| Forgot your password? |
Press
(copy of) After the gold rush
After the gold rush
'I never thought we'd get this big or stay together as long as we have.'
By Steven R. Strahler
December 15, 2003
Madison Dearborn Partners Inc., Chicago's biggest private-equity firm, got its third buyout fund off to a rousing start in 1999, plunking down $200 million to acquire Packaging Corp. of America, a stake in the Lake Forest-based maker of paper products now worth about $900 million.
Before long, the $2.2-billion fund had turned to something racier: telecom. After the industry bombed when the tech bubble burst, Madison Dearborn ended up taking a huge hit — and then a remarkable step. Without publicity last year, it stopped collecting annual management fees worth $16.5 million from investors in the fund.
A few months later, it trimmed fees by 25% on its latest fund, a $4-billion effort launched in early 2001, not because of its preliminary (and thus standard) negative returns but because immediate investing opportunities had turned so bleak.
Together, the waivers will cost Madison Dearborn more than $30 million this year in lost revenues, and vividly illustrate the tidal wave that swamped the private-equity industry after the stock market crash three years ago.
Madison Dearborn isn't the only private-equity firm to make such a drastic decision. But it is believed to be the largest.
Like his industry compatriots, Madison Dearborn Chairman and CEO John A. Canning Jr., the dean of Chicago's private-equity community, speaks confidently of a rebound in deal flow. A survey by Thomson Venture Economics, an equity information service, and the National Venture Capital Assn. offers a contrary view: Volume, which plunged two-thirds nationally between 2000 and 2002, has merely leveled off.
The average size of disclosed mergers and acquisitions backed by buyout firms through Sept. 30 was $61.4 million, up marginally from $52.3 million in all of 2002 but a fraction of 2000's $338.4 million.
Founded 12 years ago as a successor to bank-owned First Chicago Venture Capital, Madison Dearborn is in no danger of folding. According to the firm, income from management fees this year will still top $50 million — this for a company that has only 22 principals and a total of 54 employees.
With $18.6 billion in combined annual revenues among 37 portfolio companies, typically as unrelated as Ruth's Chris Steak House Inc. and Hines Horticulture Inc., Madison Dearborn is, in effect, Chicago's least-known conglomerate — three times the size of Marmon Group, the city's biggest privately held concern. Were Madison Dearborn a public company, its revenues would put it ninth, between Caterpillar Inc. and Abbott Laboratories Inc., on Crain's 2002 list of Chicago-area public firms.
"I never thought we'd get this big, or stay together as long as we have," says Mr. Canning, ranking Madison Dearborn as the nation's sixth-largest buyout firm and No. 1 between the coasts, measured by committed capital ($7.7 billion). Of the 14 principals who came from First Chicago Corp., 10 remain on board. Two retired before the age of 50.
'On everybody's list'
Notes David F. Mosher, a Madison Dearborn managing director responsible for administrative and operating functions: "We're on everybody's list now for the largest transactions." This fall, the firm restructured to accommodate additional deal teams, including one re-emphasizing mid-sized opportunities that were once Madison Dearborn's bread and butter.
Along the way, Madison Dearborn's masters of the universe proved themselves fallible several times over.
"We've had a lot of transactions where we've lost our entire investment," says Co-president Samuel M. Mencoff. "It doesn't get any harder than that."
One example was Oregon, Ill.-based Woods Equipment Co., a maker of attachments for agricultural and construction equipment in which Madison Dearborn invested $59.3 million in the late '90s. It says the outlay is now worth "zilch."
Conversely, an $85-million investment six years ago in Tuesday Morning Corp., a Dallas-based high-end closeout retailer, has returned $360 million in cash plus stock worth $460 million.
Add it all up, and Madison Dearborn puts its annual return after management fees and carrying costs at 18.8% for investors in its four funds, a figure lifted by the 28.2% and 23.3% performances of its first two funds, which totaled nearly $1.5 billion.
As for the third fund, Madison Dearborn bet heavily on non-Bell local telephone companies, which sprouted and withered after the 1996 Telecommunications Act reshaped the industry, and on the glutted fiber optic market.
A $15-million stake in Chicago-based Focal Communications Corp., once valued on paper at $1.4 billion, is, at the moment, virtually worthless. So is another $79 million Madison Dearborn poured into Focal, which emerged last summer from bankruptcy protection as a private company after being delisted from the Nasdaq stock market.
Back to basics
Madison Dearborn is counting on its telecom holdings, such as Focal and Dallas-based Allegiance Telecom Inc. and its fiber optic play in Oak Brook-based Looking Glass Networks Inc., to survive what Looking Glass CEO Lynn Refer calls telecom's "nuclear winter."
The most-senior casualty of Madison Dearborn's telecom foray is former managing director (and former Focal director) Andrew E. Sinwell, who Mr. Canning says left on good terms within the last year. The Federal Communications Commission alum, he adds, "came to do early-stage transactions, and we just aren't going to do those anymore."
