GP Profile: Irving Place Sets Own Course

Nearly a year after jumping off the sinking ship of Bear Stearns, executives at Irving Place Capital are charting a course that includes generating deal flow without direct help from its former parent, dealing with the loss of two top executives, and attempting a loan-to-own acquisition for the first time. All while coping, like every other buyout firm, with an unprecedented lack of deal financing.

How the firm navigates these challenges will likely determine its success when it eventually attempts to raise its first fund as an independent group. Irving Place Capital is nearly halfway through investing a $2.7 billion pool closed in 2006; and next time out the firm won’t be able to count on a large slug of capital from a corporate parent, as it has in the past.

Without a doubt, prospective investors in that next fund will want to explore the impact that the loss of its corporate parent has had on Irving Place Capital. When he launched Bear Stearns Merchant Banking’s first fund in 1999, Buyouts quoted CEO John D. Howard as saying: “The benefit we have, being affiliated with a big institution, is that we have a tremendous base of resources upon which to draw.” One of those benefits was access to deals from Bear Stearns bankers.

Today, not surprisingly, executives of Irving Place Capital tend to downplay those benefits. While Bear Stearns helped with information technology and back-office support, it never became a major source of deal opportunities, according to executives. Only one investment out of 14 in the second fund, a $1.5 billion pool closed in 2001, came from Bear Stearns, while the bank only had a small hand in two of the nine deals the firm has so far made with the 2006-vintage Irving Place Capital Partners III LP. Said Howard: Bear Stearns “essentially incubated us and we need to thank them for that. But we actually got very few deals from them; it was almost non-existent.”

In fact, the Irving Place Capital team, even while part of Bear Stearns, had strived to position themselves as an independent firm with Bear Stearns as a partner, not a parent. A limited partner in Fund III who spoke with Buyouts said that, while Irving Place Capital executives used the affiliation as a selling point, they also stressed their ability to find their own deals. Today, Irving Place Capital executives are also free to talk up the negatives of affiliation.

Rival bankers, for example, were cautious about floating deals to the merchant banking team. “There was often a misplaced concern that if [bankers] introduced an opportunity to us, Bear Stearns would run off with prospective future business such as financing or M&A,” said Doug Korn, a senior managing director at Irving Place Capital. Since the spinout, the number of banks covering Irving Place Capital has grown to more than 24.

“There are always those skeptical of the affiliate model,” said Gwyneth Ketterer, the firm’s former chief operating officer, discussing prospective investors in a successor fund, which Howard expects to raise in about three years. JPMorganChase, which bought Bear Stearns last year, is honoring Bear Stearns’s $500 million commitment to Fund III, whose backers also include American Beacon Advisors and the California State Teachers’ Retirement System. In return for that commitment JPMorganChase gets a cut of the general partner’s carry.

Ketterer, though she may return to the firm, has gone on sabbatical to teach a private equity business course at Columbia Business School and spend more time with family. All of the firm’s investors knew she was leaving well before the spin-out, she said. “I have 7-year-old twins. I’m thinking about spending quality time with my kids before they don’t want to spend any time with me,” she said.

In June of 2008, Irving Place Capital and Bodil Arlander, a founding partner who had moved to San Francisco for personal reasons, also decided to part ways because the firm didn’t want to support a one-person office in San Francisco without the back office support of Bear Stearns. In January Arlander started Moxie Capital LLC, a firm focused on lower mid-market deals in consumer and retail. She declined comment for this article, citing advice from lawyers. The loss of the two executives stands to figure in due diligence exercises of prospect investors in Fund IV. “It’s always a concern for an LP when you have a key member leaving to pursue other interests,” the LP we spoke to said.

Irving Place Capital executives note that while they lost a member of the investment team in Arlander, Ketterer, as COO, dealt mainly with LP relations and fund administration. Michael Doppelt, a senior managing director who joined the firm in 2005, has since taken over most of Ketterer’s duties. “I think they’ve done a good job of finding people to step up and fill [Ketterer’s] shoes,” the LP said.

Nine of the ten Bear Stearns Merchant Banking senior investment professionals identified to prospective LPs during fundraising for Fund III in 2005 remain with the firm. “By the standards of an industry that experiences meaningful ongoing turnover in the ordinary course, this represents a very high degree of continuity,” Howard said.

