Big trouble in little market anatomy - Monomoy Capital Partners

anatomyInside the operations of leadingprivate equity firmsBig trouble in little marketA recipe for a first-time distressed fund operating on the smaller end of the middle market: a strong team,plenty of deal flow and evidence of true operating wherewithal. Having raised a $280 million fund, New York’sMonomoy Capital Partners is finding this formula to be quite popular.By Wanching LeongMonomoy Capital Partners’ self-proclaimed “Summer of Love” forits portfolio companies did not go as planned. During the namesakesummer of 1967, young people relocated to San Francisco and celebratedpeace, love and understanding. During the summer of 2007,the New York-based Monomoy team had intended to drop out of thedeal race and tune in to its portfolio of nine companies, in the processreallocating resources to improving operations and preparing somefor near term exits.Some of this operational love did in fact occur, including a stint inKentucky to learn about Japanese manufacturing techniques. But atthe tail end of the summer, Monomoy found itself deluged with newinvestment opportunities: the firm currently has three deals in thepipeline. It was the time of the season for equity deployment.“We could’ve invested our entire fund by next summer,” says Monomoyfounding partner Stephen Presser, in an interview with PEIManager last month. “We deliberately decided to slow down the pacea little. Instinctively, we worried whether we would miss some significantopportunities by investing more quickly, so, beginning in May ofthis year, we raised our internal writing standards.”The firm is now seeing north of 30 potential transactions a month– a big portion of them credit-driven – from 20 deals per monthbefore. But Monomoy only wants to acquire very good companiesin need of improvement – companies like Kurz-Kasch, which has a80 percent market share in its product niche and has huge growthpotential, but requires financial and operational restructuring.“Our hypothesis when we started two and a half years ago wasthat there were a lot of opportunities in the smaller end of the middlemarket and there wasn’t a lot of supply of capital willing to takeon those transactions that require a turnaround skill set,” says cofoundingpartner Daniel Collin. “I think it’s safe to say we’ve underestimatedthe demand for capital in this part of the market.”With the amount of opportunities it is seeing, Monomoy is raisingthe bar for potential acquisitions – and for the firm itself. This summerit tweaked its financial model – it now looks for 4x return oncapital, up from 3.5x before. The firm says it will have invested $100million of its fund by the third quarter of 2007, and anticipates thatthe fund will be fully invested by the end of 2008. The firm has alsosought to fine-tune the way it manages its voluminous deal flow.Already, Monomoy’s ability to execute transactions impresses oneof its investors, who describes the team as “strong” and says it has“guts.” “I would be surprised if they don’t produce an 8x return,”says the investor.Not bad for a team who not too long ago started with “nothing butan idea.” Presser, Collin and Justin Hillenbrand left New York-basedKPS Special Situations Fund (now KPS Capital) in January 2005; thefourth founding partner, Philip Von Burg, joined two months later.The firm’s inaugural fund, which was 50 percent oversubscribed,closed on $280 million in January of this year and drew about 30percent of commitments from LPs outside North America.Partners in operationMonomoy’s office occupies the entire 17th floor of the gleamingMetropolitan Tower and overlooks the jagged stacks of buildings inmidtown Manhattan. The firm moved to its new premises in June,but the space is still spare. “We don’t really have our furniture yet,”Presser acknowledges. “We’re not about what our office looks like –we’re about returns for our investors and nothing else.”One of the ways the firm believes it can drive the kind of returnsit is seeking is by using operating partners. The firm has three operatingpartners, all full-time employees, and is on the lookout for afourth. “It’s a little unusual because we’re a $280 million fund,” saysPresser. “At our previous [larger] fund, it took us a long time to haveone operating partner. We wanted to invert that at Monomoy and toput as many resources as possible into sustained business improvement.”Monomoy hired Richard Fish in 2006, and in March this yearadded David Kreilein and John Stewart from Sun Capital Partnersand Toyota Motor, respectively.The job of the operating partners is to implement the restructuringprograms the investment team designs, but the latter plays an activerole in monitoring the portfolio companies. “It seems like we speakdaily,” says Mark Eichhorn, chief executive officer of Anchor HockingGlassware, Monomoy’s largest acquisition to date, of his dealingswith Presser, Collin and Kreilein.Eichhorn speaks admiringly – and gratefully – of Monomoy’s“substantial” investment in Anchor Hocking, as well as the firm’s understandingof the manufacturing business. These turnaround guyshave displayed a real hunger for knowledge of best practices. Thequest for higher returns and better company performance recentlybrought the whole team to Kentucky to learn about the Toyota ProductionSystem (TPS). Also known as “just-in-time” production orCOPYING WITHOUT PERMISSION FROM PEI Manager IS UNLAWFUL. OCTOBER 2007 | | 1

