Palladium Equity Partners, the New York firm founded in 1997 by Marcos Rodriguez, rang up an IRR of 20.4 percent for New York City Public Employees’ Retirement System as of Dec 31, 2014, according to the pension fund. That’s ahead of the top quartile threshold of 11.7 percent and the median of 8 percent for that vintage year, according to an annual study by Buyouts. David Perez, president and chief operating officer, spoke about the fund at the firm’s headquarters.
Bring us up to date on the firm.
Today we manage about $2 billion across three funds: the tail end of Fund II; Fund III and then Fund IV, our $1.1 billion fund which we closed in 2014. We’ve invested close to half of that fund. We currently have about 35 people and one office here in New York.
Set the stage for Fund III, a top quartile fund.
A little over a dozen years ago, Palladium was managing its first institutional fund, which was Fund II with $230 million. Its focus was on middle-market investments with an emphasis on operational improvement of companies. It was around that time that the key principals of the firm started talking about the change that the country was going through — the growth of the Hispanic demographic. This is the early 2000s. Goldman Sachs put out a piece called the “Hispanization of America,” which looked at the impact that this new demographic was having on consumer-products companies and other companies.
One example I’ve heard is that salsa sales exceeded ketchup sales in the U.S.
Exactly. Also tortillas surpassed bread.
A lot of it started in L.A., which is a trend-setting city.
Not just California. If you look at the top cities in the country — New York, L.A., Houston, Chicago — what they have in common is that at least 30 percent of the population is Hispanic. A lot of the trend-setting areas of the country are 30 percent Hispanic. What that means is what those kids are listening to on the radio becomes a national hit. What those kids are wearing becomes a national passion.
Fund III was really the first institutional fund of its size to seek to incorporate a formal and stated focus on that group. There were other smaller funds back in the day that focused on media or some specific sector. No one had raised a fund to pursue the increase in Hispanic business opportunities, with a broad industry mandate. This wasn’t a social fund. We had stated for-profit goals for institutional investors.
We put together an experienced team of private equity investors. A number of folks joined us right around that time in 2003-2005. Most of them remain with the firm and are a key part of the senior leadership. I joined in 2003. Our other partners, Luis Zaldivar and Erik Scott, and a number of our VPs and principals joined around that time to energize that focus and strategy.
For Fund III, how did you get to $775 million with a $500 million target?
We encountered some of the initial skepticism that you would find associated with a first-time fund or strategy. No one had done this before. Like anyone who’s a pioneer, it took evangelizing and a lot of educating of the constituents. Some folks even invested with us in tranches.
It was, ‘Please prove to me that this is not just a demographic trend but a business opportunity.’ No one could prove that because no one had done it before. We were the proof, but the proof took several years.
Certainly there was a lot of fundraising activity at the time, a few years before the financial crisis.
We’re talking about 2004-2007 and into 2007. The market was much more focused on brand-name buyout funds. The middle market went through a bit of a dark few years. It’s not that it didn’t get any money, but it got much less money than the megafunds. That was the time when Apollo, Carlyle and Blackstone went from funds of several billion dollars to $10 billion or more. Everyone was piling into the megabuyouts with the brand names. The middle market was not seen as an interesting space. We had to fight, to be quite honest. We had to make our case and persevere.
But we were fortunate to find 30 investors or so who ended up entrusting us with $775 million. The original target was $500 million. It took a while — the better part of two or three years — to get there.
You must have done a few deals along the way.
Yes. That helped solidify our picture and make it more real. We invested in Taco Bueno, a chain of Tex Mex restaurants in Texas and Oklahoma. That was our first investment. We made several other investments along the way, where folks would now look at the portfolio and say, ‘this makes sense to me.’ These are the types of investments I would pursue.
How’d you navigate the financial crisis?
Palladium wasn’t the IBM of private equity at that point. We had a strategy that needed to be proven. A lot of the LP officers that entrusted us with their capital, to some extent, took a risk. So we were very careful. In an environment when multiples were going up at very high clips, in 2006 and 2007, to the double-digit area — frankly, it reminds me of what we’re seeing today — we were fairly prudent. We kept our valuations at about 7x EBITDA for entry multiples. Leverage was low, about 3x EBITDA or so. The strategy was very much focused on value creation through EBITDA growth.
When the crisis came, we benefited from low leverage. We had a couple of companies that ran into headwinds with the economy. We were very fortunate in that we did not have a lot of problem situations. When you don’t have a lot of problem situations, you continue to focus not only on the portfolio but on making new investments.
We kept investing through the entire cycle. When we looked to raise Fund IV, a lot of investors were impressed that we kept investing every year. Some turned out to be our best deals.
What contributed to the firm’s ability to find assets?
That came out of having a larger firm. For a firm of our size, we’ve been told that we have a large investment staff, which we like. We also had a policy of building a diversified portfolio with at least a dozen investments per fund, not six or eight. That’s important because no one investment can bring down the fund.
What kind of performance did you see and which deals contributed?
Our stated goal is to double EBITDA of portfolio companies in five years. We’ve been able to do that in Fund III. EBITDA across the Fund III portfolio has grown by 2.3x in less than five years.
We did a roll-up in the collision-repair business, a company called Abra. EBITDA grew by more than 3x from acquisition to exit. We did an IPO of Regional Management, a company in the installment lending space. It’s still a public company that trades under the ticker RM.
We transformed Teasdale Foods, a roll-up in the Hispanic food category, from a regional company to a national company. Jordan is a home-health-care company in Texas. We’ve owned it for a little more than five years. The last one is a minerals company, American Gilsonite — EBITDA has more than doubled.
For these five companies, EBITDA has almost tripled and our equity MOIC is over 5x. This may go up a little bit because one of them is still unrealized.
Any deals from Fund III that didn’t work out?
We invested in a company called Celeritas – we were trying to do a roll-up in the sports-marketing space to focus on Hispanics. It was a good idea. We backed what we thought was a talented management team.
But we did not get to scale quickly enough. When the recession came, a lot of those advertising dollars dried up. We lost about half our money. Back to the premise of portfolio composition: When you can afford a loss, sometimes you’re better off to move on.
How did Fund III contribute to the firm’s evolution?
Fund III not only allowed us to grow the firm but to brand the firm. In some ways we helped create that — not an asset class — but that mindshare in the LP community that this is a space in the market that warrants their investment and participation. And frankly, it is profitable.
Fund III wasn’t the first time we thought about the Hispanic market. [The firm successfully grew Wise Foods from Fund II by focusing on that growing demographic.] It was the first time we executed on it. We came together. We raised a fund. We built a portfolio. We were able to prove that the market had a number of interesting opportunities.
Action Item: Palladium Partners, http://www.palladiumequity.com/
Photo of David Perez courtesy of Palladium Partners.