September 2008


It’s tough out there.  Tough to raise capital that is.  Further, things are likely to get worse before they get better.  A lack of money hanging around is not to blame.  To the contrary, in the first half of 2008 venture capitalists raised $16.2 billion, an increase of 3% in dollar value despite the number of funds raising the capital falling by 14% (see details here).  The challenge is convincing investors to be on your concept and team.

The current economic environment has VCs treading very carefully with respect to risk.  The “fast money” that seemed to be flooding the market 12 – 18 months ago has dried up, leaving for some good companies marooned, caught at a point in time needing money without the metrics to raise it.  I foresee a fair amount of capital structure rightsizing in our future.  Investors will either get on board or risk very low realizations from distressed sales.

I have empathy, for I have witnessed more than a handful of companies  try to deal with their stranded condition; their prospects quickly turning from optimistic to fleeting in a matter of months.  Deep pocketed professional investors are being forced to make difficult decisions with respect to bridging their portfolios of leaving them to seek a distressed sale or die on the vine.  Board level discord and investor dissatisfaction are sure to be the norm in some corners for the next few years as exits fail to crest invested capital.

That said, there are some lessons that have been learned from the past, that if heeded, will provide companies with a higher probability of success, even amid turbulence.  In my experience I have seen patterns emerge and I share them below.

> Appreciate that timing is everything.  What I mean by this is that, from the start, you need to have an acute awareness of when you anticipate needing capital, what the operational metrics that will enable you to raise capital at that time will need to be, and what you anticipate your company’s performance being relative to those metrics at that time.   While this is a valuable exercise in any circumstance, what it does is keep you myopically focused on what the capital markets require for success.  Additionally, it turns you into an obsessed proactive thinker about the timing and structure of your approach to the capital markets.  As an example, I recently saw a software company go to market during a period that overlapped with its annual slow second quarter.  Investors naturally paused due to the weakness in the operating results, though they could be explained away.  The company hit a cash wall due to the delay and is currently trying to attract any type of transaction.  I chalk this up, in part, to poor foresight with respect to planning and associated market timing.

> Understand what you are and where you are.  Seems simple, but this principle is violated with a high degree of frequency.  Generally speaking, missteps in this regard manifest themselves from an over inflated sense of a companies traction, quality, or attractiveness to investors.  While alignment may be real, humility is an excellent rule of thumb.  Even if it may seem tempting to try and spin your story into a masterclass  novel worthy of being on Oprah’s Book Club, it is better to present a realistic assessment of the facts told in the most favorable light.  Are you a platform or a point solution, are you a brand or a single SKU, are you a pioneer or a fast follower?  Net net, you can’t fool smart investors and trying to do so will lead to a prolonged capital raise process full of disappointments.

> Create internal alignment first.  If you have a board, you need to keep them realistically apprised of operational performance relative to the metrics needed to attract capital.   Large or influential shareholders should also be kept in the information flow and consulted.  Surprises can stop progress dead in its tracks and queer a deal.  Further, it must be clear what decisions management is empowered to make and those decisions that require the boards input.  Expectations must be realistically set regarding the potential cost of capital and the associated structure.  This is very important if you are raising your first institutional round.  Often times angel backed companies have board members whose representation is a function of the size of their historical contribution, as opposed to their value add.  In my experience I have found, at times, angels are not familiar with an institutional capital raise process and its implications.  Thus when faced with concepts that are common to raises of this type (preferences,/structure, dividends, ratchets, etc.), they encourage management to ask for terms and conditions which are out of market, delaying progress and undermining the relationship between the investor and the company.

> Keep projections realistic.  The perception of a healthy forward operating ramp is essential to attracting capital.  However, over inflation of the company’s financial prospects can undermine investor interest.  “Bottoms up” (account by account) projections are preferred to “tops down” (market sizing).  Key assumptions should be documented and kept within observed tolerances, whether with the existing company, its competitor, or a reasonable parallel from another industry that can be diligenced.  Pipeline coverage, pipeline conversion rates, and backlog must support near term forward operating results.

