Diamond Castle Tries For Edge On Operational Side

Firm: Diamond Castle Holdings

Founded: 2004, New York City

Fund: Diamond Castle Partners IV, $1.825 billion

Leadership: Larry Schloss, CEO; Ari J. Benacerraf, Michael W. Ranger, Andrew H. Rush, David M. Wittels, managing partners; H. Eugene Lockhart and Scott N. Schneider, operating partners.

Sectors: Energy, media and communications, financial services and health care.

Targets: $200 million to $2 billion

Fun Fact: The firm decided to call its first fund No. IV, believing that the partners’ combined experience administering three funds for DLJ Merchant Banking Partners differentiated Diamond Castle from typical first-time fundraisers.

It’s tempting to think of Diamond Castle Holdings as the Larry Schloss show.

After all, Schloss, Diamond Castle’s chief executive officer, is a certified boldfaced name in the buyout business, having joined Donaldson Lufkin & Jenrette in 1978 and risen to the head of Credit Suisse First Boston’s $32 billion private equity portfolio after the investment bank snapped up DLJ. Heck, Schloss has even climbed Mount Everest.

Schloss left Credit Suisse’s DLJ Merchant Banking Partners in March 2004 after the firm’s third fund was substantially invested, and he was soon followed that summer by four of his former colleagues later that year to form Diamond Castle Holdings. Those four are Ari J. Benacerraf, Michael W. Ranger, Andrew H. Rush and David M. Wittels.

“We all individually and collectively came to the conclusion that CSFB was a very, very large place, and it would be fun to try something more entrepreneurial,” said Schloss.

What’s more, Schloss is happy to turn the spotlight on the other members of his team. He and his partners agree that Diamond Castle’s strength lies in its structure—the union of investment professionals and operating partners, all of whom focus their attention on specific segments of the economy. This is by no means a unique formula among mid-market buyout shops. But Diamond Castle’s partners believe that what differentiates the firm from many of its peers is that its operating specialists are heavyweights, and they’re also full-fledged, profit-sharing partners of the firm. They don’t sit in a chair on the beach waiting to be beckoned to sit in a chair in a boardroom.

“We’re out there to help source deals and use our networks to create deals,” said H. Eugene Lockhart, a Diamond Castle operating partner and former CEO of MasterCard and Midland Bank, now part of HSBC, and a former president of Bank of America. “Like all the other partners, we invest in the company and we make sure that it’s being managed in the right way. We are absolutely not—capital N-O-T—not there to run portfolio companies.”

In addition to Lockhart, the firm employs Operating Partner Scott N. Schneider, former president and chief operating officer of Citizens Communications, one of the nation’s largest phone carriers, and a veteran of the telecommunications industry. With Lockhart and Schneider in tow, the firm has made financial services and telecom two of its four areas of concentration when making plays for companies valued between $200 million and $2 billion, or what Diamond Castle defines as the middle market.

The third sector is power and energy, the bailiwick of Ranger. He earlier ran DLJ’s energy division and, as the lead independent director of TXU Corp., now finds himself in the middle of the nation’s highest-profile energy deal. He took a seat on the board in 2002 when DLJ bought a $750 million stake in TXU. The firm exited in 2004, but TXU asked Ranger to remain on the board, according to regulatory filings. Diamond Castle is prohibited from discussing his involvement beyond acknowledging that the connection exists. Diamond Castle also plans to make plays in a fourth area, health care, although the firm doesn’t have quite the firepower there as it does in other industries.

In December Diamond Castle closed on its debut $1.85 billion fund, which it calls Diamond Castle Partners Fund IV, a reference both to the partners’ departure from Credit Suisse following the investment of DLJ’s third fund and an acknowledgement that Diamond Castle commands enough experience and clout to slip the trap that typically slows a first-time fund. Indeed, Diamond Castle Partners IV soaked in money from 50 of DLJ’s limited partners, and its debut marked one of the largest-ever first-time funds.

By the time the fund closed, it was already more than one-third invested. The fund is now nearly half spent, and the firm’s purchases to date reflect its reliance on its operating niches. Ranger’s energy experience landed portfolio company Catamount Energy, a wind-power company based in Vermont. Lockhart brought in Buckeye Check Cashing Inc., an Ohio company Lockhart knew because he was an investor in one of its largest products. Meanwhile, Lockhart and Schneider teamed up to reel in PRC LLC, a Florida-based business process outsourcing company that caters to the financial services and telecom industries.

Of the firm’s six investments so far, more than half have been proprietary. And even in the two auctions, Schloss credited the operations specialists with providing an edge. “As a buyer, it gives you great advantage when you walk in with guys like Scott and Gene and Mike,” he said. “Instead of saying just, ‘What’s your business about?,’ you instantly go to the 800-level course on the subject, and, sure enough, you become the preferred financial buyer. It tips the playing field in your direction, and that’s what you want.”

Diamond Castle’s emphasis on operational know-how also informs the firm’s approach to debt, which is to look first at fundamentals before thinking about the capital structure. “While we use financial engineering to help returns, we don’t rely on financial engineering to generate returns,” Schneider said.

Sometimes, however, having operations pros at hand can lead to more subtle results, Schloss said. Aside from providing greater certainty when doing deals, specialists can keep the egg off the faces of the investment pros. “One of the best things about having knowledge of a sector is that you don’t do certain deals,” he said. “You never see the deals we passed on or the deals we lost. People never get credit for the deals they don’t do.”