GP Profile: Castle Harlan Muscles Through Great Recession

Once closed, the sale promises to generate two times the equity the 23-year-old shop invested in the company. It would be a notable return considering Ames True Temper, like many companies relying on consumer spending, struggled during the economic downturn. The deal also marked the latest in a string of good exits from companies bought via Castle Harlan’s fourth fund, a $1.2 billion vehicle closed in 2003. Australian cable television company Austar United Communications Ltd., for example, generated 7.2x invested capital after a two-and-a-half-year hold period, while Polypipe Group, a British supplier of plastic pipes for sanitary systems, and United Malt Holdings, a maker of malt for beer and liquor, both generated 4.5x returns after relatively short holding periods.

The fund is turning out to be a top-quartile performer, according to two limited partners. “Despite the fact that they have had some challenges, they have also had some stars,” Catharine Burkett, a managing member at Camden Private Capital, said of the Fund IV portfolio. The Baltimore-based fund-of-funds invested in Castle Harlan’s fourth and fifth funds. Indeed, it wasn’t that long ago that Fund IV was looking like anything but a top-performing fund.

Challenges

Founded in 1987 by John Castle, the former CEO of Donaldson Lufkin & Jenrette Inc., and Leonard Harlan, a former vice president at DLJ, Castle Harlan has been through its share of economic cycles. It began investing its $125 million debut fund, in fact, just after the stock market crash in 1987. Nonetheless, the firm has raised successively larger funds targeting companies in the general manufacturing, industrial, energy services, specialty chemicals and restaurant sectors. In 1992 the firm raised $160 million for its second fund, and followed that up in 1997 with $632 million for Fund III. But nothing could prepare Castle Harlan for the challenges it would face over the life of Fund IV, its largest yet.

From 2007 to 2009, four Fund IV companies, including Ames True Temper, turned into serial occupants of Standard & Poor’s monthly “Weakest Links” list of companies particularly at risk of facing default. Baker & Taylor Corp., a distributor of books and music products bought in 2006, saw a drop in sales to traditional retailers in 2008 and 2009. Caribbean Restaurants, a franchisee of Burger Kings in Puerto Rico bought in 2004, nearly defaulted on its debt payments in 2008. And Perkins & Marie Callender’s Inc., a restaurant chain the firm formed in 2006, seemed in late 2007 to be close to breaching covenants on its senior credit facility, according to S&P. Morton’s Restaurant Group Inc., the chain of upscale steakhouses Castle Harlan bought in 2002 with its third fund, also struggled. It reporting a net loss of $59.6 million for the nine months ended Sept. 28, 2008, compared to a net income of $6.5 million for the same period the year before.

Ames True Temper, for its part, landed on S&P’s “Weakest Links” list in July 2007, after net income for the quarter ended June 30 of that year fell to $1.7 million, down from $7.6 million a year before. The ratings agency also suggested the company was being hurt by a small product line, the seasonal characteristics of the business, limited geographic diversification and highly levered capital structure, which included $300 million in high-yield debt and a $125 million credit facility. Between 2005 and 2007, the company, which outsourced about 55 percent of its manufacturing to China, also had to contend with higher prices for raw materials, higher taxes in China, higher shipping costs, and finally, a strengthening renminbi against a weakening dollar.

Justin Wender, president of the firm, said some of the concerns about Ames True Temper were overblown. The company, for instance, always had enough cash on the balance sheet to meet payments on debt, which he said had virtually no covenants. Still, Castle Harlan implemented a number of measures to improve the company’s position. It reduced the amount of manufacturing outsourced to China, to the point where the company outsources just 40 percent to 45 percent of its manufacturing. Among cost-cutting moves, It closed a plant in West Virginia, where 180 employees earned an average of $42 per hour, and opened a plant in Pennsylvania, where 120 employees earn an average of $17 per hour. It expanded Ames True Temper’s business with big-box retailers in Mexico and Australia. And in 2006, the company bought two competitors, Acorn Products Inc. and Hound Dog Products Inc., which broadened its product line into new categories such as hand tools and hoses.

