GP Profile: Accel-KKR Tackles Mission-Critical Software

Soap, butter, bread, and mission-critical software.

That last one may look out of place, but the professionals at Accel-KKR hope that the market for mission-critical software stays as recession-resistant as the other three have proved to be over the years. The tech-savvy buyout firm has decided to invest about two-thirds of its newly minted $600 million third fund in the niche.

These are software applications that are critical to a company’s business— determining how they place orders, for example, or communicate with distributors and customers—and they’re extremely difficult to replace. Executives at Accel-KKR have long had an interest in such software applications, and they’re betting that they will grow even more important as companies try to manage through a recession. “Companies that sell this software have highly recurring revenue and stability in cash flow,” Tom Barnds, one of the firm’s three managing directors, told Buyouts.

Case in point is iTradeNetwork Inc., a company Accel-KKR bought for an undisclosed amount last year. The company provides Web-based software that automates the supply chain for food companies such as Tyson Foods Inc., Nestle S.A. and Safeway Inc. The software allows 6,000 such customers worldwide to do business over one platform with their suppliers. iTradeNetwork, for example, allows suppliers to upload their catalogs onto its system, in turn letting customers see product categories and prices in real time. The customers can then complete an order—including shipping and tracking—electronically in the system.

Were they suddenly to have to do without iTradeNetwork’s software, these food companies would have to completely revamp how they order and distribute products to their customers; hence the adjective “mission critical.” All told, iTradeNetwork processes more than $220 billion annually in supply chain commerce, making its money from monthly and annual subscriptions. Subscription prices vary depending on the size of the customer and the number of people that use the software at the company. The price can range from just hundreds of dollars per month for a small company to tens of thousands of dollars for a larger one.

A big key to the investment strategy, Barnds said, is finding companies that provide software geared toward a certain industry, as iTradeNetwork’s does for the food industry. This expertise makes it difficult for competitors not fluent in the industry to compete. Accel-KKR is targeting industries whose business processes—how companies order products and communicate with clients—are still undergoing processes of automation. Among them are health care, insurance, government Internet technology, and retail.

Some of these deals may well result from corporations shedding divisions that don’t contribute to their core businesses. Accel-KKR last saw a lot of action with corporate orphans from 2002 to 2004, during the downturn that followed the collapse of the dot-com boom. In June 2004, for example, it teamed up with Ontario Teachers’ Pension Plan to scoop up from Silicon Graphics Inc. a division called Alias Systems Corp., which makes 3D graphics for the film and video game industry. The price was $57.5 million in cash. The firm sold it in January 2006 to Autodesk Inc. for $196.3 million.

Now, as companies tighten their spending, Accel-KKR pros expect more companies to jettison none-core assets. Almost every day, professionals at Accel-KKR check the latest reports on 75 public technology companies they track, looking for two catalysts indicative of a company looking to sell assets. They are a change in the CEO or other senior management, because new management, in taking inventory of the business, often dispenses with parts that don’t serve the company’s main clients; and an acquisition or merger, which results in a larger company with more ancillary divisions. “We expect [such opportunities] to pick up over the next six to 18 months,” Barnds said.

Evolution Of The Firm

Accel-KKR has nine investment professionals, three operational advisors and a board of seven special advisors—including Jim Breyer, managing partner at venture capital firm Accel Partners, and Henry Kravis, co-founder of Kohlberg Kravis Roberts & Co.—who oversee nine portfolio companies. With its third fund—twice the size of Funds I and II, both of which were $300 million—the firm plans to buy companies generating revenues of between $15 million and $150 million in software, Internet technologies and IT enabled services.

The firm’s strategy has evolved dramatically since Accel Partners and KKR teamed up to create the firm in 2000, at the apex of the dot.com boom. Back then, the firm, initially called Accel-KKR Internet Co., was an early-stage venture capital fund devoted to providing financial and intellectual support to established businesses expanding online.

The so-called “bricks and clicks” strategy, implemented by a different management team, didn’t work out so well, though most venture capital funds from this period had problems. The fund has earned a 1.5x total value multiple and a 5.7 percent internal rate of return as of June 30 for the Washington State Investment Board, which committed $50 million to the fund in 2000. (Another source familiar with the fund said it is on pace to achieve a 2x return on investment.) That’s not bad for funds of this vintage, but Barnds, who joined Accel-KKR in 2000 and is the only senior member of the management team left from those early days, wanted to take the firm in a different direction.

Barnds, who was named managing director in 2001, hired Ben Bisconti, a managing director in the technology group at Credit Suisse First Boston, in 2002, and they in turn hired Rob Palumbo, the co-head of the software investment banking business of Thomas Weisel Partners, in 2004. All three had started their careers together at Alex Brown, a boutique investment bank in Baltimore, between 1990 and 1992. There they helped smallish [$50 million in annual revenue] companies go public.

In their early days at Accel-KRR the trio noticed a demand for financial support from the types of companies they had earlier helped take public: lower mid-market software and technology companies generating revenues of $15 million to $150 million which, for reasons such as the Sarbanes-Oxley Act, were now too small to go public. They also thought they could leverage their relationships with Accel and KKR to identify carve-out prospects from Fortune 500 companies recovering from the technology bubble.

CRS Retail Technology Group, a retail software provider that Accel-KKR bought in 2002 for $45 million, is a good example of the type of companies the firm invested in with its re-tuned strategy. At the time, the family-owned company generated about $50 million in revenues and was too small to go public, but needed financial and intellectual support for growth. The firm invested in the company’s sales and marketing, expanded its product line, guided it through two add-on acquisitions, and eventually found a larger company to buy it.

Kathy Frommer, the former COO, said she and her family turned down higher offers from other buyout firms to partner with Accel-KKR. Her hunch was that most firms were interested in flipping the company. “I didn’t care; I wanted the right partner for CRS,” Frommer, now retired, told Buyouts. “In the short term, perhaps it was not the biggest offer, but in the long term I knew they would maximize the value of the company.” Accel-KKR and other shareholders sold CRS Retail Technology in Dec. 2005 to Epicor Software Corp. for $121 million in cash—more than 2.7x what Accel-KKR paid three years earlier.

The change in strategy has worked well. Deals made by the current team—including those Barnds led from Fund I—have achieved a gross investment multiple of 2.5x and a gross IRR of close to 40 percent, according to Mike Kelly, partner at Hamilton Lane, which advised three of its clients to invest more than $20 million in Accel-KKR III LP. (Another source said the team has achieved a 3.5x investment multiple, and a gross IRR of about 55 percent.) Kelly said Accel-KKR’s unique strategy attracted Hamilton Lane. “They’re at a [fund] size range where there’s not many people doing control growth investments with an emphasis on software or technology companies,” Kelly said.

Accel-KKR achieves its returns with modest levels of debt, typically about 20 to 30 percent of the purchase price. By contrast, from 2002 through Oct. 31, sponsors of mid-market technology buyouts typically employed 50.48 percent senior debt, 9.36 precent sub-debt and 40.13 percent equity, according to Standard & Poor’s Leveraged Commentary & Data. The firm delivers top-line growth through acquisitions, as well as new product lines and other organic growth.

Accel-KKR’s strategy has changed so much since its inception that the areas it avoids now are similar to those it initially targeted nearly 10 years ago: high growth areas seeing a lot of venture capital investment, such as software that helps network managers maintain security. Such areas tend to exhibit a lot of innovation and hence less stability, which is essential for steady cash flow—the bread and butter of a buyout firm. “We tend to focus on areas where there was a lot of VC interest 10 or 15 years ago,” Barnds said.