So what was the appeal for Monomoy—call it a contrarian play?

I spoke with Daniel Collin, a partner at the New York-based turnaround firm, to find out what was attractive about Women’s Apparel Group (their new name for the company, which did business as Missy Group under parent company Redcats Group).

At the time of the conversation, I wasn’t aware that the firm had only paid $25 million for the company. I read that detail over at The Deal today.

Considering the business has around $300 million in sales, even if it was hemorrhaging money, that’s not a bad price. Right now more than half of the company’s business is online. Collin said that after it negotiates for more flexible manufacturing contracts and integrates a “right-sized” back office administration, Monomoy would work to grow its e-commerce business, ultimately using the catalogue business as a marketing tool to drive traffic to the Web site.

The number one online retailer, Amazon.com, trades near a 56x price-to-equity ratio. There are plenty of survivors and thrivers in the online sales space: PC Mall, Overstock.com, Alloy Inc, etc, so if Monomoy can make that transition, I’d call it a viable business.

The thing I was confused about was Monomoy’s characterization of the company. The firm has mentioned its portfolio company Barjan, as a comparable investment. Barjan distributes non-food products to truck stop retail outlets (I guess that means books on tape and those dream catcher things). Perhaps, since Barjan’s products include some apparel, they have a bit in common, but aside from the distribution element of both businesses, I still say Women’s Apparel Group is a new kind of investment for the firm.

That doesn’t make it bad—in fact I think it’s got a lot more potential than dream catchers. After fixing the “low hanging fruit,” as the PE pros like to say, Monomoy can focus on competing in a growing category. 

“In the last month or two, we have seen deals pulled because there is no mezzanine appetite for them,” said the head of leverage at an international bank.

Plugging the gap between senior debt and equity in the capital structure, mezzanine has enabled buyout firms to continue to do deals despite the contraction of debt packages offered by banks since the credit crunch.

Since mid-2007 mezzanine finance has been in strong demand. Dismissed for the preceding two years as an outdated product thanks to elongated senior debt packages and the emergence of second lien, it is now firmly back on the leveraged buyout menu.

Disaster then for buyout players as mezzanine houses are reporting to have reigned in their investing in recent weeks.
“Mezzanine houses have done an awful lot of transactions since the credit crunch but over the last six weeks they seem to have got much more conservative, much more picky, much more cautious,” said a banker.

A spell of mezzanine players retreating from the lending market would be seriously bad news for private equity firms. The one or one and a half turn of ebitda that has opened up on deals cannot be filled by more equity if decent returns are going to be maintained.

Quietness on the mezzanine front is, however, likely to be a temporary affair. Mezzanine players such as ICG, Indigo and European Capital have plenty of money to put to work and the attractiveness of the mezz space over the last twelve months has prompted new fundraisings.

In April 2008, for example, Partners Group closed a mezzanine fund on €447m. Last year Lehman announced a €1bn target for its mezzanine fund and AlpInvest Partners received a €2bn mezzanine mandate from pension funds ABP and PGGM last October.

The current let-up in mezzanine activity is likely to be the result of poor trading on some of the transactions mezzanine houses completed in Q4 2007 and Q1 2008, forcing them to take a step back for the moment, or become more selective. Poor trading at sponsors’ portfolio companies, of course, is an equally big headache for private equity firms.

A substantial proportion of the mezzanine on transactions is also provided by the banks themselves and their caution seems to ramp up daily.

The second and third tier lenders who began to get a foothold in the leverage loan market as the credit crunch took its toll on the larger banks, are also known to be retreating from mezzanine lending.

With mezzanine shying away, however temporarily, making acquisitions is going to be even harder for buyout firms. Perhaps even more worrying is the almost paralysing caution at play in the lending market and what that says about the state of some portfolio companies and the economic outlook for the times ahead.

This post originally appeared at Thomson Merger News.

Today’s Big Deal (Kind Of) goes to Vestar Capital Partners. The firm inked a $1.45 billion deal for Unilever’s North American laundry business in a transaction that embodies several of the trends I’ve been seeing in credit crunch era deals: seller financing, strategic partnership/add-ons, larger equity checks, and “have to sell” corporate divestitures. Details below.

Background:

As with the Blackstone/Bain/NBC purchase of The Weather Channel from Landmark Communications, Unilever is another corporate seller who had no choice but to sell. The UK consumer products conglomerate announced its reorganization plans, which included divesting Boursin cheese and Lawry’s seasoning salt among others, more than a year ago. NA laundry went on the block almost that long ago, with books going out around the beginning of October.

