Banking & Finance and Institutional Investors and Investing and Leveraged buyouts

Buyout firm lands $202M infusion

December 24, 2007

Indiana's most successful management buyout firm just doubled in size. Locally based Hammond Kennedy Whitney & Co. closed on $202 million in new capital this month.

Its resources have vastly increased, but HKW's investment philosophy is unchanged. Under CEO Glenn Scolnik, HKW will continue to buy small and midsize specialty manufacturing companies, infuse them with cash and management expertise, then patiently wait for them to grow.

That approach has historically netted HKW's investors annualized returns of 18 percent or greater.

"People say, 'All right, they did it in the '80s, they did it in the '90s, they've done it in the first 6-1/2 years of this decade,'" Scolnik, 56, said. "That is one of the reasons why we were able to raise the amount of money we did."

The new fund ranks as the single largest private-equity fund in the state. Locally based CID Capital, which is attempting to raise a new fund of its own, has $321 million under management across several funds but only a fraction of it is available for investment.

Doubling the size of its previous fund shows that investors like HKW and its team. It also shows that, despite the credit crunch, they're still enamored of the M&A sector.

HKW, which began raising the fund a year ago, is getting some of the money from the state. The Indiana State Teachers Retirement Fund and the Indiana Investment Fund, which is underwritten by both TRF and the Indiana Public Employees Retirement Fund, are both HKW investors. The rest are major institutions, like Johns Hopkins University and John Hancock Life Insurance Co., or wealthy individuals.

Founded in 1903, HKW originally was a New York merchant bank for wealthy families. Over the next century, it moved into buying and selling manufacturers, first as a middleman, and eventually as an investor. In the 1980s, Ralph Whitney Jr., then HKW's chairman and now its senior adviser, shifted HKW into private equity--particularly management buyouts.

It was a successful evolution. For years, HKW led "club deals," in which it raised the money for mergers and acquisitions on a deal-by-deal basis. HKW set up its Indianapolis office in 1993 and has been gradually shifting its emphasis to the city since. Today, 16 of its 23 employees live and work here. The rest are spread across its other offices in New York, Chicago and Shanghai.

HKW raised a $57 million buyout fund in 2001. Four years later, the fund was doing so well that HKW went back to investors and asked for another $43 million. That $100 million underwrote the purchase of 14 companies, six based in Indiana. HKW subsequently has cashed out of five companies in its portfolio, two based in the state.

HKW originally intended to raise $185 million this time around, but aimed higher when market interest proved strong.

"If you look at it in context of the amount of money raised in other private-equity pools, it's a drop in the ocean. There is so much capital in the private-equity buyout asset class," said Joe Broecker, senior managing director of locally based investment banking firm Periculum Capital Corp., which has done deals with HKW. "But like anything else, it's relative. A $202 million fund, focused on small and middle-market transactions, is a major, significant fund."

Indeed, the leveraged buyout field is dominated by enormous global players, such as Blackstone Capital or the Carlysle Group, which manage tens of billions of dollars and concentrate on deals far larger than HKW typically pursues.

Strong results

Nationally, the average performance of the small and medium-size buyout sectors has fluctuated greatly, according to Thomson Financial. HKW declined to detail the specifics of its financial returns, beyond stating that they're consistently above 18 percent after fees. That's substantially below the 25-percent average returns of funds raised a year ago, but far above the 7-percent average return of funds raised five years ago.

HKW believes its target market--companies with $20 million to $200 million in annual revenue--is underserved. Scolnik and his partners like industries in which the threat of technological obsolescence is low. Examples include oil-and-gas production equipment-makers, manufacturers of composite auto parts, and companies that build replacement parts for the aging U.S. electrical grid.

To find them, HKW combs through thousands of business plans. It gravitates to deals in which the existing management wants to expand a successful company, but lacks the necessary money or expertise. Empowering management teams is its mantra.

"We would never buy a business if the operating management doesn't want to dig in and put their own money into the deal," Scolnik said. "Everybody buys at the same price per share. There's no preferred position. That tends to work. If it's somebody who doesn't want to put money in, we don't want them to run our company. So we'll go on to our next deal."

Three investments from its last fund did particularly well, Scolnik said. They were Coast Composites, a California-based metal tooling firm that makes composite parts for the aerospace industry. Its growth was constrained by aging equipment and a small facility. HKW paid to knock the walls out and install new machines. As a result, Scolnik said, HKW was able to sell it in December 2005 to a buyer from the same industry.

HKW did the same thing with Texas-based C&J Spec-Rent Services Inc., which makes coiled tubing used to remove natural gas from wells. Once again, an equipment upgrade shifted the firm from slow growth into a higher gear.

HKW's third home run was its investment in Muncie-based Maxon Corp., a manufacturer of combustion equipment and valves. HKW invested in September 2004 when its former owner wanted to retire. It sold the company this month to New Jersey-based Honeywell International Inc. for $185 million.

Retired real estate developer Tom Rush, a longtime HKW investor, calls his returns "very good."

"Their due diligence is pretty thorough. They look at a lot of different companies before finally concluding they want to make an offer. They typically involve the existing management in the ownership on a continuing basis, and they invest their own dollars in the deals," Rush said. "They eat their own cooking, so to speak. And their track record speaks for itself."

Steady strategy

Institutional investors laud HKW's consistency.

"They've done a good job sticking with what they know for 20-plus years," said Bob Erwin, managing director of Springfield, Mass.-based Babson Capital Management LLC, a subsidiary of Massachusetts Mutual Life Insurance Co. "With the success they have had, they probably could have raised a bigger fund."

In addition to investing in equipment, HKW installs veteran executives who can open new avenues of growth.

One example is Dave Robinson, who's now CEO of HKW's CentraSep Technologies, an Indianapolis-based maker of industrial centrifuges used to process wasted manufacturing production fluids. He'd run another HKW company, Cincinnati-based Effox Inc., a maker of dampers used in coal-fired electric plants, until it was sold in February 2007.

Robinson is leading CentraSep's development of a marketing team. Before its acquisition by HKW in October 2005, the company relied primarily on word-of-mouth sales.

"They don't try to run businesses. They try to get people in place who know how to run businesses," Robinson said. "The Hammond Kennedy Whitney people are extremely supportive and good to work with. They're always positive, there to help you with what you need."

Scolnik said there's no big secret to his formula of giving experienced managers the resources they need to expand proven businesses. He said any company's performance is tied much more to the talent and dedication of its management than to guidance from its private-equity backer.

"Align yourself with top management and support them throughout the investment," Scolnik said. "It's not sexy, it's not sensational. But getting out of the way is the best way to bring a [high] return to your investors."

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