> Put the proper spin on the opportunity.  Materials designed to market your company, should do just that — market you.  This means presenting the business and its forward prospects in the most compelling and favorable light, given the operating statistics.  It should also meet obvious investor criticisms head on and provide the appropriate data to support the company’s prospective growth.  Aesthetics are important, but it more important to tell a clear and concise story support by ample evidence.

> Align the stars.  The most valuable thing a company can do during a capital raise process is execute. well against the plan.  Closing deals that demonstrate forward operating momentum is paramount to capturing and holding interest from institutional capital.  Conversely, deal delays undermine investor confidence and prolong due diligence.  While you will cede some value by closing deals during a due diligence period, but collecting the financial benefits in the future, it is a small price to pay to ensure success.

In the best of times raising capital can be challenging.  The bad news is these are not the best of times.  The good news is that capital is available for high quality companies.  Thinking strategically well before the capital need arrives can help you realize the best result possible, irrespective of the market backdrop.

/bryan

It was the best of times, it was the worst of times, it was the age of wisdom, it was the age of foolishness, it was the epoch of belief, it was the epoch of incredulity, it was the season of Light, it was the season of Darkness, it was the spring of hope, it was the winter of despair, we had everything before us, we had nothing before us, we were all going direct to heaven, we were all going direct the other way – in short, the period was so far like the present period, that some of its noisiest authorities insisted on its being received, for good or for evil, in the superlative degree of comparison only.”  — Charles Dickens, A Tale of Two Cities.

I’ve been getting a lot of calls lately.  Some from family members (hi mom, hello uncle Danny), some from friends, and many from current clients and prospective clients.  Most of them are not calling to exchange pleasantries, for it appears these are not the times to look past the issues facing us all and bury our heads in the sand with fodder about sports, politics, and the state of our yards.   The questions usually get put to me as follows:

1) Is the decline of Western civilization as we know it upon us, or soon to be?

2) What does this mean for me (the person calling)/our engagement/my transaction?

3) What is the bailout and how will it impact the market?

4) Will you still have a job next week?

The placement of the last question in the hierarchy is how I know people do not want to exchange pleasantries. Rather than commit these answers to memory, I thought I might memorialize them here, in the blogesphere, so others could benefit from, or laugh at them, either today, or later.

Chicken Little

First, let me begin by saying that volatility is essential to financial markets and systems.  If prices do not fluctuate, there in fact is no market.  However, volatility can accelerate in times of uncertainty and price swings can be substantial.  It is not for the faint of heart.  That said, for everyone who is a seller there is a buyer on the other side.   One person’s loss is another person’s gain.  The market is therefore akin to a zero sum game.  This will not change.  The search for alpha, returns in excess of risk assumed, will continue, and vast amounts of wealth will be created in ways not previously contemplated and, potentially, by people who may not have not been otherwise positioned  to do so in the past.   Net net, all is not lost, and never will be, the game has just changed.  Who captures alpha going forward will be determined by who adapts best and most quickly.  The phoenix will again rise from the ashes.

The above is an obtuse way of saying “no, the sky is not falling” and “the sky has always been falling” at the same time.  It is simply a matter of the perspective from which you emanate.  But since most of you are not shorting the dollar and long gold, I can see why you might be predisposed to viewing things through the more negative lens.  I simply see it as a shifting in the opportunity set.  If you are one to embrace opportunity than, like me, you see large storm clouds on the horizon, but not ultimate demise.

Magic 8-Ball

As for those parties seeking a transaction, there is a significant re-pricing of risk going on in the capital markets.  Companies engaged in sales to strategic buyers should experience less impact to the extent that their buyer population is not experiencing capital constraints due to the need for debt capital or the lack of debt capital all together.  I expect smart buyers will try and compress valuations, but sophisticated bankers enjoy developing the analytics necessary to combat this sort of behavior.  Bankers will have to earn their fees, but transaction velocity will continue, albeit at a slower pace.  Foreign buyers will play an increasingly important role over the near and medium term time horizon assuming the dollar languishes as expected.

