Case studies

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FOR THE WORLD’S PRIVATE EQUITY MARKETS

DEAL mECHANICA collection of case studies detailing the operational value creation story behind some of the industry’s most successful deals.

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In 2006, Modern Dairy built its first farm in the eastern Chinese province of An’hui, with the intention of raising dairy cows and selling raw milk to branded dairy com-panies for processing into various dairy products.

China’s demand for dairy consumption had been growing rapidly for the previous two decades, but an underdeveloped raw milk supply chain – which was comprised of millions of individual farmers – had led to milk safety issues and quality risks. This culminated in the huge tainted milk scandal of July 2008, when six babies were killed and a further 294,000 reportedly taken ill. The cause was proved to be contamination by the industrial chemical melamine, which was eventually traced back to former Chi-nese dairy products company Sanlu.

So there was clearly substantial demand for a large-scale dairy operation to provide safe, high-quality milk – but a lot of opera-tional challenges to overcome too. This was the context in which Kohlberg Kravis Rob-erts chose to enter the Chinese dairy sector: between 2008 and 2009, the firm invested a total of about $150 million of equity in Modern Dairy.

The results have been impressive. Today, it’s the largest dairy farming facility in China, both in terms of herd size and (according to the China Dairy Association) raw milk production, churning out 1.8 million tones of milk per year. Between 2008 and 2011, top line revenue at the Chinese dairy farm-ing company grew 393 percent to RMB 1.4 billion (€172 million; $222 million), while EBITDA rose 520 percent to RMB 459 million. More recently, the company reported that net profits for the 12-month period ending 30 June 2012 were RMB 396 million, a 77 percent increase.

What’s more, this bottom line growth hasn’t come from cutting costs and shrink-ing employee numbers, as in many big buyouts; under KKR’s ownership, Modern Dairy has seen employee headcount more than double, from 1500 at the time of investment to roughly 3250.

While KKR has yet to fully realise its investment in Modern Dairy, the firm looks poised to generate a very healthy return. In 2010, KKR took the company public on the Hong Kong Stock Exchange alongside China-focused CDH Investments, raising $448 million. The firm sold 222 million shares in the IPO, roughly one third of its original investment, and received $79 mil-lion in proceeds.

Much of Modern Dairy’s growth is directly related to operational changes spearheaded by KKR Capstone, KKR’s in-house team dedicated to improving the operations of portfolio companies. The group spent 16 months working intensively alongside Modern Dairy’s management team. It then dialled down its involvement slightly for a period, to somewhere between nine and 13 days per month – but since July 2012 it has been back with the company full time, spending somewhere between 14 and 19 days per month with management. So what have been their key initiatives?

1 builDinG out MAnAGeMent

One of the first things KKR did to spur growth at Modern Dairy was to help the company recruit

key organisational positions it needed to improve operations.

“KKR’s partnering with the founders of Modern Dairy to enhance manage-ment capability and build a sustainable managerial platform to drive operational

DeAl MecHAnic unDer tHe bonnet oF A recent DeAl

Milk money

During the past four years, Kohlberg Kravis Roberts has turned Chinese portfolio company Modern Dairy into a cash cow thanks to a series of operational initiatives. Graham Winfrey reports

The system has transformed how Modern

Dairy manages its business and has fundamentally improved management effectiveness across the board

DeAl MecHAnic

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We helped to ensure there was a quality

control process in place to ensure that the cows were fed the best quality feed to help them produce milk safely and efficiently

DeAl MecHAnic

improvement were the bedrock to having Modern Dairy become the business it has become,” says Julian Wolhardt, KKR’s regional leader of China, who was named non-executive chairman of Modern Dairy in September.

In fact, this amounted to a substantial overhaul of the management team. “This included enhancing the already solid man-agement team of Modern Dairy by helping them find a chief operations officer, chief nutritional advisor, head of purchasing, and head of breeding, among other positions,” he tells PEI. KKR also worked with manage-ment to implement training and succes-sion plans for important functions such as farm heads and functional center heads, to improve the sharing of knowledge.

Along with the expanded management team, KKR also established a more robust and numbers-driven management system: they worked to identify the key perform-ance indicators that highlighted the most valuable operating metrics, and established a process by which they would be reviewed on a monthly basis. They also revamped the

company’s budget review and reporting system, which is linked to the compensa-tion and incentive plans of all members of the management team.

“The system has transformed how Modern Dairy manages its business and has fundamentally improved management effec-tiveness across the board,” says Wolhardt.

2 iMProvinG best PrActice

While enhancing business per-formance using tried and tested methods of operational improve-

ment is something all private equity firms with operations teams strive to accom-plish, few have had to deal with the unique set of challenges that come with having to use live cows to produce their core product.

In order to address the company’s health and safety risks – which, not surprisingly, was a hot topic in the wake of the tainted milk scandal – KKR helped Modern Dairy set up an outside advisory board and imple-mented stricter standard operating proce-dures for disease prevention and food safety.

This has had tangible effects: it helped Modern Dairy reduce milk bacteria count by 80 percent, to approximately 0.5 percent of the China national standard.

KKR Capstone and Modern Dairy also developed standard operating procedures for all aspects of dairy farm operations, such as breeding, nutrition and purchasing. The procedures increased single-cow produc-tivity – i.e. the amount of milk it’s able to extract from a single cow – and allowed Modern Dairy to expand rapidly by rolling out its operating and managerial models in new markets.

“KKR and Modern Dairy worked together to improve the performance of key functional areas by implementing best practices across all farms to increase milk productivity,” says Wolhardt. “As a result, since KKR’s investment, Modern Dairy has increased milk yield by 34 percent.”

3 FeeDinG GrowtH

As you’d expect, animal feed is a big deal when you’re dealing with this many cows. ››

Modern Dairy: bringing milk to the masses


“The quality of the cows’ feed deter-mines the quality of the milk they produce”, says Xiaoyu Xia, head of KKR Capstone for China. “We helped to ensure there was a quality control process in place to ensure that the cows were fed the best quality feed to help them produce milk safely and efficiently.”

KKR Capstone helped design a stand-ard feed planning and procurement process, plus ‘feed optimisation tools’ that identified costs savings. As a second step, the team developed a process that included demand planning, contract negotiation with local providers of the corn silage used to feed Modern Dairy’s cows, land and yield inspec-tion and harvesting planning.

Despite KKR Capstone’s many talents, optimising cow feed was slightly beyond its field of expertise. So to improve these tech-nical functions, it sought external expertise from outside the firm: for example, in order to increase the quality and quantity of corn silage, it worked with a well-known silage production expert from Australia.

All feed purchasing managers, at head-quarters and in every single Modern Dairy farm, now use exactly the same process and tools on a daily basis. This helped Modern Dairy reduce costs by 3 percent and drove

an estimated 4 percent increase in EBITDA in 2010.

After implementing this long list of opera-tional improvements, Modern Dairy’s cows were producing at a rate at least 40 percent higher than the average farm in China, and with much better quality, according to Xia.

Management incentives and risk miti-gation initiatives have also helped Modern Dairy maintain an incident-free record of providing safe milk to consumers.

“The quality of the milk from Modern Dairy is far better than that of other daily producers in China and even exceeds the standards in Europe and the US in terms of higher protein levels and lower bacteria counts,” Xia adds.

4 strAteGic PArtnersHiPs

In order to preserve and ensure further growth, KKR helped the company secure insurance cover-

age for Modern Dairy’s most essential asset – its dairy cows.

It’s also been advising the company on strategic acquisitions and partnerships. This included a 10-year agreement with Meng-niu Dairy, the leading branded milk player in China, to ensure 100 percent up-take of Modern Dairy’s production. This also opens

up another interesting angle: a possible exit route. According to newspaper reports in August this year, Mengniu Dairy was said to be mulling a takeover of Modern Dairy, although the company has thus far denied that it is in talks to be sold.

KKR also helped Modern Dairy to build on its banking relationships: this helped it improve its working capital management and secure long-term bank loans, which will support new farm expansion and develop-ment projects. At the time of KKR’s original investment, the company had four farms; now it has 20, with an additional two under construction.

Lastly, as is usual with KKR’s investments these days, the Capstone team instigated some cost-saving environmental initiatives: Modern Dairy managed to reduce electric-ity and water usage on a per cow basis by at least 10 percent and increase its utilisation of bio-gas electricity generation.

****

As China’s raw milk industry continues to consolidate – individual farmers still supply about 95 percent of China’s raw milk, com-pared to roughly 50 percent in the United States, for example – Modern Dairy is plan-ning to develop new products to generate revenue from a broader customer base, according to KKR.

The firm says it’s currently transitioning from providing day-to-day operational sup-port to Modern Dairy to “ongoing counsel”. But that doesn’t mean it’s finished on the operational improvement front: future projects in the pipeline include a second wave of feed purchasing optimisation initia-tives, to achieve further cost savings and a collaboration with the chairman and chief executive officer to develop an organisa-tional blueprint for long-term growth.

So it seems that private equity and cows have a lot in common: continuous nourish-ment is the best recipe for generating a strong return.

DeAl MecHAnic

››

Reserve cows: ensuring a constant supply

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deal meCHaniC

In June, New York-based Fenway Partners sold 1-800 CONTACTS to publicly-listed healthcare company WellPoint. Financial terms were not disclosed, but a source familiar with the situation said the exit generated a 4x return multiple for Fenway.

Fenway had bought the (then NASDAQ-listed) contact lens company for $340 million back in 2007. Started by chief executive officer Jonathan Coon out of his Brigham Young University dorm room in 1994, 1-800 CONTACTS had increased revenues from $500,000 in 1995 to $249 million in 2006.

Happily, Fenway was able to keep the business on a growth trajectory: during its time under private equity ownership, top line revenue at 1-800 CONTACTS grew by double digits every year, while EBITDA more than doubled.

However, achieving this was no mean feat – because when Fenway bought the business, it had some major problems…

1 simPliFying tHe business

model

Perhaps the most serious of these issues was that the company did

not have enough agreements in place with contact lens manufacturers to ensure a con-stant supply of product. As a result, it had even invested in manufacturing facilities in both Singapore and the UK, in case supply ever ran short.

“We were purchasing from suppliers at the same time that we were making contact lenses ourselves,” says Tim Mayhew, manag-ing director at Fenway. And the business was much better at selling lenses than making them, he admits.

Indeed, owning and operating two manufacturing facilities was proving to be a

significant drain on the company’s financial and human resources, according to Brian Bethers, president of 1-800 CONTACTS. “That was a challenging investment for us,” he says. “We weren’t manufacturers.”

Resolving this supply issue meant sim-plifying the business model. And why not – this was, after all, a company that had been founded on simplicity (just hearing the name meant knowing how to order its product).

So one of Fenway’s first acts was to sell off the company’s manufacturing divisions, and help to execute supply agreements with every contact lens supplier.

2 FoCusing on serviCe

Exiting the manufacturing side of the business allowed Fenway to focus on 1-800 CONTACTS’

core competency (and, arguably, its prin-cipal asset): customer service.

“1-800 succeeds because it provides fantastic customer service at a really good price,” says Mayhew. “It just so happens that it’s selling contact lenses.”

One of the reasons for 1-800 CON-TACTS’ previous success was that the cus-tomer experience was fast, easy and efficient. Customers could order lenses over the phone or online and receive them the very next day. And because all of 1-800 CONTACTS’ busi-ness came through the phone or the website, excellent customer service was critical to the company’s success.

“Fenway understood that our business model is structured around taking care of customers,” says Bethers. “Sometimes you can get really mired down in a focus on trying to save money, without really focus-ing on trying to take care of customers and grow the top line.”

deal meCHaniC under tHe bonnet oF a reCent deal

Profits in sightFenway Partners/ 1-800 ContaCts

In five years, Fenway Partners doubled EBITDA at contact lens company 1-800 CONTACTS, without eliminating a single job. Graham Winfrey explains how

1-800: founded on simplicity and service

1-800 succeeds because it provides

fantastic customer service at a really good price. It just so happens that it’s selling contact lenses

4

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deal meCHaniC

But Fenway wasn’t just interested in taking better care of existing customers. It would also need to attract new ones in order to continue 1-800 CONTACTS’ upward trajectory. So after simplifying the company’s supply model, the firm concen-trated on finding new ways for customers to buy the product.

“Our view was: let’s reinforce our strength by being able to sell to [customers] in places that we weren’t able to at the time that we bought the business,” Mayhew says.

3 entering wal-mart

In 2008, Fenway helped negoti-ate a marketing agreement that allowed 1-800 CONTACTS cus-

tomers to place orders in Wal-Mart stores. “The premise of the alliance was to

make the customer experience completely seamless,” Mayhew says. “A person can walk into a Wal-Mart vision center or they can call our number or they can go online, and their customer information is equally well known.”

Since establishing the agreement, 1-800 CONTACTS’ market share has increased from 7 percent to 10 percent, according to Bethers.

“We were always phone and web, but it gave us experience operating with a store-based channel,” he says. “I’ve done a lot of agreements in my professional career [and] that’s probably the best single agreement that I’ve seen negotiated, in terms of trying to address the complexity of the situation and come up with something that would be mutually advantageous for both 1-800 and Wal-Mart.”

