Leonard Green Shops For Brand-Name Retailers At Bargain Prices

Firm: Leonard Green & Partners LP

Latest Fund: Green Equity Investors VI LP ($6.25B)

Raised Since Inception: $15 billion+

Sector Focus: Retail, consumer products, health care, financial

Founded: 1989

Investment Pros: Led by Managing Partners John G. Danhakl, Peter J. Nolan, Jonathan D. Sokoloff

Private equity firms and consumers both want good value for money and a shopping experience that is pleasant enough to want to come back, again and again.

Leonard Green & Partners
, the preeminent private equity firm in the consumer retail space, has learned a thing or two about shopping in the 23 years since it was founded by its namesake, who died in 2002. The firm has owned, at least jointly, such blockbuster retail names as BJ’s Wholesale, Equinox Fitness, J. Crew, Neiman Marcus, Petco, Rite Aid, Sports Authority, The Container Store and Whole Foods.

“The companies we invest in are fun companies,” said Jonathan Sokoloff, one of the firm’s three managing partners. “People relate to them, they shop at them,” he said. At meetings “investors say they went to The Container Store last week and loved it, or my wife went to Whole Foods. It makes a meeting more tangible, more real life. And like Peter Lynch [of Fidelity Magellan-fame], we invest in what we know and what we like.” Sokoloff spoke to Buyouts at the SuperReturn conference in Boston in early June.

Great Returns

Los Angeles-based Leonard Green, which has raised $15 billion in private equity capital, has parlayed its knowledge of the consumer retail industry into a portfolio of retail store brands that has delivered some of the best returns in the industry.

Over the past 20 years, the firm has delivered 37 percent gross IRRs and a 1.9x return multiple on invested capital, according to a Sept. 2011 presentation at the New Mexico State Investment Council. And in an analysis of the 182 buyout funds from the 63 largest firms that were raised between 1996 and 2005, Leonard Green’s funds were ranked first overall in the 2009 Gottschalg Private Equity Performance Rankings.

Part of the firm’s consistent growth can be credited to what didn’t happen. “We kept our wits about us in the financial crisis,” said Sokoloff. “A lot of funds came out of the financial crisis with one or two real big problems…And while we certainly had our challenges and difficulties, and our portfolio really got smacked around and took some hits, we really didn’t make any bad mistakes.”

Leonard Green’s enviable performance has created a stampede of interest for the firm’s latest fund, Green Equity Investors VI LP, from public pensions (see accompanying chart) and other institutional investors. Fund VI closed last month having raised $6.25 billion, well above its initial $5 billion target. Moreover, the fund was raised in just nine months, an extremely rapid pace for such a large fund in the current fundraising environment.

“We carved out a very nice niche for ourselves,” Sokoloff said. “We marketed ourselves as a leader in the retail space, and investors wanted that expertise,” he added. The firm’s two other managing partners are Jon Danhakl and Peter Nolan.

Among the pension systems that have pledged at least $100 million to Fund VI are the New York City Comptroller’s Bureau of Asset Management and the Washington State Investment Board, each of which committed $300 Million; the Florida State Board of Administration, the Illinois Teachers’ Retirement System, the Minnesota State Board of Investment, and the New York State Common Retirement Fund, each of which pledged $200 million; the Oregon Investment Council, which committed $150 Million; and the State of Wisconsin Investment Board, which pledged $100 Million. Other large investors include sovereign wealth funds, insurance companies and foundations. For Fund VI, Leonard Green did not use a placement agent.

Notably absent among investors in Fund VI is the California Public Employees Retirement System, which was not, according to one industry source, granted the fee discounts that it sought. The firm “didn’t discount anyone,” said one source to Buyouts in May. “It didn’t have to.” Terms for the fund were said to be management fees of 1.5 percent and a 20 percent carry, in addition to a 100 percent fee offset, which has fast become an industry standard.

As far as deals, Leonard Green has been on a shopping spree. Since the start of 2011, the firm has bought stakes in Jo-Ann Stores, a fabric retailer, in a deal worth $1.6 billion; Savers, a thrift-store chain, in a deal worth $1.6 billion; BJ’s, the wholesale club, in a $2.8 billion deal; and J.Crew, the preppy clothes retailer, in a deal worth $3 billion. The firm also narrowly lost bids to buy Party City and 99-Cents Only Stores.

Some of the deals that the firm has done are take-privates. J.Crew, BJ’s and Jo-Ann stores were all publicly listed before being taken private. The firm is also known to buy companies from other private equity firms, including Savers, which it bought from Freeman Spogli.

One worry that investors may have is that Leonard Green has done a number of deals in combination with other private equity partners. While the firm is known to prefer doing deals on its own, it teamed up this month with TPG Capital to buy part of Savers. In addition, press reports indicate that Leonard Green and TPG were also seeking to sell David’s Bridal, a wedding-dress chain, which they bought together in 2007. Leonard Green and TPG have partnered on deals to buy stakes in J.Crew, Neiman Marcus and Petco. In addition, Leonard Green teamed up with CVC Capital Partners to buy BJ’s.

Such combinations have the advantage of making larger deals possible and spreading out a deal’s risk, but some investors may be concerned that such deals dilute a firm’s distinctiveness. And many investors are wary of being invested in the same portfolio company through different firms.

Unlike many firms, such as Kohlberg Kravis Roberts & Co., The Blackstone Group and Cerberus, that reduced their flagship fund sizes in the aftermath of the financial crisis, Leonard Green’s Fund VI was more than 20 percent larger than its 2007 vintage, $5 billion predecessor. And while a bigger fund reflects the firm’s growing success, it also presents an existential challenge to the firm, namely, what kind of a firm is Leonard Green anyway?

“We used to be at the upper end of the middle market,” said Sokoloff. “But what size we are now, I don’t really know.”

Although Leonard Green wants to avoid the mega-fund label (“mega-fund is still a bad word,” Sokoloff said), there are now several leading sector specialists that have raised multi-billion funds, including Providence Equity (media), Vista Equity Partners (software), and Energy Capital Partners.

Regardless of how investors classify the firm, however, one thing is clear: Leonard Green’s larger size means that the firm can invest in bigger companies. “We’re very happy with our fund size,” said Sokoloff. “We’re able to buy better businesses.”