Now an analyst at Dallas-based hedge fund Highland Capital Management L.P., Mr. Sinwell did not return a call.
|
HITS AND MISSES | |||
|
All dollar figures in millions | |||
|
HOME RUNS |
Initial |
Returns |
Date of |
|
Packaging Corp. of America |
$200 |
$900 |
1999 |
|
Tuesday Morning Corp. |
$85 |
$820 |
1997 |
|
Omnipoint Corp.** |
$31 |
$390 |
1993 |
|
Allegiance Telecom Inc. |
$18 |
$318 |
1997 |
|
TURKEYS |
|||
|
CompleTel Europe N.V. |
nearly |
0 |
1998 |
|
Woods Equipment Co. |
$59.3 |
0 |
1998 |
|
* If applicable | |||
In the meantime, market conditions have forced Madison Dearborn back to basics, literally.
In its biggest transaction ever, it bought Ireland-based papermaker Jefferson Smurfit Group last year for $3.5 billion, investing $452 million in equity. And last month, it followed with a $340-million offer for Great Lakes Dredge & Dock Corp., the Oak Brook-based firm that gained notoriety in 1992 for punching a hole in one of the city's underground tunnels along the Chicago River, causing a massive downtown flood. It is in line for war-related repair work in Iraq.
Treasure hunting
The deals reflect Madison Dearborn's comfort with basic industry sectors afflicted with weak demand and low-growth prospects. Those drawbacks also happen to lower acquisition prices, and Madison Dearborn picks through the tarnished merchandise, looking for marketshare leaders with good cash flows.
Moving into paper products by acquiring two pulp mills from Procter & Gamble Co. in 1993, Madison Dearborn blunted the industry's cyclical economics by striking long-term contracts with customers and suppliers. And, in the case of Packaging Corp. of America, it sold off underutilized timber holdings, paying down $800 million in debt, or more than a third of the $2.2-billion purchase price.
With $11.7 billion worth of acquisitions over the last decade, Madison Dearborn is, next to International Paper Co., the industry's biggest acquirer, it says.
"I always say the best marketing is doing deals," suggests Mr. Mencoff. "When there's a property for sale, we hear about it."
The pending Great Lakes transaction displays another feature of private equity, circa 2003. In the wake of a slump in initial public offerings (IPOs) and a scarcity of corporate purchasers, buyout firms are turning to each other in order to cash out investors (pension funds and college endowments) ahead of a promised five-year investing cycle deadline.
New York-based Citicorp Venture Capital Ltd. is selling Great Lakes after taking it over in 1998 via a recapitalization. The '92 flood led to the scuttling of earlier plans by a previous owner for an IPO.
Still, firms like Madison Dearborn are being forced to hold onto portfolio companies longer while they struggle to find other investment opportunities. Of Madison Dearborn's charge — deploying the remaining $3 billion committed to its latest fund before expiration of a six-year active investing period in early 2007 — Mr. Canning says, "It's probably going to take every bit of that time."
The remainder of a fund's 10-year life cycle is designed to provide for follow-on investments in existing holdings.
For all its troubles, Madison Dearborn's telecom-weighted fund has performed well, relative to its contemporaries started on the cusp of the dot.com crash. It ranks among the top 25%. In contrast, despite their robust rates of return, Madison Dearborn's two earlier funds rank in the second quartile of funds of their vintage.
"The bottom line is, we're well-pleased with them," says William Atwood, executive director of the Illinois State Board of Investment, a pension fund for state employees, General Assembly members and judges that has $75 million invested with Madison Dearborn. "I'm not sure how pleased we are with the private-equity asset class. That's just a tough, tough space these days."
Investors traditionally have expected to earn average annual returns in excess of 20%, or at least double the long-term performance of the stock market.
Madison Dearborn and other fund sponsors achieved this goal, historically, by targeting family-owned businesses in fragmented industries, bundling them together and beefing up management to pursue economies of scale and selling them at a hefty profit.
But the post-2000 implosion of the IPO market and corporate valuations removed a key element of the equation. Potential sellers got cold feet when they saw multiples — what buyers were offering compared with company earnings — dropping.
"We think that most of the blood bath is over — knock on wood," says Philip Halpern, chief investment officer of the University of Chicago, a Madison Dearborn investor whose $3.3-billion endowment has 16.5% of assets invested in private-equity firms, down from 24% at the peak of the bubble.
The state investment board, with 5% of its assets invested in private-equity funds, compared with an authorized allocation of 8%, is debating whether the sector's upside is worth the volatility, says Mr. Atwood. "That premise is clearly being revisited here."
High points, low points
Few investments better portray the high-wire act of private equity than Madison Dearborn's funding of Allegiance Telecom, which is now in Chapter 11.
Starting with an $18-million stake, Madison Dearborn was able to extract $318 million by selling just half of its Allegiance holdings in two secondary offerings that followed a June 1998 IPO.
"Back in the late '90s, their advice was always very good: Here is a great market opportunity; let's go and get the money; it may not be available tomorrow," says Allegiance Chairman and CEO Royce Holland.
"And yet," acknowledges Mr. Canning, "we died with 7 million shares in our pockets," referring to Madison Dearborn's unsold stake in Allegiance stock that, at the top of the market in 2000, was worth more than $700 million.
©2003 by Crain Communications Inc.
