PE Week Wire: Mon., April 9, 2007

Buyout firms have begun horse-trading size caps and carried interest on new funds, according to Buyouts Magazine. The article – which I’ve since confirmed independently with several LPs – alleges that numerous firms have raised carried interest on new funds from 20% to 25% (which LPs hate), in a de facto exchange for keeping fund ceilings below anticipated subscription (which LPs love).

It may seem equitable, but it’s not. Moreover, it’s intellectually dishonest.

This tradeoff gimmick is mostly coming from upper-middle-market firms, which make the following argument: “We only want to raise $1 billion for our next fund. That’s more than we raised last time, but it’s reasonable due to market opportunities, number of partners, etc. Our concern, however, is that even a $1 billion fund will not generate enough management fees for us to prevent top talent from getting poached by the $10 billion to $20 billion mega-funds – who obviously have a much larger fee stream. So we only have two choices: Either raise our fund size substantially (which we think there is enough LP interest to support), or increase our carried interest from 20% to 25%. We opt for the latter, because it’s fairer to our dear limited partners.”

Still sound aboveboard? Ok, then here’s a question: If a firm believes that $1 billion would best optimize its strategy and personnel, why would it threaten LPs with the prospect of raising more than $1 billion? Wouldn’t the probable result be suppressed IRRs? Sure would, which is why the only legit explanation I can come up with is short-term greed. If you’re searching for a reference point, try “Venture Capitalists, circa 1999.”

In fact, I’d go so far as to argue that bubble-era VCs were actually more ethical than today’s LBO crop (in terms of this specific issue). Why? Because VC carried interest increases did not get stapled to fund sizes. Instead, VC fund sizes grew purely as a function of perceived market opportunity/valuation. Such perceptions were wildly inflated, of course, but not intentionally so.

Instead, VCs actually believed their own BS. Buyout firms offering decreased fund sizes in exchange for raised carry clearly do not. In other words, it’s BS without qualifiers.

Finally, let me briefly address the crux of this mid-market argument: That such steps are necessary in order to retain key talent. I understand the sentiment, but think it’s ultimately a red herring. If a firm like Blackstone wants to poach a mid-market investor, it will always be successful if compensation is the individual’s deciding/motivating factor. Raising carry on a $1 billion fund from 20% to 25% might narrow the chasm a bit, but not enough to build a bridge. The reason that most mid-market pros stay put is because they prefer the mid-market biz – which is yet another argument for sticking to fund-size knitting. If your performance is strong enough, LPs will likely consent to the carry increase anyway.

*** Quiz Time: Can you name two firms that implemented the above horse-trade, only to later raise their fund sizes substantially?

Top Three

Dow Chemical Co. (NYSE: DOW) could receive a $50 billion buyout offer later this week, according to London’s Sunday Express newspaper. The buyout group reportedly includes KKR and a group of Middle Eastern investors, and is being advised by JPMorgan. News of the possible buyout has sent Dow stock up sharply, with the offer expected to be for between $52 and $58 per share (closed at $44.47 per share on Thursday). If the report is accurate, it would be the largest leveraged buyout in history.

Sirion Therapeutics Inc., a Tampa, Fla.-based drug company focused on ophthalmic products, has raised $45 million in Series B funding. Aisling Capital led the deal, and was joined by Investor Growth Capital, Atlas Venture, Advent International, Bear Sterns Healthcare Value Partners and Series A backer NovaQuest.

Gazprom, the Russian natural gas giant, plans to form a $100 million venture capital fund that will invest in companies whose technologies could be applied to future Gazprom projects.

VC Deals

Aptera Motors Inc., a developer of low-cost electric and plug-in hybrid vehicles, has raised $20 million in new funding led by Idealab, according to VentureWire.

Integrated Trade Processing Inc., a New York-based provider of customizable trade processing services to the securities industry, has raised $9 million in Series D funding led by Grail Partners.

Bioconnect Systems Inc., an Ambler, Pa.-based surgical device startup, has raised $8 million in Series A funding co-led by Cardinal Partners and Fidelity Biosciences. The company’s initial product is an anastomotic connector for dialysis patients.

H2O Audio, a San Diego-based provider of waterproof and protective sport accessories for iPods and other personal electronic devices, has raised $5 million in Series C funding led by Steelpoint Capital Partners.

Quantum Secure Inc., a San Jose, Calif.-based provider of enterprise physical security solutions, has raised $4 million in Series A funding. Dunrath Capital and Crestline Investments co-led the deal, and were joined by seed backer NexGen Capital Ventures.

