PE Week Wire: Thursday, December 18, 2008

I have never used this space to write about the protracted battle between Huntsman Corp. and Hexion Specialty Chemicals. And it would seem that the opportunity has passed me by, given that both sides recently agreed to a termination of their $6.5 billion merger agreement, and to a $1 billion settlement of Huntsman’s litigation against Hexion owner Apollo Management.

But I beg of your indulgence, because I’ve been left with a nagging question since the settlement was announced on Sunday night: Namely, who exactly is paying the various pieces of that $1 billion? To be sure, it isn’t all coming out of Leon Black’s pocket. Perhaps more importantly, some of the pockets involved seem to be getting picked.

What follows is based on interviews with limited partners in some, or all, of Apollo’s past four funds. In addition, peHUB has obtained confidential correspondence that Apollo sent its investors on December 15. Apollo itself declined to comment.

To begin, it’s important to understand the origins of Hexion and it was planning to pay for its acquisition of Huntsman.

Hexion was officially formed in 2005 as a roll-up of three different chemical companies: Borden Chemical, Resolution Performance Products and Resolution Specialty Materials. Apollo held Hexion as a portfolio company of both its fourth and fifth funds, because the Resolution investments were originally made out of Fund IV, while Borden was made out of Fund V. Apollo had also ensured that the investments were profitable for limited partners of both funds, via dividends.

By the time Hexion agreed to acquire Huntsman, however, Apollo was in the midst of investing its sixth fund and was talking about raising a seventh. Its solution was to fund the equity portion with the newer money. Funds IV would get cashed out (I’m not certain about Fund V), which was welcome news given that the vehicle was raised back in 1998.

Fast forward to last Sunday, when the deal officially died. In its official statement, Huntsman said that the agreement included an aggregate of $1 billion in considerations. This included:

• Huntsman would receive a $325 million breakup fee, to be paid by banks Credit Suisse and Deutche Bank.

• Huntsman would receive $425 million in cash payments from “certain Apollo affiliates.”

• Apollo affiliates would buy $250 million for 10-year convertible notes, which could be converted into Huntsman common stock or repaid in cash at maturity.

My assumption was that Apollo would pay most of the settlement out of its newer funds (and perhaps via its publicly-traded AAA affiliate), since they were the ones that stood to profit had the merger gone through and proven financially successful. Moreover, they were the ones financing it in the first place. At worst, it would share the pain pro rata with Funds IV and V.

What Apollo actually did, however, is troubling. Here is what it told LPs, as part of its Dec. 15 letter:

“Under the settlement, Apollo Funds IV and V will pay Huntsman $225 million. An affiliate of the General Partner will pay $200 million to settle all claims, and we are hopeful that a portion of these payments will be covered by existing insurance policies. Apollo entities will also be sharing certain proceeds when and if received by Huntsman as a result of the Texas litigation against the banks were it to settle. This is a potential offset to the settlement payments.

In addition, Apollo Fund VI and its co-investment affiliate AAA have agreed to purchase $250 million of senior convertible notes of Huntsman, with a 7% interest rate and a conversion price of $7.86. Based on updated macro-economic assumptions, this investment is underwritten to a mid 20’s internal rate of return.”

To be specific, Fund IV is being asked to pay $70 million, while Fund V is being asked to pay $155 million. In other words, the only Apollo funds paying actual penalties – monies that cannot be recovered by future performance of Huntsman common stock – are the only two funds that could never have profited from the Huntsman-Hexion merger, had it gone through. Fund VI and AAA, on the other hand, don’t pay a dime in unrecoverable monies.

But wait, it gets worse. Not yet reported is that Apollo also decided that Funds V, VI and AAA would invest an additional $200 million into Hexion “for general business purposes… This investment will be senior to the common equity.” In other words, not only does Fund IV pay out instead of cashing out, but now it’s getting crammed down on its remaining Hexion stake.

Imagine being an LP in Fund IV but not in Fund VI (and there are some). If it were me, I’d be on the phone with my lawyer before sending out a check by next Tuesday’s due date.

Apollo obviously won’t explain itself to me, but one theory is that Fund IV is no longer allowed to make new investments, due to its advanced age. In fact, the Fund IV capital call letter refers to the payment as an “operating expense.” Again: If you’re an LP in all three funds, this doesn’t matter a bit. But if you’re only in Fund IV, only in Fund V or only in both of them, you’re getting taken advantage of.

