PE Week Wire — Friday, November 11

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Clash of the Titans

Take a walk within private equity circles (figuratively or literally), and you’ll hear incessant chatter about the lawsuit filed by Abry Partners against Providence Equity Partners. It has supplanted Refco as the industry scandal de jour, in large part because Thomas H. Lee Partners continues to be seen largely as a victim in Refco, whereas Abry v. Providence will almost certainly conclude with at least one party at fault. Moreover, this represents just the third time that a sponsor-to-sponsor transaction has resulted in one sponsor suing the other, and is by far the largest in terms of both dollar amount and firm size (Willis Stein vs. Brynwood, Benchmark Capital vs. CIBC are the others). There are a lot of moving pieces and unanswered questions about this case, so what follows is more laundry list than essay – more comprehensive than cohesive. For those actually working on Veteran’s Day, please bear with me.

The transaction at issue is Abry’s $500 million buyout of Cincinnati-based magazine publisher F&W Publications from Providence Equity Partners. The deal included $150 million in equity from Abry, and a $350 million debt component from J.P. Morgan and CSFB (which also served as the deal’s auctioneer). Perhaps most importantly, it closed on
August 5, 2005. Remember that date, because it will become integral later on.

Shortly after taking ownership, Abry alleges that it discovered numerous bookkeeping irregularities. For example, it alleges that F&W began “channel-stuffing through volume discounts,” which means that it offered unusually high discounts to retailers in order to prompt additional orders and, therefore, increase Q2 revenue. Abry also alleges that F&W’s UK book division shipped out July and August orders in June, again to increase Q2 revenue. It is important to note that neither activity is fraudulent in a vacuum. Channel stuffing, for example, is regular practice among many media companies. The problem, however, would be if such practices were unusual to F&W, which Abry alleges that they were. In fact, Abry even says that an F&W employee was concerned enough about the new revenue recognition processes, that he began keeping a separate, “more realistic,” set of financial records.

Abry claims to have discovered these irregularities shortly after closing, and began a more in-depth look at the company financials. Abry filed suit against Providence on Nov. 3 in Delaware’s Chancery Court, requesting that the entire deal be rescinded (i.e., annulment, not divorce). In addition to channel-stuffing and the early shipping, Abry alleged that a distribution technology system was not working as promised, that the UK book division secretly extended the June reporting deadline and that the magazine division used “back-starting,” or sending back-issues to new subscribers (the aforementioned employee was in the magazine division). Providence has not yet issued its legal response, although a spokesman says that the firm “denies any wrongdoing” and “will vigorously defend the suit.”

Why So Fast?
One giant question is why this suit has been filed just three months after the original deal closed. Private equity firms typically like to keep such matters in house, in order to avoid both public (i.e., press) and private (i.e., LPs and other GPs) scrutiny. Out-of-court is the status quo. I would assume that there were at least some private discussions between the two sides, although neither one would comment when asked. After all, Abry had nothing to lose by at least asking for voluntary rescission.

What is important to remember, however, is that August 5 closing date, because the deal included a 90-day post-closing window for Abry to review F&W’s balance sheet. This is just an educated guess, but Abry likely felt that its legal position would be greatly enhanced if it filed suit within that window, which is why it filed on November 3 instead of spending additional time in private negotiations. There also must have been pressure from the banks, since the debt covenants are in trouble (does anyone think that it wasn’t an I-banker who first leaked word of the suit?).

Due Diligence?
Abry is obviously taking a hard-line here and, if the allegations are true, good for them. The private equity market’s secrecy is a silly vestige of a time when there were few purchases of public companies, and when most fund capital was committed by private institutions. Abry is not asking in its suit to renegotiate the deal, but for a complete hand-washing. If successful, it will be viewed as a general partner who LPs want managing their money.

