Bertelsmann's Bold Buyout Plan

The media giant's new CEO has teamed with powerful partners in unusual new plan for leveraging acquisitions and paying off debt

When he takes over German media giant Bertelsmann at the end of 2007, Chief Executive Officer-designate Hartmut Ostrowski will inherit a solidly profitable company with one big liability. After buying back a 25% stake in itself from Brussels-based Groupe Bruxelles Lambert (GBL) last year, Bertelsmann's debt soared more than 40% at the end of 2006, to $8.8 billion. The debt means that Gütersloh-based Bertelsmann, with sales in 2006 of $25 billion, will have to strain to make big acquisitions to remain within the ranks of the world's top media groups.

Now Bertelsmann has devised a clever way around that limitation. Together with the private equity arms of Morgan Stanley and Citigroup, Bertelsmann is forming a $1.3 billion fund that will make leveraged acquisitions much the way a buyout firm does. The war chest, announced Mar. 21, will allow Bertelsmann to stay in the acquisition game while it pays down the cost of the deal with GBL.

While ad hoc alliances of corporations and private equity are not unheard of, Bertelsmann's fund with a permanent management team is unusual in the media world. For Bertelsmann, the so-called Equity Fund is a creative way to take advantage of the glut in private equity while ensuring it doesn't fall too far behind rivals such as Rupert Murdoch's News Corp. (NWS). Last year, News Corp. staked out a big piece of Web 2.0 real estate with its acquisition of social-networking site MySpace.

Hinting at Targets

Privately held Bertelsmann and its partners are already in talks about potential acquisitions, Chief Financial Officer Thomas Rabe says. Most likely targets: established U.S. companies with strong cash flow and good growth prospects. "We're already strong in Europe, and the U.S. has better growth rates," Rabe told BusinessWeek following Bertelsmann's annual press conference in Berlin.

Rabe declined to name any of the targets, but said they could be in a range of media-related businesses—Internet companies, assets that would enhance sales at Bertelsmann's Random House book-publishing unit, or perhaps firms that provide services that would fit into Bertelsmann's Arvato unit. Arvato, which Ostrowski currently heads, is a fast-growing printing company that also provides outsourcing services, such as call centers and e-commerce fulfillment.

Initially, the Equity Fund will take minority stakes in acquisitions. Those investments will serve as placeholders, giving Bertelsmann the option to acquire the holdings outright after its financial position has improved. "If you then want to buy the company in total, you have better information," Rabe says. Acquisitions in Asia are also a possibility, Rabe says.

Cumulative Clout

The fund may also get bigger. Bertelsmann—which will provide half the $1.3 billion capital, with Morgan Stanley and Citigroup splitting the rest—is open to additional investors. "It would be an understatement to say there has been a lot of interest," Rabe says. Additional partners, as well as the potential to leverage acquisitions, means Bertelsmann should be able to play in the big leagues.

If Bertelsmann continues on its current path, its clout for future acquisitions should increase. The company said at its press conference that operating profit rose 16% in 2007, to $2.4 billion, as sales increased 7.9%. The 9.7% operating profit margin, driven by better ad revenue at the RTL Group broadcasting unit and a turnaround in the book-clubs business, was Bertelsmann's best in at least 25 years.

For outgoing CEO Gunter Thielen, the numbers marked a satisfying conclusion to his more than 20 years on the company's management board. For Ostrowski, they're a challenge to do better. Ostrowski is keeping a low profile during the transition period. But it's likely that he has been playing an increasing role in formulating strategy.

Wink and a Smile

He has been visiting company units around the world to learn more about the far-flung media conglomerate, though he hasn't yet moved his offices down the street from Arvato to Bertelsmann headquarters in the Westphalian burg of Gütersloh. As a member of the management board, Ostrowski almost certainly signed off on the Equity Fund idea and may have played a more active role.

Ostrowski deflected attempts by reporters to uncover clues about his vision for the one-time Bible publisher. "I'm here as CEO of Arvato and won't be making any statements about Bertelsmann strategy," he said, with a smile.

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