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THE OFFICIAL PUBLICATION OFJuly 2011RetailSavvyCastanea Partners’Brian Knez and Robert Smithcarry on a legacy of cracking thecode on consumer behaviorTheMiddleMarket.com

Castanea co-founder Brian Knez could also be considereda protege of Richard Smith. Both Knez andRobert joined General Cinema in the Eighties -- gettinga first-hand look as the company established itselfamong the prominent white knights during the goldenera of M&A. The pair got their feet wet working on thefabled Carter Hawley deal, in which General Cinemahelped the company stave off successive hostile takeoverattempts from Leslie Wexner and his retail powerhouseThe Limited. It was the 1987 cash infusion into CarterHawley, the second investment in the company in threeyears, that ultimately resulted in a control stake in NeimanMarcus, which was spun out of Carter Hawleylater that same year.Ask Smith and Knez what they picked up from theirdays at General Cinema, and their mutual backgroundas operators is evident. At the same time, the two sharean appreciation for value that suggests they chose an appropriatepath in launching the consumer-focused privateequity firm, Castanea Partners.“One of the more important lessons was the idea of‘investment with involvement,’” Smith describes. “Youhave to understand the nature and flow of business cycles,but at the same time creating value is about beinggreat stewards of the assets you control.”Adds Knez: “In the corporate environment, patiencemeans one thing and in the private equity world,it means something else. To be successful at HarcourtBrace and Neiman Marcus, you had to filter out the vagariesof the market; it meant penalizing performancein the short term to build out the business for the longterm.”To be sure, running General Cinema was in a lot ofways akin to managing a private equity firm. The companywas just as active monetizing its assets -- be it thepredecessor to Pepsi Bottling, Sunkist Soda, or minorityinvestments in the likes of Cadbury Schweppes andColumbia Pictures -- as it was in accumulating trophyproperties, such as Neiman Marcus or publishing giantHarcourt Brace. And while the public markets rarely appreciatethe kind of patience Knez alludes to, at Castaneait has served the firmwell.This patience has beenevident from the verybeginning at Castanea.Rather than banking ontheir names in retail -- having ascended to theroles of co-CEOs at HarcourtGeneral and NeimanMarcus -- the twoopted to launch Castaneawithout any outside capital.The idea was to provethe model out and onlythen raise an institutionalfund. An early Power Point presentation identifies thatthe firm’s partners set aside $75 million, a sum thatwouldn’t spread the tight team too thin, allowing Castaneato make as many as six investments over a three- tofive-year time horizon.In addition to Knez and Smith, Harcourt vets PaulGibbons and Peter Hoenigsberg and Bain Capital alumSteven Berg were among the early team. Partner TroyStanfield, another Bain & Co. vet, was an early additionhaving joined in 2002.Among Castanea’s first investments were acquisitionsof Brinker International carveout EatZi’s, FUZEBeverages and Decision Resources, where Hoenigsberg“In the corporateenvironment,patiencemeans oneone thing andin the privateequity world,it means somethingelse.”