But there is one giant problem with the Abry as white knight scenario: The firm’s due diligence seems to have been lacking. Abry is not a generalist firm that hires outside consultants to advise on this sector or that. Media is what they do, and publishing is a major part of that. The firm’s complaint doesn’t get too specific on the due diligence process, except to say that Abry requested, and received, all relevant financial data on F&W. How about talking to some actual retailers? You know, the customers who suddenly were receiving these major volume discounts? When a VC firm backs a revenue-generating company, it always talks to customers for an third-party opinion. Did Abry? If so, did they simply ask the wrong questions? Did they call the wrong people? If not, why not.

Passing The Buck?
There is an old legal maxim that a prosecutor’s case never looks better than on the day of indictment, since the accused has not yet told his side. Ditto for civil cases, so
Providence ultimately may smell like roses. Today, however, the firm simply smells.

Were Providence taking questions, I’d ask it two: First, how did it not expect the channel stuffing to catch up with F&W? The unsold magazines would get returned eventually, and Abry would eventually be asked for reimbursement. Maybe Providence just expected the trickle to be a bit slower. Second, why has Providence not yet made any statement to its limited partners about the suit? I spoke with two Providence LPs yesterday, and one had absolutely no idea what I was talking about. Maybe they just want to wait until they’ve formalized a defense strategy, but it is shameful for someone like me to be the messenger for a major institutional money manager. At least have a conference call and keeping saying “We can’t talk about that,” like TH Lee has done a couple of times regarding Refco. After all, it’s the LPs who ultimately will be helping to pay the legal bills.

More on this as it progresses. Until then, have a great weekend.

    Top Three


Silver Lake Partners has agreed to acquire enterprise software company Serena Software Inc. (Nasdaq: SRNA) for approximately $1.2 billion. Under terms of the agreement, Serena stockholders would receive $24 per share in cash, while debt financing would be provided by Merrill Lynch, Lehman Brothers and UBS. The deal is expected to close in the first quarter of 2006. Morgan Stanley served as financial advisor to Serena on the deal.

Advent Solar Inc., an Albuquerque, N.M.-based maker of solar cells and modules, has raised $30 million in Series C funding. Battery Ventures led the deal, and was joined by Firelake Capital and return backers EnerTech Capital Partners, @Ventures, New Mexico Co-Inv*stment Partners (managed by Fort Washington Capital Partners Group) and Angels with Attitude.

Oaktree Capital Management of Los Angeles has secured around $1.65 billion in capital commitments for its sixth distressed debt fund, according to a regulatory filing. The vehicle has a cap of $1.8 billion.

    VC Deals


Infinera Inc., a Sunnyvale, Calif.-based provider of digital optical networking systems, has secured $13 million of a $51.3 million Series G funding round, according to a regulatory filing. Infinera now has raised around $230 million in total VC funding since its inception, from such firms as Kleiner Perkins Caufield & Byers, Benchmark Capital, Applied Materials Ventures, Cypress Semiconductor, Mobius Venture Capital, Sprout Group, Venrock Associates, RWI Group, Worldview Technology Partners, Siebel Systems and Sutter Hill Ventures.

Kovio Inc., a Sunnyvale, Calif.-based developer of semiconductor products using thin-film technologies, has received $3 million in venture funding from Harris & Harris Group.

Newsvine Inc., a Seattle-based developer of online news content solutions, has raised just under $5 million in startup funding from Second Avenue Partners, according to The Seattle Post-Intelligencer.

BioPro Pharmaceutical Inc. has raised $5 million in Series A funding, according to a regulatory filing. Backers include Sanders Morris Harris. The company has offices in Taiwan and Mill Valley, Calif., and focuses on cancer drugs for regional Asian markets.

6th Sense Software Inc. of Raleigh, N.C. has secured $750,000 of a $1.5 million first round funding, according to a regulatory filing. Backers include Intersouth Partners. 6th Sense is focused on helping companies measure and analyze the effectiveness of their software development processes.

Inrix Inc., a Kirkland, Wash.-based developer of mobile traffic technology, has secured $6.1 million or a $6.44 million Series A funding round, according to a regulatory filing. Backers include b and Venrock Associates.

