peHUB Wire: Monday, March 2, 2009

Two months ago, we reported that Sun Capital Partners had laid off just over 10% of its 200-person staff. My gut take was one of confusion. Shouldn’t a distressed investor like Sun be preparing for its salad days? Doesn’t Sun need an outsized staff, to execute on its strategy of intense, hands-on interaction with portfolio companies (operating execs in-house instead of by the phone, weekly reporting by portfolio cos., etc.)? And shouldn’t Sun have plenty of management fee income rolling through the door, given that it’s investing out of a $6 billion fund that is just 26% called down?

All of these questions came flooding back to me over the weekend, when I got word that Sun had laid off another 12 investment professionals. These new cuts follow Sun’s decision last month to close its Tokyo office (one deal in three years), and means that the firm has canned approximately one-third of its investment staff in 2009. Moreover, the firm has no plans to either reduce its fund size or reduce its fund management fees.

So I posed my questions directly to Sun, which emailed over the following statement:

“As part of our annual review process, Sun Capital made a modest reduction in our deal, operations, and support staff by eliminating certain positions in our Boca Raton and New York offices. Roughly half the positions were eliminated in our New York office following a change in leadership. We believe Sun Capital has an excellent team to lead us into the future. We also believe this economic environment offers an excellent opportunity — perhaps the best buying environment since 1980, and the opportunity to achieve historic returns for our investors.”

While I was pleasantly surprised to receive a response outside of normal business hours, the statement itself offered little more than confirmation of the layoffs (which Sun doesn’t even characterize as such). But some current and former Sun employees were a bit more helpful, as were a couple of its limited partners. Specifically, they offered an alternate explanation for why Sun might be cutting headcount so drastically. The details of what I’m about to describe have been confirmed by multiple sources. The conclusion is mostly mine.

Like most every private equity firm, Sun Capital Partners charges its LPs an annual management fee on its funds. This works out to hundreds of million of dollars over the first few years of a $6 billion fund’s life.

Unlike most private equity firms, however, Sun does not use that money to pay staff salaries, bonuses, travel expenses or office expenses. Instead, the majority of that capital is used for the general partner contribution to Sun’s fund, on behalf of Sun’s co-CEOs and a group of other senior managers. To “keep the lights on,” Sun mostly relies on transaction fees and portfolio company monitoring fees.

Why would Sun structure itself this way? The basic answer is that it’s a tax play. By pushing management fees back into the fund as GP contributions, the senior managers can avoid paying taxes on that capital as ordinary income. Instead, they hope for carried interest – on which they’d pay at a 15% rate (at least for now).

Sun is not alone in employing this bifurcated system, and it works fine. Well, it works fine so long as transaction and portfolio management fees keep flowing. If they dry up, then who pays to keep the lights on?

That is arguably the situation Sun now finds itself in. Portfolio monitoring fees are still coming in, but new transactions (new deals, add-ons, liquidity events, etc.) are less common than flights leaving LaGuardia this morning. Less cash coming in means less cash available to go out… which means fewer mouths to feed.

To reiterate, Sun declined to comment on anything related to its fund management structure. And I’m almost certain it would argue that my analysis is off-base. But the reality is that private equity firms with billions in dry powder should have little cause to engage in mass layoffs – unless they couple such moves with fund size or management fee size reductions.

Sun, however, is requiring its investors to pay as much today as it was requiring them to pay last December, even though Sun’s personnel expenses have dropped substantially. That math just does not add up.

*** Publishing Note: I opted to push my trip to Colorado back a day, due to the weather. As such, Erin will be taking care of you tomorrow morning.

*** Shameless Plug: The Buyouts and VCJ Webinar on raising a new fund in 2009 is next Friday. If you register before March 6, you also get a complimentary copy of the Private Equity Fundraising Guide 2009.

Top Three

KKR is reevaluating its deal to acquire its Amsterdam-listed affiliate KPE, which was designed to result in KKR listing on the New York Stock Exchange.

Regency Energy Partners (Nasdaq: RGNC), Alinda Capital Partners and an affiliate of GE Energy Financial Services are forming a joint venture to finance and construct Regency’s Haynesville Expansion Project, a North Louisiana pipeline that will transport gas from the Haynesville Shale. Regency will contribute its Regency Intrastate Gas System in North Louisiana, for a 38% stake. Alinda will contribute $126.5 million in cash for a 12% stake, while GE will contribute $526.5 million for a 50% stake.

Apax Partners has completed its sale of UK supermarket chain Somerfield to The Co-Operative Group for £1.57 billion.

VC Deals

Zenprise Inc., Fremont, Calif.-based provider of mobile management automation, has raised $10 million in Series D funding. Ignition Partners led the round, and was joined by return backers Bay Partners, Mayfield, and Shasta Ventures. The company has now raised over $37 million since 2004.