currently resides today as CEO. All three were rolledinto Castanea’s debut institutional fund, a $207 millionvehicle raised in 2004, with backing from the likes ofYale University, Princeton University and other endowmentsand pensions. Only Lee Munder Capital, a minorityinvestment by Castanea, was not rolled into theinstitutional fund.While Castanea has a healthy mix of investments inthe education, information and marketing sectors, most,at the end of the day, have a consumer component. It’s acharacteristic that likely reflects Smith’s and Knez’s GeneralCinema DNA. In fact, it was Smith’s grandfather,Philip Smith, who founded General Cinema and wasamong the first to couple his theaters with shoppingcenters.Chestnuts RoastingCas•ta•nea: Latin for chestnut. Noun: a small genus ofrough-barked trees or shrubs (family Fagaceae) native totemperate regions that includes the chestnut of eastern NorthAmerica. The chestnut is symbolic for fertility, abundance andlongevity.Brian Knez and Robert Smith, in naming CastaneaPartners, focused on the “chestnut” theme, a nod to GeneralCinema’s former headquarters in Chestnut Hill, Mass. JeffreyLurie, another grandson of General Cinema founder PhilipSmith, has also shown a fondness for the name. Before hebought the NFL’s Philadelphia Eagles, Lurie founded LA filmcompany Chestnut Hill Productions. Lurie, who still dabblesin entertainment, was credited as a producer for the AcademyAward winning documentary Inside Job.In many ways, this is reflected in Castanea’s activityand the partners’ ability to stimulate growth. Whetherit’s a coincidence or not, the firm has also shown a knackfor being able to time the market, which no doubt goesback to the pair’s ability to read and assess consumer sentiment.Fuze, for instance, was sold to Coca-Cola Co.in 2007. The sale followed a three-year holding periodthat saw revenues grow by roughly four times. DecisionResources, meanwhile, was sold that same year to ProvidenceEquity Partners. Under Castanea and co-investorBoston Ventures, the pharmaceutical information companyreportedly doubled its sales and tripled its profitsin slightly more than three years.Smith notes that the sale of Neiman Marcus in the fallof 2005, acquired by TPG Capital and Warburg Pincusfor $5.1 billion, provided an early signal that the retailspace was transitioning into a seller’s market. “As we soldNeimans the ebullience was evident,” Smith cites.Castanea also unloaded Hanna Andersson in 2007,selling the company to the then publicly held KellwoodCo. for $175 million. Castanea had invested inthe company in 2004 alongside Dorset Capital. Accordingto Philip Iosca, former presidentand CEO of the childrenswearcompany, Hanna Andersson had receivedmultiple indications of interestduring Castanea’s ownership, butthe firm chose to hold onto the assetas it developed its infrastructure, andtargeted growth through buildingout its online offerings and pursuingstore openings.Of course, by now, everyone is wellversed on what happened to the creditmarkets and subsequently consumerspending shortly after 2007. Ioscareflects, “It was a time when no oneknew where the bottom was.”While Castanea was able to clearmuch of its portfolio ahead of thecarnage that followed, like every PEfirm in 2008 and 2009, it did face itsshare of challenges. Castanea acquiredcontemporary women’s apparel designer and retailerBetsey Johnson during the tail end of the year and, alsoin 2007, picked up a control stake in high-end jewelrydesigner Ippolita.Another lesson picked up from Richard Smith, orperhaps more of a world view, is a tendency toward optimism.Knez notes that the elder Smith would often“Digital allowsthese companiesto castmuch biggershadows thantheir size wouldnormally allow.”

say: “Anyone can kill a deal. The good investors find reasons to getdeals done.”Smith, meanwhile, identifies that Castanea literally sees hundreds ofopportunities each year. The challenge, he notes, isn’t doing deals, perse, but “finding reasons to believe that we will be able to add value in away that will differentiate the company.”Smith downplays the idea that Castanea foresaw the consumermeltdown that occurred in 2008 and 2009. “It was a frothy time; priceswere high and companies were performing at cyclical peaks, so we beganraising our internal hurdles,” he says, but claims that neither he noranyone else at Castanea foresaw exactly what would come next.Still, the companies that Castanea backed just ahead of the collapsewere able to survive at a time that the roof caved in on many consumerfacingbusinesses. Ippolita,for instance, was acquiredin November 2007. JosephCavalcante, who was recentlynamed CEO of thejewelry seller, describes thatwhen Castanea first backedthe business, it had fewerthan 20 employees. “Wewere almost like a venturecapital investment,” citesCavalcante, who joined thecompany two years prior tothe Castanea