anatomyInside the operations of leadingprivate equity firms“lean manufacturing,” TPS is a Japanese management philosophy tooptimize the manufacturing process.Presser explains: “We’ve been successful in turning around thecompanies we buy. We want to know whether we’re sustaining thatimprovement and how much value we’re actually creating. We continueto look for the link between acquiring companies that we knowwe can improve, actually improving them and making that improvementpermanent. Lean manufacturing is one way of thinking aboutthat value chain.”Love of laborTo be able to do the kind of restructurings the firm specializes in oftenputs them at the table with unions and in front of bankruptcy courts.Only 12 percent of the American workforce is unionized, but in themature manufacturing segment Monomoy operates in, the proportionis higher – which can lead to some contentious situations.Such was the case in the acquisition of Anchor Hocking, whichrequired negotiations with at least seven labor unions and restructuringof three major contracts. Eichhorn says the partners of Monomoynegotiated with the unions directly and came to a resolution evenbefore receiving bankruptcy court approval for the deal.“We took a bit of an interesting viewpoint in our fundraising:we turned it around. We started doing transactions first thenraise the fund later. That was the thing I think helped drive ourfundraising process the most.”Collin: underestimated the demand for capital“Monomoy asked for the opportunity to speak to the unions directly,and literally, within a couple of weeks reached an understandingwith the unions,” recounts Eichhorn. “They moved to revise theLancaster contract to improve the competitiveness of the businessand substantially lower operating costs. They replaced a defined benefitplan with a defined contribution plan. They implemented a lowercost retiree health plan incorporating a VEBA trust in lieu of theexisting retiree health plan.”Incidentally, the same discussions to incorporate a VEBA trust intoretiree insurance plans is taking place in the auto industry restructuringin Detroit. Over 90 percent of union associations at AnchorHocking voted in favor of Monomoy’s plan.By doing more work early on, Collin says: “Anchor was substantiallycash flow positive from the day we closed the transaction.”There is another element that may help explain the firm’s successwith unions: Presser, the ace up Monomoy’s sleeve. Presser is a formerpartner at union-side labor law firm Cohen, Weiss and Simon and hasworked on the restructurings in the North American airline and steelindustries. “If a transaction involves a labor negotiation, that’s toomuch fun. I’m not going to let a lawyer do that. Are you kidding me?”he asks in mock disbelief. “I do that,” he says, thumping his chest.“Our luxury or curse is that the majority of thecollective bargaining agreements in companies webuy are written by Stephen,” jokes Collin.No task too smallThere is fluidity in Presser and Collin’s interactionas they take turns yielding the floor and listeningattentively to one another. Of the two, Pressercomes off as being the proud elder, praising Collin’s eloquence, whileCollin, though younger, appears more serious.Presser eagerly regales to PEI Manager of tales of his colleagues.“Dan is a softball star,” says Presser. “He plays in a competitive softballleague. It’s a big problem: we end up having to schedule meetingsaround the softball games.”The good-natured ribbing extends to the absent partners. Hillenbrandcollects mid-century geometric abstract art; “Not your everydaycollection. He likes shapes,” says Presser dryly. Von Burg isan extreme cyclist who, at the end of the biannual 750-mile Paris-Brest-Paris race, has to wear a contraption to support his neck. Ina show of support, Monomoy created cycling jerseys for the entirefirm: black, stretchy, and emblazoned with the names of all theportfolio companies it owns, bar the latest, Transeo, which the firmaquired in mid-August. Monomoy’s logo, a lighthouse, stands aloneon the front.Presser himself is an avid fisherman who casts off the coast of theMonomoy Islands in Massachusetts – which is how the firm got itsname. His two hobbies, he declares, are his daughter and his son,who are “the greatest children in the history of the world.”The spirit of camaraderie turns serious when the two discuss work.“No task is too small for anyone in this office. We do more work upfront, we manage expectations and we exceed them,” says Collin.Presser chimes in: “No one works harder, no one cares more…The reason the four of us decided to create Monomoy is becausewe work well together. If we compete on anything, we compete onwho can add the most value.”2 | | OCTOBER 2007 COPYING WITHOUT PERMISSION FROM PEI Manager IS UNLAWFUL.

