Not one to mince words, KPS Capital's Michael Psaros offers a ...

20-35_Roundup.qxd 4/6/09 5:39 PM Page 86FRAUD continued from page 22A background check of the key people can also shed light. Spinellimentions one deal involving a bank, in which the principals involvedappeared “cleaner than Caesar’s wife.” A deeper investigation revealedtwo convicted felons.It’s often the case that the schemes are specific to a particular industry.In publishing, for instance, there was the public battle involvingAbry Partners and Providence Equity Partners. Abry claimed thatProvidence portfolio company F&W Publications used channel-stuffingthrough volume discounts ahead of the sale, which propped upthe order count, at least until the vendors started sending orders back.In retail, Steve & Barry’s is being sued for using tenant-improvementpayments to overstate its equity and assets. The company was sold lastJuly to a pair of hedge funds and ended up moving forward with aliquidation plan just a few months later.The most creative instances of fraud, according to Bahl, is alwayscollusion “involving more than one company.” Bahl cites as an examplethe manufacturing sector. “In these cases you need to look at thebusiness partners and look all the way down the supply chain,” he says.“It forces you to analyze multiple sets of transactions rather than justone person’s financials.”So how can dealmakers root out corruption? According to Spinelli,the key is to look for it. “It amazes me how little due diligence is beingdone,” he says, specifying that scrutiny should include financialand investigative due diligence as well as a very hard look at the complianceprocedures of an organization.“The vast majority of fraud is not a one-off scam,” he adds. “Thepeople who do it once, will do it again, and they’ll do it just a little bitat a time so they won’t get caught.”MEZZ continued from page 34second lien market crumbled and BDCs began showing weakness, themezz market held strong. During the first two quarters of 2008, forinstance, the percentage of mezzanine financing going into dealsgrew substantially over 2007, roughly doubling its average allocationwithin the capital structure. Meanwhile, the BDCs, CLOs andhedge funds are effectively shut out from the lending market.“Prior to the chaos that started in September 2008, the mezzmarket was getting stronger, and it was starting to shine. We werebusy,” says Michael Klofas, a managing director with Babson CapitalManagement. “But since October, we are not seeing a lot of dealactivity in general and mezz deals, in particular, have been few andfar between.”Indeed, prior to September 2008, Tower Square III had alreadycompleted 13 transactions and deployed 11% of its capital undermanagement. Since then the fund has only completed one transactionwith three in the pipeline.The bottom line is that senior lenders need to start lending againbefore mezz players can make any kind of headway.“Regular people can’t even get mortgages, how is a leverage buyoutsupposed to be completed?” asks one lender. “We need the entirelending market to start running well again, but who knows exactlywhen that will be.”While few will even guess as to when the credit markets willloosen up, commercial banks weren’t created for long term CDs.Eventually, when the remaining banks regain their appetite for risk,the mezzanine market will be positioned to benefit.“There’s a lot of private equity money on the sidelines. Senior lendingwill come back, purchase price multiples will come down andmezz will do better,” says Steuerman.For now, however, it’s just a renaissance delayed.BACK TO THE WELL continued from page 33 ADD-ONS continued from page 32activity on the part of private equity firms could be “especially pronounced”when the investors still hold an interest in the assets, eitherthrough earnout provisions or minority stakes.And even if the old targets present new challenges for the investors,Wilson notes that those are the types of deals that privateequity buyers find most tempting. “The ideal acquisition for the privateequity buyer is something slightly damaged that they understand;those are the deals that they can arbitrage and enhance, whichis where they can add value.”ensuing integration can test the mettle of even the best operators.As Welsh Carson Anderson & Stowe general partner John Almeidastated in a Mergers & Acquisitions roundtable last year: “If youdon’t know how to operate businesses, you can’t do these deals becausethat’s the quickest way to screw up a situation, period.”With that said, whether a firm can be considered an operations-orientedgroup or not, if add-ons are the only game townfor dealmaking, it’s expected that most investors will explore theopportunity.VAPORS continued from page 48over the past two years, if they added to the buyer’s debt load, mayeven spark more M&A as these companies look to shuttle assets topay down debt or rearrange the portfolio. For buyers in the midmarketspace, this will present an opportunity.Ashland, for example, recently flagged a number of assets considerednoncore, which could fetch between $40 million and $400 millionapiece. The company sold its FiberVisions unit to private equityfirm Snow Phipps Group, realizing $7 million in proceeds. SnowPhipps also assumed $90 million in debt, and the sale will create asubstantial tax loss for Ashland.Similar deals could be in the offing as more companies hit theproverbial wall. One dealmaker, who preferred anonymity, says ofLyondell and Ineos: “They are trying to figure out how to surviveright now, and their banks are getting very nervous... we will likelysee asset sales whether or not they go bankrupt.”Leland Harrs, a managing director at KeyBanc Capital Markets,notes that whether or not M&A is the solution, the status quo likelyisn’t. “More of the same doesn’t really help anyone,” he says.86 MERGERS & ACQUISITIONS February 2009