As well as establishing the agreement, Fenway helped 1-800 CONTACTS partici-pate in a number of co-branded marketing ini-tiatives with Wal-Mart to increase awareness. The firm also brought in a number of mar-keting executives to drive additional growth, including John Graham, former director of marketing at Mrs. Fields Famous Brands, who joined in January 2009 as senior vice president of business development, and Joan Blackwood, former chief marketing officer for employ-ment website Monster.com.

“Joan has helped us evolve in terms of the look and feel of the advertisements,” Mayhew says. “We’re very proud of some of the ads that she’s created.”

While ramping up advertising reduces the profit 1-800 CONTACTS earns on first time customers, the company’s level

of customer retention has made its adver-tising effort a sound investment.

“When we acquire a customer, the first transaction that we make we barely break even, because of the customer acquisi-tion costs of our television [advertising],” Bethers says. “Where we make money is through repeat purchasers.”

Today, these repeat customers account for roughly 80 percent of 1-800 CON-TACTS orders.

4going mobile

In 2009, Fenway began investing in an important new ordering platform: mobile devices.

“The first great awakening was this move to mobile, and that meant not just taking your desktop website and sticking it on a mobile device but actually taking this ››

Who better to start to explore the notion of

buying glasses than the person who is supplying your contact lenses?

5

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notion of customer service and improv-ing upon the experience, optimised for the mobile device,” says Mayhew. “Really great websites have stumbled and missed the move to mobile.”

By staying focused on that notion of a quick and easy customer experience, Fenway helped ensure that 1-800 CONTACTS’ mobile platform was simple and efficient. The firm invested in technology enabling customers to purchase contact lenses in as little as two clicks, chat with live call center operatives and reorder by taking a picture of prescription barcodes and uploading them.

Because roughly 15 percent of contact lens customers are under the age of 18, Fen-way’s mobile platform upgrade also focused on the trend among young people of texting.

“You’ve got to move where the customer is, and that customer actually wants to text,” Mayhew says. “All these things make for faster service.”

Ordering via text message was intro-duced in 2010, and to make the process of reordering even easier, the company pur-chased the SMS rights for “refill”.

Developing the mobile platform also led Fenway to reassess its main website and add new email capabilities.

“You can [now] email the company and get a live response generally within 10 minutes, if not less, from one of our cus-tomer service representatives,” Mayhew says.

In 2011, Fenway also helped launch the 1-800 CONTACTS iPhone app, which lets customers manage their entire family’s con-tact lens needs.

The investment in mobile has clearly paid off. Today, close to 20 percent of 1-800 CONTACTS’ revenue is through a mobile device, up from zero in 2009.

5moving into glasses

Earlier this year, Fenway and 1-800 CONTACTS launched eye-glass website Glasses.com.

“Who better to start to explore the notion of buying glasses online or over the phone than the person who is supplying you your contact lenses?” says Mayhew.

The website allows customers to order up to five pairs of glasses at a time for in-home trial – and send back the ones they don’t want.

Moving into glasses has given 1-800 CONTACTS another opportunity for substantial growth. While the contact lens market is estimated at between $3.6 bil-lion and $3.8 billion, the eyeglass space is roughly a $25 billion market.

The decision to expand into glasses also represents a change in the way 1-800

CONTACTS thinks about the mission of its business.

“How do you help [consumers] manage their entire optical needs – [that’s] what was really in the back of our head,” Mayhew says. “I feel very comfortable that 1-800 will continue to expand and become as signifi-cant a participant in the eyeglass market as it is in the contact lens business. And it will do that because of its emphasis on customer service.”

Today, 1-800 CONTACTS is the world’s largest contact lens store, with an inventory of almost 10 million contacts. In a single day, it sells as many contact lenses as 2,500 retail optical shops combined.

Still, according to Mayhew, the most important statistic and greatest indicator of success is the company’s customer sat-isfaction scores. In 2012, Internet Retailer magazine ranked 1-800 CONTACTS sev-enth in customer satisfaction, between L.L. Bean and Barnes & Noble.

While 1-800 CONTACTS rose to prominence well before being acquired by Fenway, much of its growth in the past five years is clearly attributable to the strategic initiatives instituted by the firm. And there was certainly no asset-stripping involved: in fact, during Fenway’s involvement with the company, headcount rose more than 10 percent. Definitely a deal that merits a closer look…

››

7%1-800 CONTACTS market share in 2007

10%1-800 CONTACTS market share in 2012

100%EBITDA growth under Fenway’s ownership

10%Headcount growth under Fenway’s ownership

deal meCHaniC


deal meCHaniC

Cadum knows all about babies. The French personal care brand, which specialises in baby-care products, would no doubt agree that young children need to be nurtured, given the skills to succeed and ultimately granted the freedom to venture out into the wider world.

It turns out, however, that the same thing is applicable to portfolio companies, and to Cadum in particular: the company recently produced a 6x return for mid-market group Milestone Capital, after being bought by L’Oreal. The French cosmetics giant beat out several other bidders in a highly competitive auction process run by JP Morgan; the eventual price tag of €200 million was a healthy sum for a company that generated €58 million in revenues last year.

This might seem unsurprising, given Cadum’s long and venerable history (the company is over 100 years old), its strong brand recognition, its established presence in its core French market and a growth strategy that has seen it expand into three new countries in the last three years.

But as recently as 2007, it was a very dif-ferent story. It has taken five years of serious operational improvement from Milestone to return Cadum to a level of performance befitting its pedigree…

1 FindinG a new PlatForm

Five years ago, Cadum still had the

long history and the brand recogni-

tion in France – but it was struggling

to convert this to sales

“Cadum was already well known in France. In the street you would ask ‘What is Cadum?’ and they would say, ‘Baby products, soap brand’ – 90 percent brand recognition

in the street, fantastic,” says Milestone man-aging partner Erick Rinner. “But then if you ask people, ‘Well, have you bought a product from them?’ they would say ‘No’.”

Milestone first came across Cadum and its management team in 2006, while exploring a deal for a different company. Three years earlier, the brand had been acquired (with no staff) from long-time owner Colgate-Palmolive by a pair of entrepreneurs, with the backing of CDC Enterprises and CIC Finance. But despite their best efforts – and those of the small team they had built up around themselves – they’d been unable to take the company to a level commensurate with their ambi-tions. At the time, Cadum was generating around €18 million in sales and €2.5 mil-lion EBITDA.

Part of the problem, according Rinner, was that the company had been largely ignored while under Colgate-Palmolive’s control. “It had been with the Colgate family for [50] years, and they had just neglected it,” he says. “I think that that’s the problem sometimes with global brands. They forget about the smaller, local brands and don’t give them enough attention.”

However, the current ownership struc-ture was not making life any easier either, Rinner suggests. “I developed a good rela-tionship with the CEO of Cadum … He said, ‘We’ve got a quality group of guys in our capital structure, but they’re French, they’re local, and they don’t understand we could grow more quickly.” As a result, he’d been thwarted in his efforts to inject more capital into the business, and also to hire the people he needed to build the business up.

By contrast, Milestone was intrigued by the company’s growth prospects.

deal meCHaniC under tHe bonnet oF a reCent deal

Smelling of rosesmilestone/ Cadum

Back in 2007, Cadum was a well-known French personal care company with a long heritage but a crippling lack of infrastructure. Enter mid-market specialist Milestone Capital… By Sam Sutton

Cadum: big in France


deal meCHaniC

Nevertheless, the company’s lack of infrastructure clearly posed a problem; building a platform of the requisite scale from scratch would have been prohibitively expensive and time-consuming.

So instead, Milestone spent six months looking for another company whose plat-form could be merged with Cadum’s. Eventually it settled on IBA, a niche air freshener provider; its growth prospects were limited, but its infrastructure, €20 million annual sales and €4 million EBITDA created a large enough platform to accomodate Cadum’s future expansion, Rinner says.

The firm acquired both Cadum and IBA in September 2007 for €50 million. Mile-stone’s equity contribution was €17.5 mil-lion, with Cadum’s management chipping in a further €2.5 million; the remainder was financed with a package of senior and mezzanine debt.

2 staFFinG uP

At the time of the Milestone acqui-

sition, Cadum only had about 10

staff, all in marketing, purchasing

and accounting. The company had out-

sourced most of its infrastructure to exter-

nal service providers: formulation, logistics,

sales and merchandising were all largely

handled by outside groups, Rinner says.

After the acquisition, the firm merged the companies’ internal operations and replaced its two external sales forces with a single internal one. No fewer than twenty-five sales professionals were hired to broaden distribution channels, and new executives were brought in to supplement Cadum’s existing management team.

“[Merging IBA and Cadum] was a good decision, not only for the business itself… We were in a better position to sustain our growth,” says Jacques Deret, who was

brought in by Milestone as a non-executive chairman. Deret, a former executive at Sara Lee, was already familiar with the com-pany, having assisted in the 2003 deal that extracted Cadum from Colgate-Palmolive.

The entrepreneurs who had led that deal stayed with the firm after Milestone took over – but they got some additional help. “We had two great founders – the guys were excellent,” says Rinner. “But they were doing everything. One was running around, running the business day-to-day. The other one was more the creator; he was running the marketing team… It was very small, very thin on the ground. We needed to get a professional team around these guys.”

In addition to hiring Deret, Milestone also created a six-person management commit-tee, adding a financial director, a commercial director, a marketing director and purchas-ing director to the existing management pair. (The head of IBA, who was retiring, was not brought into the fold, Rinner says).

The new set-up paid dividends – quickly. The brand’s market penetration (i.e. their distribution in relevant stores) doubled to between 50 percent and 55 percent; within four years, it had jumped to 70 percent. In fewer than five years, the combined EBITDA of Cadum and IBA leaped from around €6 million at the time of the acquisi-tion to €13.2 million in 2011. ››

The management was quite lucid

and very clear about the potential of what they could achieve, but didn’t have the means to do it


That’s a serious change of pace – but according to Rinner, the existing manage-ment team embraced the change with open arms.

“It was quite smooth, because [the man-agement] were frustrated … The manage-ment was quite lucid and very clear about the potential of what they could achieve, but didn’t have the means to do it. So the frustration level was very high,” Rinner says. “When we started, it was like freeing up athletes who wanted to run [but] were pre-vented from running. So it was like, ‘whoa’ – there was a big explosion of energy.”

3 lookinG FurtHer aField

Some of this energy was directed

into new geographies. After

spending two years building up

Cadum’s distribution and sales resources in

its home country, Milestone started casting

its eye toward foreign markets.

Cadum had already ventured into new territory, so to speak, with the expansion of its product lines. In addition to devel-oping a broader range of baby care prod-ucts, Cadum created a new hygiene line for children between the ages of 5 and 12, as well as products for adults. Shower gels

were distributed in larger bottles, to target family shoppers. And a greater emphasis was placed on natural ingredients in their products.

The expansion was hurried along by a revived marketing campaign. Milestone used IBA’s mature EBITDA to reinvest into the Cadum brand, tripling the marketing budget over three years.

“[This meant] going to TV more, going to billboards. It was in existence before we came, but we also enhanced the annual elec-tion of the ‘Baby Cadum’,” Rinner explains. “It’s a contest in France. Every month they elect a baby through the internet; then at the end of the year there’s a grand finale, and they elect the baby of the year.”

According to Deret, convincing Mile-stone to invest heavily in marketing wasn’t always easy – but the increased visibility paid off. While France’s personal care market tends to run relatively flat, grow-ing at a rate of 1 percent to 2 percent per year, Cadum’s growth rate was around 30 percent per year, Rinner says.

Through the development of new prod-uct lines, Milestone had opened the door to opportunities outside of France. The firm tested the international market in 2009 by expanding into Belgium through a distribu-tor and, after seeing some success, decided to broaden its footprint by crossing the English Channel in late 2009. The company’s new intimate hygiene line for women was considered perfect for the move, as the firm believed the market for similar products was underdeveloped in the UK.

Less than a year later, investor appetite for Asia’s consumer products sector led the firm to undertake an even more aggres-sive expansion into Vietnam – where they quickly captured 15 percent of the baby product market.

“[Vietnam] was just a test market, and it was a good market. My view is that L’Oreal bought [Cadum] because it’s a great French brand; it’s a heritage brand with a fantastic

image. But it has the potential to grow – if not global, then at least multinational,” Rinner says.

4 FindinG a better owner

By early 2012, Cadum’s growth

was starting to outpace Mile-

stone’s capacities as a mid-market

specialist. Sales had jumped from €18 mil-

lion in 2007 to €58 million in 2011, with

projections of €70 million in 2012.

“At the back end of last year, we felt that the business was going so fast… We had refi-nanced the mezzanine after two years. And we had repaid more than 65 percent of the senior debt. So we were doing very well,” Rinner says. “[But] we felt that, as we were becoming one of the big brands in France, we were going to have to spend more and more. And you reach a point where you’re playing with real big boys – and we’re still a relatively small business.”

Under the aegis of L’Oreal, Cadum should have no such problems.

It may have been the right time to sell (and Milestone is unlikely to be complain-ing about the healthy return the deal gen-erated). But it’s clear that the company would not have reached the sort of size that allowed it to take on these ‘big boys’ had it not been for Milestone’s strategy – which focused heavily on building the company up and achieving greater scale rather than engaging in financial engineering.

