McCown De Leeuw & Co. (MDC) is almost out of dry powder from its $750 million fourth fund, and doesn’t have strong enough performance to justify a follow-up.
Bob Hellman, CEO of MDC, met with several fund placement agents last year, and basically was told that MDC had neither the performance nor personnel to raise a fifth fund. Its current vehicle is underwater with little hope of returning more than 80% or 90% of investor capital, despite continued ROI hopes for cemetery operator StoneMor Partners (Nasdaq: STON).
The typical responses might be to close up shop or send out PPMs, but MDC thinks it has found a third option: The firm is raising investment capital from the public markets.
If successful, the move could shine a viable beacon for other private equity firms fearful of being shunned by “traditional” limited partners.
If the effort fails, however, it likely would signal a death knell for MDC after 23 years of middle-market investing.
“I think it’s grasping at straws, but they deserve extra credit for trying,” says an MDC limited partner who would not have supported a fifth fund.
MDC’s strategy involves the formation of a special purpose acquisition company (SPAC), which otherwise might be known as a “blank check” acquisition company. Such vehicles have a history as the domain of penny-stock traders, but they have experienced a recent surge in respectability and volume due to the involvement of such respected boutique underwriters as EarlyBird Capital, Rodman & Renshaw and Broadband Capital.
The typical SPAC involves a group of operating executives who raise an IPO with the promise that they will try to acquire one or more companies in a loosely defined industry. There also exist a few shareholder protections – such as about 90% of IPO proceeds must be held in escrow and acquisitions require a majority of shareholder approval – but SPACs are basically amorphous, asset-less vehicles that ask investors to trust the managers, not the plan.
So will the public markets bite? Probably, say market analysts, noting that MDC Acquisition Partners is unique among SPACs, in that it is offering public investors a chance to buy into a private equity team (no matter how diluted). Moreover, the SPAC market is huge right now among hedge fund managers attracted to detachable warrants.
But what does the offering mean for MDC? And what would a SPAC signify for the private equity market? The answers depend on success or failure, but failure likely would mean the end of MDC and probable stillbirth for any more reverse PIPE (private investment in public equity) efforts:
If MDC raises its IPO and makes a couple of profitable deals, the firm may receive more than just kudos. It may also earn MDC another shot at the private equity fund-raising market, given a revised and timelier track record. In fact, a placement agent who met with MDC thinks that this might be the entire idea. If not, MDC could always just keep raising SPACs, so long as its reputation continues to be rehabilitated.
MDC’s previous fund had an 8.7% IRR – or 1.3X committed capital – as of Dec. 31 of last year, according to the California Public Employees’ Retirement System, which put MDC in the third quartile. Fund III returns will be pumped up by the pending $1.6 billion sale of 24 Hour Fitness Worldwide Inc. to Forstmann Little & Co., but many of the fund managers from that time are long gone.
In fact, CEO Hellman is arguable the only active investing partner left, with George McCown basically retired, Jack Murphy, serving strictly as an operating partner and a long list of folks who since have moved on to other firms – including David King of Bear Stearns Merchant Banking and Tyler Zachem of MidOcean Partners. The firm added former Wit Capital pro Matthew Carbone this year, although he was brought on to help with the SPAC.
Nonetheless, other private equity firms may follow MDC’s lead. This is particularly true in the middle-markets – in which MDC specializes – given the glut of private fund-raising efforts and the difficulty of finding more than a few proprietary deals. The management and transactional fees may not be as lucrative as with a traditional fund, but it’s better than being out of business.
Hellman declined to comment, citing SEC “quiet period” restrictions. MDC Acquisition Partners currently is in registration for an $80 million IPO (Wedbush Morgan Securities is the lead manager). The firm says its acquisition targets are companies “that provide services to businesses and those that focus on the consumer as the end customer, although [its] acquisition efforts will not be limited to any particular industry.”
Executives Hellman, Matthew Carbone, George McCown, Judith Bornstein, Jeffrey Zawadsky, Kunel Sarkar and Nancy Katz are members of MDC, while independent directors include Jeff Drazen of Sierra Ventures and Mark Lerdal of energy company KC Holdings.