12-Year History

Howard, a former co-CEO of Vestar Capital Partners, founded Bear Stearns Merchant Banking in 1997. That same year he brought on Arlander, a former vice president at Lazard Freres & Co. LLC. Ketterer, a former senior vice president of the former Lehman Brothers merchant banking group, joined in 1998, and Korn joined the firm in 1999 after co-founding private equity firm Eos Partners LP. Today the firm, which has raised $4.2 billion across three funds, employs 34 investment professionals, along with 16 operating partners and senior advisors who source deals and help run portfolio companies.

Irving Place Capital burnished its reputation for investing in retail and consumer products with its $200 million, 1997-vintage premier fund, which returned 5.3x its invested capital.

The firm made a big jump in fund size with its sophomore effort—its first to tap outside investors—raising $1.5 billion in 2001. It continues to hold eight of the 14 platform investments from Fund II, but several exits have generated impressive returns. The firm made 4.2x its invested capital, for example, when it sold Aearo Technologies, a maker of protective eyewear and other safety products, to Permira Advisers Ltd. in 2006. It has made 5x its money to date on New York & Co., the women’s retailer it took public in 2001 and in which is still holds a 51 percent stake. It doubled its money after a two-year investment in Reddy Ice Group Inc., an ice maker the firm bought in 2003. And the firm generated a 60 percent return on its $100 million investment in designer jeans company Seven For All Mankind when it sold the company to VF Corp. in 2007 for $775 million. Fund III, meanwhile, has generated a negative IRR of 5.69 percent as of Sept. 30, 2008 for CalSTRS, though that fund is still in the earlier stages.

According to executives, the majority of Irving Place Capital’s portfolio is performing well, although some companies face challenges. Howard described business at Transamerican Autoparts LLC, a Compton, Calif.-based auto parts supplier that the firm bought in 2005, as “decimated.” The firm has renegotiated the capital structure and invested more equity in Alter Moneta Corp., which leases equipment to businesses in construction and other industries. Net sales at New York & Co., suffering from declining mall traffic, fell nearly $40 million for the first quarter ended May 2. On the positive side, Howard said that New York & Co. has no debt and significant cash flow, and EBITDA at Vitamin Shoppe, the specialty retail chain Irving Place Capital bought in 2002, grew 16.9 percent in the first quarter of 2009 from the same period of 2008.

New Strategy

Irving Place Capital has $1.5 billion of capital left from Fund III and three years to spend it. After avoiding retail and consumer products for three-and-a-half years because of what they considered to be inflated valuations, executives said they’re seeing more rational purchase prices for debt-burdened companies in need of assistance. “In 2006 and 2007 many firms were tripping over each other to pay peak multiples on peak earnings for businesses tied to the U.S. consumer,” Korn said. “Our experience told us that it was a time for caution, which turned out to be correct.”

The firm instead has focused on other sectors—financial services, packaging, health care and transportation and logistics. Investments included Alter Moneta; Caribbean Financial Group, a lender in the Caribbean, Mexico and Central America; Chesapeake Corp., a paperboard and plastic packaging company; Doral Financial Corp., a financial services provider in Puerto Rico; Ironshore Inc., a property and casualty insurance company; MC Shipping, a company that ships liquefied petroleum gas; Playcore, a company that makes playgrounds for municipalities and schools; Rimrock Energy LLC, an oil and gas exploration and production company; and Universal Hospital Services Inc., a company that provides medical equipment to hospitals.

The challenge today is the lack of leverage. Irving Place Capital has employed debt capital at an average of 4x EBITDA across its entire portfolio, although it has done deals with little to no leverage. It didn’t finance any of its 2005 minority investment in Stuart Weitzman Holdings LLC, a maker of women’s shoes and handbags; and it used less than 2x leverage for Seven For All Mankind, which turned out to be one of its most successful deals.

Looking ahead, the firm expects to do more deals with little or no debt. It also plans to acquire target company debt with the intent of gaining a meaningful stake, as it did in May with the $485 million acquisition of Chesapeake Corp. Irving Place Capital had originally planned a straight buyout of the company, but as the credit crunch took hold, Chesapeake had amassed $550 million of debt. Shifting gears, Irving Place Capital for the first time began buying the company’s bonds and bank debt last summer as a strategy to gain control of the business. It brought in Oaktree Capital Management, a firm experienced with debt and turnaround investing, as a 50-50 co-investor, and the firms bought the company out of bankruptcy—another first for Irving Place Capital.

The switch to a new strategy could give prospective LPs in Fund IV pause. But executives point out that Chesapeake operates in an industry—packaging—with which they’re comfortable. The LP who spoke with Buyouts felt the same way: “I just saw it as another way to gain entry to a company,” the LP said.