This deal had Vestar’s name written all over it from the start. Interest from the logical strategic buyers was lackluster, since few were looking to go up against leading detergent maker, Procter & Gamble. Financing difficulties, combined with the overhead costs associated with a carve-out, made PE buyers unlikely.

But in another parallel to The Weather Channel deal, Vestar had strategic power—the buyout firm owns the country’s largest private label detergent manufacturer, Huish Detergents. So, Unilever’s need to sell, plus Vestar’s strategic synergies, led to not only a rational price (in the rough neighborhood of 5X EBITDA), but a rational leverage ratio (under 5X leverage for the combined business).

Financing:

Huish retained its original senior debt vehicle, a bank financing led by JPMorgan. So, for the Unilever add-on, GE Commercial Finance provided incremental senior notes. GE also provided mezzanine debt. Further, the deal used seller financing, in which Unilever takes $375 million worth of preferred shares in the new company. Keeping the existing senior debt in place was an important step, a source familiar with the deal said.

Other Key Takeaways (based on my conversation with Brian Ratzan, a managing director at Vestar):

-The business is strong enough to be levered more than 5X, but Vestar decided to hold back, given the state of the economy.

-The combined company, named Sun Products Corporation, will be the second largest in its category (trailing Procter & Gamble, but taking the number two spot from Clorox). Ratzan declined to comment on anti-trust concerns, suffice to say that Sun Products Corporation with be a “strong but distant” number two to P&G.

-Vestar would not have been interested in the business if it didn’t already own Huish. The back office/overhead investments involved in carving out such a large business from a corporate parent would have made the deal unattractive.

-The firm has lined up a crack team of execs led by Neil DeFeo, who you may remember ran Playtex before selling it to Energizer last summer, and before that worked at Remington Products (a Vestar company), Clorox and P&G.

***
And another one gone and another one gone… Today SemGroup, an energy service provider backed by Carlyle Group and Riverstone Holdings, filed for Chapter 11. It’s apparently the largest bankruptcy this year, in terms of assets. The company had assets of nearly $6.14 billion and liabilities of around $7.53 billion.

In light of SemGroup’s filing and the rumors surrounding Sun Capital’s Mervyns, I thought we ought to revisit the LBO Bankruptcy Class of 2008. I started this chart a few months back in Buyouts, but it turns out the chart isn’t available online, and anyways I’m sure you’re all hungry to see an updated one.

But before we look at the already-dead fish, a list of some of the ones still gasping for air. The most at-risk companies, as compiled from Buyouts’s analysis of the Standard & Poor’s “Weakest Links” list, include 16 companies with CCC+ or lower ratings.

At a glance, it looks like Eurofresh, owned by Bruchmann Rosser Sherrill & Co, and two Cerberus companies, Residential Capital and IAP Worldwide Services, are in the most danger of default. The three companies have been assigned a “CC” credit rating with CreditWatch Negative. They ratings affect, respectively, $234 million, $535 million, and $234 million in debt. Eurofresh recently got upgraded (from a “D”!) thanks to an amendment with its senior secured lenders, but IAP got downgraded thanks to covenant violation and a high likelihood of Chapter 11.

Anyways, on to the body count. I think it really supports the idea that if you play too close to the fire, you’re going to get burnt. Just look at Cerberus and Sun Capital, two turnaround artists that make the most repeat appearances. Not to speak for them, but I’m guessing their response would go something like this: Since they’re in the business of buying broken companies, they don’t ever pay much to start with. That explains how Sun Capital scored a 25X-plus return on a company like Mattress Firm last year.

Here’s the corrected chart: LBO Bankruptcies 7.25.08.xls 

That profit was more than likely made when the firm began selling its interest in the operating company to Sun some time last year. Its unclear if that interest has been fully completed to date. According to a source, all Cerberus now owns of the company is 15% of the real estate business. Remember, the 2004 LBO of Mervyns split the business into real estate and operating companies. (This isn’t unusual for buyout firms to do, often because buyout firms aren’t real estate experts and vice versa. Look to Toys ’R’ Us for another example.) What’s unique about this deal is that Cerberus and Sun didn’t own equal parts of the operating company. The breakdown remains unclear. They each own a small part of the real estate company; Lubert-Adler and Klaff Partners LP own part of that, too.

The key here is that Sun Capital has been buying back Cerberus’s stake in the operating company and may be left holding the bag.

