During the private equity boom of the mid-2000s, getting into deals was relatively easy for buyout firms. But with the financial world turned upside down in the past couple of years, getting the money out of these deals is not so easy. In brief, these firms face a shortage of exit strategies. From 2006 to 2008, the U.S. private equity industry bought up $1 trillion worth of companies large and small. But the private equity model works only if, after a few years, the firms can sell their holdings and provide some return to their investors. That has been difficult, to say the least. After the credit crisis, buyers can't get financing. After the recession, the value of many businesses has plunged. And, after the past years' market turbulence, the environment for initial public offerings has been unpredictable. On Nov. 13 arrived news of a rare private equity success: Castle Harlan and affiliate CHAMP Private Equity announced the sale of United Malt Holdings for $655 million to an Australian company, GrainCorp (GNC.AX). The sale was no easy feat. An earlier attempt to sell off United Malt Holdings had failed, a victim of last year's economic turmoil. BusinessWeek was given exclusive access as the parties completed the deal, which enabled the private equity investors to book a significant profit at a time when such gains are increasingly rare. how they did itNew York-based private equity firm Castle Harlan and CHAMP, its Australian affiliate, bought the malt business in 2006. Joint owners Conagra Foods (CAG) and South African firm Tiger Brands had decided to sell off the division. "We have a strategy of buying companies that are unwanted divisions of large corporations," says a Castle Harlan senior managing director, David Pittaway. The properties included malt plants in the U.S., Canada, Australia, and the United Kingdom. Also coming along in the transaction was a Conagra executive, Jim Anderson, who had an idea for his new employers. Produced from grain such as barley, malt is used in the production of beer and whiskey. The previous owners had been treating malt mostly like a commodity product. "It wasn't doing very well," Anderson says. He thought: "There's got to be something we can do to make our product look more like a solution rather than a raw material." Malt can be produced in dozens of different ways, each affecting the flavor of the beer or whiskey it produces. Anderson's idea was to provide brewers and distillers with malt made according to their exact specifications. The new independent company, renamed United Malt Holdings, could sell malt at a higher price because the specially made malt helped customers produce better products for less. "Our goal is to do everything we can to help your brewery and distillery run efficiently," Anderson says. tapping the growing microbrew segmentUnited Malt Holdings, which operates as Great Western Malting in the U.S., also made other changes. It bought a small company focused on supplying the growing American microbrewery segment. According to the Brewers Assn., the U.S.'s 1,525 craft breweries saw sales rise 9% in the first half of 2009, following a 6.3% increase in 2008. "We went after the microbrew business [and] really diversified the customer base," Pittaway says. The new private equity owners also locked in long-term contracts and used hedging strategies to reduce the risk that profit margins could be jeopardized by currency movements or swings in the price of commodities. The company invested in expanded plants in Australia and Scotland that should boost production capacity 14% by 2011. "It really has been a textbook example of how private equity firms can add value to the assets they acquire," Pittaway says. In 2006 the company was producing earnings before interest, taxes, depreciation and amortization, or EBITDA, of $27 million. In 2009 it expects EBITDA of $114 million. Castle Harlan won't reveal the total purchase price it paid for United Malt Holdings in 2006. But the firm says the $655 million sale to GrainCorp will allow a return that is 4.5 times the $90.5 million in equity invested, an internal rate of return of 80%. Investors in United Malt Holdings may have found a solution to a puzzle that has confounded many other private equity deals. simple solution: add valueThere are basically three ways that private equity firms can make money for their investors, says Dartmouth University professor Colin Blaydon, director of the Tuck School of Business's Center for Private Equity and Entrepreneurship. "You can be a smart buyer and seller," buying low and selling high. Second, he says, you can load up deals with risky debt. Both approaches don't work anymore because of the weak economy—which has pushed down valuations—and the tough credit markets, which make getting credit difficult, if not impossible. The only other profitable path for private equity, says Blaydon: "You can actually improve the company." Many private equity firms are focusing heavily on ways to boost earnings and revenue at the businesses they own, says Kevin Hovorka, who leads the private equity group at accounting and consulting firm Crowe Horwath. "There is a greater emphasis today on operational improvements rather than financial transactions," he says. Private equity firms disclose little to nothing about how well their current holdings are doing. (Castle Harlan will not discuss any of its other holdings, which include the Perkins and Marie Callender's restaurant group bought in 2005.) But, private equity experts say, there is no doubt that many PE firms overpaid in 2007 and earlier for companies that are now suffering from the effects of the recession. Traditionally, private equity firms have been good financial operators, but they've been only O.K. at actually growing profits and sales, Blaydon says, but "they're getting better at that." But even if, like United Malt Holdings, you can boost profits, you still must find a buyer willing to pay a fair price. In the past couple years that has not been easy. In fact, Pittaway explored a sale of United Malt Holdings last fall. "Of course, you know what happened to the markets a year ago," he says. After the markets crashed, the sale was postponed. without profits, no investorsIt's a familiar scenario. Although private equity firms own more businesses than ever, the number of exits is down 54% since 2007, according to PitchBook Data. Falling fastest is the number of sales of businesses from one private equity firm to another. But other exit strategies, including initial public offerings and acquisitions by public corporations, are also down significantly this year. The dearth of PE exits is a mounting problem because, without sales, private equity firms can't book profits for their investors. And without delivering profits, they can't raise further funds from investors. "There are many funds that will look to divest investments in order to position themselves to raise new funds in the future," says Ezra Field, managing director of private equity firm Roark Capital Group. Expect a growing number of private equity firms to try to sell off businesses in early 2010, Field says, as these outfits "test the market." key draw: a well-managed companyCastle Harlan and CHAMP Private Equity were planning an IPO in Australia this fall, when, Pittaway says, "GrainCorp called up and said they'd be interested in buying this." GrainCorp, a grain storage, transportation, and trading firm with operations only in Australia, saw United Malt Holdings as a way to expand internationally while diversifying its revenue stream. "Our revenue is highly dependent on seasonal conditions," says David Ginns, GrainCorp's manager of corporate affairs. To accomplish the deal, GrainCorp issued new shares worth almost 800 million Australian dollars. "One of the things that attracted us to United Malt Holdings was the way in which it's being managed," Ginns says. GrainCorp plans no major changes to operations. "There is no need to fiddle with them," he says. Private equity firms don't disclose information about their holdings, making it hard to gauge the true impact of the recession and credit crunch. As markets heal, however, many should begin trying to do the kind of exit deals they did earlier this decade. That will reveal just how many deals look like the one for United Malt Holdings and how many firms are stuck with less profitable businesses that are bleeding their investors' equity.
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