“It was not about cutting costs. On the contrary, it was about investing in infrastruc-ture, investing in people, building a sales and marketing machine that could grow much more quickly than before,” Rinner says.

››

€18mSales in 2007

€58mSales in 2011

30%Cadum’s annual growth rate

25sales professionals brought in by Milestone

It was like, ‘whoa’ – there was a big

explosion of energy

deal meCHaniC

In February, Dutch cable operator Ziggo sold a 21.7 percent stake on the NYSE Euronext Amsterdam stock exchange, ini-tially raising €804 million and valuing the business at €3.7 billion. That made it the biggest IPO in Europe since July 2011.

What’s notable about Ziggo is that it’s a business that only came into being five years ago: it was the result of a consolidation process led by private equity firms Warburg Pincus and Cinven, who combined three regional players into a single market leader.

For a consortium to bring together three separate busi-nesses – all with their own management teams, sales forces, specialisms, head offices and so on – and take the new company public within five years was no mean feat. And while this deal was interesting from a financing perspective (it was done during the boom era at a debt multiple of almost 7x EBITDA, since reduced to less than 4x via three refinancings), there was also some genuine heavy lifting on the operational side.

the back storyChronologically, the process began back in 2004. Warburg Pincus had identified cable as a promising sector, given its growth prospects and consolidation possibilities, and had picked out the Netherlands as one of the most attractive markets. During the summer of that year, the firm first met with the management of Multikabel: the fourth largest player in a national industry dominated by three much bigger rivals, it was being put up for sale by its owner Primacom as a part of a restructuring process. During the time this took to play

out (nearly 18 months, all told) Warburg Pincus was able to position itself as the preferred buyer for management, the seller and even the labour unions. The deal was eventually finalised in December 2005.

With an enterprise value of €530 million, Warburg Pincus had envisaged Multikabel as a relatively small growth capital style investment, at least in the short term. But its original investment thesis was rapidly overtaken by events: the follow-ing year, the second and third largest players, Kabelcom and Casema, both came up for sale at more or less the same time (Warburg Pincus had been expecting a consolidation period to happen – just not quite so soon). At this point, the game changed: now the big carrot was the prospect of combining these businesses to create a market leader.

However, this deal was too expensive for Warburg Pincus to do alone (requiring as it did a seven figure equity cheque).

Enter Cinven. Although both firms cheerfully admit that they prefer not to work with a partner, in this case they didn’t have much choice: they needed each other’s cash. What’s more, both sides brought something extra to the table: Warburg Pincus obviously owned Multikabel, which increased the scope of the consolidation opportunity, while Cinven had lots of experience in cable, primarily in France. It was this combi-nation of resources and know-how that helped them, in late 2006, to win Casema for €2.1 billion, and then subsequently Kabelcom for €2.6 billion. The three businesses were combined to create Ziggo – and judging by its subsequent IPO success, this integration went pretty well. Here are five key reasons why it worked.

1. creating an entirely new company“The most important thing was the approach we adopted to the post-merger integration,” says Joe Schull, the partner who led the deal for Warburg Pincus. “It was about bringing together three companies into one that would incorporate the best of all three, [but] ultimately build a better company. [So] unlike most mergers, there were no winners and losers.”

“We started off with three head offices dotted around the country; now the vast majority are based in Utrecht – and it’s mostly new people. So we’ve effectively built a new company,” says Caspar Berendsen, Cinven’s partner on the deal.

Warburg Pincus and Cinven created Dutch cable company Ziggo from three regional players in 2007. In March it became the biggest European IPO for nine months. James Taylor reports

Network grailz i g g o

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The value-creating aspect of this was that combining the three companies allowed the new owners to cut plenty of costs – they managed to strip out ‘synergies’ of €120 million a year, equivalent to about 20 percent of the cost base. Assum-ing a valuation multiple at exit of about 8.5x EBITDA (as per Cinven’s investment thesis) putting €120 million back onto the bottom line creates over €1 billion of value.

This did, of course, mean job losses: Ziggo lost about 10-15 percent of its headcount in the short term (although it’s now about 25 percent up on where it was). There was also a degree of hardware sharing. But that wasn’t necessarily the most important aspect: creating a national player reduced the charges payable to the central network operator, because they could cut out the middleman. “The big cost is not really the cables in the ground; it’s the central network costs,” Ber-endsen explains.

2. building a new senior management teamOnce they’d taken control of the three businesses, the new owners set about testing the top 20 managers across the three firms. They brought in an external consultant to do this, largely so the process would look more objective from the inside. But the result was a fortuitous one: it was able to fill the top three roles with one person from each company. Kabelcom CEO

Bernard Dijkhuizen became Ziggo CEO, while Multikabel’s CEO became the chief commercial officer, and the Casema CFO took the CFO job.

This was remarkably convenient: by having a representative from all three firms at the top table, the new owners could ensure a degree of continuity, and avoid the impression that the merger favoured one of the constituent businesses over the other two. The two buyout firms insist that if the outcome had been that all three jobs had gone to (say) Kabelcom people, they would have gone with that – though we imagine that would have been easier said than done in practice.

This screening process also helped Warburg Pincus and Cinven identify skill gaps. “If there was an internal candi-date whom we could promote to a role, we absolutely chose that option – but the most important criterion had to be the requirements of the role,” says Schull. “So if we didn’t have suitable internal candidates – and in several cases we did not – we always went outside the company.” A ‘Young Turks’ programme was also established, to try and fast-track up-and-coming managerial talent.

3. finding the right chairmanThe private equity owners are not there to manage the com-pany directly, of course. But it is their job to challenge the management team, set stretching targets, and make sure they

We took the view that we’d invested in a network-based business, so we were going to make the investments required

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get hit. In this, perhaps their most important appointment was that of Andy Sukawaty, chairman and CEO of cable com-pany Inmarsat, as Ziggo’s non-executive chairman. Since he was already used to working with private equity owners at Inmarsat, Sukawaty was well placed to mediate.

“He understands the objectives and speaks the language of both management and shareholders, so he’s a great bridge between the two,” says Schull. “We generally have had a very good rapport with the management team. But there are always occasions when the wheels grind a bit – so having someone who can speak authori-tatively in the language of each side is always helpful.”

4. boosting capexIn total, Ziggo has invested over €1 billion in capital expend-iture during Cinven and Warburg Pincus’s ownership. This included rolling out a software-based technology called DOCSIS 3.0 across the network, which can increase broad-band speeds without the need for new cabling.

“Fundamentally its network is one of Ziggo’s principal sources of competitive advantage; and maintaining the resil-ience of that competitive advantage takes investment,” says Schull. “Some shareholders with a shorter term time horizon might have sought to extract savings on capex to achieve a short term financial result. But we took the view that we’d invested in a network-based business, so we were going to make the investments required.”

5. getting the product mix rightOne of the most important growth areas for Ziggo was squeez-ing more cash out of its existing users – and a key element of this was increasing the sale of all-in-one ‘bundles’, which include voice, data and TV. This has become Ziggo’s main sales focus.

“We strongly encouraged management to make bundles the main service offering, and Ziggo is now by far largest bundle provider in the market,” says Schull. By the end of 2011 – a year that saw bundle subscribers climb 17 percent – its market share was up to around 43 percent.

Digital TV has also been a big growth area. As with most developed countries, Holland had already started making the transition from analogue to digital – but in many cases, the demand was not there because customers didn’t know what

they were missing. So Ziggo chose to try and get out ahead of the market by educating its subscribers about the benefits. This included TV advertising – which as Berendsen points out, was another benefit of the company’s increased scale. Nearly 75 percent of Ziggo’s customers now subscribe to digital TV, up from less than 15 percent in 2007.

The company also put much more effort into selling to busi-nesses, particularly SMEs. This was a relatively easy win, since many of these firms were already subscribers – but this leg of the business is now growing much faster than the B2C side.

That’s not to say the owners got everything right, of course. Perhaps the most high-profile snafu came when they tried to migrate the three companies’ IT systems onto a single, sepa-rate platform. As often happens with these big IT integration projects, it went badly wrong. “The issue with the database was that rather than trying to merge two of the systems into the third, we tried to merge all three into a fourth – over the course of a single weekend,” says Berendsen.

But although the episode resulted in some bad PR – man-agement had to spend the next few weeks publicly apologis-ing – the actual impact on revenue was negligible. “It wasn’t pleasant, but we didn’t get much additional churn as we reacted quickly to the problems,” says Berendsen. “We’d learned from our previous cable investments that customers were very sticky, even during periods of operational upheaval.”

And there was at least one upside, according to Schull. “It was a very good trial by fire for a management team that had had a lot of success up to that point; it made them very mindful of the need to pace and sequence complex internal changes.” So it stood them in good stead for the rest of the integration process.

Either way, the numbers certainly suggest a company that’s now going in the right direction. Ziggo’s full year results for 2011 showed a 7 percent jump in revenues year-on-year to €1.48 billion, while EBITDA jumped 6.5 percent to €834.6 million. It was a similarly positive picture when Ziggo reported its Q1 2012 results recently (the company did end up in the red, but that was largely due to one-off IPO costs).

So it’s hard to argue with Schull’s assessment: “Ziggo should stand as one of the singular successes of European M&A... a business that went through a massive programme of change and came out as a better and stronger company.”

€120mAnnual costs stripped out of

combined company

€1bnZiggo’s capital expenditure

under PE owners

€835m2011 EBITDA, up 6.5%

year over year

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UK readers of a certain vintage may, in their younger days, haveoccasionally found themselves in pet shops: chances are these were usually dark, dingy fetid places that you wouldn’t wish as a home on your least favourite gerbil. That’s a world away from the sleek, modern superstores of Pets at Home. With their giant rabbits, gleaming aquariums and pooch pampering tables, they’re more like a visitor attraction than a shop (as many parents with small children have discovered to their advantage).

Happily, part of this success story is a private equity suc-cess story. Pets at Home initially rose to national prominence with the backing of 3i in the 1990s. UK mid-market firm Bridgepoint then bought the business for £240 million in 2004 and owned it until 2010, when it was bought by its current owner, US giant Kohlberg Kravis Roberts, for £955 million (after an auction process that attracted most of the industry’s big names).

Pets at Home turned out to be a great investment for 3i, which reportedly pocketed £91million when the company was sold in 2004. And it was an even better deal for Bridgepoint: that sale to KKR equated to a money multiple of eight times its invested capital, and an internal rate of return of over 90 percent. No wonder managing partner William Jackson recently told Private Equity International that the deal was a

“clear favourite”.But that’s not why it’s a worthy subject for this column. The

key point is that its time under private equity ownership has unquestionably been good for Pets at Home, too. 3i invested some £25 million over eight years to help the chain grow.

During Bridgepoint’s time at the helm, revenues more than doubled (growing, on average, by 14 percent a year); profits almost quadrupled (from £22 million in 2004 to £84 million in 2010); and its store estate expanded from about 100 to about 250, creating about 1,500 new jobs. Last year, in its first full year as a KKR portfolio company, profits climbed 11 percent. From the humble beginnings of a single store in Chester in North-West England, Pets at Home is now a fully-fledged billion-pound retail giant.

In other words, private equity did what it’s supposed to do: make the business substantially better. But how, exactly?

upgrade potential

Guy Weldon, a partner at Bridgepoint and the head of its UK investment activity, admits that the firm’s task in 2004 was not to fix a broken business. “It was really all about unlocking the potential of an already good business, rather than executing some sort of turnaround.” This was a good solid business, in a nation of animal-lovers, with customers who are likely to keep buying and spending whatever the weather, season or economic cycle. That’s why Bridgepoint had to fight so hard to win the business in a very competitive auction (in fact at the time, it was thought to have paid a high price).

Operationally, Bridgepoint’s first priority – and the area it felt offered the greatest opportunity – was margin improve-ment. This had two major consequences.

The first was a huge emphasis on boosting own-label sales – an area that had been previously neglected. “That was very important,” says Weldon. “Pets at Home developed from scratch their value, core and silver ranges, which is the equiva-lent of good, better, best in supermarket language. They also developed their own brand specialist ranges, the two best known of which now are Wainwrights and Purely. Because own-label has a gross margin that’s something like 13 percent higher than branded products, it’s not only good from a top line perspective but also very powerful from a profitability growth perspective.” From a standing start, these own-label goods ultimately came to constitute more than a quarter of all revenue by the time of the sale to KKR.

The other big contributor to margin improvement was the business’s success in developing a direct import programme,

Three successive periods of private equity ownership have transformed Pets at Home into a billion-pound retail behemoth. James Taylor looks at how it happened

Gain in cats and dogsp e t s a t h o m e

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predominantly from China, to reduce costs. By 2010, it was buying up to $70 million of goods from China – again, from a standing start.

There was only one major strategic change: a plan already in place to pursue a smaller high-street format was quickly abandoned. “They thought it would be interesting to pursue a dual rollout strategy, with this high street concept and the retail park stores. We canned that at the outset, and said we thought it was better to focus on the already established and successful concept.”

With that established, it was full steam ahead; Bridgepoint felt there was a big expansion opportunity, given the weakness of the com-petitive landscape. However, it was also keen to update the look and feel of the stores – which ultimately accounted for a large part of the extra £90 million of capital expenditure Bridgepoint ploughed into the business. “We developed a new store concept which became the bedrock of an accelerated rollout program, as well as a refurbishment of quite a big part of the exist-ing estate.”