investment.Three and a half yearslater, with the great recessionnow in the rearview, Ippolita has grown to more than 80 employees.The company, this past March, was named by investment bankingboutique Consensus Advisors, as one of its “next great brands.”Of course, the Neiman Marcus connection doesn’t hurt either. “Wewere growing like crazy at Neiman’s,” Cavalcante says, citing that it’searly performance reflected that the brand was resonating with consumers-- a fact that was not likely lost on either Knez or Smith.At the depths of the downturn, throughout much of 2008, dealflowessentially dried up, especially for retail and consumer product companies.And while Smith says the firm largely sat on its hands that year, assoon as more visibility entered the market and consumer buying patternsagain took shape, Castanea was among the earlier firms to act. AMarch, 2009 investment in Urban Decay was the result.Knez describes that Castanea spent close to a year working withthe cosmetic company prior to the actual deal. “It was an interestingopportunity then and even now to ascertain how the company wouldperform in an uncertain environment.... We were able to see howwell it is positioned with its customer, which at the time gave us theconfidence to invest.”Deal pros, now two years removed from early 2009, may forget justhow touchy the markets were during this period. Castanea’s investmentin Urban Decay was announced on March 30, 2009, the sameday the government effectively took over the auto industry when itturned away the restructuring plans of General Motors and Chryslerand ousted GM CEO Rick Wagoner. To invest in any consumer-facingasset at that time, underscores the Richard Smith chestnut thatgood investors find reasons to get deals done. Both Knez and Smithcite that the leap of faithhas paid off, and that UrbanDecay underscoresthe key factor they lookfor in consumer businesses-- namely a highlyengaged customer.Even as activity slowed,Castanea stayed ahead ofthe curve. The firm alsobrought in Marketspacefounder Jeffrey Rayportas an operating partner inSeptember, 2009, a leaderin e-commerce who hasproven valuable in preppingCastanea’s portfolio companies for the social media opportunity.Knez and Smith note that their aspirational brands, in particular, lendthemselves to the new distribution channels and go-to-market strategiesthat are cropping up as a result of the social media explosion.“We try to be very aware of the evolution,” Smith describes, notingthat disruptive strategies in retail should be viewed with an opportunisticas opposed to a suspicious eye. “We will pursue those strategiesaggressively,” he adds, citing Urban Decay and Donald J. Pliner astwo companies that have already made digital inroads under the firm’swatch.Adds Knez, “All of this opens a huge new avenue for smaller brands;it allows these companies to cast much bigger shadows than theirsize would normally allow, so it’s a significant game changer in thatregard.”

To be sure, Castanea is merely following in the footsteps of GeneralCinema, which confronted “new” technologies such as television andVCRs over its lifetime.Based on the level of activity recently, Castanea has been able tofind a level of comfort with where things currently stand in the market.Last year, the firm sealed two exits, selling Integrity Interactive Corp.to SAI Global and Medley Global Advisors to The Financial TimesGroup. The firm also secured a pair of deals last year, backing HealthResources and Vitamin Research Products, and subsequently mergedthe two branded nutritional supplement makers.In 2011, Castanea jumped out of the gates, backing shoemakerDonald J. Pliner in February, Astor & Black Custom Clothiers inMarch, and Fitness Anywhere in April. Castanea, which still hasroughly 40% remaining in its $575 million third fund, expects tostay busy.While Castanea’s co-heads see the credit markets loosening up, theyknow that it will be a long time before the consumer environment everapproaches the atmosphere of 2007. But that doesn’t mean the firmisn’t confident.“It’s still pretty choppy out there... It’s still a tough environment forthe more moderate customers,” Smith observes. But as long as thereis visibility, he says, brands that resonate with consumers will be protected.The challenge, though, is making that call, especially when a companyis either in transition or still ahead of the growth stage in its lifecycle-- the points at which Castanea prefers to enter. “There is no universaltruth when it comes to backing consumer businesses,” Knez says. “Youjust have to try to get underneath the value proposition in a very meaningfulway. If you perceive that the customer is either highly engaged orcould be, that’s the most important factor.”©2011 SourceMedia, Inc. and Mergers & Acquisitions. All rights reserved. SourceMedia, One State Street Plaza, New York, N.Y. 10004 (800) 367-3989