Sun Capital’s annual investor meeting last week in Boca Raton wasn’t a very sunny affair, according to attendees who spoke with peHUB. The firm discussed its writedowns, including company-specific ones, and a plan to prop up its fourth fund with money from its fifth fund. We have all the details below.
Fund To Fund
Sun Capital was previously reported to be raising an annex fund to its fully deployed fourth vehicle, Sun Capital Partners IV. The word “annex” is not accurate, peHUB has learned, as the firm has told investors it would take too long to go through the formal process.
Instead, Sun Capital has created an amendment to Fund IV. The plan is to commit $150 million to Fund IV from its existing funds and investors. Half of the $150 million will come from its fifth fund, Sun Capital Partners V, a $6 billion pool that is only one quarter deployed. That money will be treated as an investment. The other half will come from new money from fund four investors. The $150, from both fund five and fund four investors, will be “preferred.” This means the new money gets a preferred return of both 2x its money and a 25% IRR before distributions reach the other investors.
A number of investors were unhappy about the plan, one LP said. It would be dilutive to Fund IV investors who do not re-up. Meanwhile, some fund five investors see it as throwing good money after bad. It has been approved by Sun Capital’s advisory board of investors and requires a vote from fund four investors.
The reason for the amendment is that Sun Capital’s Fund IV portfolio companies are in need of capital and liquidity is not available. They are positioned for a sale but cannot exit because of the market conditions. They need capital infusions for working capital or add-on acquisitions.
Good After Bad or Doubling Down?
The “good money after bad” argument doesn’t apply to every investment in fund four, since many of Sun Capital’s acquisitions were financed across multiple funds. Sun’s largest investment was $467 million for Kellwood, a women’s apparel company, in which fund four contributed 25% of the capital and fund five 75%. That investment has been written down to zero, but the firm told investors it expected to get at least some of its money back on the investment.
The firm probably won’t be so lucky on Mark IV Industries. Like Kellwood, the company has been written down to zero. Unlike Kellwood, Sun Capital does not expect to recover any of its $135 million investment in Mark IV, its managers told investors. The firm said it is working through restructuring options for the company and its $1 billion debt load, but is not optimistic. “They basically said the investment was permanently impaired and that they were ‘managing it down,’” one LP said. Sun Capital’s fourth fund put up 30% of the investment in Mark IV; fund five covered the remaining 70%.
To be sure, Fund IV fared better, valuation-wise, than Fund V. Sun Capital’s portfolio of funds took a 36% writedown overall, on par with reported mark-to-market writedowns from other private equity firms. Fund five suffered the worst, with a 50.7% writedown in Q4 alone and a greater than 60% writedown for the year.
But that doesn’t mean the Sun won’t rise again. Despite the headlines, one investor said his firm has faith. “We don’t ultimately think fund five will be a money-losing fund,” the investor said. In fact, his firm is looking to purchase more stakes in Sun Capital’s fifth fund on the secondary market.
Sun Capital Partners V LP is trading at a discount of up to 100% on the secondary market, the investor said. With only 25% deployed, the investor said it was an attractive buying opportunity. “The reason it’s selling so cheaply has little to do with the underlying value of the companies. They’re not all healthy at the moment, but the selling is being driven by LP liquidity issues.”
Part of this faith is based on some of the success stories in Sun Capital’s portfolio. The firm has taken conservative holding values of companies that have outperformed their target metrics but were forced to take large mark-to-market writedowns thanks to the poor performance of public comparables. Friendly’s and Bruegger’s Enterprises are two examples. “We do think there’s an embedded value and a real buying opportunity,” the investor said.
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