So what did this mean in practice? As well as introducing a more contemporary feel, and a stronger departmental organisation (so dog owners could shop in one place, cat owners in another, and so on), the key, says Weldon, was “bringing a sense of theatre and occasion to the stores”. This focus on the overall retail experience was smart thinking: having giant rabbits for children to pet encourages families to come to the shops, and possibly even to spend money. “The animals in the stores probably accounted for less than 3 percent of total sales, but they were at the heart of what the retail proposition was about.”

A similar ethos underpinned the Groom Room, a new service introduced for washing and grooming dogs. This has obvious financial upside: it’s an extra revenue line, with a high margin, and by virtue of being a service, potentially represents a recurring revenue stream. But because it all happens in a glass-walled room within the main store, there’s also an ele-ment of theatre about it. And there’s nothing like the sight of a poodle being shampooed to loosen the purse strings.

managing change

Management was one area that did change substantially under Bridgepoint. “11 of the 15 person management board were appointed under our ownership,” Weldon explains. “But it was less a case of upgrading the people in existing functions

– though there was a bit of that – and more about broaden-ing the team by appointing people into new functions. So for example the buying director, the multi-channel director, the marketing director, the head of pets, the logistics director – none of those titles existed when we bought the business, but they were all senior members of the management team six years later.”

deal mechanic

From a standing start, these own-label goods came to constitute more than a quarter of all revenue

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As Jackson told PEI last year: “It had a less than perfectly formed management team, but they had many of the ingredi-ents of success.... [They] had huge energy and benefited from youth in the sense that they were open-minded and keen to learn, and as a consequence were much more flexible than most management teams. They really had a hunger to drive change.”

Internally, the new and improved management team made some interesting changes. Staff training received a lot of attention: staff were put on a ‘steps’ programme whereby they could earn more money as they completed more training, with the ultimate aim of creating more in-store experts. Recruitment was improved by introducing the so-called ‘hamster wheel process’, which focused on candidates’ behaviour rather than the past experience. The focus was on hiring enthusiasts: 93 percent of staff, from the CEO down, owned a pet.

Feedback was also encouraged via an annual survey called ‘We’re all ears’, where staff were able to rank their part of the business by a number of criteria.

All told, this had measurable benefits. Staff engagement (as measured by the survey) jumped from 66 percent to 89 percent. Even more impressively, staff turnover fell from 78 percent in 2003/4 – a high number even by the standards of the retail industry – to 19 percent in 2010. So judging by these stats, Pets at Home became a better place to work.

Commercially, management also oversaw big improve-ments in product innovation – driven by head office, the

business got to the point where it was churning 30 percent of its products every year – and in marketing, including the launch of a national TV advertising campaign to boost awareness.

onwards and upwards

So what will the next chapter be in the Pets at Home growth story? After all, KKR would not have paid out a sum like that (equivalent to 11.4 times the company’s projected earnings for 2010) without being pretty confident that Pets had plenty more left in the tank.

The firm refused to talk about its specific plans – as you’d expect with such a new investment. But the likelihood is the strategy will be broadly the same, only more so: more new stores, more own-label ranges, more grooming salons... The attached veterinary business, Companion Care, may also be a focus: it expanded to 53 practices under Bridgepoint, but it still looks to have some growing room.

It’s likely that Pets at Home will also benefit from being part of a bigger portfolio, both in terms of costs savings and idea sharing; KKR knows retail pretty well, having previously invested in the likes of Alliance Boots, Toys’ R’ Us, Dollar General and Maxeda. And it’s already welcomed Pets into its Green Portfolio Program, the initiative aimed at improving environmental performance (and thus financial performance) across KKR’s portfolio.

The salient point though, perhaps, is that ten years ago KKR wouldn’t have got out of bed for this company. Now, thanks in no small part to private equity investment, Pets at Home is the kind of retail proposition that would interest every big financial buyer on the planet. That’s worth cel-ebrating.

Pets at Home began as a single pet shop in Chester in the early 1990s. Its expansion was backed by UK listed group 3i in the late 1990s

UK firm Bridgepoint bought the business in 2004. During its seven years of ownership, revenues more than doubled and profits almost quadrupled to £84 million. 150 new stores were opened and 1,500 jobs created

Investment in own-label ranges and sourcing more products from China boosted profit margins from 10 to 18 percent

11 of the 15 senior managers at the time of the company’s eventual sale were Bridgepoint appointees

KKR bought the company for £955 million in 2010. Profits jumped 11 percent in its first full year of ownership

DIAGNOSTIC: KeY FACTS

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“I’ve spent 22 years – that’s half my life – immersed in turning around troubled or underperforming businesses. And I can tell you unequivocally: I have never seen a company that was as poorly run as Waterford Wedgwood. In many cases with a turnaround you have a marketing problem, or a strategic problem, or maybe a combination of both. This was a case where every single aspect of the business was broken.”

This is how Mike Psaros, the managing partner of New York-based KPS Capital Partners, describes the company he found when, in early 2009, his firm agreed to buy some of Waterford Wedgwood’s assets from the receiver in Ireland (a deal that ended up spanning ten separate legal jurisdictions).

The aim of this column is to take a detailed look at examples of private equity transforming companies for the better. And in 2009, there were few companies in greater need of transforma-tion than Waterford Wedgwood. The Irish company clearly had some famous brands: it makes Wedgwood and Royal Doulton china, as well as Waterford crystal. But financially, it looked like a basket case: after years in the red, it collapsed into receivership in early 2009 with debts of more than a billion dollars. At the time, it was making $450 million in revenue a year – but losing nearly $100 million, even before interest payments. Various pri-vate equity firms had looked at it; not one had submitted a bid.

However KPS – which Psaros describes as “a hardcore, full-body-contact, operations-driven turnaround firm” – saw potential where others did not. “The big picture was: you had

three magic brand names, each with a 200-year heritage, and you had spectacular products that were selling in 80 countries around the world – despite it being the worst-run business I’d encountered in two decades. That really speaks to the power of the brands,” says Psaros.

Today, Waterford Wedgwood is a very different business. KPS won’t give out specific profit numbers, but the company climbed back into the black in the very first year of the firm’s owner-ship, and has been growing the bottom line steadily ever since. Its debt burden, which in 2009 stood at $1.1 billion, is now less than $50 million. KPS has cut more than $130 million of cost out of the business, while effectively doubling productivity thanks to a number of organizational changes and manufacturing improvements (and it was all done in-house, without the use of external consultants). Not bad for a basket case…

cost-cuttingIt helped of course that WWRD, the holding company formed by KPS to buy the Waterford Wedgwood assets, started out free from the huge debt burden that had brought the old company down (it been spending $60 million a year on interest payments). By contrast, NewCo’s only debt was a £50 million asset-backed loan facility from Bank of America to provide essential working capital (it’s now even lower).

The WWRD workforce was also much smaller. When it went bust, the original company had employed about 6,600 people;

Waterford Wedgwood, the famous china and crystal company, almost went out of existence in 2009. Three years later it seems to be thriving under its new owner, New York-based turnaround firm KPS. James Taylor talks to the principals involved

Crystal clearw a t e r f o rd w e d g w o o d / k p s c a p i ta l pa r t n e r s

It’s almost impossible to explain how bad this company’s cost structure was

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KPS offered jobs to about 3,600 of them (Psaros is very keen to emphasise that this doesn’t mean KPS made 3,000 people redundant, since all 6,600 had already lost their jobs as part of the liquidation process). This clearly made a big difference to the company’s cost base.

However, this headcount reduction – much of which was due to KPS deciding not to buy the company’s loss-making retail opera-tion – did not lead to a huge drop in output. In fact, by overhauling the structure of the company and boosting productivity, the new company was actually able to produce the same amount of stuff, but with far fewer staff.

One of the first things KPS had done on taking over the business was to appoint a new CEO, Pierre de Villeme-jane, who had already worked with the firm on the turnaround of technology business Speedline Technologies. It’s easy to see why KPS wanted to work with him again: he made the fund a return of 15.5 times its invested capital in just three years. “Pierre spent the early part of his career at L’Oreal – so he understands manufacturing and logistics and distribu-tion, but he also has the classic L’Oreal luxury goods marketing training. He was the perfect guy for the job,” says Psaros.

“I’ve known KPS since 2003 and this is my second turnaround, so we have a great working relationship,” de Villemejane tells PEI. “Whatever your equity structure, when you have this level of trust between a CEO and his board/ shareholder, that’s the best you can hope for. KPS’s business model is to be very lean in terms of people but they’re very involved in the business; they trust what I do, and of course they’re very involved in any major investment we make.”

But while the new boss was primed for a challenge, he hadn’t expected things to be quite so bad. “Everything was broken,” says de Villemejane. “That’s what shocked me at the beginning – the extent of the turnaround required. Everything had to be re-thought.”

For instance, the four divisions of the business, previously independent, were combined into one. “It’s almost

impossible to explain how bad this company’s cost structure was,” scoffs Psaros. “There were four different manufacturing processes; four different marketing heads; four different sales forces… Every single area where there should have been one consolidated function, there was four. And all four brands were out in the market competing with each other.”

Yet Psaros boasts that despite this internal overhaul, the com-pany did not miss a single order during the transition process. In fact, he says: “[WWRD] is designing, manufacturing and selling the same amount of product as [Old Co] with half the amount

of people. So the question I still wonder about to this day is: why was [Old Co] staffed in such an inefficient manner?”

Improving manufacturing productiv-ity clearly played a big part. The compa-ny’s factory in Indonesia is now, accord-ing to Psaros, “the most cost-effective plant for high quality bone china in the world.” So what did KPS change, exactly?

“Our operations team has spent an enor-mous amount of time on the shop floor in Indonesia. It’s about worker training, manufacturing metrics, shop floor layout, product flow throughout the plant… And of course management.”

KPS had decided not to buy the exist-ing Waterford factory in Ireland from the receiver, on the grounds that it was no longer competitive (by the end, it was down to a single production line). However, recognising the need to have a base in Waterford, it persuaded the Irish government to pay for the construction of a new site – part factory, part show-room, part shop. KPS claims the new Waterford facility is now Ireland’s second biggest tourist attraction, and attracted some 200,000 visitors last summer.

KPS and de Villemejane also over-hauled Waterford Wedgwood’s supply chain, and its distribution model. “The manner in which the product was distributed around the world was a disaster. It was handled too much; it was shipped to too many warehouses; the warehouses were in the wrong place… We literally had to start with blank piece of paper. How should this

DEAL MECHANIC


company distribute its products worldwide? That meant a new warehouse footprint, a new logistics provider, and new freight companies.”

All told, KPS cut costs line by $130 million. Psaros couldn’t say how much of this was people-related, but he stresses that it couldn’t have been done without “attacking every single aspect of how the product is designed, manufactured, distributed and sold… There were hundreds of unique individual discrete actions taken to achieve [that saving], over an 18-month period.”

early offensiveGaining the trust of staff was clearly a challenge too; particularly in Ireland, where KPS took on a shrunken and demoralised work-force. “It was a very difficult time,” de Villemejane admits. “When we took over there were all kinds of rumours about us dismantling the group and selling assets piecemeal… It took a good 12 months of high-profile measures to convince people that we were there to grow a portfolio of brands, not strip assets.”

But although there were plenty of fires to fight, de Villeme-jane was already thinking about the next stage of the company’s recovery. “Usually on KPS turnarounds we play defense first – so you do the turn, and then you play offense,” says Psaros. “This was one of the rare occasions when Pierre started playing offense on the day we created the company.”

The key to this was sorting out the company’s outdated and badly targeted product range.

“One of the issues was a lack of focus on understanding the consumer,” says Villemejane. “Because it had gigantic problems financially, the old management team didn’t spend time thinking

about what type of new products they needed to deliver to the next generation of consumers.”

The first task was to reduce the number of products. “The old company was carrying tens of millions of dollars of excess inventory, largely associated with product that was manufac-tured but not properly test marketed to see whether there was consumer demand,” says Psaros.

The second was to revitalize all three brands; so Waterford, Wedgewood and Royal Doulton are no longer mere tablewear, but “luxury home and lifestyle brands”. Waterford and Wedgwood have become the premium aspirational ranges, while Royal Doulton is intended for a slightly younger, trendier audience. It has also relaunched Royal Albert, an English floral vintage china range.

With developed markets stagnant, the company is throwing resource at Asia, which now accounts for a third of its revenues.

“We’re on full attack in China,” says Psaros. “We believe that within the next two or three years we can have 200 different locations there. It’s going to be a huge growth market for us.”

Hospitality will be, too, it hopes; it’s already signed a deal with Emirates to supply fine china for its first and business class cus-tomers (supposedly the biggest such deal an airline has signed to date), and has just start building a specific team to exploit what it believes can be a big market opportunity.

Both Psaros and de Villemejane say they now wish they’d pushed their growth strategies harder, sooner. “It’s difficult because you always want a little bit of continuity,” admits the Frenchman. “But there are a couple of changes made over last two years that could have been done earlier.”

