At Dlj, Will Lbo Lightning Strike Twice?
In February, 1994, Victor M.G. Chaltiel left his post as chairman, president, and CEO of home-health-care provider Total Pharmaceutical Care following the sale of the Torrance (Calif.) company. Minutes after the story hit the wires, a merchant banker at Donaldson, Lufkin & Jenrette Securities Corp., TPC's investment banking firm, phoned to propose they team up on a brand-new venture.
Chaltiel and DLJ's merchant banking unit soon crafted a deal to acquire a majority stake in a Tenet Healthcare Corp. kidney dialysis unit, which Tenet was shedding in a restructuring. Over the next two years, DLJ helped the new company, Total Renal Care Holdings Inc., snap up 71 treatment facilities, took it public at $15.50 a share, led two secondary stock issues, and participated in a $400 million loan. DLJ's net annual return on its original $10.5 million investment in TRC: a robust 386%.
HISTORIC PEAKS. DLJ's ability to supply one-stop financial shopping and react rapidly to opportunities for deals appears to be among the reasons that its first merchant banking limited partnership fund, which raised $1 billion in 1992, has turned out to be one of the most lucrative on Wall Street, with a net annual return to investors of 75%. And it explains why many of the same institutional investors and wealthy individuals--including about 500 DLJ professional employees who pledged $750 million of their own money--rushed to commit $3 billion to the firm's second fund. That was $1.25 billion more than the original target. It's the third-largest buyout fund ever, after two $5 billion-plus Kohlberg Kravis Roberts & Co. funds. Says Steven Galante, publisher of newsletter Private Equity Investor: "This was probably the most sought-after LBO fund of the 1990s."
To be sure, DLJ has invested in a few losers. For example, its $66.3 million interest in Coastal Capital Funding Corp., a mortgage banking concern, which it acquired in 1993, was decimated in 1994 by the surge in interest rates and the resulting collapse of the mortgage refinancing market. DLJ jettisoned Coastal in November for $20 million.
Nonetheless, the overall results seem to ratify DLJ's somewhat controversial decision in the 1980s to emphasize merchant banking, in which bankers invest as principals in transactions. Sometimes that strategy rubs its investment banking clients the wrong way. That's because, as a merchant banker, DLJ often competes for deals with the same buyout firms, including Leon D. Black's Apollo Advisors and Hicks, Muse, Tate & Furst, for which it underwrites junk bonds and raises money. Several firms, notably Merrill Lynch & Co., have addressed this conflict by moving to dissolve such funds, while others, including Morgan Stanley & Co., have erected Chinese walls between their investment banking and principal investing activities. "I'm sure we've lost some clients along the way," admits Lawrence M. Schloss, 42, head of DLJ's merchant banking group. But he defends the strategy: "We've uniquely grown our merchant banking and leveraged-buyout client business using the same pool of capital."
Right now, however, Schloss's main concern is finding deals that can deliver returns approaching those achieved in the first fund. But with price-earnings multiples at historic peaks, investing the $3 billion will likely prove harder than raising it. "I don't think the return will be as high" as it was on the first fund, says Michael O'Reilly, chief investment officer at Chubb Corp., which has invested in both. "I'd be delighted if it was."
Still, Schloss and fund co-manager Thompson Dean, 38, say they plan to stick closely to the eclectic, international, middle-market investment strategy that worked well the first time. Underpinning that strategy is their ability to write big checks to make deals happen quickly. DLJ also supplies the merchant banking operation with a bountiful deal flow, says Schloss--more than he would see at a buyout boutique. There, he says, "I would just be another guy with $1 billion."
Schloss now favors technology companies and makers of health-care devices and specialty chemicals. Frequently, as in the case of Total Renal Care, DLJ creates companies when larger enterprises cast off units no longer deemed part of their core business. Says Schloss: "It's a bizarre collection of stuff." DLJ does steer clear of some businesses, such as restaurants and apparel makers.
The firm also employs a wide array of deal structures, including conventional leveraged buyouts, minority stakes, and particularly, leveraged buildups. In such deals, investors buy an anchor business as a platform for acquiring similar companies with a view to eventually taking the much larger entity public. DLJ successfully used that technique in expanding Total Renal Care and Phase Metrics, a maker of computer testing equipment, among other transactions.
PLANTING "SEEDS." One thing that will surely change is investment size. The first fund averaged just $35 million on 31 transactions. That number will likely grow to about $60 million. DLJ completes smaller transactions, and more of them, than most other buyout funds in the $1 billion-plus club. "Bringing multibillion-dollar resources to middle-market situations can be powerful," says Dean. That's because a big fund can quickly underwrite all the pieces of a small deal--including the initial bridge financing, equity, junk bonds, and syndicated loans--without incurring excessive risk. Schloss has dispatched colleagues to emerging markets to find more deals like the $14.1 million convertible debt investment it made in an Indonesian concern that finances motorcycle purchases. Says Schloss: "We're trying to plant seeds in a lot of regions." So far, most of those seeds appear to be germinating.