Whole thing reminds me of a political campaign I was once a part of. Everyone worked the field on election day, and we were told during orientation to knock on our voters’ doors at least five times throughout the day. Someone pointed out that such persistence might actually annoy our voters, particularly if they’d already gone to the polls. Our field director replied: “If they’ve already voted for us, then we can’t lose their vote. It no longer matters if we annoy them.”

Apollo apparently believes that its Fund IV and Fund V LPs have already voted. It no longer matters if they get annoyed.

Top Three

BCE Inc. has sued its would-be buyers, arguing that it is entitled to a C$1.2 billion breakup fee.

MatlinPatterson has agreed to make a $250 million PIPE investment in Flagstar Bancorp Inc. (NYSE: FBC), the largest publicly-held savings bank based in the Midwestern U.S. Following the transaction, MatlinPatterson would own approximately 70% of Flagstar’s fully diluted outstanding equity.

CalPERS has named Anne Stausboll as its new CEO. She previously had been serving as its interim CIO. An official selection for CIO is expected later this week, with The Carlyle Group’s Bob Grady reported to be a leading candidate.

VC Deals

Prosensa BV, a Dutch developer of RNA-based therapeutics, has raised €18 million in Series B funding. GIMV and AGF Management co-led the round, and were joined by return backers Abingworth Management, Life Sciences Partners and MedSciences Capital.

Mavenir Systems Inc., a Richardson, Texas-based provider of network convergence solutions, has raised $17.5 million in Series C funding. An undisclosed new investor was joined by return backers Austin Ventures, North Bridge Venture Partners and Alloy Ventures. The company has now raised $51 million in total VC funding since October 2005.

Pixim Inc., a Mountain View, Calif.-based provider of image sensors and processors for enterprise security cameras, has raised $13 million in new VC funding from return backers Mayfield Fund, Ridgewood Capital and Tallwood Venture Capital.

ExaGrid Systems Inc., a Westborough, Mass.-based provider of disk-based backup solutions with byte-level data de-duplication, has raised $12 million in Series D funding. Listed shareholders include return backers Highland Capital Partners, Lehman Brothers Venture Partners and Sigma Partners. The company has now raised over $87 million in total VC funding since 2002.

Taptu, a Cambridge, UK-based pure-play mobile search engine, has raised £6.45 million in Series B funding from return backers 3i Group and Sofinnova investments.

Clear2Pay, a Brussels-based provider of payment solutions for financial institutions, has raised €6 million in VC funding from return backers AGF Management, IRIS Capital, Big Bang Ventures, GIMV and Trust Capital.

ProspX Inc., an Austin, Texas-based provider of collaboration and automation applications for the commercial insurance industry, has raised $6.5 million in Series A funding led by Adams Capital Management.

Cornerstone Pharmaceuticals Inc., a drug development company focused on cancer bioenergetics, has raised $6 million in new angel funding. It has offices in both Stony Brook, N.Y. and Cranbury, New Jersey.

Overture Technologies, a Bethesda, Md.-based provider of decisioning software solutions for mortgage and educational lending, has raised $6 million in Series C funding. Capital Trust Ventures led the round, and was joined by return backers CNF Investments and New Markets Growth Fund.

Entra Pharmaceuticals Inc., a Waltham, Mass.-based drug delivery startup, has raised $4.23 million in the first tranche of its Series A round, according to a regulatory filing. The round would be expanded to $12.5 million by November 30, 2009, based on the company reaching certain milestones. Backers include Flybridge Capital Partners and North Bridge Venture Partners.

CalciMedica Inc., a La Jolla, Calif.-based drug startup focused on autoimmune and inflammatory diseases, has secured $4 million of a $12 million Series C round, according to a regulatory filing. Backers include Biogen Idec, Sanderling Ventures and S.R. One Ltd. Inc., a London-based operator of an online tracking index for concert listings, has secured $3.5 million of a $4 million Series A round led by Index Ventures. The round includes an option to be expanded by $2 million. SongKick previously raised a $1.1 million round of convertible note funding from individual angels.

Solar Cell Repower, a Norwegian company focused on improving the efficiency of solar cells, has raised NOK 10 million ($1.48m) in Series A funding from return backer NorthZone Ventures. It also has secured another NOK 12 million in grants and loans from Innovation Norway.

Nayatek, a Newark, Del.-based provider of enterprise information management solutions, has raised an undisclosed amount of Series A funding led by Originate Ventures.