Still, they’re both clearly very proud of what KPS has done with Waterford Wedgwood. As Psaros puts it: “A 257-year old enterprise went into bankruptcy, and nobody wanted to touch it. Now look at where it’s at today.” The proof of the pudding will come when KPS sells the business – but it’s hard to imagine this being anything less than a highly profitable exit.

When it went into receivership in 2009, Waterford Wedgwood had debts of over $1 billion and was losing almost $100 million a year (even before its $60 million a year interest payments). it is now profitable and has less than $50 million of debt

Headcount is now 3,600, down from 6,600 – but without any drop in overall output

Costs have been cut by $130 million thanks to an organisational overhaul (whereby the company’s four separate divisions were consolidated into one), an increase in manufacturing productiv-ity, and an entirely new sourcing and distribution model

Opened a new factory in Waterford, ireland (the old one had been closed down by the receiver) to make high-end, hand-made crystal. it’s now a popular tourist attraction, with more than 200,000 visitors last summer

Repositioned and re-launched all three major brands – plus a fourth, Royal Albert

A third of its revenues now from Asia; it plans to increase its number of retail outlets in China from 30 to more than 200 in the next few years

DiAGNOSTiC: KEY FACTS

DEAL MECHANIC


As retail investments go, buying a high-end shoe business for £95 million in Feb-ruary 2008 – just before the onset of the deepest recession in living memory

– was definitely at the riskier end. Yet in the subsequent three years, Graph-ite Capital, a UK mid-market manager with a good track record in retail, man-aged to boost revenues at Kurt Geiger by over 70 percent to £205 million and create 600 new jobs – before selling the business to US firm The Jones Group for £215 million. This would count as a good deal in any circumstances. But to pull it off in the middle of a precipitous fall in consumer spending makes it all the more impressive.

So how did Kurt Geiger succeed where so many other retail businesses failed? It’s true that many luxury goods firms have (perhaps counter-intuitively) fared pretty well in the downturn. And it’s also true that many members of the fairer sex appear to have an insatiable appetite for new shoes, recession or oth-erwise. But its private equity owners can take some of the plaudits, too...

the initial dealKurt Geiger had spent the previous three and a half years under the aegis of Bar-clays Private Equity, which had backed a £46 million management buyout of the business from department store Harrods in July 2005. It proved to be a pretty lucrative investment, too: Barclays PE doubled its initial investment with the sale to Graphite. At the time, that looked like a pretty good deal. With a recession clearly in the offing, Kurt Geiger looked very exposed to the likely downturn in UK consumer spending – and having

been through one period of private equity ownership already, there was presumably a chance that the lowest hanging fruit had already been picked.

Graphite had other ideas, how-ever. “We assess a business by the management team’s vision: how well prepared they are for the economic circumstances,” explains Andy Gray, a senior partner at Graphite who co-led the deal. “In this case, they had a very strong plan, with lots of potential avenues for growth. It was clear that if one of these avenues was less fruitful, it could be offset by opportunities in other avenues – and this gave us the confidence that even in February ‘08, we could still do a deal like this.”

Nonetheless, Graphite did structure the deal conservatively: it made sure debt was kept to a relatively low level (about 40 percent of the transaction value) and that the attached covenants were suitably generous, in case trading went really pear-shaped. “It was obvi-ous that businesses with a lot of lever-age were going to suffer. When things are volatile, especially in a sector like retail where you have a lot of fixed costs, you have to make sure the debt doesn’t sink you.”

Gray rejects the idea that it’s harder to generate outperformance from secondary deals. “It’s a double-edged sword. With a primary deal, you’re in earlier but you have more to do; so there can be more potential on the upside, but you have to work really hard to get it and it all takes a bit longer to do. With a secondary, some of that work has been done, so there’s a bit less risk there and you feel like you have to

In the first of our new regular series on operational value creation, Private Equity International takes an in-depth look at Graphite Capital’s success with shoe retailer Kurt Geiger. By James Taylor

Sole trader

Gray: management team was key

Golser: Jones was best possible buyer

DEAL MECHANIC


give away a little bit on price as a result. But it’s not an exact science; some of our best deals have been secondaries.”

So was he confident at the time that they’d bagged a bargain? “You’re never confident – you always think you’ve paid too much! But it was a price we were comfortable paying because we felt there were good opportunities for us to exploit in the next few years and the business was led by a great senior management team.”

easy to manageThe management team was arguably Graphite’s biggest advantage on this deal: in CEO Neil Clifford, buying and creative director Rebecca Farrar-Hockley and FD Dale Christilaw, Kurt Geiger already had a well-established and close-knit senior leadership group (it helped, too, that its non-executive chairman Neil McCausland also chaired Graphite portfolio company sk:n, giving Graphite a natural way in).

“The top three people were very good so that didn’t change at all,” says Gray. “We meet dozens of management teams, and they were certainly one of the better ones

– very complete and very professional, with an excellent underlying knowledge of the business and a strong feel for all the different opportunities they had.” Graphite’s key role, then, was to help them prioritise those opportunities – and to strengthen the second tier of management as the company grew.

Importantly, management were also used to working with private equity owners. What this meant, according to Graph-ite’s Markus Golser (the other senior partner on the deal) was that their reporting was very good, and they were always open to new ideas. For instance, one of Graphite’s first moves was to commission an external brand review. Rather than feeling threatened, management embraced the idea, co-commissioning the report and ultimately making some substantial changes as a result of its findings (including the decommissioning of one of Kurt Geiger’s brands, Solea).

The same was true of cost control, another early Graph-ite focus. “What we always do is look at the cost structure

and see if there’s anything to be gained there,” says Golser. “We tend to be very active in that area and it tends to bear fruit, because most businesses have a bit of slack – particularly if they’re growing very strongly, as that creates inefficiencies.” So Graphite brought in a purchasing consultant, who worked with management to reduce overheads, particularly in the company’s supply chain and logistics.

new frontiersPerhaps the key strategic change insti-tuted by Graphite was the expansion of Kurt Geiger’s distribution channels.

This was partly about consolidating the existing business. At the time of the Graphite buyout, the biggest chunk of the company’s revenue actually came from running the shoe departments of some of the UK’s largest department stores, including Harrods and Selfridges. The latter, which was on a mission to build the world’s biggest luxury shoe department, was already in discussions with Kurt Geiger about expanding that relationship; so Graphite’s first task was to help conclude a long and complex negotiation over the terms of the deal (how much space Kurt Geiger would have within the department, who would

be responsible for what, how the revenue should be split, and so on).

It did so successfully, and was also able to roll out a simi-lar offering into other department stores like Debenhams and Fenwick (helped by the collapse of Shoe Studio, a big competitor in this space – one definite upside of the difficult operating environment).

But Kurt Geiger’s own-brand store network also grew substantially under Graphite’s ownership. In the UK, it rolled out an extra 24 stores in various airports, shopping centres and high streets. Retail landlords were falling over them-selves to win the company’s business. “We opened a dozen stores in a year because we basically got into them for free,” admits Gray. “In some places landlords proactively wanted us in as anchor tenants, so we were able to do some very good

Most businesses have a bit of slack – particularly if they’re growing very strongly, as that creates inefficiencies

DEAL MECHANIC

20

deals – long rent-free periods, and kit-out costs paid in full by the landlord”.

Expansion was also rapid overseas. Kurt Geiger had already started negotiating with Landmark International about a franchise deal to open stores in the Middle East; later on in the investment, Graphite signed similar deals with partners in Russia and Turkey. All told, the international business was producing revenues of more than £15 million by the time the business was sold, compared with very little when Graphite took control. But the real significance went beyond that boost to the top line: it proved the Kurt Geiger brand would sell overseas, which ultimately made the business much more attractive to an international trade buyer like Jones.

Another important development was the re-launch of the Kurt Geiger website, which gave the company a genuine online retail platform for the first time (it did have a site before, but without all the bells and whistles we’ve come to expect of good e-commerce operations).

Achieving and managing this expan-sion required lots of new staff. For instance, the company invested heav-ily in its in-house design function as it sought to develop new brands and products to differentiate these new offerings without cannibalising sales elsewhere. All told, headcount almost doubled during Graphite’s period of ownership.

It also required lots of homework, as Graphite worked with management to evaluate potential opportunities. Here, Graphite clearly benefited from its previous experience in the retail sector. For instance, it walked away from one potential franchise deal in Turkey because it was worried about the potential reputational damage of expanding too far, too fast, within that market; having had a bad experience with a franchise partner in Australia during its ownership of Japanese restaurant chain Wagamama, it had

learned this lesson the hard way. “One of the main issues for a business like this is planning growth,” says Gray. “You need to make sure it doesn’t try to do too many things at the same time.”

selling upThe other crucial factor, of course, was that Graphite found the right buyer at the right time. In early 2011, the firm received an approach from The Jones Group, a big US clothing

company that had practically no pres-ence in Europe. “We probably would have looked to sell in the following 12 months anyway, so we were beginning to discuss next steps with management,” says Golser. “We debated with them whether they should do another buyout, but we felt that given the market, and given the lack of debt funding for retail businesses, it would be very hard for private equity to match a trade price.”

And the strategic fit was obvious: Kurt Geiger gave Jones an immedi-ate foothold in Europe, while Jones gave Kurt Geiger a strong platform to expand in the US. As a result, Graph-ite was able to get what was generally regarded as a pretty generous price – given this was still, after all, a high-end retailer operating in a global downturn.

So was it the firm’s best ever retail deal? “It was a good one for us,” Gray admits. “Not necessarily the best – but in the circumstances, we were really pleased. As the environment got worse, we were able to sell to the only party that would pay that price at that time

– i.e. a party that wanted to do other things with the business.”

Kurt Geiger is a business that’s been transformed in the last few years. Clearly the management team has to take a lot of the credit for that; but its private equity owners also deserve a lot of credit for some smart strategic moves. It would be hard to argue that Graphite’s investors don’t deserve the juicy return this deal generated...

We opened a dozen stores in a year because we basically got into them for free

DEAL MECHANIC


private equity international february 201326

Last July, Equistone Partners Europe sold travel-related payment services company Global Blue to Silver Lake Partners and Partners Group for €1 billion – generating a return multiple of more than 4x.

When Equistone – formerly Barclays Private Equity – bought Global Blue (then called Global Refund) for €360 million in 2007, it was the second largest invest-ment in the firm’s history. The Switzerland-headquartered business provides tax refund services for retailers to offer to overseas travellers visiting Europe: after making pur-chases at luxury goods stores within the European Union, foreign customers are able to claim tax refunds at Global Blue locations, which are primarily in airports.

One of the first companies to enter this market more than 30 years ago, by 2007 Global Blue owned roughly half of the market. It was also attractive to Equistone because it ticked two of its favourite sector boxes: finan-cial services and consumer/retail.

The timing wasn’t ideal: the business had to cope not only with some unexpected shocks – such as when two volcanic erup-tions in Iceland shut down European air travel for six days in 2010 – but also the global financial crisis, which inevitably had an impact on tourism.

Nonetheless, during Equistone’s period of ownership, Global Blue doubled its rev-enues and grew earnings before interest, tax, depreciation and amortisation from €35 million to €97 million. Here are some of the key operational drivers.

1bolsterinG ManaGeMent

In order to drive growth at Global Blue, Equistone strengthened the company’s management team by

adding a number of senior level executives.It hired Philipp Manser, former chief

financial officer of Hotelplan Europe, as Global Blue’s new CFO, and added Arjen

Kruger, former chief marketing officer at MasterCard Europe, as CMO. The firm also brought in Henning Boysen, former president and chief executive officer of airline catering company Gate Gourmet, as non-executive chairman.

“Whilst the chief executive officer was very strong, we did feel that to develop the senior team with those additions was really important,” says Owen Clarke, Equistone’s chief investment officer.

2exPanDinG tHe offerinG

One of the first initiatives Kruger spearheaded after joining the company in 2008 was a rebrand –

in order to facilitate the launch of a number of new products and services tailored spe-cifically for individual consumers, rather than just retail stores.

“As the new CMO, I felt that we needed a rebrand to be able to do that successfully – so we weren’t seen purely as a business-to-business organisation, and could start to build a brand that would appeal to consum-ers as well,” says Kruger. “So I put that strat-egy forward to the board and Equistone.”

After changing the name of the company from Global Refund to Global Blue, Kruger and Equistone helped add new products that encouraged repeat sales by offering shoppers loyalty schemes, introducing them to specific brands and enabling them to research various shopping locations.

“All of a sudden, this was a brand that had a presence in the consumer space, which we’d never really had,” Kruger says. “We’re now starting to see the brand in the eye of the consumer.”

3GoinG DiGital

As part of this process, Global Blue focused on making the customer experience as seamless as possible.

One way to do this was to digitise the process

Deal MeCHaniC unDer tHe bonnet of a reCent Deal

Betting on blue equistone/Global blue

Over a five-year period, Equistone doubled revenue at tax services business Global Blue thanks to a series of improvements to the company’s products and services. Graham Winfrey reports

Clarke: bolstered senior team

There were actually fewer Americans and Japanese travelling and

spending, but more Chinese, Russians and Brazilians

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february 2013 private equity international 27

Deal MeCHaniC

of customers getting their tax refunds, which had been largely paper-based in 2007.

“You’d print out the form at the retailer, take that form to customs at the airport to get it stamped, then take it to the Global Blue booth at the airport to get your refund,” says Clarke.

