peHUB Wire: Wednesday, May 27, 2009

Today’s guest column is from Chris Douvos of The Investment Fund for Foundations (these views are solely his own). While Dan is out, send press releases for peHUB Wire to

A Hundred Days, A Hundred Months

Sometimes, I envy public market investors; occasionally I think, “wouldn’t it be nifty to actually see your investment theses play out in less time than a presidential term or two?” But then I remind myself how cool it is to watch portfolio companies flourish and strive and struggle and dream. It’s like watching your nieces and nephews – the ones you see only about once a quarter – grow and mature. And all that waiting and watching pays off. Doesn’t it?

I’ve been asking that question a lot lately. After all, on Day One of LP School we’re taught that there is compensation for patience. Illiquidity is one of the key risk premia we collect (right?). At Old Ivy, we always said, “fifteen percent compounded forever is a lot of money…”

But I worry that some in the PE world seek illiquidity solely for illiquidity’s sake. Or even more cynically, I occasionally fear that there are some who hide investments gone sideways behind a veil of prudent patience. So, let me ask heretically: what if all of the talk of long term horizon is misguided? What if the compensation for holding an investment to the out-years is inadequate relative to the risk?

Let me double-click on that for a moment: nowadays most buyout shops tout their Hundred Day Plans. Think: Metrics! Dashboards! Flash reports! SWAT teams! (Or are those SWOT teams?) Some firms have upped the ante and talk about working to kick off The Plan even before they close on deals (how proactive!). And all of this stuff is music to LPs’s ears, giving the impression of catalytic ownership. Now we know why we’re paying these guys the big bucks: it’s because they do . . . stuff (and they do it fast!). And, sure enough, skilled owners can help businesses achieve real value inflection points. Some even have grand plans for strategic repositioning that will take many years and a half dozen or ! more add-ons to come to fruition.

But here’s a question: how long should one hold a company to capture value? Come in, rock your 100-day plan, catalyze a bunch of change, stabilize the company, get eight quarters of growth under your belt, and hope for a good exit market in years three or four. Easy. (Of course, easy can be very, very hard.)

But think about it another way: if there’s a value creation curve for the typical company, I’d imagine it’s very steep in the early years, with a flattening in the out-years. There might be an inflection point or two beyond the initial surge, but the rate of change almost certainly slows as time passes. Meanwhile, business is moving ever quicker – just talk to a biz dev team using The Cloud to fast-cycle product testing and launch, or a manufacturing group using lean production – and execution challenges are unending. One could even posit that owning companies in the out-years is more risky than anyone expected; there might even be a case to be made that risk-adjusted returns go down in the out-years.&n! bsp; Maybe that’s why so many LPs grouse that their portfolios are full of over-ripe companies.

Perhaps there’s a way to think rigorously about which of the ripe fruits to harvest and which need some more vine time: I know of at least one group that methodically re-underwrites their portfolio every six months and asks, “what is the distribution of the prospective returns for each of our portfolio companies?” Implicit in the exercise is a belief that at any moment, you’re either a buyer or a seller. Those companies that exceed a certain hurdle rate stay; those that don’t go out for sale.

Now don’t get me wrong: I’m not saying that folks should sell prematurely or sub-optimize exits. Instead, I’m talking about a meticulous re-underwriting process that asks hard questions about prospective return, risk, uncertainty, and liquidity horizon. Of course, GPs are generally incentivized to let their winners run, even as rate of return slouches (as long as the multiple contribution is positive). LPs, on the other hand, want their money back yesterday. These divergent views express the tension inherent in unknowables: what does the future hold? What are the opportunity costs? For the GPs? For t! he LPs? Is it worse to sell too early – or run the risk of holding on too long?

And whenever I ponder these kinds of questions, my mind wanders back to one of my mentors, a dyspeptic Frenchman who seemed to be forever enshrouded in fogs of Gauloises and cynicism. Once, after he’d helped me finish a thorny financial model, I asked him what he thought. “Bof,” he replied with a shrug, “after year three, life is all terminal value anyhow. The important thing is to make sure you get those three years right and the terminal value will take care of itself. The first steps are often more important than the last.”

***Congrats to Fred Schwarzer of Charter Life Sciences for getting yesterday’s trivia question right. The answer: Arthur Rock was the first venture capitalist to appear on the cover of Time magazine.

Top Three

Facebook announced that Digital Sky Technologies, has made a $200 million investment in Facebook in exchange for preferred stock, representing a 1.96 percent equity stake at a $10 billion valuation. DST is an internet investment groups globally with significant stakes in Eastern European and Russian internet businesses. Meanwhile, when asked about the lower valuation, Facebook Chief Executive Mark Zuckerberg said Microsoft invested when “we were right at the absolute peak of the market.”

New York state’s pension fund has cut its fund of funds investments to about $500 million from $5 billion since January 2008, after deciding direct investments were preferable.

SumTotal Systems Inc agreed to be acquired by Vista Equity Partners for $160 million and terminated its previous deal with Accel-KKR, putting an end to a long-drawn bidding war between the two private equity firms.

VC Deals

Celtra Inc., a Cambridge, Mass.-based provider of SaaS mobile marketing platforms, secured $1.2 million in Series A financing from RSG Capital, a Slovenian based venture capital fund.

Ophthonix, San Diego-based vision correction company, closed its $25.9 million “Series AA” financing. In addition to an investment by a new, undisclosed investor, each of the company’s current investors participated: Kleiner Perkins Caufield & Byers, Enterprise Partners, DAG Ventures, Gund Investment Corporation, InterWest Partners, Trex Enterprises and Wasatch Advisors’ Cross Creek Capital Fund.