By May 2008, S&P took Ames True Temper off its list of stressed companies, citing its improved liquidity. At the time Castle Harlan announced the sale of the company, its trailing 12-month EBITDA had reached $80 million, compared to about $55 million when Castle Harlan bought it in 2004. “Ames is a huge win for them, considering it got off to a difficult start with weak sales, production cost increases and other unexpected cost increases related to offshore manufacturing,” said Marc Bonavitacola, head of North American private equity for SVG Advisers, an investor in Fund IV.

Meanwhile, Castle Harlan also had to contend with personnel issues while plotting its fifth fund. In 2005, two managing directors, Marcel Fournier and Benjamin Sebel, had to reduce their time at the firm for personal reasons. Sebel went on to join CHAMP Private Equity, Castle Harlan’s Australian affiliate, while Fournier continues to work for the firm on a reduced basis. These were considerable blows to a firm with 19 investment professionals, all of whom are expected to contribute on every deal. To buttress its senior leadership team, Castle Harlan tapped Gary Appel, a founding member of DLJ Merchant Banking, in November 2005 for the new position of vice chairman. And a few months later, the firm promoted Wender, its chief investment officer, to president. Wender replaced Harlan, who took over as chairman of a new executive committee, and solidified his position as the heir apparent to Castle, who remains chairman and CEO.

The challenges made life difficult for Castle Harlan on the fundraising trail for Fund V, launched in late 2007 with a target range of $1.5 billion to $2 billion. A representative for one backer told Buyouts the organization didn’t re-up for Fund V in part because the LP wasn’t comfortable with the firm’s succession plans. (Castle and Harlan say they are still actively involved in day-to-day operation, while two other LPs point to Senior Managing Directors Howard Morgan, David Pittaway and William Pruellage, who joined the firm in 1996, 1987 and 1997, respectively, as strong leaders.) The firm would need until March 31 to close the fund at $800 million, well short of target but still an achievement during a time when investors were particularly stingy.

Outlook

Castle Harlan still has some hairy situations to get through with Fund IV, most notably Perkins & Marie Callender’s. The firm is hoping a $10 million cost reduction program it recently implemented will help turn it around. “It would be better if the economy were stronger and people were a little more enthusiastic about eating out,” Castle said.

The situation at Morton’s, the Fund III investment, meanwhile, has improved: Revenue rose 4.9 percent to $75.3 million in its fiscal first quarter, which ended April 4. Castle Harlan executives also said in an e-mail that Baker & Taylor and Caribbean Restaurants have “continued to perform well” and “are on a good path,” though they declined to discuss specific financials.

Castle and other executives are noticeably upbeat about Fund IV performance, the firm’s future and the near-term investment environment. Fund IV was generating a 1.39x investment multiple and a 17.1 percent IRR for the Oregon Public Employees Retirement Fund as of March 31, before its latest exit, of Ames True Temper. Other successful exits from the fund include AmeriCast Technologies Inc., a maker of complex steel castings (3x/21-month hold); RathGibson Inc., a tubing manufacturer (2.5x/16-month hold); and Horizon Lines, an ocean carrier (3.2x/two-year hold).

The firm has made two acquisitions so far this year with Fund V, which has about $680 million in dry powder. In February, it bought Pretium Packaging LLC, a maker of plastic bottles for the cosmetics and health care industries, for $200 million, or about 4.5x EBITDA. And in June, Castle Harlan bought IDQ Holdings Inc., a maker of air conditioning products for automobiles, for $160 million, or about 5x EBITDA. “Generally in a time like this, corporate earnings tend to be lower, and there are opportunities to move into situations and buy them at very reasonable prices and get the benefit perhaps of higher earnings in the future,” Castle said.