Converting to digital not only enabled Global Blue to save on processing costs; it also increased the efficiency of tax-free shopping.

“[It] makes the whole process very traveller-friendly and indeed very retailer-friendly, which means that more people use the service,” Clarke says. “The bigger win was the fact that it just made the service better. It meant that travellers find it easier to get a refund.”

Annual transactions doubled under Equistone’s ownership – from 13.5 million in 2007 to 27 million in 2012.

4enterinG eMerGinG

Markets

While the majority of Global Blue’s customers in 2007 were

Europeans traveling within Europe, one of the most significant changes Equistone helped implement was attracting more business from travellers in emerging mar-kets.

“There’s been really strong growth in emerging markets [and] middle class appe-tite to travel and to buy luxury goods,” says Clarke. “Strategically, what we were doing was positioning the business to take advan-tage of that trend as much as possible – by opening additional offices and outlets in Asia, and by positioning an international website that was operated in Chinese and Russian as well as English.”

Today, roughly 70 percent of Global Blue’s revenue comes from emerging market countries such as Brazil, China, Indonesia, Russia and Singapore. The company now

has operations in 42 countries, up from 37 at the time of Equistone’s investment.

“It was taking advantage of a trend that worked very much in the business’s favour – but making sure that we really rode that wave of increasing affluence of Chinese and other emerging market travellers who really wanted to come to Europe and other places and spend money on luxury goods.”

Handily, this also offset a fall in devel-oped market travel after the onset of the financial crisis. “There were actually fewer Americans and Japanese travelling and spending, but more Chinese, Russians and Brazilians. So those sorts of things were balancing each other out,” says Clarke.

5PositioninG for future

GrowtH

Though Equistone has already reaped a strong return on its

investment, Global Blue is poised for continued growth under Silver Lake and Partners Group’s ownership, according to Kruger.

“The things that we were able to put in place whilst [Equistone] were our owners are really going to benefit us over the next four to five years,” he says.

One of the key strengths of Equistone as an owner, according to Kruger – and thus one of the main reasons for Global Blue’s success – was the firm’s highly col-laborative style of working. This meant allowing the senior management team to put forward its own plans for growth – and helping to execute those plans when needed.

“They left a lot of discretion to manage-ment,” Kruger says. “[For] the issues that mattered and that were important to the future valuation of their investment, they very much had their hands on that. And that was appreciated.”

Clarke agrees. “It wasn’t a case where we came in with our operational partners or our own views and said, ‘You need to do this, that and the other’. This was [about] developing a strategic plan that the manage-ment team was leading.” n

Global Blue: rebranded for greater B2C appeal

private equity international march 201326

TrimCo in 2005 was a small Hong Kong-based supplier of care-and-content labels to apparel brands that manufactured in Southern China. It was a 30-year-old, family-owned shop that had reached a plateau – just the kind of busi-ness that appeals to Navis Capital Partners, a small-cap buyout firm based in Malaysia.

TrimCo was well-run by the founder, explains Bruno Seghin, senior partner at Navis. Cash flow was steady, but revenue growth and margins were little more than flat despite the surge of garment manufac-turers setting up in China.

In 2005, Navis bought a majority stake in TrimCo for an equity cost of $11.1 million. During a seven-year holding period, top-line revenue grew 3.1x and EBITDA grew 3.3x. The firm divested TrimCo in 2012 in a sale to Partners Group, reporting a 10x exit.

The exit result came in part from buying well, Seghin says. But the critical ingredi-ent was the relationship between TrimCo’s founder and Navis.

“Some founders say they agree with you, but inside they do not agree,” Seghin says. “But with TrimCo it worked perfectly. She saw we could help the business. We could find people, make acquisitions, talk to banks, things she didn’t do before.”

He believes the key to operational change is the receptivity of the entrepre-neur. “We could give the best of ourselves because we felt that what we were doing was being recognised and we could add value. Then it becomes a virtuous circle.”

So what value did Navis add, exactly?

1exPanDinG out oF honG

konG

The small care-and-content tag attached to clothes and sport shoes

may seem trifling, but it actually helps to regu-late the entire global garment industry. The tag, which is more difficult to copy than the garment itself, verifies product authenticity.

Tags are produced by TrimCo for brand name clients in specific numbers that match a spe-cific apparel production run. One tag goes to one item, giving the brand some control over outsourced production.

The trouble was, TrimCo was manufac-turing only in Hong Kong and shipping to Southern China factories – while garment manufacturing was popping up all over Asia. Navis, which is well-established in South-east Asia, did some research to help identify the most relevant locations. It ended up bringing TrimCo into Thailand, Singapore, Malaysia, India and China, using its local channels to identify acquisition targets and recruit employees. As a result, employee numbers went from 83 in 2005 to 288 in 2011. Production output also grew by 1.62x during the same period.

2brinGinG in a seconD tier

oF manaGement

Like most family-owned busi-nesses in Asia, TrimCo had no

second line management. In order to grow, particularly in the new markets it was entering, the business required profes-sionals in key positions.

Navis brought in a chief financial officer and worked with her (all of TrimCo’s man-agement are women) on developing a finan-cial control system to track KPIs, explains Agnes Lee, Navis’ investment director. Pre-viously, TrimCo had an external accountant and the company looked only at total sales and profits. The financial control system Navis introduced looked at product type and profit by region, which helped support board-level decisions, Lee says.

A marketing manager was also recruited to review how to improve service offerings to clients and sell to new markets. “TrimCo had a good margin and a good product, and we believed there must be more clients who liked what they do,” Seghin says.

Deal mechanic unDer the bonnet oF a recent Deal

Tag teamnavis caPital Partners/trimco

Over a seven-year period, Navis’ operational work with TrimCo grew EBITDA by 3.3x and helped turn a small family-owned labelling business into a global player – resulting in a 10x return. Drew Wilson reports

Seghin: aligning with the founder

TrimCo had a good margin and a good product, and we believed there

must be more clients who liked what they do

march 2013 private equity international 27

Deal mechanic

Private equity’s role in recruiting manage-ment is crucial – but tricky, he explains. “The chemistry between new people and a com-pany that has been running its own way for 30 years has to click in the first two minutes of the interview. It can be frustrating sometimes. You can introduce very good quality people, but the meeting goes badly and you have no recourse. We know there is no point to insist. We have to accept that the entrepreneur is very instinctive and thinks very quickly based on experience. We are the opposite.”

Management retention is also important, adds Lee. Both the CFO and marketing man-ager were put on incentive programs linked to performance targets, and as a result both women have stayed on at TrimCo.

3imProvinG service via

technoloGy

TrimCo manufactures millions of tags per day, which go to dozens

of different orders. At the same time, labels are becoming more complex. One mistake on the label and the shipment is blocked at customs, raising TrimCo’s costs.

Navis saw that mistakes sometimes came from the tag ordering process, which was manual and clumsy. Customers would look at various websites for the constantly changing labelling regulations required by each desti-nation country, then download the informa-tion and email it to TrimCo.

The founder had an idea to make the ordering process more efficient through technology, but plans were not concrete and management was hesitant. Discussions with Navis led to the idea of implementing an information management system that centralised and simplified the whole supply chain, from order to delivery, including tracking. On this project, Navis acted as a supportive partner, encouraging manage-ment to realise the idea and backing them with expertise as needed.

“Most entrepreneurs are risk-averse when we first meet them because all their eggs are in one basket,” Seghin says. “After Navis buys a controlling stake, they are able to de-risk and try new things because less is at stake – and they are not alone. That’s what we’ve brought, rather than the specific technical expertise.”

The IT system was the first in the label industry and it shored up TrimCo’s competi-tive advantage, Seghin believes. Big competi-tors were slow to do the same because only a small portion of their business was garment labels – while the small players competed on cost, not service. The IT platform was part of the reason some large brand name garment makers became TrimCo clients.

“We took the business away from the big guys,” he says.

4builDinG a PlatForm For

Growth in euroPe

In April 2012, as Navis was about to exit TrimCo in a secondary sale

to Partners Group, it closed the acquisition

of a large UK-based label manufacturer it had been talking to for two years. On exit, Partners bought the company together with TrimCo.

The add-on acquisition brought TrimCo a presence in the UK, Turkey, Romania and Bangladesh – key garment manufacturing markets. In addition, the integration will bring the UK manufacturer significant cost structure savings by using TrimCo’s Asia-based manufacturing, Seghin says.

Navis had already done full due diligence on the UK manufacturer, so Lee provided the buyer with a detailed integration plan that laid out the growth strategy.

“The UK target was totally complemen-tary to TrimCo and gave the buyer reserve growth for the coming 2-3 years,” Seghin says.

The double acquisition increased the potential for problems. But Seghin says Navis was able to complete them together because it had built trust with the seller, which the Navis team had been in talks with, and the buyer, having worked with Partners Group for many years. n

TrimCo: boosted production by 1.62x under Navis’s ownership

private equity international april 201324

Rosemont Pharmaceuticals occupies an unusual niche: founded in 1967, it makes oral medicines for patients – mostly old people – who have trouble swallowing standard pills and capsules. In 2006, UK-based lower mid-market group CBPE Capital paid £93 million to buy the busi-ness from former owner Savient Pharma-ceuticals.

CBPE’s previous pharma experience was key to winning the deal, according to partner Sean Dinnen. “When we met the management team, they could tell quickly that we had a good grasp of the pharma sector – which is relatively rare in the lower mid-market, because it’s a specialised area.”

Dinnen and his team felt the business would benefit from more active ownership. “Savient had bought the business oppor-tunistically, and hadn’t really done anything with it. We could see that if certain things were done, it had significant growth poten-tial.”

So it proved. During its six years of own-ership, CBPE helped the company more than double EBITDA, from around £8.7 million to £19.2 million, while expanding staff numbers from 156 to 209. This year, it was able to sell the business for £183 mil-lion, banking a 3.25x return on its original £53 million equity cheque. Here’s how.

1stiCkinG to tHe knittinG

The first key decision, according to Dinnen, was to remain focused on liquids, rather than branching

out into other related areas (like creams, ointments and so on). “Our fundamental strategy was to develop a business that had a reputation for being best-in-class glo-bally in oral liquid formulations. Another owner could have gone down a different route, but we wanted to remain pure-play liquids.”

As part of this drive to become best in class, it stopped doing contract manufac-turing for other pharmaceutical companies – a high volume but low margin business – to focus on its own products.

It didn’t shun the pharma giants alto-gether, however; on several occasions it worked with one of the big players to develop a liquid version of their drugs (notably with Lundbeck on its epilepsy drug clobazam, which Rosemont eventu-ally took to FDA approval in the US). But that was a different sort of relationship – and by establishing Rosemont as a trusted expert, it helped to bolster the company’s best-in-class credentials (and thus its even-tual valuation).

2iMprovinG tHe

ManuFaCturinG proCess

As soon as it acquired Rosemount, CBPE gave the green-light to a

plan – worked on but not executed under the previous ownership – to “materially upgrade” the company’s manufacturing facility in Leeds, and to expand and refur-bish its warehouse.

With the help of some specialist man-ufacturing consultancies, this project was completed over a period of almost three years, at a cost of about £6 million.

“When we bought the business, the manufacturing facility had a totally illogi-cal and inefficient layout,” explains Dinnen. “For instance, the half-finished product had to be transferred from the end of the pro-duction line across the site to the quality assurance and bottling area. So we totally reconfigured the site – both to make it more efficient and to increase capacity.”

By the time the company was sold, capacity had increased from 6 million bot-tles to 10 million (current production is about 4 million bottles, so Rosemont still has plenty of growing room).

Deal MeCHaniC unDer tHe bonnet oF a reCent Deal

Liquid returnsCbpe/roseMont pHarMaCeutiCals

In its six years as owner of Rosemont Pharmaceuticals, CBPE helped the business to overhaul its manufacturing process, expand its product line and bolster its management team – more than doubling EBITDA in the process. By James Taylor

Dinnen: let management run the business

We totally reconfigured the site – both to make it more efficient

and to increase capacity

april 2013 private equity international 25

Deal MeCHaniC

3investMent in new

proDuCts

New product development was a major focus. The new owners

brought in a new R&D director – who had previously worked at Sinofi and Merck – and during their ownership, boosted the new product team from 10 people to 24.

“What this did, over time, was to sig-nificantly enhance the product portfolio – both in terms of number and quality,” says Dinnen.

The result was that Rosemont went from having 58 molecules and 103 separate prod-ucts to having 94 molecules and 160 prod-ucts; by the time of sale, over a third of the company’s revenues came from products that didn’t exist when CBPE bought the business.

It also led to a more balanced product portfolio. By 2012, the proportion of rev-enue generated by its top five biggest sellers had fallen from 45 percent to 28 percent.

4unloCkinG tHe

CoMpany’s international

potential

Rosemont also made great strides in a related area: the licencing or regula-tory side of its business, which involves taking products through an approval proc-ess (including biostudies) that ultimately gives the company the exclusive right to sell that product.

Most of Rosemont’s products start off as ‘specials’ – non-standard preparations designed to meet a particular medical need.

But as the market for a particular product grows, and other suppliers get interested, the company has the option of licencing it. Under CBPE’s aegis, this bit of the business was beefed up substantially – from five to 11 people. This helped it increase the com-pany’s roster of licenced products by a third.

