Diamond Castle deal hits stumbling block

A stalled contract is derailing one of Diamond Castle Holdings’ first investments, triggering a series of liquidity problems for a portfolio company that was acquired shortly before the firm closed its $1.85 billion debut fund last year.

Just after Diamond Castle invested in PRC LLC, the company’s financial outlook took a turn for the worse. The firm says that a major North American client held up on signing a new contract with PRC, and the loss of that one client has virtually shut off its cash supply. Plantation, Fla.-based PRC, which provides sales, telemarketing and call center services for companies, is now relying on a $20 million revolving loan as its main source of liquidity, the firm said.

Diamond Castle staved off the company’s default in the third quarter by investing an undisclosed amount of equity in PRC, and the New York-based investor may have to do so again in the fourth quarter, according to Standard & Poor’s analyst Andy Liu. Under the terms of PRC’s loan agreement, Diamond Castle is allowed only two quarterly “equity cures” every four quarters, and Liu wrote in a recent research note that PRC’s ability to avoid default after 2007 “remains in doubt.”

S&P in November downgraded PRC’s debt to a default-prone ‘CCC+’ from ‘B.’ In the last 25 years, more than a quarter of all companies that S&P rate ‘CCC+’ or below default on debt within a year of attaining the rating, the ratings agency said.

Andy Rush, a Diamond Castle senior managing director who sits on the PRC board, downplayed the S&P report. “The company is not in default,” he said. “The company is in compliance with all its covenants through 2007.”

The plight of PRC is denting a portfolio that was carefully crafted by a group of long-tenured buyout pros. Diamond Castle bought PRC for an undisclosed sum in November 2006 from IAC/Interactive Corp., the media conglomerate run by Barry Diller. A month later, the LBO firm, composed of professionals who spun out of Credit Suisse’s private equity arm, closed its maiden fund with $1.85 billion in commitments.

Buyout shops have grown enamored of so-called business-process-outsourcing companies, and S&P’s Liu says that the outsourcing industry is generally doing well.

PRC’s troubles, however, aren’t attributable to a larger trend but rather arise from particular circumstances, Liu says. “When the company was purchased from IAC/InterActive Corp., they had certain expectations and growth plans that involved cost cutting and boosting their ability to service contracts,” S&P’s Liu says. “But those things didn’t work out as well as the company had planned.”

PRC’s underperformance prompted Diamond Castle in August to fire the CEO and CFO and install an interim management team. Still, the company had to tap its $20 million revolver to make up for cash shortages, according to Liu. PRC’s debt-to-EBITDA ratio stood at 8x at the end of September, he said. The Royal Bank of Scotland, which underwrote the debt package, could not be reached for comment.

In addition to the revolving credit line, PRC has $207 million in long-term debt, according to S&P. The package includes a senior secured loan of $115 million; a $67 million second-lien term loan; and a $25 million delay-draw capital expenditure credit facility. The privately held PRC does not disclose its financial results. Rush of Diamond Castle declined to describe the debt’s covenants, and he also would not say how much equity Diamond Castle has put into the company.

Diamond Castle was launched by Lawrence Schloss in 2004 after he departed from his position as head of DLJ Merchant Banking Partners, an affiliate of Credit Suisse. Four of his colleagues followed him to Diamond Castle.

Although it’s never a healthy sign for a new firm to stumble so quickly out of the gate, two of Diamond Castle’s limited partners said they have few worries about the fund’s overall performance. “Larry’s a seasoned veteran,” says Jay Fewel, senior equities investment officer for the Oregon Public Employees Retirement Fund, which committed $100 million to Diamond Castle’s fund. “He’s been around a long time and has assembled a team around him. We wouldn’t have committed to them if we didn’t have faith in them.”

Howard Bicker, executive director of the Minnesota State Board of Investment, echoed Fewel’s confidence, citing the management team’s history of working together. “They’ve done a good job for us in the past,” Bicker says “We have every hope that they’ll be able to do that going forward.” Minnesota also committed $100 million to Diamond Castle’s inaugural fund.

Diamond Castle’s portfolio contains eight companies, including PRC. The other companies are in better health, Rush said. “Our portfolio in general is doing fine,” he says. “You’re not going to invest a whole fund without problems, and this is one of our problems. We’re trying to work it out.” —Joyce Pellino Crane