Sun Capital To Maintain Deal Pace

By Joshua Payne

For buyout shops that specialize in turnarounds, the past few years have been lean ones. A healthy economy and generous credit markets allowed many struggling companies to borrow their way out of trouble rather than seek a new owner. With today’s challenging credit market and the prospect of an economic downturn looming, established turnaround shops like Littlejohn & Co. LLC, which only did one deal in 2006, and new ones such as Stony Lane Partners, are primed for a back-to-school style shopping spree.

But not all turnaround shops slowed down during the good times. Sun Capital Partners, the Boca Raton, Fla.-based buyout shop, has been on a sustained buying streak, building an ever-expanding stable of companies. That the firm did not wait for a sagging economy to deploy considerable capital raises the question: Can Sun Capital take full advantage of the downturn when it comes?

There’s no doubt the firm has been on an acquisitions tear. It bought 15 companies in 2004, 30 in 2005 and 33 more in 2006. Sun Capital has already racked up 28 companies this year and is on track to surpass last year’s record.

Sizable gains in successive fundraising rounds fueled its hearty appetite for companies. Rodger Krouse and Marc Leder launched the firm in 1995, and their first investment vehicle was a $28 million pledge fund, which gave way to Sun Capital Partners II LP, a $200 million fund that closed in 2001. The firm came back with a $500 million vehicle in 2003, and raised the $1.5 billion Sun Capital Partners IV LP in 2005. In April, the firm quadrupled its prior haul, closing on Sun Capital Partners V LP, a $6 billion fund that took roughly a month to raise.

Given the amount of money already spent and its bulging portfolio—Sun Capital owns 72 companies—it’s reasonable to wonder if they have taken on too great a load.

Plenty Of Capacity

Managing Director Michael Kalb, the firm’s first employee, doesn’t think so. The firm has spent only $300 million of the $6 billion it closed on in April, and Kalb foresees no difficulty in deploying the rest. “Will we go from 30 to 60 [deals a year]? I don’t necessarily see that happening. But we’re planning to continue at the current rate,” he said.

According to Kalb, the firm was able to accomplish so much so quickly by constantly planning one step ahead, always adding to the firm’s roster of in-house turnaround executives before its portfolio became too unwieldy to manage. “There was a recognition that we wanted to grow the firm not just with transactional professionals, but also operational professionals,” Kalb said. To that end, Sun Capital has hired a raft of experienced managers, including Thomas Taylor, a one-time executive vice president with The Home Depot Cos., and Christopher Metz, the former president of Black & Decker’s hardware and home improvement group. Rather than simply invest in distressed debt, Sun Capital dispatches its managers for hands-on retooling of struggling companies. The firm has more than 100 professionals on staff.

“We are in the business of acquiring risky companies,” Kalb added, emphasizing that not all of Sun Capital’s companies are broken and struggling. In addition to its truly troubled possessions, the buyout shop invests in underperformers like Indalex, a manufacturer of shaping tools for aluminum and soft alloys, and Exopack Holding, a provider of paper and plastic packaging for the food, industrial and medical industries. These are cases of “taking decent companies and making them more profitable,” he said. Asked to identify the weakest portfolio company, Kalb demurred, saying every case is different.

Sun Capital specializes in two areas: mid-market turnarounds, which it defines as companies with negative EBITDA and account for nearly half of deal flow; and underperformers, those it classifies as having positive EBITDA and the potential to generate much higher earnings. The firm targets companies generating $50 million to $5 billion in revenues. While Kalb said there is no textbook Sun Capital transaction, he pointed to Horsehead Corp. as an example of the firm’s turnaround strength. The Pennsylvania-based zinc producer was on track to lose roughly $30 million when Sun Capital acquired it in 2003. The firm installed a fresh management team, renegotiated labor contracts, consolidated Horsehead’s operations and got a boost from a thriving zinc market. When the buyout shop exited a little over three years later Horsehead was galloping toward $140 million in positive EBITDA.

Recession Risk

Another tough question for Sun Capital is whether it would feel an economic downturn more acutely given that it’s saddled with companies that weren’t thriving during a good economy. “We’re set up to be able to benefit from the exact type of economic environment we’re currently facing,” Kalb said, adding that Sun Capital wouldn’t feel a recession’s impact more than any other firm. By being what he calls “disciplined investors,” Kalb said that Sun Capital has avoided overpaying for deals during the past three years, when target companies could command a higher price. He cited that discipline as the reason why the firm won’t go on a buying binge now. “We see operationally complex situations all the time, whether there are good or bad times,” Kalb said.

Limited partners clearly have faith in the firm’s approach. Prior investors in Sun Capital funds include Adams Street Partners, Duke University, Goldman Sachs, Notre Dame, PPM America, M.I.T., Government of Singapore, The Wilton Private Equity Fund and Yale University. One LP who attended the firm’s annual meeting in March at the Boca Raton Marriott told Buyouts that the scene looked more like a Sun Capital Fan Club convention than a financial presentation. A Marriott conference room designed for 200 people had to hold twice that number as LPs and wannabe-LPs packed the venue to sign up for Fund V and hear about the buyout shop’s other vehicles.

“People flew in from Denmark, Japan, everywhere to hear these guys. Tables were crammed into that room” to accommodate the throng, according to our source. “They raised $6 billion in a flash and could have had double that,” said the LP, who had invested in the $200 million Sun Capital Partners II LP, which closed in 2001. The LP described that fund’s returns as “insane.”