Significantly though, in the latter years of its ownership it also worked hard to obtain more Europe-wide licenses. Rose-mont had just one product with an EU licence in 2006; by 2012, this was up to 50, and most of those were done in the last two years. CBPE didn’t actually get to see much of the financial benefit, since it takes time for these new licences to pay off in sales. But it meant that the licences, potential distribution networks and even possible pricing structures were all in place for the next owner – making the company much more saleable.

5bolsterinG seConD tier

oF ManaGeMent

“The chief executive and the finance director were very good;

in fact they were part of the attraction of the deal,” says Dinnen. “John [Blythe, the CEO] had worked there for 40 years and knew more about liquids than anyone else.”

However, CBPE was active in supple-menting the team around these two. “We brought in a strong chairman in Kevin James, who used to run Wyeth in the UK. We also upgraded the second tier of man-agement, bringing in people with more experience at a higher level from bigger pharma companies.” That included the aforementioned R&D director, plus a new clinical director who was ex-Merck and a head of quality who had previously been with Reckitt Benckiser.

This became particularly significant when it came to addressing one of the big-gest problems CBPE faced when selling the

business: the fact that the two senior people were both retiring. Because Rosemont’s second-tier of management was much stronger, it gave potential buyers a bit more comfort about how the business would cope (although Blythe is staying on for at least six months to manage the transition).

Blythe certainly has no complaints. “We got on very well with CBPE right from day one. The most important thing is that we believed they would allow us to manage the business ourselves on a day-to-day basis. PE houses always say that they’ll let manage-ment get on with it, and you’re always a bit unsure about whether that’ll be the case. But CBPE recognised that we knew what we were doing, and that we had the build-ing blocks for a very strong business. That doesn’t mean we had carte blanche – we had to justify all our ideas. But if they were backed up by sound arguments, CBPE were always supportive and forthcoming.” n

£8.7mRosemont’s EBITDA at the start of CBPE’s ownership

£19.2mRosemont’s EBITDA at the end of CBPE’s ownership

private equity international may 201330

When Swedish wheelchair business Per-mobil was set up in 1967, the founder, a medical doctor, wanted to provide help-ful products for disabled people using the latest technology. His vision, as Permobil chief financial officer Carl Bandhold puts it, was to improve the life of “some of the most unlucky people in our society”. As a result, Permobil has always had a culture that is focused on making sure the patient gets what they need.

So when Nordic Capital acquired a 75 percent stake in 2006 (the founding fami-lies retained the remaining 25 percent), it quickly realised it had to be mindful of that. “The users of these wheelchairs are very disabled people, so it’s important that the users are always in the centre,” says Fre-drik Näslund, a Nordic partner. “We have been managing the culture very closely – it was very important for Permobil to keep the family spirit and the very user-focused ideas. For example, wherever you go within Permobil [e.g. when travelling to other manufacturing sites], you hug each other – because that was a habit that the founder had.”

However, Nordic felt the addition of some extra financial resources and knowl-edge would enable the management team to transform Permobil “from a diamond in the rough into a real jewel”.

By the time Nordic sold Permobil to fellow Swedish firm Investor for SEK5.5 bil-lion (€661 million, $849 million) in April, reportedly making a 5x return, sales had almost doubled to approximately SEK 1.6 billion (€190 million, $250 million). Staff numbers also increased.

1imProvinG eFFiCienCy

The first thing Nordic did was to refocus the business. “The organi-sation is extremely entrepreneurial

and was trying [to do] many things at the

same time with limited resources,” says Bandhold.

The firm also invested heavily in research and development, according to Näslund, so Permobil could get technical innovations into the product in a quicker and smarter way. Permobil, which is a high-end wheelchair provider, doesn’t manufacture its products in their entirety, but assembles them from different compo-nents. This means the wheelchairs can be tailored without actually making a product solely for one customer.

The company also went from a station set-up to a paced production assembly. So instead of having staff moving through the factory, the products did instead; this improved quality and productivity, says Näslund.

2movinG ProDuCtion

abroaD

One of the key things Nordic did was to open a US factory

(in Nashville) and a Chinese factory (in Shanghai), in a bid to further improve efficiency and reduce costs. “Instead of doing everything out of Sweden, Nordic Capital supported Permobil to source in low-cost markets,” says Näslund. The first half of the products are now assembled in China and shipped to the factories closer to the market.

“Once an order comes in, we build it for that person [depending on where they are] in our factories in Sweden and the US,” says Bandhold. This helped to expand profit margins – Permobil’s EBITDA margin grew from approximately 16 percent to approximately 23 percent during Nordic’s ownership – and almost double staff levels, from 400 to 750. Much of this headcount growth was in the US and China, but the company also increased its workforce in Sweden.

Deal meCHaniC unDer tHe bonnet oF a reCent Deal

Embracing changenorDiC CaPital / Permobil

In the seven years that Nordic Capital owned Permobil, it supported the company’s expansion into the US and China and streamlined its operations – doubling sales as a result. Yolanda Bobeldijk reports

The organisation is extremely entre-preneurial and was trying [to do] many

things at the same time with limited resources

Carl bandhold

may 2013 private equity international 31

Deal meCHaniC

3aCCessinG international

markets

Although Permobil had been expanding into continental

Europe and North America in the 1990s, it didn’t have much capital committed to further expansion, says Bandhold. So Nordic invested heavily in developing new sales markets, including the US, Australia, Canada, Argentina and Brazil.

In the US, for example, market share went from below 15 percent to more than 22 percent. “The US historically has very poor technical aids, but in recent years standards have improved,” says Näslund. And he believes there is a potential to grow further. “As healthcare has improved, disa-bled people are living longer, so therefore they will use Permobil longer.”

Countries like China and Brazil, where there is great unmet demand for products like these, will spend more resources on medical aids and drive growth, he adds. “The communities we interact with in China are very eager to provide better serv-ices for their people in these communities,” agrees Bandhold. This year, the company is starting sales operations in Brazil, China and Argentina, as demand starts to pick up. “As the market develops, we want to make sure we are there from the start.”

Partly due to this international expan-sion, sales almost doubled to approxi-mately SEK 1.6 billion (€190 million, $250 million). The company has had close to 10 percent organic annual growth during Nordic’s ownership, “even during the tur-bulent financial crisis years of 2009 and 2010”, says Näslund.

4stiCkinG to tHe HiGH-enD

Another key decision taken by Nordic was to keep the com-pany focused on growing and

improving its existing product – complex

wheelchairs for severely disabled people – rather than trying to branch out into additional products.

“Nordic allowed Permobil to con-tinue to focus on this product, rather than trying to be like competitors and provide everything for disabled people,” says Bandhold.

“Permobil provides wheelchairs that enable users to mechanically change them into various positions, to lower the risks of developing pressure ulcers,” Näslund explains. “In many cases [our customers] can only move their head [and they] run the risk of developing pressure ulcers, which could get infected – and they need a technical aid to stop this.”

“We are the only company that is nar-rowly focused on that segment of the market, and that has been the reason for our success,” adds Bandhold.

***By investing in the company’s R&D, improv-ing the assembly process, building additional

factories and expanding into new markets, Nordic is handing on a company that’s well set for future growth and expansion.

As well as developing its presence in emerging markets, the company also plans to expand further in Europe, says Bandhold. “We have a very good market position in Scandinavia. In continental Europe there is a case for us to ensure more people have access to our product.”

“There is still a lot to do, especially in emerging markets,” adds Näslund.

Overall, both organisations agree that the partnership between Nordic and Per-mobil has been a good one.

“[We teamed up with a family] that needed help and wanted to do a lot of things [and] Nordic Capital had both the financial resources and the knowledge [to improve the business],” says Näslund. “Now the company is set up to grow at a quicker pace. And that is what Investor, the new [private equity] owner, sees in [Permobil] – a Swedish super-success.” n

private equity international june 201322

In April, UK-based Synova Capital sold dental support services business dbg to The Carlyle Group and Palamon Capital Partners for an undisclosed sum. It was an impressive first exit for the lower mid-mar-ket firm: after just three years of ownership, it generated a 5.8x return on its original investment and a 77 percent IRR.

Back in 2009, Synova had identified the dental services market as attractive, not only because of its size – the UK market is worth around £6 billion a year, according to market research firm IBISWorld – but also as a result of new regulations coming into force. “We could see that there were changes coming down the line,” explains David Menton, managing partner at Synova. “The government was putting in place annual inspections of dental practices through the Care Quality Commission, and we knew there would be winners in the outsourcing space.”

As it conducted its research into the market, the firm came across what was then called The Dental Buying Group and contacted the owner. The discussions led to a deal in 2010 that enabled the original founder to exit the business and retire, with John Rochford, the chief executive at the time, leading a management buyout.

Back then, dbg was providing a number of mainly subscription-based services to the dental sector, centred around engineering services (equipment repairs) and selling products and materials to customers. This was a 20-year-old business with an annual EBITDA of £1 million, a strong reputation and high levels of repeat business (95 percent of customers renewed their membership to dbg’s services annually) – but it wasn’t set up to take advantage of its growth potential.

Fast forward three years, and dbg is now making annual EBITDA of £3 mil-lion. It has also expanded into new areas, such as providing services to medical GPs,

online training and other web-based serv-ices. Membership numbers have doubled: it now counts more than 10,000 practices as members. And it’s eyeing further expan-sion in areas such as veterinary practices. podiatrists and chiropodists, as well as expanding its existing services.

Here are the key changes under Synova’s ownership that made this possible:

1strenGtHeninG

manaGement

At the time of the deal, dbg was solid and profitable. However, the

founder was retiring and the chief executive was also looking for an exit in the not-too-distant future. So the plan was to bring in a new chief operating officer who could take over the reins at a later date. The candidate chosen was ex-Capita executive Kanesh Khilosia, who brought with him experi-ence of running outsourcing services to corporates – an area that dbg was looking to tap into. Over time, Khilosia took up the CEO postion, with Rochford moving to a non-executive role.

In addition, Synova brought in David Carman as chairman. An experienced hand at acting as bridge between private equity and business, Carman could see that cul-tural change was essential to ensuring dbg could expand rapidly.

“One of the key areas for us to work on was getting employees, many of whom had been at dbg for several years, to under-stand the impact their actions had on the business,” says Carman. “We had to create a culture where people understood that in a small business, everything they did affected the bottom line.”

2imProVinG systems As with many smaller, founder-led businesses, dbg needed investment in new systems and processes.

deal meCHaniC under tHe Bonnet oF a reCent deal

Drilling downsynoVa CaPital / dBG

In just three years, Synova Capital helped reposition dental services business dbg, tripling EBITDA in the process and generating a 77% IRR on exit. By Vicky Meek

We had to create a culture where people understood that

everything they did affected the bottom line

june 2013 private equity international 23

deal meCHaniC

“The employees had a great customer-serv-ice ethic,” says Carman. “Yet few understood the potential the business had, because the data wasn’t readily available to analyse.”

Synova and management set about restructuring dbg in the first nine months and then spent the next 18 months invest-ing in IT, including new CRM systems. “The business often knew more about an indi-vidual practice than the practice manager,” explains Carman. “The problem was that the records were spread over several data-bases and so it was very difficult to keep track. An IT upgrade was essential if we were going to start offering compliance services to customers.”

It was also essential if dbg was to start offering services to larger, corporate dental practices.

3rePositioninG tHe

Business

When Synova invested in dbg, half of revenues came from engineer-

ing services, such as repair and maintenance of equipment, and the other half from materials and product sales. Synova felt this was a low margin, highly competitive business – and that there was much more potential in offering services, in particu-lar to new, larger clients. “The corporate market was an important area for dbg to go for,” explains Menton. “These made up around 10 percent of the market.”

Having overhauled the IT infrastruc-ture, the owners then got their Rolodexes out. “Once we had the right systems and people in place, we had the credibility to take our offering to the corporate practices. These were mainly private equity-backed businesses and so we knew the owners. We could effect introductions through our con-tact base.”

In addition, dbg trimmed the number of products it offered, moving to a smaller

range that included the items most impor-tant to customers. This freed up more time and resource to focus on outsourced serv-ices, such as payroll, compliance (to help customers ensure they were meeting CQC requirements) and online or onsite training. “We built our online capabilities, as pre-viously the business did not even have an e-commerce platform,” says Carman. “We put in place a virtual compliance suite and then used that as a fulcrum around which to build other services.”

The result is that 80 percent of dbg’s revenues now come from services, boost-ing EBITDA margins from 15 percent to 30 percent. And its customers now include many of the nationwide chains of dentists, in addition to the individual practices it already served.

4aCquirinG neW Business

lines

Once dbg had built the right platform from which to offer its

services and to expand within dentistry, it started to think about exporting its model to other relevant types of practice. This allowed organic growth to be comple-mented by acquisitions.

“We relied on Synova to help us identify the right business to acquire – they knew and understood the strength of our offering

and to which markets it was applicable,” explains Carman.

In 2010, the opportunity arose to acquire TAG Medical, a Nottingham-based tester of medical equipment that focused on GPs, hospitals and pharmacies. The acquisi-tion brought with it a whole new market into which dbg could cross-sell its compli-ance and training services: TAG served a third of GP practices in the UK.

