JPMorgan Partners Pulls Surprise Split –

JPMorgan Partners will become the latest bank-affiliated private equity firm to spin out from its corporate parent, under a plan announced earlier this month. The move will result in a pair of independent firms-one focused on venture capital and one focused on growth equity and leveraged buyouts and one focused on venture capital-that both are expected to feature J.P. Morgan Chase as a significant limited partner.

One Equity Partners will remain under the J.P. Morgan Chase umbrella, while JPMP will retain management of a second Asia Opportunity fund currently being raised with a $1.2 billion target. The actual spinout will occur whenever each group holds a first close on their new funds, with the VC group looking for $400 million later this year, and the buyouts group seeking to raise $4 billion (inclusive of $1 billion from J.P. Morgan Chase) in early 2006. It still is investing out of its $6.5 billion global fund, which has approximately $2 billion of dry powder remaining.

But why spin out, and why now? Dan Primack, editor-at-large of Buyouts, last week put these questions, and more, to three senior JPMP partners who will help lead the prospective growth equity/buyouts firm: Jeffrey Walker, managing partner and co-founder of JPMP; Michael Hannon, a JPMP partner and co-head of the groups telecom, media and technology practice; and Steven Murray, a JPMP partner focused on the consumer, retail and industrial sectors. What follows is an edited transcript of that conversation.

Buyouts: The original market talk was that J.P. Morgan Chase would spin out One Equity Partners, but they’re staying and you’re leaving. When did serious discussions begin about a JPMorgan Partners spinout?

Jeffrey Walker: We’ve been talking since the [Bank One] merger about how we should interface with the organization. That’s taken a number of different iterations, including if One Equity Partners should spin off, or if we should spin off or what the mix should be. The bottom line in the end is that the institution came to the conclusion that they like private equity, but that they wanted to fund it all themselves. This is a little different than what we have, because our last fund has both inside money and outside money 65% from the bank and 35% from outsiders.

So we were given the choice as a group that we could either stay [with J.P. Morgan Chase] and be internally financed, or we could leave and continue to use outside money; but go for 75% instead of 35%, which is what we decided to do.

We have a great relationship with the institution and, particularly, with the senior managers who have been supportive of this process. Making the decision now was important because [One Equity Partners’] Dick Cashin and his team had to understand whether they were going to be out raising money, or if they were going to be internal. So again it was our choice, and we made it over the last several weeks.

Had you chosen to stay internal, does that mean that the bank would have put up all $4 billion for the next fund?

Walker: Well the current fund is $6.5 billion, and they would have put up an agreed-upon amount, but you don’t really need an official fund if all the money is coming from the bank itself.

A lot of banks have been spinning out or trying to spin out their private equity groups recently, often citing conflicts of interest with I-banking clients. The only such conflict I’ve heard about with JPMP involved the Warner Chilcott deal, so I was wondering how big a role that issue played in the spinout decision, if at all?

Stephen Murray: If you look at [private equity] groups at CSFB and Goldman, for example, they’re part of the investment bank. We’ve never been part of the investment bank, so the opportunity flow between the bank and JPMP has always come, more or less, on the basis of a banker/client relationship… a close relationship, but more arm’s length than the other firms. In addition, the investment decisions are made by the partners at JPMP, and in certain cases someone at the corporate level-but not at the investment bank-might sign off on those, depending on the circumstance. So I think we’ve always had a structural differentiation.

The Warner Chilcott example was the anomaly in terms of our interactions with both the bank and with the bank’s clients over time. And while that was a conflict as described by the other competing bidders, I don’t think that was a driving force behind this [spinout] decision.

Will the spinout have any significant investment strategy differences from JPMP, save for not having the venture capital component?

Michael Hannon: The short answer is no. We do a broad mix of growth equity and leveraged buyout transactions, and that is what the focus is going to be going forward.

Walker: We are lucky to have a team that is staying together going forward. We will remain global in the way we operate, with integration of the Asia team with the Europe and U.S. teams. We’re going to stay in the same industry concentrations, whether that be media, telecom, consumer retail, healthcare services, industrial, energy these are all core areas of expertise we have, and we’re not changing any of that.

Mike, you just mentioned growth equity. What are the smallest deals that JPMP will do?

Hannon: We’ll do deals that might, at first blush, appear very small. For example, I have a history of starting up with a couple of managers, and putting a couple of million of dollars behind them to work through the development of a business plan. But we’re not going to do that unless we think we can build those small $1 million or $2 million investments into $100 million-type investments. So that might be through build-ups, organic growth or some combination thereof.

A current example is a media company in the business-to-business space called Ascend Media, which just bought Medical World. That deal started with a couple managers and a million dollars, and we now have north of $50 million in that company, and it will continue to grow.

Are there certain bank-related research functions that you’re going to have to recreate in-house?

Murray: We’ve never had access to any of the bank’s research, so we already have that capacity in-house. To the extent that we reach out for economic or industry forecasts, we’d generally reach out to sell-side banking relationships both at J.P. Morgan and elsewhere.

