Unlikely Pairing

Private equity firms and strategic buyers usually operate on different planes, characterized as synergies versus financial engineering. While the two sides usually face off as rivals, recently it is not an uncommon sight to see PE groups pair off with corporate buyers on deals -- as sponsors can provide much needed liquidity and strategics offer an outlet to deploy capital as the debt markets mend.

Of course, other draws to these partnerships also exist. Randy Peeler, a managing director at Berkshire Partners LLC, for instance, notes that these kinds of deals allow PE buyers to capitalize on additional industry expertise and take advantage of synergies that wouldn't be available in a straight leveraged buyout. Moreover, firms have access to deal flow that may not normally come their way.

Berkshire has pursued a number of these investments. One of its more famous deals involved the 1999 merger of Holmes and Rival, makers of small kitchen appliances. Berkshire had already invested in Holmes, but made a new commitment when the deal presented itself.

In recent months, meanwhile, Catterton Partners teamed with Pepsi Bottling to invest in coconut beverage maker ONE, and last year, the triumvirate of NBC Universal, Bain Capital and the Blackstone Group acquired The Weather Channel in one of the more notable deals from last year.

Jordan English Gross, chief operating officer of Saber Seven, sees these partnerships as a cause for cheer. “I definitely see advantages to these types of transactions,” he notes. “People are looking for opportunities that a couple quarters ago they may not have been as open to last year.”

Of course, there are clear reasons that both sides may be reluctant to consider these kinds of pairings. It's typically the case that strategic buyers enter into these transactions with an expectation that they will purchase their private equity partner’s stake. They usually see the investments as long-term investment. PE firms, on the other hand, traditionally don't want to hold the assets for any more than five years. And it may not be the case that their best exit is through a sale to their strategic partners.

A private equity source, who preferred not to be named, notes, “Your options may be more limited than a straight investment where you buy a company and you can sell it whenever you want to.”

He describes that usually buyers in these situations will consider making structured investments that dictate the exit ahead of time based on various milestones. It depends, of course, on the type of transaction and whether or not the strategic partner is actually integrating the assets or holding as a standalone affiliate.

David H. Lee, a partner in Mayer Brown’s private equity practice, says that strategic buyers will often impose a right of first refusal or a buy-sell agreement to help prevent an unwanted outcome. In addition, Lee says, corporate buyers “have the ultimate leverage in terms of an exit.”

H. Hiter Harris III, co-founder and managing director at Harris Williams & Co., echoes the concern for a private equity firm’s exit options. He describes that when a strategic partner purchases a private equity investor’s stake “the corporate buyer is going to try to buy it for as low as possible.”

It can be extremely difficult to arrange an exit price during the initial deal negotiations, since market valuations are unpredictable.

Meanwhile, other pros are reluctant to closely intertwine the target company with the corporate entity. As a result, the investors can't necessarily bank on expected synergies.

Another challenge to the deal structure may be the inability to easily separate the target as a separate spin-off from the corporate buyer once the unit has been integrated.

George Bobbitt, corporate vice president of Camber Corporation, identifies the catch-22, noting that the best way to achieve growth is to integrate the acquired business, but forced exits could impede that. “I would want to avoid having to divest the original relationship," he says, calling it a "very messy and problematic” scenario.

And strategics may find that they don't have as much control as they assumed at the onset of the deal. Sony, for instance, paired off with TPG Capital and Providence Equity Partners to buy Metro Goldwyn Mayer. The deal, from Sony's perspective, helped solidify Blu-Ray as the standard for high definition DVD players. However, MGM did little else for the company, and Sony has often found itself at odds with the PE backers as it relates to distribution deals and content rights.

MGM, in November, said it was exploring strategic alternatives, hiring Moelis & Co. as adviser.

Still, there have been enough successes involving PE and strategic partnerships that these types of deals will continue to occur, especially as debt remains tough to find.

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