***For Synova, one of the key reasons for

the deal’s success was the company’s latent potential. “We saw a business that could grow,” says Menton. “It was clear that it had a robust business model with a diverse membership. From that we could roll out new services. In addition, it had strong recurring revenues and high cash genera-tion – dbg converts over 100 percent of cash to EBITDA.”

And for dbg, the “hands-on inter-est Synova brought to the business was invaluable,” says Carman. “It was a true partnership between Synova, dbg manage-ment and me. The strategy for the business was clear from the outset and the exit was well planned even in the early stages. There was a constant dialogue with poten-tial buyers so that when it came to exit, they knew and understood dbg’s unique characteristics.” n

private equity international july/august 201324

Marcos Rodriguez, founder of Palladium Equity Partners, remembers eating Wise potato chips while he was growing up in Manhattan’s tough Washington Heights neighborhood. The iconic brand was part of his – and many New Yorker’s – childhood. And when he saw the chance to acquire Wise Foods in 2000 from its corporate parent at the time, Borden, he didn’t hesitate.

“What I loved about the company was it was really an iconic American brand,” Rod-riguez tells PEI at the offices of his private equity firm, Palladium Equity Partners, in June. “I’ve been eating Wise potato chips since I was six.”

The company had been founded in 1921 by Earl Wise in rural Berwick, Pennsylvania, who decided to make use of excess pota-toes at his delicatessen by frying them up and distributing them in brown paper bags. Four years after making his first chips, Wise opened his first production plant. In the 1960s, the company was taken over by con-sumer foods conglomerate Borden, and in 2000, was sold to Palladium for about $96 million.

However, the deal quickly went side-ways as the Atkins diet craze – which eschews carbohydrates in favour of protein – spread across the country. Potato chips, bread and pasta were out – and Wise, like other purveyors of salty snacks, suffered accordingly.

At the lowest point, Palladium marked its $60 million equity investment in Wise Foods down to $3 million; this was a major blow to Fund II, since Wise was the larg-est investment in the vehicle, according to a market source. The partners were faced with a difficult decision: was it time to “hand the keys over to the bank and walk away”?

In the end, the firm decided to stick with the investment – but make some big changes. And in December 2012, the famous potato chip maker that had seemed at one point to be a lost cause was sold to Arca Continental, generating a successful 2.7x return for Palladium and its LPs.

The success not only benefitted Palladium and its limited partners; the turnaround also helped secure the jobs of close to 1,000 workers at Wise, many of whom are second or even third generation employees at the company. Here’s how Palladium did it.

1Building tHe rigHt

management team

“People are always going to be eating potato chips. It is a great brand; the

awareness is very good. We felt that if we got the right people in, and we repositioned the company to play [to its] strengths, we could at least get our LPs’ money back,” Rodriguez says.

The first step in turning around Wise was putting in the right management team. Previous management favoured a rapid national expansion for Wise, and also had ideas about coming up with a healthy line of snacks.

Edward Lambert joined Wise in 2004 as part of a restructuring team put together by The Meridian Group, and became chief executive officer in 2006. Lambert’s vision was more pragmatic: “He said: ‘Find out what our core strengths are and get down to a size that makes sense’. Once that was stabilised, then it was: ‘Now how do we grow’,” Rodriguez says.

In 2008, the company began grooming Mike Scott and Dewey Armstrong to take over leadership of the company, which they did in 2011, with Scott becoming CEO and Armstrong president.

deal meCHaniC under tHe Bonnet oF a reCent deal

Wise guysPalladium / Wise

Palladium’s investment in iconic potato chip maker Wise took a rapid nosedive when the company was hammered by the Atkins diet craze in the early 2000s. Christopher Witkowsky explains how the firm turned it around

Knowing the difference of when to pull the plug on a company and

when to tough it out, that’s the hardest part of our business

marcos rodriguez

july/august 2013 private equity international 25

deal meCHaniC

2going BaCk to its roots:

Earlier in the turnaround, Pal-ladium recognised the need for Wise to reinvigorate sales around

its traditional market, the “up and down the street” ‘mom and pop’ network. Wise had always been very strong on the East Coast and especially in urban areas, according to Alex Ventosa, a managing director at Pal-ladium.

As part of that effort, Wise worked to reposition Wise toward the heavily Hispanic bodega market, and hired top sales per-sonnel from rival Frito Lay to manage that channel. Wise also launched some grass-roots promotions to re-establish its appeal to its traditional blue collar customer base.

For instance, the company struck a pro-motional deal with The New York Mets to become the team’s official potato chip. In 2009, Wise and The Mets held a promotion called Big City Crunch, where everyone in the stadium was given a bag of chips, and at the designated time, took a bite of the chip. The promotion made the Guinness Book of World Records for the most people “crunching” a potato chip at the same time.

“It got blasted all over television – so we probably ended up having hundreds of thousands worth of promotional or mar-keting dollars equivalent spent,” says Yue Bonnet, a vice president at Palladium.

This brand rejuvenation put the brakes on declining revenue and led to more than 20 percent sales growth in key Hispanic markets by 2012, according to the firm.

3PriCing strategy:

Wise shifted a greater portion of the portfolio to “everyday low price”, a concept that eschews

frequent discounts and two-for-one deals in favour of a consistently low price. It’s

based on the notion that consumers become fatigued by constantly changing prices in stores. Wal-Mart is one major retailer that follows this sort of ‘everyday low price’ strategy, according to Ventosa.

Along with the implementation of eve-ryday low price, Wise phased out its 25 cents bag in favour of a 50 cent bag.

Another notable change was the addition of a $2 bag of potato chips that included a bright red tag saying ‘$2’. This did so well the firm thought competitors would quickly introduce their own versions, but it took them two years to come out with similar products.

All told, this pricing strategy helped Wise overcome the $13 million in price increases that occurred between 2008 and 2009.

4taking it national:

By 2010, the company was stable, and management could begin to work on growth. The main focus

was taking the brand national. Wise tripled the size of its national sales team and started selling the brand directly to national retailers.

The company tested the market through a few early promotions with national chains,

who quickly discovered that the product was flying off the shelves, Ventosa says. “It showed us that even in areas where we never advertised before, [the product] sold,” he says.

Eventually, Wise was able to win an account with Family Dollar to sell its prod-ucts, which in turn boosted the brand with other national chains. The growing expo-sure helped take that national business from zero to almost a quarter of Wise’s total rev-enue in two to three years.

***In June 2012, Wise and Palladium began talking to Mexican corporation Arca Con-tinental, which eventually agreed to buy the company. Palladium declined to disclose financial details of the transaction, which closed in December 2012, but sources in the market have pegged the exit at about 2.7x cost.

“Knowing the difference of when to pull the plug on a company and when to tough it out, that’s the hardest part of our business,” Rodriguez says. “In 2008, it looked like we made the wrong deci-sion; in 2012, it was clear we had made the right one.” n

58 private equity international september 2013

In 2001, a Swiss private bank called Sarasin – then owned by Holland’s Rabobank – had promoted to its clients a vehicle called New Energies Invest (NEI), raising about €90 mil-lion from institutional and private investors. A local Swiss M&A boutique called Remaco was brought in as investment advisor, and NEI set about building a portfolio of mostly minority venture and growth capital stakes in renewable energy companies.

Initially, everything went pretty well. But in the aftermath of the financial crisis, amid a difficult period for the renewable energy industry, performance went backwards. By 2011, the vehicle was basically a lame duck: some of the six remaining businesses in the portfolio were in urgent need of restructur-ing and/or refinancing, but the vehicle was fully invested and so had no way of injecting extra capital. NEI had not yet distributed any capital to its investors (any proceeds had been used to make new investments and cover the management fee), and market conditions made it particularly difficult to exit these ailing companies. In addition, many of the original team were no longer with the advisor.

Enter Evoco, a relatively new group founded by Felix Ackermann and Michel

Galeazzi, who had previously worked together at 3i Group (before the latter moved onto HgCapital for three years). Evoco specialises in taking over and restruc-turing ailing funds, injecting capital as required and managing out the portfolio in a way that delivers liquidity for existing LPs.

Having come across NEI, it got in touch with the management team and persuaded them that a fundamental restructuring was required. In practice, this meant pulling the plug on the existing vehicle and transferring the portfolio to a new closed-end Jersey-domiciled limited partnership, with Evoco acting as the new GP. The financial backing for this €20 million transaction was pro-vided by Headway Capital, a UK-based secondaries firm that specialises in small and complex deals like this.

Since the deal closed in the third quar-ter of last year, Evoco has largely focused on restructuring the portfolio compa-nies (which, it admits, took longer than expected due to the ongoing woes of the underlying market). However, it’s now start-ing to move into harvesting mode; indeed, it has already started distributing capital to LPs, thanks to a partial divestment.

It’s planning to exit all the assets within three years, so it will be a while before the merits of the deal can be assessed fully. Nonetheless, it does seem to be heading in the right direction – and it does seem to illustrate three of the key aspects necessary for a restructuring like this to work.

1a situation tHat demands

aCtion

One of the biggest problems in deal-ing with ailing funds is inertia: GPs

have little incentive to move the process along, as long as they’re continuing to pick up the management fee; and while LPs

Zombie repowereddeal meCHaniC: eVoCo/ nei

Evoco’s restructuring of an ailing private equity portfolio (backed by independent secondary firm Headway Capital) illustrates one way that the industry can deal with its many dysfunctional funds, writes James Taylor

The fund was fully invested and the companies needed money –

so it was clear that a deal had to be done

SecondarieS

››Solar power: a key focus of the NEI portfolio

60 private equity international september 2013

may be dissatisfied with the situation, there’s often no particular impetus forcing them to address it. The result is that funds limp on much longer than they ought to (and the inevitable restructuring ends up being all the more painful).

In the case of NEI, however, doing nothing was not really an option. This was a quasi-public vehicle that published its accounts annually (it had previously hoped to float one day). So the problems in the portfolio were very clearly visible to the outside world: net asset value was declin-ing, and the vehicle’s running costs were painfully high.

It was also in the interests of Sarasin find a solution that would benefit inves-tors, many of whom were long-standing clients of the bank (NEI’s chairman worked at Sarasin, as did one of the other independ-ent directors).

Equally, changes were urgently and pat-ently needed at asset level. “The fund was fully invested and the companies needed money – so it was clear that a deal had to be done,” says Galeazzi.

2an enGaGed and Capable

seller

Significantly, NEI’s management recognised and accepted this

urgency. Ackermann admits that when Evoco first approached them, he was worried that they would be reluctant to engage – not least because they were aware of the time and effort it would require, and because the vehicle’s quasi-public nature made it impossible to conduct the process behind closed doors (as LPs often like to do in a restructuring situation).

There was also a concern that they might be too hands-off. “You might have thought that they would not be very close to the situation, so they wouldn’t be interested in talking to active restructuring specialists. But in fact the contrary was true: they were very professional and very aware of the issues.”

Another important point was that NEI’s management had the power to make change happen. As Galeazzi points out, this is not always the case with dysfunctional funds. In some cases, the LP group is too disparate or divided to act collectively; in others, they don’t have sufficient resolve or clout to take on a strong-willed GP.

In this case, the fact that the principals were talking to each other directly, without an intermediary, clearly made the process much easier.

3a deal struCture tHat

WorKs For all ConCerned

According to Ackermann, the first problem in negotiating the deal

was agreeing on valuations. “When things turn sour, there’s obviously going to be a gap between what the new GP thinks a portfolio is worth and what the existing GP thinks it’s worth.”

The key to resolving this, he says, was to put in place a flexible structure. Evoco would not be drawn on the details – citing confidentiality constraints – saying only that the structure allowed them to share some of the risk with existing investors (by rolling over their interests) while giving the new money a share of any upside.

There was also the related issue of nego-tiating an exit for the existing adviser, who

ultimately received a package compensation (Evoco wouldn’t say what, but in previous situations like this it has tended to be about six months of management fee).

It didn’t help that the portfolio continued to be, as Galeazzi puts it, “a moving target”. One of the companies even went bust in between the signing and closing of the deal, further delaying the process and eventually requiring an extra injection of capital.

On the other hand, the fact that Evoco started its portfolio management activity even before the completion date was one of the main reasons the deal was able to “get across the line”, says Ackermann – because it showed the other parties involved (par-ticularly the management teams of the operating companies) what difference an active partner could make.

These were lengthy and complex negoti-ations, taking over six months to complete. But since due diligence is always going to be more difficult in this sort of deal (given the number of assets and the time and access constraints), structuring becomes more important. Says Galeazzi: “Our focus is on having a structure that works when it’s sunny and when it’s rainy … There were both positive and negative surprises, but the structure we had in place worked quite well to iron those out for the benefit of all concerned.” n

SecondarieS

››

Evoco: zombie hunters

Our focus is on having a structure

that works when it’s sunny and when it’s rainy

PEI London140 London Wall6th FloorLondon, EC2Y 5DN, UKTel: +44 20 7566 5444Fax: +44 20 7566 5455

PEI New York16 West 46th Street4th FloorNew York, NY 10036, USATel: +1 212 645 1919Fax: +1 212 633 2904

PEI Hong Kong14/F, Onfem Tower29 Wyndham StreetCentralHong KongTel: +852 2153 3240Fax: +852 2110 0372

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