Fund Profile: Bear Stearns Spinout Gets Tested – Corrected

Firm: Irving Place Capital

Year founded: 1997, as Bear Stearns Merchant Banking; spun out in 2008

Investment strategy: Cuts checks of $75 million to $250 million for control stakes in consumer, retail, industrial and health care companies with more than $20 million of EBITDA

Key executives: John D. Howard, CEO

Office location: New York

Assets under management: Has raised more than $4 billion; current fund is $2.7 billion

Fundraising status: Anticipates raising a fund of $1 billion to $1.5 billion in the second half of 2013

Number of portfolio companies in current fund: 16

Web address:

Launched in 2006 when the firm was still known as Bear Stearns Merchant Banking Partners, the fund was rocked by the 2008 collapse of its parent company and key financial backer. Then the fund rode out the financial storm of the Great Recession, largely curbing its investment activities while executives re-examined their position as a buyout shop unaffiliated with a major financial conglomerate.

Ultimately the firm shed a couple of its focus industries—financial services and energy—to double down on the other four—consumer, retail, industrial and health care—and undertaking a flurry of deals in the past couple of years.

Now Irving Place Capital is closing in on the last few deals that will round out its $2.7 billion Fund III as the firm begins thinking about its successor, a smaller vehicle of probably $1 billion to $1.5 billion that executives plan to begin to promote in the second half of 2013.

CEO John D. Howard said in June that the fund has $900 million left to be deployed and a year to go on its investment period. Irving Place Capital expects to do three or four in the next nine months, Howard said at the Buyouts Chicago conference. “We like to identify a terrific platform business and do acquisitions around it.”

At this point, Fund III is not showing stellar results. According to the limited partner Oregon Public Employees Retirement Fund, the vehicle was returning a 1.03x investment multiple and a 0.9 percent IRR as of March 31.

Executives, however, believe the fund continues to offer good upside. Of the 13 investments identified by Buyouts as Fund III portfolio companies through the T-1 Banker private equity database (published by Thomson Reuters) and independent research, Irving Place Capital has exited only three.

One of those was Doral Financial Corp., a troubled Puerto Rican bank for which the firm led a $610 million equity infusion announced in May 2007 while it was still under the Bear Stearns banner. The firm led a investor group that also included Marathon Asset Management, Perry Capital, the D. E. Shaw group, Tennenbaum Capital Partners, Eton Park Capital Management, Goldman Sachs & Co., Canyon Capital Advisors and GE Asset Management, according to a Doral announcement at the time. As a result, the investment consortium took a 90 percent stake in the company, paying $12.60 per share.

After the collapse of Bear Stearns and its sale to JPMorgan Chase in March 2008, Bear Stearns Merchant Banking partner David E. King reiterated the firm’s commitment to Doral, as the newspaper American Banker reported. And although JPMorgan Chase agreed to honor Bear Stearn’s $500 million commitment to Fund III, Irving Place Capital eventually exited the investment, according to T-1 Banker. A

Although the database does not disclose the price, it cannot have gone well. Doral stock, which was trading in the 20s in early 2008, has tumbled since then, due both to persistent accounting problems that necessitated the 2007 rescue in the first place, along with the financial crisis and the continuing collapse of Puerto Rico’s tourism-oriented economy. In mid-October, Doral stock was trading for less than $1.

Indeed, while Fund III undertook five investments through mid-2007, the Doral deal was its last until May 2009. As the economy slowed, sliding into recession in December 2007 and into full-blown crisis mode in 2008, the firm battened down. And after the merchant banking group announced in June 2008 that it would become an independent private equity firm, its executives undertook a thoroughgoing review of its strategy.

Narrower Focus

It was that review that led the firm to shed its financial services and energy strategies, although Fund III continues to hold at least one financial company, Caribbean Financial Group Inc., another Puerto Rican lender, according to T-1 Banker. Those sectors had always been opportunistic, according to a person familiar with the firm, who asked not to be identified discussing internal strategy; the thinking had been that synergies with Bear Stearns’s financial businesses could lead the merchant bankers to more attractive opportunities. But that promise largely failed to materialize, as executives discussed with Buyouts in a 2009 firm profile.

When Irving Place Capital returned to investing in 2010, as the financial crisis receded, its first new deal was for a Livonia, Mich., franchise operator called Pet Supplies Plus Inc. In some ways, the company was the archetype of the kind of businesses that the firm likes—a mid-market company in one of its targeted industries, with an opportunity for growth through operational revamping.

Retailing has proven to be a fruitful sector for the firm in the past; Irving Place Capital won the Buyouts 2011 Mid-Market Deal of the Year Award for its stewardship of the food-supplement merchant Vitamin Shoppe, a Fund II investment. The firm wrote a $121 million check in 2002 to take over the 128-store chain, quadrupling it to 484 stores and taking it public in 2010 for a 3.6x return, counting both realized and unrealized gains at the time.

In the case of the pet supply company, Irving Place Capital saw the opportunity not for a turnaround but a transformation. In addition to buying the franchisor, the firm also bought several of its largest franchisees and a distribution company, making Pet Supplies Plus into a vertically integrated operating company.

Irving Place Capital also saw potential in the fact that the company lacked operations that competitors offered, including a loyalty program and an e-commerce Web site. “To us this is an opportunity to pick up 15 percent of sales,” Howard said at Buyouts Chicago. “The e-commerce piece of the business can be exponentially more profitable if you know how to do it properly.”

The firm is pursuing a similar strategy with another retailer, the womenswear chain Dots LLC, which it acquired in January 2011. Dots pursues a mid-price strategy, serving the kind of shopper who frequents Walmart. In fact many of the chain’s 400 outlets are near Walmart outlets. Irving Place Capital believes it can double the company’s operating margins and expand it to 1,000 or 1,500 stores by improving its marketing and merchandising. To that end, the firm is relocating the creative operation to New York, with its concentration of fashion talent, while leaving the corporate headquarters in the Cleveland area.

In all, the firm has completed at least six acquisitions in the past 18 months, and Howard estimated in April that the firm could lift Fund III’s returns to the range of 2.5x to 3.5x Irving Place Capital’s initial investment, based on the investments made following the Bear Stearns spin-out (rather than the portfolio as a whole), as sister Web site peHUB reported at the time, when it appeared that the firm would be launching Fund IV by the end of this year.

That has now been pushed back, in part because the firm still has more than $800 million to invest out of Fund III, and also because, in the post-Bear Stearns era, the firm also needs to demonstrate its ability to deliver results, said an independent market watcher.

“They’re still in the process of proving up their strategy because of the upset,” this person said, who still believes the firm will achieve its goal. “They realized they needed to get some exits done to attract investors back to them.”

CORRECTIONS: A version of this story posted on October 29 said the firm had made 12 portfolio investments, rather than 16; that the firm made four portfolio investments before its spin-out from Bear Stearns, rather than five; and that Doral was its last portfolio investment until September 2010, rather than May 2009. In addition, the characterization that the fund could achieve returns to the range of 2.5x to 3.5x Irving Place Capital’s initial investment was based on the investments made following the Bear Stearns spin-out rather than for the portfolio as a whole.