Daniel Collin and Stephen Presser, with products made by their portfolio companiesMonomoy Capital PartnersFounded:March 2005Office:New YorkKey personnel:Stephen Presser, founding partnerDaniel Collin, founding partnerJustin Hillenbrand, founding partnerPhilip Von Burg, founding partnerRichard Fish, operating partnerDaniel Kreilein, operating partnerJohn Stewart, operating partnerAndrea Cipriani, chief financial officerTotal employees:14Fund:Monomoy Capital Partners, LP ($280 million; 2007)Type of investments:Control in distressed companies with annual revenues between$20-$200 million that require operational or financial restructuringSelected investors:JPMorgan Asset Management, Drum Capital Management,Bear Stearns Asset Management, Oppenheimer & Co,St Paul-Travelers, Morgan Creek Capital, Horizon 21Strategic relationships:Kirkland & Ellis, Aubridge PartnersDeals:Investment LOCATION Sector Closing date AmountAwrey Bakeries, LLC Livonia, Michigan Foodservice A aug-05 $25 millionHess Industries, Inc South Bend, Indiana Capital equipment manufacturing Sep-05 n/ABarjan LLC Rock Island, Illinois Consumer products distribution Jan-06 $20 millionCasting Technology Company Franklin, Indiana Automotive manufacturing Jun-06 $9 millionWestern Recreational Vehicles, Inc Yakima, Washington Automotive manufacturing Dec-06 n/ARossborough Supply Company, Inc Cleveland, Ohio Automotive manufacturing Dec-06 n/AKurz-Kasch, Inc. Ohio, Indiana & Virginia Industrial manufacturing Feb-07 n/AThe Anchor Hocking Company Lancaster, Ohio Glassware manufacturing mar-07 $75 million 1Transeo LLC Dayton, Ohio Vehicle solutions provider aug-07 n/A1and assumption of $20 million in liabilitiesCOPYING WITHOUT PERMISSION FROM PEI Manager IS UNLAWFUL. OCTOBER 2007 | | 3

Building the firm was an 18-month process, during which it investedin a proper back office. The first hire was a chief financial officer,Andrea Cipriani, who, like them, is from KPS. Next came investmentprofessionals, analysts and a controller. Everyone at the firm, includingoperating partners, is given carried interest in the fund.Unusually for any private equity firm, Monomoy has built threeplatforms to monitor the firm’s activities,from the initial call about a potentioalacquisition through an exit: these“We’ve been successful in turning around the companies we buy. Wewant to know whether we’re sustaining that improvement and how muchsystems can be accessed remotely bythe partners, who are often traveling. value we’re actually creating. We continue to look for the link between“Deal Tracker” tracks deal flow, “Data acquiring companies that we know we can improve, actually improvingRoom” houses all documents from investmentmemos the team writes onthem and making that improvement permanent. Lean manufacturing isone way of thinking about that value chain.”portfolio companies to financial andlegal information, and “Quick Look” isa monitoring tool from which monthly statements of the portfoliocompanies are produced.“Unexpectedly, our internal data room turned out to be an interestingfundraising tool too,” says Presser. “You can see in real time howour investments are built: literally, seeing how the sausage is made.Some of our LPs want, and we give them, access to our data room.We’re building our investment thesis on this database. If a portfoliocompany had a bad quarter, our LPs can go back to our investmentmemo. It’s an interesting disciplinary mechanism for us.”Deals before fundAs a first time fund with a track record that belonged to anotherfirm, and with a small fundraising target to boot, the odds seemedto be stacked against the firm with the unusual name when it wenton the fundraising trail.“We took a bit of an interesting viewpoint in our fundraising:we turned it around. We started doing transactions first then raisethe fund later,” says Collin. By putting their money where theirmouths were and building the track record while pitching to investors,Monomoy had six companies to its name by the time the fundclosed; the companies were later sold to the fund at cost. “That wasthe thing I think helped drive our fundraising process the most,”adds Collin.With MVision, a placement agent, Monomoy focused on LPsthat would be committed to the firm’s investment goals for the longhaul. This meant turning away investors who are subject to changesin public policy, for example, and accessing endowments and foundationsthrough fund of funds.“We made a conscious decision not to raise $500 million,” saysPresser. “The main focus of the firm is to raise a series of smallerfunds over the next 15 to 20 years. We’re not doing that to be clever.We’re doing that to implement and discipline our investment thesis:$280 million is the right-sized fund for the smaller end of the middlemarket. Until we convince ourselves we’re wrong about the smallerend of the middle market, and that the better opportunities are notPresser: plans to raise a series of same-sized fundsout there, we’re going to raise the same-sized fund.”Presser adds: “Most of our investors think we will raise a muchlarger second fund. But we’re going to prove them wrong.”The partners are also contemplating establishing complementaryfunds to take advantage of ancillary investment opportunities thatcome with the acquisitions it makes. One consideration is a real estatefund, another is a hedge fund. “Once you own a large enoughportfolio, you see more than you expect about a particular industrialsector. For example, we think we see as much as anyone in the worldabout movements in sugar pricing. We want to capture some of thatvalue as well,” says Presser.Next summer could be a very different one for Monomoy CapitalPartners. If the partners’ predictions are right, there will be no summerof love for the foreseeable future. There will, however, be plentyof companies to be rescued and more funds to be raised.4 | | OCTOBER 2007 COPYING WITHOUT PERMISSION FROM PEI Manager IS UNLAWFUL.