The Siren Song of Private Equity Money

After a lull during the past few years, private equity money is again flowing into the catalog industry. For shallow-pocketed catalogers, this can be great news indeed.

“Private equity firms have the money to infuse the cataloger with much-needed money and stability,” says Mike Petsky of New York-based mergers and acquisitions firm Petsky Prunier. “They bring a more professional environment to running the business.”

But even as it alleviates some dilemmas, equity money can create new ones. When you accept an investment from an equity firm, “it’s like a marriage,” says Craig Battle, managing director at Princeton, NJ-based investment bank Tucker Alexander. “You need to know who you’re getting into bed with.

A match made in heaven

The catalog industry has seen a number of high-profile deals during the past 12 months. Equity firm Cortec Group entered the catalog industry last year by acquiring Dr. Leonard’s Healthcare for about $200 million; leveraged buyout firm Riverside Co. purchased auto parts cataloger J.C. Whitney & Co.; JP Morgan Partners, the private equity arm of JP Morgan Chase & Co., bought the majority share of Figi’s and Arizona Mail Order from Federated Department Stores; and Potpourri Holdings was sold from one private equity firm (HIG Capital) to another (Linsalata Capital).

Such an influx of private equity money hasn’t been seen since the late 1990s. Then, many investors viewed catalog companies as a way to enter the promising e-commerce arena without having to build the infrastructure from scratch, says Claire Gruppo, president of New York-based investment bank Gruppo, Levey & Co.

The bursting of the Internet bubble, however, led many equity firms to withdraw from the catalog market. What’s more, private equity firms generally shy away from putting a lot of their own money into a deal, so as to minimze their risk. Instead they typically borrow a substantial portion of their investment — called leveraging in private equity parlance. When the economy began souring in late ’99, though, it became much tougher for the firms to find lenders.

But last year, Gruppo says, “the debt markets started opening up,” and it became easier to borrow money. As a result, “some private equity firms started coming out from under the bunker,” she says. These firms see catalog companies as well positioned for future online and retail growth. And because the economic recovery hasn’t yet kicked into gear, it’s a buyer’s market.

Private equity money can give catalogers the boost they need to take their business to the next level. Chapel Hill, NC-based Performance Bike is a case in point. New York-based private equity firm Apax Partners, formerly Patricof & Co. Ventures, led a $50 million round of investment in the cataloger of bicycle parts and accessories in September 1999. Performance Bike subsequently bought fellow catalogers Bike Nashbar in April 2000 and Supergo this past October, as well as several small retail chains.

“Performance is doing well in a tough environment,” says Apax partner David Landau. “We grew the business in part by providing Performance with increased buying power, by adding bicycle accessories, and by developing some private-label programs as well as better sourcing of product.” The cataloger’s annual sales are roughly $150 million.

For better or for worse

But for some catalogers, the honeymoon period with their equity firm ends faster than a Jennifer Lopez marriage. If you’re an entrepreneur accepting an outside investment for the first time, “you have to understand that you are going to lose some control of your business,” cautions Tucker Alexander’s Battle. “In the old days in a good year, you could have given yourself a $1 million bonus. Those days are over when you take private equity money.”

Another potential drawback of accepting equity money is the very nature of most equity firms. For such companies, growth and return on investment are the priorities. Growing companies generally generate much higher multiples at the time of exit, ensuring the owners a higher return. For example, an equity firm may buy a cataloger for three to four times earnings. If the firm can significantly build the cataloger’s revenue and market share — and show that such growth is likely to continue — the property could fetch five or six times earnings.

While many entrepreneurs expect to stay with their company till death do they part, most equity firms look to reap a profit by selling off their investment within three to five years, says Gruppo. Of course, she adds, “that doesn’t mean some firms don’t stay in longer, such as seven years.”

Then there’s the chance that a cataloger could end up paying for the equity firm’s sins — or more likely, its debt. When economic times get tough, the equity firms’ lenders become jittery and, as a result, more stringent about loan covenants and debt loads. They may subsequently require the equity firms to pay down some of the debt or restructure their loans.

This past August, Brea, CA-based catalog holding company Centis filed for Chapter 11 bankruptcy protection. The $155 million Centis owned four catalogs: G. Neil Cos., a cataloger of human-resources supplies; Century Business Solutions (formerly 20th Century Plastics) and Century Photo Products, which sell photo organizer and protection products; and business presentation materials cataloger Light Impressions.

Centis was actually a catalog conglomerate created by private equity firm Heritage Partners, whose excessive debt led to the bankruptcy filing. Yet G. Neil itself is profitable, according to the catalog’s president, Terry Jukes. At press time, the four Centis catalogs were on the selling block.

Being diligent about due diligence

So if you’re a catalog entrepreneur looking to sell your catalog business, be sure you’re armed with the facts before you seek private equity money.

That, of course, requires establishing an open line of communication with the private equity firm. “The best partnerships always occur when the expectations are clearly laid out at the beginning,” says Fred Anderson, president of South Orange, NJ-based financial and strategic consultancy Anderson Direct. If you don’t communicate properly, relatively minor details, such as budgeting properly for systems growth, can become major headaches.

Also look at the equity firm’s portfolio of holdings. Research how the other companies in the portfolio have fared. You should definitely talk with these companies, especially if any of them are catalogers as well, before getting into bed with a private equity firm.

In addition, consider whether you have the same growth expectations as your potential investor. “The odds are that growth expectations of the private equity firm are faster than the catalog can realistically deliver,” Anderson says. “If the private equity firm has no experience in direct marketing, it’ll have little understanding of the circulation risks involved. You can’t grow a catalog at meteoric rates unless you can subsidize the customer acquisition costs and be willing to accept reduced near-term profits.”

Finally, Anderson says, be sure you understand your rights, responsibilities, authorities, and reporting relationships under the management contract. “Should a personality conflict arise,” Anderson notes, “the primary protection [the entrepreneur] will have is his management contract.”


Private equity (financial) partner vs. strategic buyer: the pros and cons

Sale to financial partner Sale to strategic buyer
Advantages ▪ Offers near-term shareholder liquidity
▪ Seller controls process and criteria
▪ Financial buyers are typically more sophisticated investors committed to growth
▪ Opportunity for management to implement business plan and participate in upside
▪ Access to expansion capital to accelerate growth
▪ Provides institutional credibility for additional capital raises and potential IPO
▪ Maximizes near-term shareholder value; potential consolidation cost savings and less reliance on debt markets facilitates ability for higher valuations
▪ Process and criteria controlled by seller
▪ Possible synergies, exchange of skills
▪ Multiple potential buyers
Disadvantages ▪ Financial sponsor may desire to change strategic direction
▪ New outside directors
▪ Reliance on debt for transaction structure adds variable of uncertainty for transaction closing
▪ Upside for existing shareholders may be diluted
▪ Fate of management and employees unknown
▪ May face integration issues
▪ May have to accept buyer’s currency
Source: Petsky Prunier

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