The Daily Reel, a provider of user-generated video filtering and reviews, has raised an undisclosed amount of first-round funding from Prism VentureWorks. The news was first reported by PaidContent, whose former COO Jeff Stern is Daily Reel’s co-founder and CEO. Its other co-founder is Jaime Patricof, son of legendary VC Alan Patricof.

Buyout Deals

CVC, Blackstone Group and TPG have sweetened their £9.7 billion offer for British supermarket chain J Sainsbury PLC, according to The Times of London. The consortium – which last week lost KKR – reportedly offered to provide J Sainsbury shareholders with one-quarter of the company in stub equity. It also has pledged to create 16,000 new jobs by opening new stores and expanding existing ones (as part of a £3 billion capital expenditure commitment). J Sainsbury last week rejected the group’s initial 562 pence per share bid, saying it was too low.

Bupa, the UK’s largest private healthcare organization, has put its 26 UK hospitals on the auction block. The move comes less than two years after Bupa sold nine UK hospitals to Legal & General Ventures for £85 million, and is expected to generate approximately £1 billion. Suitors reportedly include Blackstone Group, Cinven and Macquarie Bank. Citigroup is managing the process.

Mirant Corp. (NYSE: MIR) said today that its board has decided to explore strategic alternatives, including a possible sale. The Atlanta-based power company has a market capitalization in excess of $10 billion, and previously had disclosed intentions to sell its Philippine business, Caribbean business and six U.S. natural gas-fired power plants. JPMorgan is serving as Mirant’s financial advisor on the possible sale.

The Carlyle Group and Gresham Private Equity are considering an offer in excess of Au$400 million for glass manufacturer Pilkington Australia Ltd., according to The New Zealand Herald. Other interested suitors could include Catalyst Investment Managers and the pairing of Pacific Equity Partners with DMS Glass.

Cerberus Capital Management has agreed to acquire Madison, N.C.-based firearms and ammunition manufacturer Remington Arms Co. from GTCR and Bruckmann Rosser Sherrill & Co. The deal is valued at approximately $370 million, which includes the assumption of Remington’s $252 million of revolving credit facility and other indebtedness. GTCR acquired Remington from Dupont in 1993, and later brought BRS on board as majority owner via a dividend recap.

Thoma Cressey Bravo has agreed to acquire Embarcadero Technologies Inc. (Nasdaq:EMBT), a San Francisco-based provider of data management solutions. The total deal is valued at approximately $200 million, with Embarcadero stockholders to receive $7.20 per share. Morgan Stanley advised Embarcadero on the deal, while Wells Fargo Foothill has committed to provide leveraged financing. Thoma Cressey had previously agreed to acquire Embarcadero at $8.38 per share, but the deal was canceled late last year, after Embarcadero disclosed evidence of stock option backdating and a restatement of historical financials.

Quadriga Capital has acquired 2D Holding GmbH from Bain Capital and Odewald. No financial terms were disclosed. 2D is a Germany-based decorative paper printer whose brands include Suddekor and Dakor.

Audax Group has acquired a control position in A&A Manufacturing Company Inc., a New Berlin, Wis.-based designer and manufacturer of highly-engineered and customized protective systems such as accordion bellows and way covers. End-markets include mobile equipment, automation, machine tool, transportation and medical equipment. No financial terms were disclosed for the deal, which was done in partnership with company management. A&A was advised on the sale by Robert W. Baird & Co., while GE Antares Capital led the leveraged financing syndicate.

KKR has agreed to acquire Singapore-based electronic components manufacturer MMI Holdings Ltd. (SG: MMIH) for approximately $664 million.

Harrah’s Entertainment shareholders have approved a $90 per share buyout offer from Apollo Management and Texas Pacific Group. The two firms originally had offered $83.50 per share, and later sweetened the bid to $87 per share. The total dealwill be worth around $17.1 billion.

Summit Partners is nearing a deal to acquire National Veterinary Associates Holdings Inc. from Willis Stein & Partners, according to LBO Wire. Willis Stein formed Westlake Village, Calif.-based NVAH in 1997 as an acquisition platform for animal hospitals.

PE-Backed IPOs

Virtusa Corp., a Westborough, Mass.-based provider of IT consulting, technology implementation and application outsourcing, has filed for a $92 million IPO. It plans to trade on the Nasdaq under ticker symbol VRTU, with JPMorgan serving as lead underwriter. Shareholders include Sigma Partners (24.6% pre-IPO position), Charles River Ventures (16.2%) and Globespan Capital Partners (15.6%).