And since Dan’s argument unleashed a mildly heated debate, here’s further proof that Cerberus and Sun had a “heads we lose, tails we lose” situation. In 2004, the president hired by Sun and Cerberus was quoted in Women’s Wear Daily as saying, basically, that this deal didn’t depend on the company’s success or failure:

“Everybody said it was a real estate play,” Leto recalled. “The operating company was not valued and the three owners knew they’d get their money back from the real estate. But they asked me to come out here and see what I could do.” Later in the article he says, “Everyone thought this was a straight liquidation play.”

***I’m waiting to hear back from Sun and Cerberus to see if they’ll disclose the size and breakdown of their investments in the company—will update tomorrow morning when I do.

***Rick Leto, by the way, left his post at Mervyn’s in 2007.

Well, turns out that wasn’t the only “New Age of Buyouts” lesson to learn from The Weather Channel deal. This week I read that the deal’s debt, provided by Deutsche Bank, among others, was “pre-placed” before the deal even closed. Meaning, Deutsche took care to underwrite most of it in advance, selling the paper off to private equity firms and hedge funds. According to Debtwire, this technique isn’t new—Carlyle did it with Booz Allen and PQ Corp, underwritten by Bank of America and UBS, respectively.

I asked Randy Schwimmer of mid-market lending house Churchill Capital if this will be more common in deals to come, and the answer I got was affirmative. “Essentially the large cap deals are taking a page out of the traditional middle market syndication strategy, which is to club deals up,” he said.

All you need to do is find a large, market-leading business in a good, defensible sector, find a way to maintain a BB rating and LIBOR spread in the 400 neighborhood, and you’ve got yourself a buyout! What are some other deals that have used pre-placed club lending?

Global Scenarios for Private Equity and Venture Capital
Commissioned by: The European Private Equity and Venture Capital Association
Goal: Examine four potential scenarios for the future of private equity and offer long-term perspectives on each.
Scenarios: “Three Towers,” in which investment activities stays regulated to three large regional blocks, thanks to geopolitical tensions. Benefits firms with deep local knowledge and relationships. “Gulfstream,” in which global economics are fully integrated and investments flow within wealthy nations and to emerging markets. Benefits firms with broad international reach. “Trading Up,” in which institutions strongly support global economic integration. Benefits venture capital in Europe. “Going East,” in which European and North American economic and social problems lead its investors to increasingly successful and sophisticated Chinese and Indian markets.
Find more info: http://www.evca.eu/default.aspx

2007 Annual Review of Private Equity and Outlook 2008
Prepared by: SCM Strategic Capital Management
Goal: Self-explanatory
Most surprising conclusions: Asia and the BRIC companies are expected to grow in line with trends of recent years despite economic uncertainty in other parts of the world. The study also projects that vintage 2008 and 2998 funds may end up with excellent performances thanks to the abundance of debt buying opportunities and rock-bottom evaluations in financial services, retail and lodging sectors. I am very skeptical of this conclusion, since there is a small population of private equity firms that are prepared to jump on those types of investments.
Least surprising conclusions: Most of it proves what we already know—the slowdown will continue through 2009, the stock markets haven’t corrected enough to reflect flower earnings growth, and returns on US and European priate equity funds will decrease for 2008. SCM predicts they may even turn negative.
Find more info: http://www.scmag.com/#/en/portrait/scm

Doing Deals in Tough Times
Commissioned by: KPMG
Surveyed: 160 U.S. and European Companies
Goal: Identify organizational and implementation attributes of successful corporate M&A teams.
Most surprising conclusion: The study outlines 5 practices used by successful M&A teams (how they defined which teams were “successful” or “unsuccessful,” I’m not sure). The practices aren’t surprising, but certainly useful. For example, successful M&A teams spend 33% more time doing diligence than their less successful counterparts. They interview an average of 50 external sources per transaction. Likewise, 60% of successful teams pass “Day One” preparation responsibility on to business development teams. Most of the successful teams plan integration budgets during due diligence.
Least surprising conclusion: Leading M&A teams stabilize the new business quickly. Even though we all know time is of the essence, its still fun to see in numbers exactly how directly speed correlates with success.
Find more info: Here

