GP Profile: Nogales Still Has A Lot To Prove

Firm: Nogales Investors Management

Offices: Los Angeles

Leader: Luis Nogales, Founder

Strategy: Equity investments—including management buyouts, build-ups, acquisitions, growth financings and recapitalizations—of $10 million to $30 million in high-growth small- to mid-market companies.

Number of Investment Professionals: 7

Luis Nogales’s stellar corporate background and unique strategy made it easy for him to attract top institutional investors to his debut buyout fund, managed by Nogales Investors Management. But returns on that debut fund have been lackluster so far. Now, with a beefed-up staff and a second fund that’s more than double the size of the first, the pressure is on for Nogales and his partners to prove those investors right.

Nogales began raising a fund for Nogales Investors in 2001 after a storied career that included stints as president of Spanish-language television network Univision, CEO of United Press International, and board member at Bank of California, Coors, Levi Strauss, Lucky Stores, and the Mayo Clinic Trust. He’s also worked in the administrations of Presidents Bill Clinton and Richard Nixon.

The firm’s investment strategy centers on buyouts, buildups and growth financings of small and mid-sized companies. Nogales also has a feel for working with companies that target the growing U.S. Hispanic population, a strategy shared by only a handful of buyout firms, such as Palladium Equity Partners. At deadline, the firm was prepping an announcement of its first investment in a company—a chain of grocery stores in California—that caters specifically to Hispanics.

With help from the California Public Employees’ Retirement System and the California State Teachers Retirement System—two of the private equity world’s most sought after institutional investors, which both contributed $25 million—Nogales Investors raised $100 million for its inaugural fund.

“He has a sterling record in Los Angeles and Chicago,” Andre Rice, president of Chicago fund-of-funds manager Muller & Monroe Asset Management LLC, said of Nogales. Muller & Monroe invested $10 million in Nogales Investors Fund II LP.

Lackluster Returns

But results so far on Fund I are mixed. According to CalPERS, the fund has generated a 1.00x investment multiple and earned a negative 1.4 percent internal rate of return as of Dec. 31, 2007, figures that take into account all of the fund’s exits to date. By contrast, the firm targets a 2.7x investment multiple and 25 percent to 30 percent IRRs. “There were home runs and others that didn’t perform as well as we hoped for,” Nogales told Buyouts.

The firm made a total of six investments with Fund I: $9 million in Graphic Press in 2004; $11.5 million in G.I. Joe’s in 2004; $15 million in Alfa Leisure in 2005; $4 million in Chick’s Sporting Goods in 2004; an undisclosed investment in Insync in 2007, which merged with Graphic Press.; and an undisclosed investment in Video King Gaming & Entertainment. It’s unclear if the firm pumped more equity into the companies after the initial investments.

Nogales said his firm earned 3x its money and an IRR of more than 70 percent on both G.I. Joe’s Inc., a sporting goods retailer in which the firm invested $11.5 million in growth capital in 2004; and Chick’s Sporting Goods, another retailer in which it invested $4 million of growth capital in 2005.

Jim Chick, the company’s former owner and CEO, credits Nogales Investors with prepping the company to be bought by a larger entity. Mark Mickelson, a Nogales Investors partner, and Nogales helped the company better manage inventory costs and expand into four new locations. In 15 months, the company increased its revenues from $100 million to $146 million, Chick said. “They taught us to add value so there was an exit strategy down the road,” Chick said. “They were low-key. They spent a lot of time [learning] to understand [our] business before making suggestions on how [we] should be doing things.”

On the down side, Nogales Investors lost its $15 million investment in Alfa Leisure Inc., a maker of recreational vehicles in which the firm invested growth capital in 2005. High gas prices and the general economic downturn that hit soon after the investment killed the company, which closed its doors in April. Nogales said the firm could not have foreseen how bad the housing crisis—which naturally curtailed sales of gas-guzzling RVs—would become. “We were caught,” Nogales said. “We knew [the business] was cyclical, but we thought it would turn around.”

