Symposium Wrap-up

Carlyle Group’s Co-Founder Debunks Myths

There’s been a lot of press attention recently on the LBO industry—a business that the mainstream media often portrays as being run by a posse of money-hungry robber barons. In a first-day key-note address at the conference, Dan D’Aniello, a co-founder of The Carlyle Group, took a shot back.D’Aniello doesn’t believe LBO firms destroy jobs, he doesn’t believe they are secretive, and he doesn’t think the industry only benefits the wealthy. In debunking the top 10 myths of the buyout market, D’Aniello addressed almost every anti-LBO argument ever made. He even took a shot at a certain Michael Moore movie, saying it made a mountain out of the molehill of Carlyle Group’s connections to a few U.S. Department of Defense officials. As for the industry only benefiting the wealthy, D’Aniello cited the tremendous returns buyouts have generated for public pensions, which provide for the retirements of teachers and public employees nationwide. He said that few LBO firms actually use the strip-and-flip model of ownership. Interestingly, he cited as an example Hertz, which Carlyle Group bought in 2005 with Clayton Dubilier & Rice and Merrill Lynch & Co. The company has posted strong earnings growth since the LBO, and the buying consortium still owns more than 70 percent.The topic of Carlyle going public came up during a Q&A session, and D’Aniello said that Carlyle Group is studying the possibility, though the public markets could well undervalue his firm due to the short-term volatility inherent in private equity investing. “Even if we didn’t want to study it, the investment banks would want us to study it,” he added.

LPs See The

Flow Of Funds Slowing

It’s going to be nearly impossible for limited partners to match their 2006 contributions to buyout funds in 2007, according to principals from four top investment firms who spoke on the panel “Where LPs Are Placing Their Bets.” “Last year was extraordinary,” said Andrea Kramer, vice president of due diligence for funds-of-funds manager Hamilton Lane Advisors. The firm looked at 512 funds in 2006, up from 478 in 2005; it also reviewed 100 funds in the first quarter of 2007. James Clarke, of the Ewing Marion Kauffman Foundation, foresees a similar dip. “We’re not going to make the decision to take cards off the table,” he said of the foundation’s planned commitments in 2007. “We’re also not going to double down.”

In Negotiating Terms, GPs Should Observe The Golden Rule

While a handful of general partners have come to market with higher carried interests, fund terms only bounce around in a very narrow band, agreed four speakers on the “Funds of Funds Weigh In On Terms, Investor Relations” panel. Charles Jacobs, a partner with law firm Nixon Peabody, did note that, while the pendulum swings back and forth between GPs and limited partners, it tends to “stay a little longer on the GP side.” Later in the panel, fund-of-funds manager Kevin Kester of Siguler Guff & Co. advised GPs to follow the golden rule when dealing with LPs: treat them the way you’d want to be treated. “They’re your customers. Don’t try to take every last crumb off the table. The markets do change and you’re going to want your investors to back you when you’ve had a bad fund.”

Buyout Shops Should Leverage Their Purchasing Power

While there has been much talk about private equity portfolio companies leveraging their collective purchasing power, Bear Stearns Merchant Banking Partners is one of just a handful of private equity firms to actually do so. Leading a workshop on the subject, David Hinkel, principal of Mercer Consulting, a division of Marsh & McLennan Cos., said his firm is advising a few of those that are, including four of the top 10 LBO firms. An LBO firm would have to have at least 1,000 employees across its portfolio to really generate savings, Hinkel said. The easiest places to cut costs are in prescription drug and dental benefits.

Asset-based Loans Become A Popular Way To Finance LBOs

The asset-based lending market is booming, even as the cash-flow lending market remains strong. Over the past couple of years, more than $60 billion in asset-based securities have been issued, about $10 billion of which was used to finance LBOs, according to Deutsche Bank Managing Director Mark Funk, speaking on a panel called “Leveraged Lending Innovations To Enhance Your Returns.” Funk said this is the first bull market where cash flow loans and asset-based loans are competing for market share. Steven Robinson, managing director at GE Antares Capital, noted that traditionally, when lending multiples are high in the cash flow loan market, they’re low in the ABL market, and vice versa.

Technology Specialists Favor The Hairy, The Complex

Large buyout firms with eclectic tastes have piled into the technology market in recent months—as well they should have. Not only have they found herds of mature, cash-flow rich companies grazing undisturbed, they’ve also encountered swarms of banks, finance companies and hedge funds willing (perhaps too willing) to supply few-strings-attached leverage. That all sits fine with two veteran technology buyout professionals who were on our “Technology Sector Spotlight” panel, Alex Slusky, managing partner, Vector Capital, and Robert Smith, managing principal, Vista Equity Partners. Both are far more interested in the hairy and complex transactions that give other bidders pause—the spin-out of an investment-starved division, say, from a corporate parent, or the purchase of a software company in a market so competitive that it shouts out for a consolidation play. A quick example: Vector’s take-private last month of Safenet Inc., provider of encryption technology, for $634 million. Bad omens such as turnover at the top, a shareholder lawsuit, a criminal investigation, and a lack of audited financials scared off most of the original 45 suitors. At the end of the day, “there were no other credible bidders,” Slusky said.