FSV Payment Systems, a Houston, Texas-based provider of prepaid technology and stored value processing, has raised $6 million in VC funding, according to the Tampa Bay Business Journal. Backers include Ballast Point Ventures and North Hill Ventures.

Zibo Qilu Yixi Luhua Chemical Co., a Chinese maker of C5 separation products, has raised $2.5 million from Shenzhen Capital Group and China Israel Value Capital.

Shackleton Ventures, a UK-based secondaries firm, has acquired existing equity and loan interests in OmPropt Ltd., a UK-based messaging connectivity company. No financial terms were disclosed, except that Shackleton now holds a 49% equity interest in the company, and has committed to invest an additional £1 million for growth capital.

Buyout Deals

Clarion Capital Partners has won a bankruptcy auction to acquire the assets of fine china maker Lenox Group Inc. The deal is valued at approximately $100 million, including assumption of debt. KPS Capital Partners announced last month that it was the successful bidder for Lenox, but Clarion said the bidding process was reopened during a bankruptcy court hearing on Feb. 25.

Dow Chemical Co. is in talks to sell a piece of its agricultural sciences unit to private equity firms, according to The Wall Street Journal. The entire business is valued at between $5 billion and $7 billion, with potential buyers reported to include Blackstone Group and KKR.

KPS Capital Partners has agreed to buy certain assets of luxury tableware maker Waterford Wedgwood. No financial terms were disclosed for the deal, which includes assets within Waterford Crystal, the pottery business Wedgwood and fine china maker Royal Doulton. Not included are either German porcelain maker Rosenthal or the company’s production facilities at its Waterford crystal plant in Ireland.

MSouth Equity Partners has sponsored an acquisition of LMS Intellibound Group Inc., a provider of outsourced managed labor services, primarily to the grocery and food service sectors. No financial terms were disclosed, except that MCG Capital Corp. sold its position for $40.5 million.

Peter Davies, former CEO of UK women’s fashion brand Principles, has submitted a bid to buy his old company. No financial terms were disclosed. Principles is owned by Mosaic Fashions, in which Icelandic investment group Baugur holds a 49% stake.

TowerBrook Capital has agreed to acquire a 62.5% stake in French auto parts distributor Autodistribution Group, as part of a debt-for-equity swap. TowerBrook will invest 88 million, while AG’s prior owner, Investcorp, will invest €22 million to retain a 16% position. And additional €50 million will be made available for future acquisitions. Olivier Roux, an operating executive wit! h TowerBrook, will take over as CEO.

TPG Capital is offering to provide bankruptcy financing to portfolio company Aleris International Inc., according to The Financial Times. Specifically, TPG is asking the bankruptcy court judge to let it participate in a $500 million DIP financing consortium, which already would include Apollo Management and Oaktree Capital.

PE-Backed M&A

Aspen Surgical Products Holding Inc., a portfolio company of RoundTable Healthcare Partners, has acquired of the Wound Care and Ophthalmics business of UK-based Unomedical Ltd. No financial terms were disclosed.

PE Exits

3i Group has postponed its £100 million auction of UK luxury yacht and powerboat manufacturer Fairline.

Qualcomm has acquired certain assets of Digital Fountain Inc., a Fremont, Calif.-based provider of data content delivery systems. No financial terms were disclosed. The remaining Digital Fountain employees, including company founder and CTO Michael Luby, will work out of Qualcomm’s Santa Clara facility. Digital Fountain had raised over $60 million in VC funding from firms like Granite Ventures and Matrix Partners.

Firms & Funds

ABRY Partners has closed its Advanced Securities Fund with $700 million in capital commitments, according to Buyouts magazine. It had originally targeted $800 million for the fund, which will buy debt in struggling media companies. Read more (sub. req)

Human Resources

Ricardo Caupers has joined Palamon Capital Partners as a vice president. He previously was a principal in the London office of Boston Consulting Group.

Les Lyall has joined Toronto-based Kirchner Private Capital Group as a managing partner of the firm’s fund management subsidiary. He most recently was chief operating officer of GrowthWorks Capital.

Darcy Lai has left Barclays, where he served as head of Asia-Pacific investment banking. No word yet on the reason for his departure, or on a successor. He joined the firm in 2001, anmd also was in charge of debt capital markets.

Erik Prince has stepped down as CEO of private security firm Xe (f.k.a. Blackwater Worldwide), in order to focus on an unrelated private equity effort.

Alvaro de Molina, CEO of Cerberus-controlled GMAC LLC, was awarded $11.62 million in 2008 compensation, according to a regulatory filing.

Wells Fargo & Co. has suspended its bonus program for certain top executives, according to a regulatory filing.