Mergermarket Canadian M&A Round-up
Goal: Report on state of M&A in Canada for the first half of 2008
Most surprising conclusion: Deals are up in the second quarter of 2008, totaling $32.2 billion.
Least surprising conclusion: Canadian deal flow took a sharp dive in the first half. No surprise there, but is it interesting to note that 74.1% of all Canadian deal value is in the energy, mining and industrials sector, but just 33.8% of the volume.
Find more info: http://www.mergermarket.c…elease-Canada-H1-2008.pdf

M&A Beyond Borders: Opportunities and Risks
Commissioned by: Marsh, Mercer, and Kroll
Surveyed: 670 senior executives
Goal: Report on attitudes of senior executives toward global M&A
Most surprising conclusion: Managers in emerging countries China, Russia and India have undergone an increase in IPOs, but not because they need capital. It’s because they want to do M&A, and the best way to garner interest from international suitors—strategic or financial—is to show transparency and prove their reputations.
Least surprising conclusion: The biggest cross-border M&A hurdles remain: human capital issues and cultural integration. Its not surprising to learn that a number of Western European countries (which came in as the third most attractive place to invest) have significant legal roadblocks in place to stymie major lay-offs.  It is surprising to learn that parts of Latin America, Africa and the Middle East employ the same rules.
More: Interesting heat chart documenting low to high risk factors across regions. The biggest risks factors are inadaquete infrastructure in Africa, bribery and corruption in Africa, litigation culture in North America, intellectual property issues and organizational cultural differences in Southeast Asia.
Find more info: http://www.kroll.com/libr…BeyondBorders_excerpt.pdf

Previous Installments of the Summer Survey coverage:
Thomson Reuters/ACG Mid-Year Survey
Ernst & Young PE Study

* One third of those surveyed expect M&A to increase in the second half of the year. Six months ago only about a fourth of the respondents were as optimistic. (See chart below.) A slightly smaller group of respondents answered that things will get worse.

* One third of respondents are adjusting their investment strategy. Eek. I know there are many ways to talk around a strategy shift (or worse, drift), but at the end of the day, even the smallest adjustment is still a move away from what investors thought they were getting when they committed. If a firm has to adjust because its strategy no longer works in today’s environment, perhaps it should consider Guy Hands’s suggestion—give the money back.

* To follow on that point, those surveyed recommended the best ways to weather the drought. In order of most to least popular: Stick to their original strategy, focus on portfolio companies, cut costs at portfolio companies, diversify geographically, diversify by industry, sit it out till things get better, cut costs at the firm (a mere 8% liked this idea), and lastly, focus on their LPs.

Least surprising:* Less than half of those surveyed say the current deal environment is “good” or “excellent.” No surprise there, the deal landscape stinks. But it is interesting to note that even in December, 72% of those surveyed said things were peachy keen. Perhaps reality hadn’t sunken in yet? And compared with that figure one year ago, when 93% said the dealmaking environment was excellent, it’s certainly telling of the drop-off.





]]> http://www.pehub.com/wordpress/?feed=rss2&p=2772 http://www.pehub.com/wordpress/?p=2772 http://feeds.feedburner.com/~r/pehub/blog/buyoutdeals/~3/341769221/ http://www.pehub.com/wordpress/?p=2769#comments Mon, 21 Jul 2008 17:17:45 +0000 Dan Primack All Buyout Deals http://www.pehub.com/wordpress/?p=2769 WSJ today reports that department store chain Mervyn’s may be the next PE-backed retail bust, just four years after the company was carved out of Target Corp. for $1.2 billion. Certain vendors have stopped shipping, longtime lender CIT has cut ties and there is no rising economic tide to lift all boats (unless your vessel is made of petroleum).

By any objective standard, this should be a disaster for Mervyn’s current owners: Cerberus Capital Management, Sun Capital Partners, Lubert-Adler and Klaff Partners. But this is private equity, where operational failure can be rewarded with financial hedging.

According to WSJ, the original transaction was structured in two parts: One for the retailer and one for its real estate. While the former is an apparent failure, the latter made money off rising valuations (remember, this is compared to 2004) and leases to both Mervyn’s and other retailers.

Great structure, unless you happen to work for Mervyn’s or are an unpaid vendor. And that’s what really pisses me off about this new private equity narrative, which is titled: Heads we win, tails you lose. Buying a company is first and foremost about making money, but it should also be about helping the company prosper – because so many people’s livelihoods rely upon that prosperity. This isn’t to say that all deals are going to work out for everyone, but interests should be closely-enough aligned that big gains or big losses are experienced by both company owners and the company itself. In this case, it looks like the owners are breaking around even, while the company loses everything.