Buyout Deals

The Arena Football League has chosen to suspend its 2009 season. The league reportedly had been in talks with Platinum Equity about a $100 million investment, in exchange for a 40% ownership stake.

BIA Digital Partners has acquired the assets of Douglas Publications LLC, a Richmond, Va.-based business information resources company. No financial terms were disclosed for the deal, which includes renaming the acquired company Briefings Media Group LLC.

Caltius Equity Partners of Los Angeles has invested $15 million in SeniorBridge Family Cos., a New York-based provider of home chronic care services. The deal is the sixth investment out of Caltius’ second private equity fund, Caltius Equity Partners II LP.

Checksmart Financial Co., a Dublin, Ohio-based check cashing business owned by Diamond Castle Holdings, has closed its payroll advance operations in Ohio. The move comes following a new state law that made the business more difficult to maintain, and caused Moody’s to suggest that Checksmart may be unable to service its leveraged loans.

Chrysler said yesterday that it would shut down all of its manufacturing operations from the end of this week for at least a month. Cerberus Capital Management holds a majority stake in Chrysler.

Marsun Company Ltd., a Thai shipbuilder, has raised $5.6 million from the Aureos South-East Asia Fund.

Windjammer Capital Investors is in talks to buy S.T. Specialty Foods Inc., a Brooklyn Park, Minn.-based maker of pasta and rice products, from Swander Pace Capital.

PE-Backed IPOs

BioTrove Inc., a Woburn, Mass.-based maker of instruments and consumables for genomic analysis, high-throughput screening and molecular diagnostics, has withdrawn registration for a $75 million IPO, citing unfavorable market conditions. It had planned to trade on the Nasdaq, with Piper Jaffray and Lazard Capital Markets serving as co-lead underwriters. BioTrove has raised over $43 million in VC funding since 2002, from firms like Catalyst Health & Technology Partners (35.1% pre-IPO stake), CB Health Ventures (17.1%), Vox Equity Partners (14.3%), Biofrontier Partners (6.1%), Fletcher Spaght Associates (6.2%) and Pfizer.

Zonare Medical Systems Inc., a Mountain View, Calif.-based developer of ultrasound systems for diagnostic imaging, has withdrawn registration for an $86.25 million IPO. It had planned to trade on the Nasdaq under ticker symbol ZONE, with Citi and Piper Jaffray serving as co-lead underwriters. The company has raised around $171 million in total VC funding since 1999, from firms like Frazier Healthcare Ventures (25.2%), 3i Group (18.4%), Earlybird Venture Capital (13.9%), Draper Fisher Jurvetson (13.2%), Mosaix Ventures (9.9%) and CB Healthcare Ventures (7.1%).

PE Exits

Wyeth Pharmaceuticals, a unit of Wyeth (NYSE: WYE), has acquired Thiakis Ltd., a UK-based developer of peptide hormones for the treatment of obesity. The deal includes a $30 million up-front payment, and up to $120 million in possible earn-outs. Thiakis raised a £10 million Series A round in 2006 from Novo AS, Advent Venture Partners, The Royal Society, Esperante, Consensus Business Group, NPI Ventures and Imperial Innovations.

PE-Backed M&A

Axeda, a Foxboro, Mass.-based provider of on-demand remote service software, has acquired Questra Corp. of Redwood City, California. No financial terms were disclosed. JMI Equity formed Axeda in 2005 by acquiring the DRM business of ITA Holdings. Questra had raised over $52 million from Menlo Ventures, SAP Ventures and Trident Capital.

Firms & Funds

Kingsman Capital has launched as a Chicago-based private equity firm focused on opportunities in the middle markets. It is being run by Keith Konesman, who has previously held positions with Merrill Lynch, Dresner Partners, Divine Interventures and Banc of America Securities.

Sequoia Capital has raised $200.75 million for its fourth Israeli venture capital fund, according to a regulatory filing.

Pantheon Ventures is raising upwards of $4.75 billion for its fourth global secondaries fund, according to a regulatory filing.

Human Resources

President-elect Barack Obama plans to nominate Mary Schapiro to become chairwoman of the SEC.

James Gamett has joined StepStone Group to run the firm’s new secondaries division. He previously was a vice president with Portfolio Advisors.

Erik Thornell has joined Segulah Advisor as head of banking. He previously was with Swedish bank SEB.