Clovis Solutions Inc., a Petaluma, Calif.-based provider of a device infrastructure software platform for data communications, has received an undisclosed amount of strategic funding from AT&T. Clovis previously raised a total of $17 million in VC funding from firms like Sevin Rosen Funds, Walden International, Intel Capital, American River Ventures and Diamondhead Ventures.

    Buyout Deals


Man Group PLC won a bankruptcy auction for the last solvent subsidiary of Refco (Refco LLC), with a $282 million bid. The deal also includes $4 million in “other considerations” and $37 million in assumed debt. Refco’s other subsidiaries remain tied up in litigation. In other Refco news, former company CEO Philip Bennett was formally indicted on securities fraud charges.

Industri Kapital has agreed to acquire KwintetAS, a Denmark-based supplier of professional wear, for an undisclosed amount. Sellers include Axcel.

    PE-Backed IPOs


Magellan Midstream Holdings LPof Tulsa, Oklahomahas filed to raise nearly $600 million via an IPO. It plans to trade on the NYSE under ticker symbol MGG, with Citigroup and Lehman Brothers serving as lead underwriters. Significant shareholders include Carlyle/Riverstone Global Energy and Power Fund and Madison Dearborn Capital Partners. Magellan owns and controls Magellan GP LLC, the general partner of Magellan Midstream Partners LP (NYSE: MMP), a provider of transportation, storage and distribution of refined petroleum products.

GSI Technology Inc., a Santa Clara, Calif.-based provider of SRAM circuits for the networking and telecom markets, has withdrawn its proposed $103.5 million IPO, citing “unfavorable market conditions.” Merrill Lynch had been serving as lead underwriter for the company, whose significant shareholders include Monet Capital.

Global Secure Corp., a Washington, D.C.-based provider of products and services for the homeland security industry, has reduced its proposed IPO terms to 8.25 million common shares being offered at $6.50 per share (previous range was $8-$10 per share). It still plans to trade on the Nasdaq under ticker symbol GSEC, with Morgan Keegan & Co. and Jefferies & Co. serving as lead underwriters. Sky Capital Enterprises holds a 17.8% pre-IPO ownership position.

Promotora Ambiental SA de CV, a Mexico-based garbage collection company, is planning to raise up to $115 million via a public floatation in Mexico, according to Reuters. Company shareholders include Darby Overseas Inv*stments and Citigroup Private Equity.

    PE-Backed M&A

SkyTerra Communications Inc. (OTC BB: SKYT), a portfolio company of Apollo Management, has agreed to acquire the remaining 50% of Hughes Network Systems Inc. that it doesn’t already own from The DirecTV Group Inc. (NYSE: DTV). The deal is valued at $100 million in cash, which SkyTerra will finance via a $100 million short-term debt financing from Apollo. SkyTerra acquired the initial 50% interest from DirectTV earlier this year for $246 million in cash and approximately $11.4 million worth of SkyTerra stock. Hughes provides broadband satellite networks and services to enterprises.

Emcore Corp. (Nasdaq: EMKR) has acquired Phasebridge Inc., a Pasadena, Calif.-based photonics company. No financial terms were disclosed. Phasebridge has raised around $17 million in venture capital funding since its 2000 inception, from firms like Clearstone Venture Partners, Intel Capital and TriQuint Semiconductor Inc.

    Firm & Fund News

Rosewood Capital of San Francisco has secured $203.5 million in capital commitments for its fifth fund, according to a regulatory filing. The filing indicates a maximum cap of $300 million.

Linden Capital Partners, a Chicago-based middle-market buyout firm focused on the life sciences market, has secured over $100 million in commitments for its inaugural fund. The firm was formed in 2002 by former One Equity Partners pros, and has an exclusive co-investment alliance with Madison Dearborn Partners.

Portfolio Advisors reportedly has closed its third private equity fund-of-funds with $661 million in capital commitments.

    Human Resources

Davor Hebel has joined the London office of Fidelity Ventures as an associate. He previously served as co-founder of Croatia-based Experia.

Babak Nivi has joined Bessemer Venture Partners as an entrepreneur-in-residence. He previously has served as a consultant to Atlas Venture and as an associate at Seed Capital Partners.