NOW LBO STANDS FOR `LET'S BREAK OUT'
Dealmakers are bolting old-line firms--and money is following
Much of the spectacular success of Kohlberg Kravis Roberts & Co., the New York buyout firm, is rightly attributed to the financial savvy of principals Henry R. Kravis and George R. Roberts. But lesser-known dealmakers like Saul Fox have also played a crucial role in KKR's good fortune. Recruited by Roberts in 1984 from a Los Angeles law firm, Fox quickly distinguished himself by putting together some of KKR's most lucrative leveraged buyouts, including American Re-Insurance Co., its biggest home run to date. It bought the company in 1992 for $1.4 billion and will sell it in late November for $4.1 billion.
But after 12 years at KKR, Fox, 43, has struck out on his own. In October, he set up shop as Fox Capital Inc. in Woodside, Calif. He hasn't done any deals yet, in part because he had to make do with cellular phones for six weeks while waiting for permanent lines. He plans to continue doing what made him successful at KKR, albeit as a one man show: "I want to stay involved in the company after the acquisition to work with it as a director, consultant, and adviser."
EASY MONEY. Fox is part of a wave of defectors from big-name LBO firms. Over the last few years, a spate of veteran LBO specialists have leapt from the safety of established firms such as Thomas H. Lee Co. and Forstmann Little & Co. to hang out their own shingles. Steven P. Galante, publisher of Private Equity Analyst, a Wellesley (Mass.) newsletter, says that more than half of the nearly 50 spin-off LBO firms formed since 1980 have cropped up since 1994.
The driving force behind the spin-offs is a flood of pension and other institutional money seeking net annual returns that have averaged nearly 20%. According to Boston-based research firm Venture Economics, buyout funds raised a record $14 billion in 1995 and may surpass that level this year, including $5 billion raised by KKR. "If ever there was a time to sever the ties with your parent, the last couple of years was certainly it," says Leslie A. Brun, head of consultants Hamilton Lane Advisors Inc. "Almost anyone with a good track record can get funded in this market."
The spin-offs, indeed, sport a special allure to investors. Many have more focused market, investment, and operational strategies than the KKRs. The spate of easy money into spin-offs might not bode well for investors, though. The bull market has sharply pushed up prices for target companies, making it increasingly difficult for all LBO firms, which try to buy undervalued or inefficient companies with minimal equity and lots of borrowed money, to find good deals and maintain high returns.
Some industry watchers say that newcomers may be anxious to put their money to work quickly, even at inflated prices. If the economy or stock market falters, acquired companies might lack the wherewithal to repay their debt, and the buyout firms could be forced to unload their positions at distressed prices or hold onto them longer than they might have hoped. Some new LBO spin-offs, says Joseph L. Rice III, a principal at veteran buyout firm Clayton, Dubilier & Rice Inc., "may feel a lot of pressure to get something done that will probably lead to them paying higher prices. They've got to establish that they have the knowledge and discipline to make sensible deals."
None of this fazes new outfits like Fenway Partners, the Cypress Group, and J.W. Childs & Associates, which all told have easily raised about $2 billion, mostly from institutions. Betting on the maxim that a fund's best returns are often the early returns, these investors have happily opened their wallets in their search for the next KKR. "We want to balance our portfolio with old-line, proven LBO firms and with new ones we hope will become first-class producers down the road," says Barry J. Gonder, senior investment officer for the California Public Employees Retirement System.
One such newcomer is Jupiter Partners. It was created in 1994 by John A. Sprague, formerly a partner at Forstmann Little, and Terry J. Blumer, a former executive director at Goldman, Sachs & Co. In January, Jupiter, which runs a $350 million fund, partnered with Smith Broadcasting Group Inc., a TV station operator, to acquire four network-affiliated TV stations for $92 million. In November, Jupiter/Smith sold the same four TV stations for $160 million. "You can still make money in this industry," says Sprague.
The newcomers use a variety of strategies. Some pursue investments in companies with revenues of $50 million to $500 million, a segment that is often neglected by larger, more established players. Others are focusing on industry niches, such as wholesale distribution or high technology. Still others are looking for minority stakes. And some are focusing more on operational strategies, including the increasingly popular "build-out" technique of using a core acquisition as a platform to buy related businesses and eventually take the much larger company public.
HOME RUN. That's the game plan of New York-based Fenway Partners, which was formed in 1994 by longtime best friends Peter Lamm, then the No.2 man at Butler Capital Corp., and Richard C. Dresdale, a former managing director at Clayton, Dubilier & Rice. Avid Boston Red Sox fans, they named their firm after the team's ballpark and set out to raise $300 million, on which they hope to produce net annual returns of 25% to 30%. Thanks to huge investor demand, they eventually closed at $527 million. Fenway has been among the most aggressive new LBO outfits, gobbling up 10 portfolio companies in its first 18 months of operation. All of these deals have been outright purchases of underperforming units of large companies with well-known brands.
Fenway seems off to a good start. Since three of the firm's four partners have extensive experience in the food industry, the firm has specialized mostly in food-related deals. In September, 1995, Fenway started building a frozen-food empire with the $190 million purchase of Van de Kamp's frozen seafood business and select lines of Pillsbury Co. Inc.'s Pet-Ritz frozen dessert business. Since then, Fenway has forked over an additional $260 million to buy three other branded frozen-food lines, including Mrs. Paul's and Aunt Jemima. Fenway hopes to boost profits by building a critical mass of well-known brands. Other deals include buyouts of a manufacturer of artificial flowers and a maker of coin-operated pool tables.
In contrast, the Cypress Group, which was formed in 1994 by four top principals of the Lehman Brothers Merchant Banking Group, has embraced an eclectic investment strategy. This includes making majority and minority investments in companies--it calls them "corporate partnerships"--as well as outright purchases, an approach that certainly worked for them at Lehman. Thanks to picks such as Infinity Broadcasting, Lear Seating, and Loral Aerospace, the $911 million that they raised at their old firm in 1989 is now valued at $3.1 billion. After raising more than $1 billion for their buyout fund, Cypress Group's first deal was a $139 million investment in Dallas-based Cinemark USA Inc., the nation's fifth-largest theater chain. Cypress got a 44% stake in Cinemark and two board seats from the buyout. The fund's goal now is to help the theater chain expand both in the U.S. and internationally. Says Cypress Chairman James A. Stern: "We've never let structure stand in the way of doing a deal. If we find the right investment, we will figure out how to make that investment work."
Other young LBO firms, such as Little Rock-based Center Street Capital, hope to make their fortunes by investing in industry and market niches where there is less competition. The $110 million Center Street Capital fund--formed in 1994 by Michael W. Roher, former head of the merchant banking and investment unit at Little Rock's Stephens Inc.--focuses exclusively on the wholesale distribution industry. That's a departure from Stephens' opportunistic strategy, which called for Roher to look at all types of investments. "Being focused makes a huge difference," says Roher. "We don't waste a lot of time trying to figure out a business. We know immediately if something is right for us." In July, the firm decided soft-drink bottling and distribution was right; it paid $14.9 million for the 7-Up/RC Bottling Co. of Puerto Rico.
As long as investor money continues to flow like 7-Up from a tap, expect more new LBO firms to chase after it.By Stephanie Anderson Forest in Dallas, with Leah Nathans Spiro in New YorkReturn to top