Class rings. Airport baggage carts. Deepwater oil ports. Chemicals for tire-making.
As investments, these unglamorous niches do not appear to be the stuff of dreams, let alone fortunes. Yet John K. Castle and Leonard M. Harlan, the principals of Castle Harlan Inc., a New York-based leveraged buyout outfit, are hell-bent on going after little-known companies that are leaders or strong contenders in low-profile, highly concentrated industries. "We migrate to them since the value is there," says Castle. The firm's acquisitions typically generate strong growth--and fetch high resale prices. The $280 million fund it launched in 1992 using the niche strategy, Castle Harlan Partners II LP, has a stellar 68% annual return.
Take IndSpec Chemical Corp., which dominates the market for resorcinol, a bonding agent used in tires. Castle Harlan's 1993 equity investment of $12 million was returned threefold last April when it sold IndSpec to Occidental Petroleum Corp. For Castle Harlan's talent scouts, IndSpec stood out among the hundreds of possible deals they review yearly: Its product was in increasing demand. More and more, resorcinol is used by makers of sunscreens and fire-retardant plastics. As a result, cash flow for 1996 has increased 46% since the buyout.
MUST-HAVE LIST. The same reasoning popped Smarte Carte Inc. onto Castle Harlan's must-have list in 1993. As the nation's No.1 airport baggage-cart vendor, the company met the requirement for a strong market share--and had room for expansion. Castle Harlan's people figured that with the economy growing, air travel would, too. Since the buyout, the company added 7,500 carts to its existing 25,000, and installed devices that accept credit cards. Smarte Carte has seen cash flow almost triple, to an estimated $16 million this year. Now, Castle Harlan has sold it to Dallas buyout firm Haas, Wheat & Partners for $113 million, many times its $9.7 million equity investment.
The Castle Harlan strategy has limits, namely antitrust considerations. To please the Justice Dept., it had to drop one of three class-ring makers it sought to buy. Consolidating all three would have given its newly formed Class Rings Inc. almost half the market.
Castle, now 55, founded the LBO firm in 1987 with Harlan, 60, a buddy from his days at Donaldson, Lufkin & Jenrette Securities Corp. Castle was DLJ's CEO and before that headed its merchant banking effort, including the highly regarded Sprout Group, a pioneer in venture-capital investing. Harlan, who left DLJ in 1969, formed a real estate investment group, Harlan & Co., that enjoyed success even during the property busts of the mid-'70s and early '90s.
They raised $125 million to create their first LBO fund, Legend Capital Group LP. But that fund has generated a lackluster 10.75% annual compounded return to investors. The main reason: two showy but disastrous investments, Sharon Steel Inc. and Long John Silver's Restaurants Inc.
CODFISH FACTOR. Acquired in 1990, specialty steelmaker Sharon faltered in the recession as steel prices collapsed, and two years later, it fell into Chapter 11. Castle Harlan has since sold most of the steel company's assets. "Sharon," says Castle evenly, "was a mistake." Long John Silver's, bought in 1989 with the help of a $235 million bridge loan from First Boston Corp., had similar bad luck. The price of codfish zoomed, hurting cash flow. Worse, the junk-bond market fell apart in 1990, so Castle Harlan couldn't refinance the bridge loan. First Boston ended up taking control of the company.
Sobered by the experience, the firm shifted strategy in the early 1990s, eschewing high-profile deals. Despite the early missteps, the reputations of Castle and Harlan were so solid on Wall Street that they had little trouble raising money for a second fund. "They overcame our concerns about Legend Capital," says John B. Fewel Jr., senior equities investment officer at the Oregon Public Employees Retirement Fund, which sank $23.5 million into Castle Harlan's 1992 LBO kitty. "They're known as top-notch people."
Last year, with the firm's niche strategy going strong, Castle made an atypically glitzy personal acquisition, the Palm Beach estate of the Kennedy clan, for $5 million. Given his track record, he's entitled.