A Genteel Style of Buyouts

Most private equity outfits didn't get to the top by being nice guys or good sports. But the partners at Madison Dearborn are proving that gentlemen can win at this game, too

by Judith Crown

The 30 partners at Madison Dearborn negotiate leveraged buyouts as smart as anyone's. They're just so much nicer about it. Chicago's Madison Dearborn Partners—among the nation's largest private equity firms—has delivered average returns of 22% to investors over its 15-year run. Sure, its portfolio companies, like any taken private in a leveraged buyout, are laden with boatloads of debt. But at Madison Dearborn, the deals usually are bloodless; the partnership invests only in companies where it can keep incumbent management. It rarely extracts special dividends and has even cut fees to investors when the partners determined performance was lagging.

Named for its headquarters address at the northwest corner of Madison and Dearborn Streets, the firm is a bastion of Midwest sensibility. Offices in its 38th-floor suite are understated, save for a giant, red fiberglass bull purchased at auction for $28,000 by co-founder and Chairman John A. Canning Jr. after the city's "Cows on Parade" street art exhibit in 1999. Ties are mandatory, and there are two spares at the reception desk lest anyone forget. Why? "This is serious business," says co-CEO Paul J. Finnegan.

Contrast that to the swagger of the boys from Blackstone (BX), Kohlberg Kravis Roberts, and other East Coast buyout shops. It's hard to imagine Canning, 63, a pillar of Chicago's civic community, throwing a birthday party for himself like the highly chronicled bash Blackstone CEO Stephen Schwarzman hosted last year when he turned 60—a $3 million blowout at the Park Avenue Armory for more than 250 of New York's glitterati, including Donald Trump and Barbara Walters. For his 60th, Canning went to a Cubs game with his family and had a cookout at home. (To be fair, Canning isn't leading the lunch-bucket life: His wheels include a 2000 Bentley.)

Larger and Larger Deals

A Middle America CEO looking to sell a business could easily be intimidated by a New York hotshot. "They talk fast, they're too slick," says T. Bondurant French, chief executive of Adams Street Partners, a regular Madison Dearborn investor and a specialist in private equity. "Madison Dearborn is just as sharp, and there is less arrogance."

Madison Dearborn cannot match the biggest in private equity, outfits such as Carlyle, Blackstone, and KKR, whose war chests total upwards of $35 billion. But controlling $16 billion in funds, it places No. 13 among more than 500 firms ranked by Thomson Financial (TOC). Bloomberg puts Madison Dearborn among the 10 biggest private equity firms in dealmaking from January, 2005, through last September.

Its returns are anything but middling. Three of its funds place in the top quartile, which return more than 20% a year, and another ranks in the top half, according to London-based Private Equity Intelligence, which surveys 3,600 funds worldwide. Its fifth fund is too recent to be ranked. And its deals have been growing larger. Madison led the $6.9 billion buyout of Vernon Hills computer distributor CDW and the $6.4 billion takeover of investment firm Nuveen last year. It's a 9% partner in a much bigger deal, the $42.4 billion buyout of Bell Canada Enterprises (BCE).

In November, Madison Dearborn started raising money for a $10 billion fund, its sixth and largest, up from the $6.5 billion fund raised in 2006. With a profit of $1.2 billion in the sale of Bermuda-based satellite-service provider Intelsat in February, its biggest single gain yet, Madison Dearborn is on track to have its best year, with a projected distribution of more than $2 billion to investors. That would top 2005, when it returned $1.93 billion.

Deals, of course, will be harder to execute in the midst of the credit crunch. Buyout firms will probably have to hold on to companies longer. And with banks and investors wary of even low-risk deals, they'll likely have to pay higher rates on debt, which would pinch their own returns.

But Canning and his crew remain on the lookout for new possibilities, such as all-equity deals. Signaling faith in itself, the partnership is expanding its offices by 54%, moving up to space that had belonged to Sara Lee (SLE) on the 45th to 47th floors of Three First National Plaza. "If you have good returns, people throw money at you," says Steven N. Kaplan, a professor at University of Chicago Graduate School of Business who specializes in venture capital and private equity.

Old-Line Heritage

Madison Dearborn has its roots at First Chicago, now part of JPMorgan Chase (JPM). Canning, a native of Bayport, N.Y., high school baseball star, and Duke University-educated attorney, began running the bank's venture capital operation in 1980. Co-CEOs Finnegan and Samuel M. Mencoff each logged more than a decade there before the venture arm was spun out in 1992. One of its first deals was the buyout of Procter & Gamble's (PG) absorbents operation, which earned $310 million, a more than eightfold return when Buckeye Cellulose went public in 1995.

The heritage of the regulated banking industry could explain Madison Dearborn's conservative bent—it is accustomed to orderly processes and controls. In contrast, most rivals hail from the freewheeling investment banking world. Blackstone's Schwarzman, for example, was head of mergers and acquisitions at Lehman Brothers (LEH), while Apollo Management founder Leon Black was a protégé of junk-bond kingpin Michael Milken at Drexel Burnham Lambert.

Madison Dearborn prides itself on collegiality and community. Fees from investors and portfolio companies pay for base salaries and for keeping on the lights, but it is profit from the sale of portfolio companies that brings home the bacon. Madison Dearborn, like other private equity firms, takes 20% of those earnings, called the carry. No one owns more than 9.9% of the partnership, and profits are shared among 30 principals, which encourages younger partners to stay put. Eight of the firm's 14 founders are still at it, while five have retired, and one has died.