Nogales Investors might still be able to salvage the performance of Fund I with its two remaining companies: Video King Gaming Entertainment, which makes electronic gaming equipment, and Insync Media, a commercial printer. The latter industry has been suffering from declining advertising sales, although Nogales said new customers in the entertainment sector and the automotive industry have led to increased revenues at Insync Media.

Second Fund

CalPERS and CalSTRS committed $46.5 million and $30 million, respectively, to the $245 million Nogales Investors Fund II LP, closed in September 2007. The firm also landed commitments from the State of Connecticut Retirement & Trust, The Los Angeles City Employees Retirement System, and the Philadelphia Board of Pensions & Retirement, as well as from Muller & Monroe.

“We helped Luis Nogales form a fund in 2001. He has done a good job raising money from other partners and is building his firm,” CalPERS spokesman Clark McKinley said in an e-mail. “It will take a few years to develop a track record.”

Rice, of Muller & Monroe, said his asset management firm invested in Fund II in mid-2005, when the outlook for Fund I was brighter. “The jury was still out with Fund I, and obviously Fund I has had its difficulties, which always gives you pause,” he said. But he added that anyone who invested in the automotive industry at the time Nogales Investors invested in Alfa Leisure probably got burned, and credited the firm with being much more conservative since the economic downturn. “They’ve been very cautious on investing,” he said. “They’ve taken their time, and they’ve kept us posted very diligently.”

Nogales Investors recently made its first investment with Fund II—a year after it closed—pumping $15 million into Naartjie Custom Kids Inc., a retailer of children’s clothes. And at deadline, the firm was nearing the close of its investment in the California supermarket chain. Nogales said the firm had been holding back on deals because sellers’ expectations have not come down to market realities—a prevalent theme in today’s deal market. “You’ve got sellers wanting pricing from a year-and-a-half, two years ago,” Nogales said.

Another challenge for Nogales Investors has been stemming turnover: Since Fund I closed, Nogales Investors has lost three executives. According to Nogales, Steve Tolbert, the CFO, left to join a non-profit organization; Mina Martinez, a v.p., relocated to New York with her husband, who Nogales said is employed by Apollo Management; and Kenny Leung, v.p., also relocated to New York when his fiancé moved there. None of them could be reached for comment.

Nogales to some extent downplays the departures, noting that he and Mickelson, who helped start the firm, comprise the core of Nogales Investors. Further, Nogales said that a number of senior advisors have been associated with the firm from the beginning, including Bob Smith, a former chairman of Security Pacific National Bank; Matthew Fong, the former California State Treasurer; and Art Velasquez, founder and CEO of Azteca Foods in Chicago.

In addition, Nogales Investors has been beefing up its staff, which now boasts seven investment professionals compared to the four that invested Fund I. Hires include Keller Norris, principal, who has 11 years of mid-market investing experience at Vintage Capital Partners, a mid-market shop, and as a senior associate at Houlihan Lokey Howard & Zukin; Omar Karame, principal, formerly of growth equity fund Stone Canyon Venture Partners, who also has experience as a senior vice president of mergers and acquisitions at Alliance Imaging Inc. and as an investment banker at Donaldson, Lufkin & Jenrette Securities Corp.; Vince Lawler, principal, who specialized in advising mid-market companies as a director at Greif & Co., a Los Angeles investment bank; and Jorge Sandoval, vice president, a former vice president in the structured finance division of GMAC Commercial Finance. Joseph Choi, vice president of finance and former assistant vice president of portfolio accounting at Koll Bren Schreiber Realty Advisors, replaced Tolbert, the former CFO.

If the pressure is on Nogales and Mickelson to prove themselves with Fund II, the pair are pushing their newly expanded team just as hard. Nogales went so far as to say that he doesn’t expect all members of the investment team to make the cut. That’s because at a small firm, mid-level investment pros have more responsibility, he said. “Not everybody progresses,” he said. “In small firms, everybody has to be carrying their water.”