This was originally published in August 2005:
Parthenon Capital last week washed its hands of Atkins Nutritionals Inc., the low-carb company that went from plump to emaciated in less than a year. Parthenon is asking LPs to forgive its transgression, and to pony up for a new $1 billion fund.
“Atkins is a big issue for us, and I still don’t know if we’ll get over it,” says an exiting Parthenon investor whose organization has not yet agreed to re-up. “They continue to have positive exits that are going to make the current fund a top performer, but some of the decisions [regarding Atkins] might be too egregious to ignore.”
Parthenon took control of Ronkonkoma, N.Y.-based Atkins in October 2003, as part of a $533 million leveraged buyout that also included minority participation from Goldman Sachs Capital Partners. At the time, most market watchers gave Parthenon high marks for the win, due to Atkins’ position as the unrivaled king of a dietary movement laying waste to doughnut shops across the nation.
Atkins’ rapid growth was based on retail sales of food products, such as low-carb snack bars, rather than on membership dues or meeting fees similar to Weight Watchers.
But for Parthenon investors, however, not all that glittered was gold. First, Parthenon had committed about 20% of its $750 million second fund to the deal. Such outsized ratios are generally frowned upon by LPs, and many partnership agreements specifically prohibit more than 10% of fund capital going to a single portfolio company (although such language is not present in the Parthenon fund agreement).
Also, the Atkins deal was large enough to have qualified for a deal-sharing and co-investment arrangement between Parthenon and Summit Partners. The two firms were operating under what could generously be called a tenuous relationship – Parthenon co-founder Ernest Jacquet was a former Summit GP who had violated his old partnership agreement when Parthenon bought a former Summit portfolio company – and Summit was outraged when it wasn’t informed of the Atkins deal.
It immediately cried foul, and Parthenon agreed to pay $20 million to placate Summit and to cancel the deal-sharing agreement. The money came from the personal coffers of Jacquet and his fellow Parthenon co-founder John Rutherford, but LPs were left wondering why Summit hadn’t been cut in, particularly when it could have reduced Parthenon’s massive capital commitment. Some also weren’t pleased that they learned about the deal-sharing arrangement only after Parthenon had agreed to pay the $20 million.
The saving grace was continued faith that Atkins would produce mega-returns, but signs soon appeared that the company was headed for trouble. Most problematic was that the number of low-carb devotees seemed to drop while the number of low-carb products increased. Shipments of foodstuffs from Atkins and its rivals went unused and rotted while in warehouses, as more and more dieters began to remember how much they liked bread.
Atkins’ revenue slumped, its bank debt was informally discounted on the secondary market and the company laid off some of its 370 employees in September 2004.
But Parthenon remained convinced that it had at least a modest winner on its hands. The Boston-based firm launched its third fund-raising effort in October, with a $1 billion target and expectations of a final close occurring well before year-end.
Most LPs, however, were cautious. Parthenon received some interest from large institutions, but others wanted more information on the Atkins investment, particularly after The New York Times ran an Atkins-centric article asking, “Is the Low-Carb Boom Over?”
“I think Parthenon wanted to get the fund closed while Atkins was still up in the air,” suggests a Parthenon LP who has still not committed to Fund III.
As Parthenon and its placement agent kept making fund calls, the Atkins situation continued to deteriorate. Parthenon took a 50% valuation cut on the deal at the end of December, installed a new CEO in February and wrote off the entire investment at the end of March.
Last week, the company filed for Chapter 11 bankruptcy protection, as part of a reorganization that will transfer Parthenon and Goldman Sachs’ equity to Atkins lenders. Rutherford plans to remain active as an advisor during the transition, but Parthenon no longer will have a financial stake in Atkins’ future.
Will They Commit?
Atkins is not the only reason that Parthenon has yet to close its fund, and Parthenon’s second fund may still produce quality returns.
According to documents made public by The University of Texas Investment Management Co., Parthenon Investors II had a 23.6% internal rate of return (IRR) through the end of February (which would include the December markdown of Atkins, but not the March write-off).
Among its bigger hits have been successful IPOs for Interline Brands Inc. and Rackable Systems Inc., and sales of Arrow Financial Services Inc. and Spheris.
Existing LPs say said that Parthenon likely would hit its target, particularly after promising that Jacquet and Rutherford will remain in place as senior managers. They add, however, that the firm likely realizes that several Fund II investors will not return for Fund III.
Parthenon declined to comment, citing regulatory restrictions related to its ongoing fund-raising effort.