Shareholders seeking majority recapitalizations will likely face the most significant challenges in getting their deals done.  Ultimately, it will take some time for this market to re-plumb.   Absent the availability of debt capital, multiples must come down and/or return hurdles must decrease.  I don’t expect private equity folks to cede the later.  However, strong companies with no “need” to engage in a transaction are likely going to sit on the sidelines if valuations and terms and conditions deteriorate precipitously.  Seller subordinated financing will bridge the gap in certain markets and instances, but not all.  Expect funding contingencies in term sheets. Funds like Bertram Capital, who have dedicated debt funds, are well positioned.  Funds with limited partners who are licensed lenders with fresh capital to deploy, created by the “bailout” or otherwise, are also better situated.  How the messy middle gets resolved is as yet unknown.  Ultimately, I suspect sellers are going to have to reconcile themselves to lower purchase prices and more structured transactions.  The delevering of the U.S. financial system will leave a significant mark on the private equity landscape.

As for growth capital, there will be a significant re-pricing of risk in this market as well.  However, this populous tends to be comprised of companies that are long on growth and short on earnings.  Restated, they need money to remain viable.  Capital will remain available but venture investors will engage in a flight to quality seeking greater traction, larger preferences, and lower valuations.  Firms who do not recognize this paradigm and wait to go to market or who cannot reconcile valuation in the new world will peril.  There is a considerable amount of venture capital on the sidelines.  It will get invested, but investors will be patient and look for attractive risk return profiles.  First time entrepreneurs should proceed with caution, emphasizing cash conversation at the expense of growth potentially.  I expect a handful of bold entities who have the iron stomach to invest in early stage big opportunities that are pre-revenue will clean up if they are able to pick winners, as deals will be had in this arena at attractive prices.

Modern Use for a Bucket

The “bailout” that is being hotly debated in many corners, is, in my opinion, necessary to free up funds for lending and economic growth. Yes, those who created the problem, will in turn benefit from the plan, but the taxpayer burden, I suspect, will not be as far reaching as some pundits are predicting, assuming an auction system for the debt of these banks is in fact utilized to determine their value and forward ownership.  It will take years to wring out, but the alternative is to sit stagnant, allow things to work out organically.  The net result of this will be a prolonging of the problem and a halt to corporate formation and economic expansion.  I’ll take the devil I don’t know over the devil I know in this case.  We need to free up the lending markets to put money into business to finance growth, otherwise their will be none and the economy will further contract; it’s a vicious cycle.  We will face inflation as or easy money policy of the past 18 months comes home to roost.  An engine of growth will be necessary to get us out of the predicament.

In these matters I prefer to turn to others whose daily job is to understand the economy and its cycles.  I thought Bill Gross, Chief Investment Officer at PIMCO, a fixed income investment management firm, got it right in his Washington Post article.

Et Tu Brute?

As for me, I’m still employed and expect to be tomorrow, next week, next month, next year, etc., etc.  I was a few years early on my ejection from the world of Wall Street, but my direction was accurate, the prior system was unsustainable and I found that hard to ignore (the same reason I did not go into tech banking when I graduated from business school in 2000).  I’m lucky in that I work for a small firm, focused on a defined market that is provincial, and we face limited competition.  We are nimble and occasionally smart in our planning. In fact, I’d like to hire some of the great people who are being displaced for reasons not of their own making.

Yes, there will be tough times ahead, maybe very tough times, but I have always adhered to the strategy that you live within your means and you take precautions to ensure your future.  I’m one of those people who actually have an earthquake preparedness plan.  My grandparents lived through the Great Depression.  As a result, I never get too high or too low.  This will help me navigate the challenges ahead.  Your support will be welcome.

This weekend I will sit down, open up a nice bottle of wine and toast to the future, whatever it may bring.  I’m confident that we will work through our troubles and the system will be better for it.  I hope you all find your way as well.

