Feature: For Heartland, the Rust Belt Looks Sexy –

Like most of today’s buyout professionals, David Stockman is absolutely smitten by technology. The former managing director at The Blackstone Group says he is bullish on the Internet, e-commerce, telecommunications and broadband. In fact, there isn’t a sector in the so-called New Economy he doesn’t like.

But, unlike most of his tech-happy counterparts, Stockman resolutely will not invest in those sectors. Too risky, he says. Instead, Stockman is seeking $2 billion for a buyout fund that will target a decidedly less sexy list of industries, including automotive supply, chemicals and basic metal forming-sectors that have remained relatively stagnant while the price multiples for tech and telecom companies have soared.

Through his new firm, Heartland Industrial Partners, Stockman hopes to preside over a vast holding company for manufacturing businesses, which he says are greatly undervalued and poised for a comeback (BUYOUTS Sept. 27, 1999, p. 1). Stockman also says North American manufacturing companies ultimately will be the chief beneficiaries of advances in information technology once the many efficiencies promised by the technologies gain momentum. But before Heartland Industrial’s first platform can be established, Stockman must persuade investors that betting money on the “rust-belt” economy is a good way to start the new century.

Motor City LBOs

Though Heartland Industrial will have its main offices on Park Avenue, perhaps the least industrial and least-heartland street in America, the firm has opened an office in Detroit that will be headed by Timothy Leuliette, the former president of Pensky Corp., a manufacturing conglomerate. Leuliette, who recently was named board chairman for the Detroit Branch of the Federal Reserve Bank of Chicago, will oversee many of the operational aspects of the fund’s deployment, while Stockman and Dan Tredwell, a former managing director from Chase Securities, specializing in high yield, will arrange financing from the Park Avenue office.

Stockman declined to discuss details of the fund for this article, citing the private placement gag rule.

Heartland’s proposed strategy makes it one of the few major buyout firms not to have earmarked a significant portion of its future investment activity for tech and telecom deals. In 1999, many otherwise traditional buyout firms made unexpectedly large equity investments in technology companies. Furthermore, the year just past saw the formation or planning of a number of buyout mega-funds that will target the tech sector, including offerings from Texas Pacific Group, Hicks, Muse, Tate & Furst, Thomas Weisel Partners, Thomas H. Lee Co. and Silver Lake Partners LLC.

The pull of technology has had an especially strong effect on Stockman’s former employer. Blackstone is preparing to launch a separate telecommunications fund with a target of nearly $2 billion (BUYOUTS Jan. 10, p. 3). A gatekeeper source said Blackstone, like other large buyout firms, felt compelled to create the new fund because telecom and tech investments were beginning to use up a disproportionately large share of the equity from the firm’s main fund. The source said Blackstone also saw the new fund as a “defensive measure” to keep talented professionals at the firm who might leave if Blackstone began to limit its extremely successful telecommunications investing. Last year, Blackstone lost one high-profile partner to a tech fund when Glenn Hutchins left to co-found Silver Lake.

But Stockman never waded into the high-tech fray. While at Blackstone, he led industrial deals, such as the recapitalization of American Axle & Manufacturing Holding Inc. and the establishment of platform company Republic Technologies International, a steel conglomerate. Stockman says he felt his ambitions of creating a “virtual GE” for manufacturing companies would best be realized outside of Blackstone. The relationship continues, however-Blackstone will invest in the Heartland Industrial fund.

The Old Economy Beckons

While the rest of the buyout community plans ways to cash in on enthusiasm for the new economy, Stockman says signs of an impending upswing in the performance of North American manufacturing companies are everywhere.

Currently, 8% of the U.S. gross domestic product is being spent on durable equipment, versus a historic rate of 5% to 6%. New technologies are bringing the cost of distributing information to nearly nothing. Labor disputes are at a minimum. “Crony capitalism” in Asia and other regions was dealt a severe blow by the economic meltdown in 1997, promising an end to government-subsidized goods being “dumped” on U.S. markets.

In addition, the companies Heartland Industrial wants to target look cheap. Stockman says the values of small- and mid-cap industrial companies are at a 50-year low relative to the broader market. Whereas these types of companies normally carry a 75% to 80% relative valuation, they now show relative valuations of approximately 30%.

Stockman believes that the old economy is, in fact, the future of the U.S. economy. He challenges the prediction of some economists that manufacturing will move increasingly to other countries as the U.S. economy becomes reliant on services.

“[Foreign countries] will always be more competitive in labor-intensive products,” Stockman says. “But we’re not going to make toys. We don’t have a competitive advantage in North America for those products. But if you’re a supplier of modules to an auto assembly plant in northern Ohio, they can’t touch us from South Korea.”

Internet a Danger Zone

While Stockman admits that the Internet is changing the way business is done around the world, he thinks many of his buyout peers who invest in the sector are getting involved in a high-stakes game of technology-picking. “The market in its artful way is trying to sort out the winners from the losers,” he says. “I think it’s a little bit risky for an illiquid buyout-type investor to be in the high-tech company-picking game today.”

The gatekeeper source says he believes Stockman, who used to serve as the budget director in the Reagan White House, should have little trouble attracting investors to his fund. Not only does he have high name recognition, but Stockman knows his stuff.

“When we’ve done due diligence on him, it was surprising to us how deeply involved and how analytical Stockman was in looking at deals,” the source said.

And in a buyout market where many funds are trying to seem more like large-scale venture capital vehicles, the source said, Stockman’s fund will be seen as a diversifying asset.

But if the manufacturing sector is a screaming “buy,” why aren’t there more funds like Stockman’s? One placement agent said he felt the Heartland Industrial fund was an anomaly in an otherwise tech-obsessed fund-raising market.

“It would be difficult for me to be convinced that the successful raising of this fund would signify a trend,” he said. “There’s a lot of public [pension] funds that haven’t even begun to get into the technology sector yet. The [Heartland Industrial] fund probably looks a lot like other more traditional funds” in which many pensions are already heavily invested.

The placement agent says he thinks that eventually there will be a refocus on the core buyout business, but that may not happen until one to four years from now, by which time the drive toward technology investing will have been played out.

Stockman does not want to wait for that to happen. His pitch to investors is to have faith in the vast swath of the U.S. economy that makes things.

“Everything that’s going to be purchased over the Internet is going to be a physical, tangible product that has to be manufactured, handled and assembled somewhere,” he says. “The underlying production structure [of the economy] is going to be turbo-charged by the new IT and Internet economy and the profit potential is going to be enormous.”