BladeLogic Inc., a Lexington, Mass.-based provider of data center automation software, has filed for a $75 million IPO. It plans to trade on the Nasdaq under ticker symbol BLOG, with Morgan Stanley and Merrill Lynch serving as co-lead underwriters. The company has raised around $35 million in total VC funding since its 2001 inception, from firms like Battery Ventures (21.3% pre-IPO stake), Bessemer Venture Partners (21.7%), Globespan Capital Partners (17.2%) and MK Capital (7.2%).

CardioMEMS Inc., an Atlanta-based developer of wireless medical pressure sensors, has set its proposed IPO terms to 6 million common shares being offered at between $12 and $14 per share. It plans to trade on the Nasdaq under ticker symbol SENS, with Banc of America Securities serving as lead underwriter. The company has raised around $52.6 million in total VC funding from firms like Arcapita, Easton Capital Partners, Boston Millennia Partners, Foundation Medical Partners, Medtronic, Inc. and Johnson and Johnson Development Corp.

PE-Backed M&A

Global Aero Logistics Inc., owner of ATA Airlines, has agreed to acquire World Air Holdings Inc. (OTC: WLDA.PK) for $315 million in cash. Under terms of the agreement, World Air stockholders would receive $12.50 per share. GAL is majority-owned by private equity firm MatlinPatterson. Friedman, Billings, Ramsey & Co. Inc. advised World Air on the deal.

MediMedia USA, a Chatham, N.J.-based healthcare education provider controlled by Vestar Capital Partners, has acquired a majority interest in Complete Healthcare Communications Inc., a Chads Ford, Pa.–based medical communications agency that specializes in strategic publication planning, medical writing and related marketing services. No financial terms were disclosed. Berkery, Noyes & Co. advised CHC on the deal.

Automated Resources Group, a Montvale, N.J.-based provider of subscription fulfillment, database marketing and web services solutions, has acquired the Reader Services division of MediaBrains Inc. No financial terms were disclosed. ARG is a portfolio company of Shore Points Capital Partners and TSG Equity Partners, while the acquisition was partially financed via a $15 million one-stop financing from Fifth Street Capital.

PE Exits

Verso Technologies Inc. (Nasdaq: VRSO) has agreed to acquire SentitO Networks Inc., an Acton, Mass.-based provider of voice gateway and signaling solutions for telecom service providers. The deal is expected to close later this month, with SentitO backers to receive 7.7 million restricted shares of Verso common stock (2.2 million subject to escrow provisions) and around 841,000 warrants to purchase Verso common stock. SentitO has raised around $69 million in total VC funding since its 2000 inception, from firms like Core Capital Partners, Columbus Nova Capital, Inflection Point Ventures, Kodiak Venture Partners, Mid-Atlantic Venture Funds and Technology Venture Partners

Advent International is offering 18 million common shares of Aspen Technology Inc. (Nasdaq: AZPN), via a secondary public offering. The deal would reduce Advent’s ownership position from 34.1% to 13.7 percent.

Firms & Funds

Newstone Capital Partners is expecting to close its inaugural fund by the end of May, according to LBO Wire. The Los Angeles-based firm was formed last year by former TCW/Crescent Mezzanine managing directors Timothy Costello and John Rocchio, with a regulatory filing indicating that it had closed on around $375 million of its $500 million target through last August. The final close is expected to come in between $600 million and $800 million. Limited partners include MetLife, Prudential, New Jersey State Division of Investment, Oklahoma Police, Vermont State Pension and Golding Capital Partners. PTP Securities is serving as placement agent.

Burrill & Co. is raising both a China-focused and India-focused venture capital fund, according to VentureWire. Each vehicle is expected to raise between $100 million and $200 million. The San Francisco-based firm also closed on $150 million for a so-called Malaysia fund, which was mostly raised from Malaysian LPs and will co-invest alongside Burrill’s third general life sciences fund.

QuestMark Partners of Baltimore is planning to raise between $250 million and $300 million for its third fund, according to VentureWire. Its current fund closed in 2003 with $233 million.

Permira reportedly is planning to open an office in either Shanghai or Hong Kong, in order to help facilitate investments in Chinese companies.

Human Resources

OVP Venture Partners said that general partner Dave Chen will transition to a venture partner role, effective July 1. In a statement the firm said that Chen will retain an economic interest in the firm’s most recent two funds while moving to independently pursue opportunities in sustainability and new and emerging markets.”

Evan Blum has rejoined Communications Equity Associates as a New York-based managing director, focused on M&A and corporate finance transactions in the communications and media markets. He began his career with CEA in 1993, and later went on to co-found restructuring firm Triax Capital Advisors.

Lindsay Barnett and Joanna LaPlaca have joined Polaris Venture Partners as directors of portfolio recruiting. Barnett previously was a senior associate in Spencer Stuart’s Boston office, while LaPlaca was a senior consultant with ZRG.