Diamond Castle Hits Early Stumbling Block

A stalled contract is derailing one of Diamond Castle Holdings’s 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 a year ago.

Just after PRC LLC entered Diamond Castle’s portfolio, the company’s financial outlook took a turn for the worse. What the firm describes as a major North American client has held up on signing a new contract, and the loss of that one client has virtually shut off its cash supply. The company provides sales, tele-marketing and call-center services for companies.

The company’s main source of liquidity is now a $20 million revolving loan. Diamond Castle staved off default in the third quarter by pumping equity into PRC, and the firm may have to do so again in the fourth quarter, according to S&P 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 rated ‘CCC+’ or below defaulted on debt within a year of attaining the rating, according to the ratings agency. Andy Rush, a Diamond Castle senior managing director, 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 the Plantation, Fla.-based 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, a $1.85 billion vehicle.

Buyout shops have grown enamored of so-called business-process-outsourcing companies, and S&P’s Liu said the outsourcing industry is generally doing well. PRC’s troubles, however, aren’t attributable to a larger trend but rather arise from particular circumstances. “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 said. “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. 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 publish its financial results. Rush declined to describe the debt’s covenants, and also would not say how much equity Diamond Castle has put into the company. On Nov. 7, Diamond Castle requested that S&P cease rating PRC’s credit.

Diamond Castle was launched by Lawrence Schloss in 2004 after he departed from his perch atop DLJ Merchant Banking Partners, an affiliate of Credit Suisse. Four of his colleagues followed him to Diamond Castle, including Rush, who now sits on PRC’s board of directors. Given the firm’s track record at Credit Suisse, Diamond Castle has sought to portray itself as something other than a spin-out team. Indeed, the shop labeled its first fund Diamond Castle Partners IV LP.

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,” said 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 said “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 said. “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.”