the Colorado Public Employees’ Retirement System, DLJ Merchant Banking Partners III had called down over 70% of its capital as of year-end 2003. At that time, it reported an internal-rate-of-return of 15.16%, compared to a pooled vintage year benchmark from Thomson Venture Economics of 2.9 percent.

In related fund-raising news, Diamond Castle Holdings is prepping its inaugural fund with a target in excess of $1.5 billion. Neither Schloss nor Ranger would comment on the process, or on CSFB. Also, CSFB is in the market with a $100 million secondaries fund, and already has closed on $83 million.