Hannon: Because of our structure, we’re really treated like a third-party…

Walker: And because the regulators make that a requirement.

The spinout is expected to happen in late 2006. Why announce it now?

Walker: One reason is that we feel we have a fiduciary responsibility to tell limited partners when there is a material decision made. Also, because the bank is a publicly filing business, they believe they have to get out and release a decision related to a major strategy. And, third, Dick Cashin was on the verge of going on the road, so we had to announce it both for him and for the marketplace.

This also gives our organization a period of time to complete the investments in our global fund-which is about 60% invested-and to make sure that people making a decision about our Asia fund -which is on the road right now -understand what’s going on. The venture guys will probably start to raise funds in summer, early-fall…

Of this year?

Walker: Of this year, so we wanted to have a good story to talk to LPs about, and give them the broad picture: We’re going to continue to invest the current fund, continue to manage the current investments in an organized way, this is how the team is going to stay together, here is how we’ll do the Asia fund-raising, here is how venture will be included and, yes, we’ll be in the market probably at the beginning of 2006 raising the next global fund.

What has the initial LP reaction been to the news?

Walker: Feel free to call some-CalPERS is a big investor in our fund, as well as Caisse de Depot and CDP-but the basic response was “good job.” They asked if we were OK with it, and we told them it was our idea and that the team is staying together, so they said they were supportive.

You mentioned CalPERS. With your firm soon to be free of the public reporting requirements related to J.P. Morgan Chase, do you have any inclination to reduce your exposure to public funds, in order to reduce transparency?

Walker: We’ve been so public, that any adjustment is going to be less. But there is a point where I just philosophically believe we should be disclosing. If someone wants to track us on an annual basis performance-wise, or what deals we have, great. I don’t think any of them are really proposing disclosing really confidential information like results of our portfolio companies… but as for our performance, why shouldn’t people understand that and know that? In fact, I’ve been a big advocate-we all have-of a common valuation approach.

What’s going to be the relationship, if any, between your firm and the spun-out VC group? Any common management or ownership?

Murray: I don’t think there’ll be any common ownership. There probably won’t be cross-advisory boards, unless by coincidence there’s an LP who chooses to invest in each fund and sits on both advisory boards. But I would strongly emphasize that there are a variety of spaces in which coordination and cooperation will continue to be of value to both sides. We will have a portfolio with a significant number of companies that likely will be purchasing the enabling technologies-whether they be life sciences, technology or software- that our venture guys are investing in.

That’s kind of been the model for the last 20 years, but we just think that the specialization and the dedicated efforts and the compensation systems have drifted apart a bit too much. Therefore, having them independent from a structural, managerial and economic perspective is appropriate for both the general partners and limited partners.

One of the big back-office tasks you would seem to have is splitting up your total returns into VC and LBO buckets, so you have something to show prospective LPs. Has this been done yet, or is it in the process of being done?

Walker: Our prior fund documents had returns split up by categories, so we’re going back and updating that for the last couple of years. Venture will probably be done in the next month or so, and they look pretty good. And then we have ours which continue to look good, if not better, because the market has actually been pretty good over the last two years.

Are there any senior managers who will be leaving the group, as part of the spinout?

Walker: We have a group of founding partners who really are the senior partners going forward. So nothing really changes there. Tim Purcell is not going to be with the new fund on a long-term basis, although he is still working with us here.

He’s the guy who was running the Latin America activities for J.P. Morgan, and he continued to do that when we combined with J.P. Morgan. He just had twins and he and his wife would like to spend more time with their parents down in Chile, which is where they’re from. So we’re really supportive of that process.

How much attention have you paid to the proposed spinout-or perhaps non-spinout-of DLJ Merchant Banking Partners from CSFB, particularly in regards of things not to do?

Murray: Candidly, we all read the paper, so we’re aware of what’s going on there. And the leadership of J.P. Morgan Chase also reads the paper. So a lot of things that have developed there-as reported, we’re obviously not intricately involved- have been things that we have endeavored very hard to avoid, and I think we’ve been successful.

We worked this through cooperatively with the leadership of J.P. Morgan Chase, and I think we have the best interest of both J.P. Morgan Chase’s shareholders and of our limited partners-both the bank and the third-party money-at heart. What you read is what is being done. It’s something being done to enhance, for everybody, the business and economic opportunity.

Has there been any significant discussion yet of what you plan to call yourself?

Hannon: There has been a lot of discussion, but no conclusion. It’s amazing how many really great names there are out there that are already taken. Got any ideas?

Have you thought about Oak? It seems fairly popular…

Hannon: Something wood…

Or Granite…

Murray: Should we run a contest in your publication?

Works for us (Editor’s note: No such contest is being run:). Any final thoughts?

Walker: Our goal is to make this transparent to the market. The name might change, but we’re still the same people with the same strategy and the same profile. If we can make that transition smooth, we’ll be successful.