Going To Great Lengths To Dodge Auctions

During the “Auction Strategies To Beat the Competition” panel, Genstar Capital Managing Director J.P. Conte said that in today’s market, there are no bargains, period. A majority of the other panelists heartily agreed. Genstar’s attempts to avoid auctions has led the firm to pursue companies that, for example, are growing at 5 percent per year in a market that is growing at 10 percent. Underperformers, Conte said, are more difficult for investment banks to dress up. Fellow panelist David McKenna, a partner at Advent International, noted that capital alone is not enough to compete in today’s auctions. In auctions today, you have to be ready to present 100-day growth plans on the spot and to bond hard with management.

Evaluate Potential Managers As You Would A Target Company

Hiring mistakes are the number-one problem buyout firms have, Ted Bililies, a managing director at consulting firm ghSMART noted during the “Selecting The Right CEO For Your Portfolio Company” workshop. Studies show that people hire the wrong CEO to run their companies about 50 percent of the time, he added. Bililies said that general partners should learn to apply the same rigor they use during financial due diligence to selecting their management teams. To do this, the have to learn how to measure people quantitatively, rather than judge them qualitatively. “Make [the data about people] as hard and analytical as that other data,” he said.

Take-Privates Are Still Worth It

Even with greater activism from shareholders and more scrutiny from the press, delisting big public companies is still worth the effort, said four leading buyout players taking part on the “Taking Advantage Of The Gusher Of Take-Private Opportunities” panel. “If we thought we were overpaying, we wouldn’t do the deal,” said Bud Watts of The Carlyle Group, referring to rising price pressures. Still, the swirl of information and speculation that surrounds take-privates makes them even more difficult. A leak “doesn’t affect the pricing, but it can affect the dynamic,” he said, adding that Carlyle typically prepares the boards of target companies for the real possibility of a leak.

Outsourcing Has Passed Many Companies By

Surely by now all U.S. manufacturers are taking advantage of opportunities to outsource operations, source parts, and sell products in China and India, right? Actually, while companies generally recognize the opportunities in these regions, many just don’t know what to do about them, according to panelists in the session, “Guiding Your Portfolio Companies to Success In India And China.” Chip Chaikin, a Shanghai-based partner at Blue Point Capital, a buyout shop that acquires companies with revenues of $25 million to $250 million, said that a lot of companies remain governed by what he calls “tribal lore.” Their one attempt at sourcing parts in China fails, say, and they then conclude for all time that it’s a bad idea. Other companies cling to the outdated belief that outsourcing works for simple-to-manufacture items, but not for highly engineered products. Chaikin and his fellow panelists agreed they ideally like to find companies slow to adopt an Asian strategy but has become open to the idea of pursuing one.

The Distressed Market Has Become Distressingly Crowded

The distressed market isn’t as inefficient as it used to be. “We don’t see any opportunities that don’t have a blue book wrapped around them today,” observed Angus Littlejohn, chairman and CEO of Littlejohn & Co., during the “Opportunities For Turnaround Investing In 2007” panel. “Even if we find them first, they never talk to us without hiring an investment bank first.” Littlejohn said that there are fewer distressed companies in the market today than he anticipated. “We have seen some companies beat up against their covenants, but so far all they’ve had to do is just refinance their way out of trouble, and they get to live another day.”

Is Green The New Black?

Green is in. Or is it? During the “Consumer Products Sector Spotlight,” panelists debated whether a company’s friendly environmental policy is a good reason to consider an investment. Michael Sweeney, a managing director at Goldner Hawn Johnson & Morrison, believes the answer is no—at least when it comes to consumer product companies. If a company is chosen on the premise that it is environmentally sound, and then a much bigger competitor chooses to go green, the smaller company would lose the one thing that differentiated it, he said. Catterton Partners Managing Director Scott Dahnke said added that makers of biodegradable packaging foam are very much in demand and can both hold and gain market share.

New LPs Still Getting Access

Despite the increasing power of general partners to limit access to their funds, newly active limited partners agreed that they could still find ways in. “We’ve had good access to the [GPs] we’re interested in,” said Shawn Wischmeier, chief investment officer of Indiana Public Employees’ Retirement Fund, speaking on the “Newly Buyouts Share Hopes, Dreams For The Asset Class” panel. “We can get in the door because we can write a bigger check.” Tom Danis, managing principal of fund-of-funds manager RCP Capital Advisors, offered another tip: “The squeaky wheel gets the grease, although there’s a fine line between being persistent and being annoying.”

