Parthenon Still Biting From Atkins Deal –

Parthenon Capital recently washed its hands of Atkins Nutritionals Inc., the low-carb company that went from plump to emaciated in less than a year. Now, Parthenon is asking limited partners to forgive its transgression, and to pony up for a new $1 billion fund.

“Atkins is a big issue for us, and I still don’t know if we’ll get over it,” said an existing Parthenon investor whose organization has not yet agreed to re-up. “They continue to have positive exits that are going to make the current fund a top performer, but some of the decisions [regarding Atkins] might be too egregious to ignore.”

Parthenon took control of Ronkonkoma, N.Y.-based Atkins in October 2003, as part of a $533 million leveraged buyout that also included minority participation from Goldman Sachs Capital Partners. At the time, most marketwatchers gave Parthenon high marks for the win, due to Atkins’ position as the unrivaled king of a dietary movement laying waste to doughnut shops across the nation. Even better, Atkins’ rapid growth was based on retail sales of its branded and co-branded food products like low-carb snack bars, rather than on membership dues or meeting fees (a.k.a. the Weight Watchers model). This was not about moral support-it was about tangible and pragmatic help for the millions of Americans who wanted to lose weight without giving up meat or dairy.

For Parthenon investors, however, not all that glittered was gold. First, Parthenon had committed approximately 20% of its $750 million second fund to the deal. Such outsized ratios are generally frowned upon by limited partners, and many partnership agreements specifically prohibit more than 10% of fund capital going to any single portfolio company (although such language is not present in the Parthenon fund agreement).

Second, the Atkins deal was large enough to have qualified for a deal-sharing and co-investment arrangement between Parthenon and Summit Partners. The two firms were operating under what could generously be called a tenuous relationship-Parthenon co-founder Ernest Jacquet was a former Summit general partner who had violated his old partnership agreement when Parthenon bought a former Summit portfolio company-and Summit was outraged when it wasn’t informed of the Akins deal.

It immediately cried foul, and Parthenon agreed to pay $20 million to both placate Summit and to cancel the deal-sharing agreement. The money came from the personal pockets of Jacquet and his fellow Parthenon co-founder John Rutherford, but LPs were left wondering why Summit hadn’t been cut in, particularly when it could have reduced Parthenon’s massive capital commitment. Some also weren’t pleased that they learned about the deal-sharing arrangement only after Parthenon had agreed to pay the $20 million.

The only saving grace was continued faith that Atkins would produce mega-returns, but signs soon appeared that the company was headed for trouble. Most problematic was that the actual number of low-carb devotees seemed to be dropping while the number of low-carb products was increasing. Shipments of foodstuffs from Atkins and its rivals went unused and rotten while sitting in warehouses, as more and more Americans began to remember how much they liked bread and disliked dieting. Atkins’ revenue began to slump, its bank debt was informally discounted on the secondary market and the company was forced to begin laying off some of its 370 employees in September 2004.

Despite the dark clouds, Parthenon apparently remained convinced that it had at least a modest winner on its hands. The Boston-based firm launched its third fund-raising effort in October, with a $1 billion target and expectations of a final close occurring well before year-end. Most limited partners, however, were cautious. Parthenon received a few immediate soft circles from large institutions, but others wanted more information on Atkins, particularly after The New York Times ran an Atkins-centric article asking “Is the Low-Carb Boom Over?”

“I think they wanted to get it closed while Atkins was still up in the air,” suggested another Parthenon limited partner who has still not committed to Fund III.

As Parthenon and its placement agent kept making fund calls, the Atkins situation continued to deteriorate. Parthenon took a 50% valuation haircut on the deal at the end of December, installed a new CEO in February and then wrote off the entire investment around the end of March. Last week, the company filed for Chapter 11 bankruptcy protection, as part of a reorganization that will transfer Parthenon and Goldman Sachs’ equity to Atkins lenders. John Rutherford plans to remain active as an advisor during the transition, but Parthenon no longer will have any financial stake in Atkins’ future.

Will They Commit?

Atkins is not the only reason that Parthenon has yet to close its fund, but it’s a big one. What makes the decision difficult, however, is that Parthenon’s second fund may still produce quality returns.

According to documents made public by The University of Texas Investment Management Co., Parthenon Investors II had a 23.6% internal rate of return (IRR) through the end of February (which would include the December markdown of Atkins, but not the March write-off). Among its bigger hits have been successful IPOs for Interline Brands Inc. and Rackable Systems Inc., and sales of Arrow Financial Services Inc. and Spheris. There also are a couple more under-performers in the mix, but the IRR and redistributed capital seems to speak for itself.

Existing limited partners said that Parthenon likely will hit its target, particularly after promising that Jacquet and Rutherford will remain in place as senior managers. They add, however, that the firm likely now realizes that several Fund II investors will not return for Fund III.

Parthenon declined to comment for this story, citing SEC restrictions related to its ongoing fundraising effort.