I’m not making any judgments here on whether or not Mervyn’s apparent failure is due to operational mismanagement or outside factors (probably a combination of both). But I do hold Cerberus and Sun accountable for helping to remove moral hazard from private equity. They should be losing more if Mervyn’s is indeed liquidated.

As it currently stands, what is preventing them – or other firms — from making the exact same deal again? Nothing, which is exactly what many Mervyn’s employees and vendors are about to be left with.





]]> http://www.pehub.com/wordpress/?feed=rss2&p=2769 http://www.pehub.com/wordpress/?p=2769 http://feeds.feedburner.com/~r/pehub/blog/buyoutdeals/~3/339118083/ http://www.pehub.com/wordpress/?p=2752#comments Fri, 18 Jul 2008 15:44:25 +0000 Erin Griffith All Buyout Deals http://www.pehub.com/wordpress/?p=2752

Today’s column covers last night’s Tax Loophole Protest (in front of KKR’s New York Headquarters), which I peeled myself from my air-conditioned cubicle to attend.

The Service Employees International Union has expressed a number of complaints about private equity firms: they aren’t socially responsible, they deplete a company’s cash reserves, and they take on too much risk, to name a few. But for this event, the SEIU kept it simple: Change carried interest tax law, or in the words of a rally poster, “No Tax Breaks For Buyout CEOS.”

One thing I noticed about SEIU’s message during “The Great Debates” panel at Buyouts East is that it’s simple and catchy, but doesn’t always examine the nuances of a situation; it doesn’t always “get it.” And that’s what a lot of the crowd looked like at this protest. Other than 40 or so people in the front, most of the rally’s attendants looked hot, unengaged, and content to chat among themselves. I can’t blame them. Private equity is complicated, difficult to understand, and even a little bit boring (admit it, nothing kills a conversation like leveraged lending).

But here is where I take issue. It is one thing to simplify a message in order to get people behind it. But vilifying the entire industry isn’t going to win me over. (There were accusations of “secret shareholder meetings.”). The message seemed to be that private equity, along with Henry Kravis, money, suits and big business, is evil. The rallying cry called for health care for all workers, which I agree is necessary, but the protesters would have me believe it’s as simple as “taking our money back.”

First of all, a carried interest tax hike—if passed—would be used to replace existing revenue from the outdated AMT tax. No new money for health care here. Secondly, the carried interest income lining Henry Kravis’s pockets isn’t being stripped from the companies he owns or their employees, it’s generated when a company that his firm improved is sold for more than it was bought for. Why would someone pay a higher price for a business if it wasn’t more valuable? Which brings me to my point. Despite my ribbing of the corporate phrase “value creation,” I do believe private equity firms create value. Revisit last week’s Ernst & Young PE study, which concludes that, for the third year in a row, private equity has outperformed public benchmarks in both growth and enterprise value. (Studies on job growth haven’t excluded synthetic growth through add-on acquisitions, so I’m leaving that issue out of this.)

Private equity has its place. Perhaps it got bigger than it needed to be (rising tide, anyone?) and perhaps some firms make all their money on leverage and carried interest. But if we’re going to point the finger of evil, let’s keep in mind that public companies cut costs and health care, too. And think of all the once-struggling but now-thriving businesses that wouldn’t be around if not for turnaround shops.

But enough cheerleading, because I happen to agree that carried interest should be taxed as ordinary income. Plenty of alternative investment professionals I’ve talked to agree, too. Look at the testimony of InterMedia Partners’s Leo J. Hindery for further proof. It’s even been said that no matter who gets elected this fall, the carried interest jig is probably up. Obama will certainly approve of a hike; with McCain it’s less clear. A number of firms are planning for the change in their LP agreements.

But I ask you, SEIU, is it so hard to make that point without attacking the business of private equity? For me, the rallying cry of the SEIU and its partner, the Working Families Party, doesn’t add up. Sure, if the tax loophole gets closed, returns will surely take a hit, and Henry Kravis may take home a little less money. But that won’t make private equity disappear, or knock businesspeople down a whole tax bracket. And even more importantly, it won’t stop public pensions and institutional investors from earning returns from the best players in the asset class.

Check out the photos from the rally here and the Private Equity Counsel’s response here.

Further reading:
***More info on carried interest. peHub has covered the issue extensively, too.
***The Wall Street Journal pointed out yesterday that SEIU’s own pensions are underfunded.
***More protest coverage from The Guardian, DealZone, San Mateo County Times






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