Media Is Alive And Kicking

Buyout pros might be bearish on big daily newspapers, but they’re bullish about other areas of the media industry, according to the speakers on the “Media Sector Spotlight” panel. “The demand for content and information is insatiable,” said James Rutherfurd, executive vice president and managing director of Veronis Suhler Stevenson. That translates into little “macro risk” for media as a whole, he said. Daniel Black, partner at the Wicks Group of Cos., said that sensitivity to Internet fragmentation pushed his firm toward newspapers that serves local markets. In terms of new media, private equity’s long hold time can provide a perfect incubation period for a traditional media outlet to develop a Web presence, Rutherfurd said.

Small Market, Big Pay Check

Some say there’s a personnel war raging in the buyout market—with smaller firms on the defensive. It’s difficult enough for small buyout firms to attract top talent, let alone keep them from being poached by mega firms. That’s part of the reason why we’ve seen a number of small and mid-market firms increase their carried interest fees, said Riverside Company Partner Loren Schlachet during the “Mega vs. Mid vs. Small: Does size Matter?” panel. Arsenal Capital Managing Director Terry Mullen agreed that a premium carried interest can be a selling point for a smaller firm. Arsenal tries to attract key players with the promise of frontline action, and the possibility of receiving large amounts of carry generated from the firm’s deals. The firm target returns of 3x to 4x.

Making A Big Newspaper Work

Conventional wisdom holds that civic pride prodded moguls David Geffen and Jack Welch to consider pouring money into failing enterprises like daily newspapers. But Brian Tierney, who led an investment group in the $515 million purchase of Philadelphia’s two daily newspapers, said they may not be foolish investors. “I look at them as Brian Tierney wannabes,” Tierney joked in a workshop hosted by Royal Bank of Scotland on dealmaking in a challenged industry. Few are willing to give big dailies a chance for long-term survival, yet Tierney said critics undervalue the power newspapers wield in metro markets. His team has found growth through big investments in Internet operations and circulation, while reaching a landmark labor pact with the papers’ unions.

The Great Debates: Are Buyout Pros Behaving Badly?

In the final session of the conference, Andrew Ross Sorkin, private equity reporter and columnist for The New York Times, needled the industry for its many foibles. He chided buyout firms for quickly taking money out of portfolio companies while ostensibly providing little value in return; for appearing to have gentlemen’s agreements not to compete for one another’s deals; and for participating in a market rife with conflicts of interest. While conceding a point here and there, Kevin Conway, managing partner at Clayton Dubilier & Rice, forcefully defended the industry, often by taking examples from his own firm’s activities. Moderating the debate was Dan Primack, editor-at-large of Buyouts. The account below represents an edited version of their give and take.

DP: Buyout firms talk a lot about how they create value. But in fact they often take money out of portfolio companies within weeks or months of closing a deal. Is that a sustainable model?

ARS: I don’t think it can possibly be a sustainable model long-term. Look at the Hertz transaction [a 2005 take-private led by Clayton, Dubilier & Rice], a transaction that obviously looks like a quick flip. How is it possible that after 12, 14 months, you can make this amount of money? What possibly could have been done operationally that actually fixed this company in any meaningful way? From a perception perspective, that is the problem.

KC: I agree that the time period we’re in right now is not sustainable. The financing markets have driven much of the recapitalizations where buyout firms can take all of their equity off the table, sometimes within nine to 12 months. On the issue of how private equity firms make changes that quickly, the fact is, sometimes there haven’t been many changes made. Our particular model is very driven by making operating improvements. Many people focus on the closing date of a transaction. But in many of our transactions we’ve been looking at an industry for literally years. Often we’ll look at a particular transaction and work on the inside with the management team for as long as a year or two. And it often takes months from signing a deal to closing. You end up having four or five or six months lead time. We don’t wait until the closing. We’re already working with the management team on the organizational structure. We ask questions like, Are the right people responsible for the right things? Is the compensation system aligned with what we’re trying to get done? If you get a head start, it’s not impossible to make changes and see dramatic results.

DP: Do you believe there is collusion among private equity firms today?

ARS: Sort of. When I wrote a column two years ago raising the issue it wasn’t so that the Justice Department would look into this. I didn’t think of it as a legal issue so much as a process issue for boards that were considering selling companies. I don’t think there’s direct collusion, but I do think there are gentlemen’s agreements where firms, in effect, say, I’m not necessarily going to jump a deal here. You see evidence of that in how ineffective go-shop provisions are. I don’t think it’s a real legal issue, but I think if you’re a seller it’s an issue you have to think about.

KC: I don’t think there’s collusion. Buyout firms are 100 percent economic. Many don’t go after a business under a go-shop provision because they look at the company and say, That other buyout firm’s been in there for a year, they’ve done all sorts of work, I can’t get within 20 percent of the price based on public information, and it’s going to take a lot more resources to chase after the company. They drop out, and people look at that from the outside and say, “Oh that’s collusion, or a gentlemen’s agreement.” In fact, the firm is basically saying, “I have a better place to spend my time with the promise of a higher return.”