Mark Logic, a San Carlos, Calif.-based information technology company, closed a $12.5 million round of financing led by Sequoia Capital and including participation from Tenaya Capital.

UltraCell Corporation, a Livermore, Calif.-based producer of fuel cells for mobile power applications, today announced $3.8 million in new funding. The round of new funding was led by existing investors BASF Venture Capital GmbH, OnPoint Technologies, Espirito Santo Ventures (ES Ventures) and Miami Valley Venture Fund. To date, UltraCell has attracted $30 million in investment since it was founded in 2002.

O4 Corporation, an Atlanta, Ga.-based developer and marketer of software targeted at consumer products companies, has received a $15 million Series A financing from buyout firm ABS Capital Partners.

Buyout Deals

Vogo Fund, based in South Korea, has agreed to acquire shares in BC Card from Hana Bank, a unit of Hana Financial Group, and SC First Bank, a unit of Standard Chartered.

Formation Group Plc, a UK sports and talent management agency, is in exclusive talks with Gresham Private Equity over some parts of its business, The company said the private equity house had not expressed interest in the company as a whole.

Rio Tinto may break up the aerospace segment of its business, after its minerals business failed to attract bids, Bloomberg reported. Apollo Management, Carlyle Group and TPG all expressed interest in the minerals business, Alcan Engineered Products, but did not submit bids because they could not arrange financing for the deal, worth around $5.6 billion (EUR$4 billion).

TPG has agreed to invest RMB 550 million ($80.19 million) in the convertible bonds of Daphne International Holdings Limited, a footwear company based in China.

Roberto Cavalli is no longer sure about selling a stake in his fashion house and expects 2009 turnover to be down 12 to 13 percent. The company has been in talked with buyout firm Clessidra.

Bain Capital leads KKR and Warburg Pincus in the bids for Chinese electronics maker Gome, Bloomberg reported. Bain is interested in buying 20% of the business for approximately $500 million.

PE-Backed M&A

ACS Group, a plastics processing business backed by St. Louis-based private equity firm, Harbour Group, acquired Walton/Stout, Inc., a Lithonia, Ga.-based material handling, blending, crystallizing and drying application business. Terms of the transaction were not disclosed.

Voxeo Corporation, a VoiP business once backed by Crosspoint Venture Partners and Mayfield Fund, -focused acquired IMified, a hosted instant messaging application development and deployment platform. According to VentureWire, Voxeo is looking to sell between 5% and 15% of the company for as high a price as $50 million.

PE Exits

Permira, a British private equity group, said it had sold its 14 percent stake in soft drink maker Britvic.

Firms & Funds

Israel said it would exempt foreigners from taxes on investments in private equity funds in an effort to make Israel more attractive to foreign investors.

Pantheon International, a listed UK private equity fund-of-funds investment trust, announced that in it has entered into various agreement! s with institutional investors in which a number of the firm’s fund interests will be sold, reducing its unfunded commitments by GBP 154 million from GBP687 million (as at 31 March 2009) to GBP533 million.

UK buyout firm JZ Capital Partners asked shareholders for more capital to repair its balance sheet, the FT reported. The firm seeks $147m (£92m). The firm told the FT that it was raising money to repay preference shares and have some leftover for acquisitions.

Harbert Australia Private Equity announced a first close on Harbert Australian Private Equity Fund I. The firm has raised A$40 million in seed capital from Alabama-based parent Harbert Management Corporation. In the next year, the fund plans to raise around A$100 million from outside investors. The firm also announced its first investments. Harbert Australia Private Equity purchased an 18.1% initial equity interest in Solar Shop Australia Pty Ltd, an installer of grid connect solar systems in Australia. The transaction values the business at an enterprise value of A$50 million.

Global Leveraged Capital, a private investment firm based in New York and San Francisco, said on Wednesday it is launching a new restructuring advisory group that will bring a different approach to fundraising at a time when struggling companies have little access to the credit markets.

Castle Alternative Invest, a Swiss-listed fund of hedge funds, plans to list in London to improve the liquidity of its shares, its investment manager LGT Capital Partners said on Tuesday. The fund, which has assets of more than $500 million and which is on a discount to net asset value of 27 percent, will list its shares in London from June 5.

Rising India, Inc., a digital special effects and 3D character animation business based in Omaha, Neb., agreed to take a $10 million equity investment form Auctus Private Equity Fund LLC, a Massachusetts fund. .

Human Resources

Robert Maguire has joined Perella Weinberg Partners as a partner in the firm’s Corporate Advisory Group in London. Maguire was an investment banker and head of Global Oil & Gas Group at Morgan Stanley prior to joining Perella Weinberg.

David A. Spuria joined middle market private equity firm Southlake Equity Group as Partner and General Counsel. Mr. Spuria was formerly the General Counsel of Fort Worth-based TPG Capital, one of the world’s largest private equity firms. Mr. Spuria joins Doug Wheat, Tom Keene and Todd Robichaux as Partners in the firm.

Justin Abelow has rejoined investment bank Houlihan Lokey from Deutsche Bank. He will resume his role as a Managing Director of the Financial Sponsors Coverage Group and will focus on private equity coverage in the United States and Europe.

Sharad Sharma has joined Menlo Park venture firm Canaan Partners as an Entreprenuer-in-Residence. Previously Sharma led Yahoo! India R&D.