Forstmann Little Exits General Instrument –

Forstmann Little & Co. last month sold nearly all of its remaining 15% equity stake in General Instrument Corp. (GI) for $650 million, mostly to Liberty Media Corp. The New York-based buyout group also sold its remaining 15% stake in General Semiconductor-a spin-off of GI-for $35 million in a block trade to Donaldson, Lufkin & Jenrette.

Forstmann Little’s nine-year investment in GI illustrates the importance of internal means of financing for buyout firms and also highlights the difficulties of exiting a company through the public markets.

Forstmann Little has generated a 58% net IRR from its $180 million equity investment in GI-which in 1997 was split into General Instrument, General Semiconductor and CommScope-returning $1.7 billion to investors, said Partner Steven Klinsky.

However, it was not always smooth sailing; when Forstmann Little in 1990 acquired 100% of General Instrument for $1.5 billion, buyout firms had lost access to the most common means of financing, high-yield debt. Forstmann Little was able to engineer two of the biggest buyouts that year, its acquisition of General Instrument Corp. and the $850 million buyout of Gulfstream Aerospace Corp., because it had raised a subordinated-debt fund that could provide financing for the firm’s equity investments.

For General Instrument, Forstmann Little issued $600 million in sub-debt in which the principal was not due until the 11th year of the investment. The company, however, was able to pay the sub-debt piece within three years, thereby netting L.P.s in the sub-debt fund a 26% IRR, Mr. Klinsky said.

That tranche helped the manufacturer of cable television equipment grow by providing capital for research and development in the early 1990s, a time when the cable industry was in a recession and GI’s earnings were not meeting expectations. The company, in fact, did not record a profit until three years after the firm’s initial investment. “We could not have managed the company for growth had we not used our own debt,” Mr. Klinsky said. “This capital structure helped us keep our balance.”

Forstmann Little then took the company to an initial public offering in June 1992 at $15 per share. The firm followed up with secondary offerings in March 1993 at $30.50 per share and September 1993 at $51 per share-after a 50% increase in revenue from the prior fiscal year-thereby reducing its stake to 30%.

Through these offerings, Forstmann Little returned $1.1 billion to its investors, generating more than a 70% IRR, and paid off its subordinated debt.

However, rather than cash out completely, Forstmann Little maintained a stake in GI for another five and a half years, generating only mixed results.

The firm sold half of its holdings in an April 1995 offering priced at about $40 per share. After last month’s offering at $28 per share-which is equivalent to $74 per share factoring in the 1997 stock split, or 85% higher than the September 1993 price (an increase of about 15% per year)-the firm was left with less than a 1% stake in GI.

Profitability was stifled by problems encountered after the initial realization events. In 1995 GI attempted to enter the market for phone gear, acquiring fiber-optic equipment maker NextLevel Communications for $85 million. A Texas jury in 1996 ruled that NextLevel’s founders were using trade secrets from a prior employer and ordered the founders to pay $369 million in damages impacting NextLevel’s ability to generate revenue and stalling GI’s entrance into this market.

At this point, GI opted to split its stock to generate investor interest, moving most of its debt to the two smaller businesses. General Instrument continued to specialize in cable box manufacturing, while CommScope took control of selling wires for cable television and General Semiconductor began specializing in the manufacture of electrical components.

At the time of the split, General Instrument’s stock was trading at $23 per share. “In the scheme of things, splitting might have been slightly positive,” Mr. Klinsky said.

Forstmann Little had planned to sell its remaining stake at about $25 a share last August but scrapped its plans when the stock price fell to $17 a share, Mr. Klinsky said.