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LBO HOT-RODDERS RETOOL

A few years back, Wall Street investment firm Blackstone Group was playing the leveraged buyout game like everyone else. Among its big acquisitions were Chicago & North Western Transportation Co. and the Six Flags theme-park chain. But after Blackstone raised a new $1.3 billion war chest late last year, its first deal wasn't a buyout at all. Instead, Blackstone shelled out $50 million for a majority stake in a startup reinsurance company, La Salle Re Ltd.

Forget Barbarians at the Gate. The swashbuckling leveraged buyout firms that swaggered across the financial landscape in the late 1980s have matured, even mellowed. With stock prices high, competition stiff, and affordable companies scarce, today's buyout mavens are looking for deals in unlikely places and pursuing a variety of new strategies. "It's the evolution of the LBO business," says J. Tomilson Hill, a Blackstone general partner who played in the 1980s takeover game as a top-level Lehman Brothers investment banker. "You can't just sit with a pool of money waiting for the phone to ring, for somebody to say: `Here is a company to buy in an auction."'

CASH SURGE. Even the term "leveraged buyout" no longer describes what many firms are doing. Some prefer to be known as "private equity" investors. In part, that's because of the bad name LBOs got in the 1980s takeover frenzy. But also, today's deals involve much less leverage. Some of the current investments are not even buyouts but involve taking minority stakes, purchasing bank debt, or pursuing novel tactics such as "leveraged buildups."

Behind the fragmentation of the buyout industry is a familiar tale: too much money chasing too few deals. Although both buyouts and the amount of money flowing into them slowed after the late 1980s, cash has poured into the sector in the past few years. Indeed, Steven P. Galante, editor of The Private Equity Analyst in Wellesley, Mass., predicts that buyout funds will raise a record $11 billion this year, up 53% from last year and even greater than the 1987 record of $10.2 billion (chart, page 84).

In part, the surge may be cyclical. It's been four or five years since many big buyout firms raised a lot of money, and now they're simply going back to satisfied investors for more. But there's also a more fundamental dynamic at work. Enticed by returns for buyouts that dwarf those for traditional investments, many pension funds and other institutions have upped the percentage of their portfolios earmarked for the sector. At the same time, overall pension assets are increasing, so buyouts are getting a bigger piece of an expanding pie. "There's plenty of money available," says Robert F. Johnston of Beacon Hill Financial Corp. in Cohasset, Mass., who helps raise money for buyout funds. "The existing [buyout] groups will continue to be funded, unless they really screw up."

Finding places to invest all the money has kept fund managers scrambling. Kohlberg Kravis Roberts & Co. has barely touched a $1.9 billion fund it raised a year ago. And Forstmann Little & Co. hasn't done a deal for more than a year--it still has some $2 billion in unused funds.

The problem: With the stock market at such high levels, most deals involving public companies or their divisions are too pricey. When an attractive private company comes up for sale, there are so many hungry buyout groups on the prowl that they find themselves bidding against each other. One example: the auction of U.S. Playing Card Co. a few months back. The private Cincinnati-based company, whose Bicycle and Bee brands dominate American poker and bridge tables, elicited more than two dozen bids, primarily from buyout firms, says one insider. Although some bidders thought the company wasn't worth much more than $120 million, it eventually fetched about $155 million from a group of Cincinnati investors who are allied with management.

SMALL BUT PROMISING. Hence the search for new ways to invest. One twist to the traditional financing is the so-called leveraged buildup. Instead of paying big bucks for a leading company in a field, a buyout firm acquires or starts a small company and uses that as a platform from which to make acquisitions. In theory, the management discipline instilled by the buyout firm creates value, while the enlarged company can later be taken public or sold at a higher price. The best-known proponent of the technique is KKR, which is becoming a force in publishing through K-III Communications Corp. and has been gobbling up upscale golf resorts through KSL Recreation Corp.

Many buyout firms are taking unleveraged minority stakes in companies, previously anathema to LBO managers who felt they needed a certain degree of control to exercise the kind of tight discipline required for squeezing out costs. Another strategy, popularized by Boston financier Thomas H. Lee, famed for the Snapple Beverage Corp. deal, is the so-called growth buyout. Rather than buy stable companies in order to milk their cash flow, as in a traditional LBO, Lee tries to spot promising companies in hopes that they will grow quickly.

Then there are players such as Leon D. Black's Apollo Advisors LP, best described as opportunists. They delve into everything from distressed debt to minority investments to full-fledged buyouts. "You have to be able to seize opportunities as they present themselves," says Philip Pool, a banker at Donaldson, Lufkin & Jenrette Securities Corp. Pool helps fund managers raise money. "One strategy could be good for one environment, but disastrous for another."

The maturation of the buyout industry also has spawned hordes of niche players. Los Angeles-based Bastion Capital has just raised $80 million to invest in buyouts of companies that serve ethnic minority groups. Boston-based Heritage Partners claims to be the first fund aimed at deals involving family-owned companies. And a host of groups have sprung up trying to tap into the craze for international investing, especially in Asia.

"It's almost a gypsy-like community," grouses Leslie A. Brun, head of Philadelphia-based Hamilton Lane Advisors Inc., which advises pension funds on alternative investments. "Whatever is hot in the marketplace, within nanoseconds a number of people are parading through the door, saying they're the best."

Even some industry veterans wonder if risks will rise as firms delve into unfamiliar territory. "People labeled LBO experts have been transmuted into something more exotic," says Tully M. Friedman, a managing partner at the big San Francisco private equity firm Hellman & Friedman, which has long done nonbuyout deals. "The question is whether they know what they're doing in these exotic areas." Although most investors are still expecting annual returns of 20%, they could be in for a shock if the innovative strategies that are pursued by the LBO managers don't work as planned.

"VERY TRICKY." A hard-nosed management technique was the major edge for buyout firms in the past, says Michael C. Jensen, a Harvard business school professor who has championed LBOs. "If all they're doing is putting eut capital, they have no comparative advantage," he says. And buying growing firms rather than the stable, cash-generating ones usually favored by LBO operators, he adds, "is very tricky. It's incompatible with high debt and involves a very different management philosophy." Still, Jensen remains optimistic that the best LBO managers are nimble enough to make the leap.

Pension fund managers who invest in private equity funds are aware that the business has become much tougher. "It certainly puts pressure on the ability to find good transactions and get the kinds of historical returns we've seen," says Russell W. Steenberg, who manages the alternative investment part of AT&T's $35 billion pension fund. "But this business is full of smart, opportunistic investors. Those who adapt to the market will do the best. It's still a wonderful investment area."

Think of it this way: If the heady early 1980s was the youth of the buyout business, and the wild and crazy late '80s was its adolescence, today we're into full-fledged adulthood. With maturity has come more cash in the bank, more wisdom--and a lot more hard work.Mark Maremont in Boston


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