/bryan

As many of you are aware, as I have left the evidence hanging in my prior post, I may have been underestimating the extent to which we were on the precipice of a total financial markets meltdown.  We now can say with certainty that there will be no  Wall Street bulge bracket investment banks in the “new paradigm” since Goldman Sachs and Morgan Stanley are now money centered banks, having undergone a charter conversion, likely bowing to the pressure of federal regulators  While we all contemplate a future of Goldman Sachs ATMs, I thought we would talk about something really important related to the demise of Lehman Brothers — what will happen to  Lehman Brothers Merchant Banking’s (LBMB) pending investment in SRAM Corporation (SRAM)? Inquiring minds want to know.

For those of you who are avid cyclist or Tour De France devotees, you are likely to be familiar with Chicago based SRAM; after all Lance rides it.  For those of you who are not close with their bicycle or fans of Bob Roll and Phil Ligget, let me explain.  Launched in 1987, today SRAM is a manufacturer of bicycle components, shifting systems and wheels under the SRAM, RockShox, Avid, Truvativ, and Zipp brands.  The $500 million sales company is now the second largest components manufacturer and one of the hottest companies in the global bicycle components industry, historically dominated by Shimano, Inc. and its smaller foil Campagnolo S.r.l. (better known as “Campy”).  While most die hard roadies are Campy flag waivers, most American cyclists ride Shimano as it offers a broad range of shifting systems that are easier to maintain.  SRAM has successfulyl injected itself into the equation over the past 5 years, growing 15% – 20% annually, and bridging into the Tour De France world with Team Astana and Sauiner Duval-Scott through its SRAM Red product line.  I believe Alberto Contador rode SRAM Red to the Tour De France crown in 2007.  In November 2007, it celebrated another milestone when it bought Zipp Speed Weaponry, one of the hottest makers of aerodynamic wheel products for the road and triathlon bike communities.

Net net SRAM is “cool” to bike geeks worldwide.  So mouths were agape when, on August 6, 2008, SRAM announced that it was selling a 40% stake in the company LBMB.  The money will go for research and development, acquisitions, and $2 million annually for 5 years for a bicycle advocacy program.  The company actively sought a strategic financial investor who could help support its forward growth.  While no financial terms were disclosed, LBMB generally invests in companies with more than $10 million of trailing EBITDA, enterprise values as high as $600 million and writes equity checks between $25 – $100 million.   Shimano, while much larger and more diversified, trades at 1.4x Trailing Twelve Months (TTM) Revenues and 7.1x TTM EBITDA.  Shimano enjoys EBITDA margins of nearly 20%.  Under no mathematical applications of Shimano’s multiples can we get SRAM into LBMB’s valuation range absent a healthy amount of leverage not seen recently.   Its profitability must dwarf that of its larger rival who possess significant economies of scale and scope.  No matter, we can assume it received a premium valuation due to its strong growth, forward prospects, and brand value.  J.P. Morgan advised SRAM on the deal, which was expected to close in late September or early October according to the press release.

As you are likely to be aware, a strange thing happened on the way out of the wedding chapel — the groom checked in to bankruptcy.  While the demise of Lehman Brothers was well documented, LBMB appears poised to be kept intact, assuming a buyer can be found.  Although an affiliate of Lehman Brothers, LBMB isn’t likely to be impaired by the bankruptcy filing except in the sense that Lehman itself won’t be serving as a limited partner of any future funds and the business unit could be sold for the benefit of Lehman’s creditors.  Once a company goes into bankruptcy its creditors receive first claim on its assets after certain employee preferences has been paid.  The bankruptcy custodians of Lehman Brothers appear to be engaged in an orderly sale of assets.  LBMB is likely the prized piece of Lehman remaining after Barclays and Nomura Securities have picked the investment banking bones clean.  LBMB could be the subject of a management buyout backed by a private equity investor.

While the future of LBMB hangs in the balance, the first words out of SRAM were that the bankruptcy would not impact the closing of the deal.  SRAM co-founder and president Stan Day noted that LBMB was a separate entity, in tact, financially sound, and had nothing to do with the transactions that led to the peril at the parent company.   Four days later on the eve of Interbike, Day was singing a slightly different tune — that the bankruptcy, while again not caused in any way by LBMB, may result in a delay or the demise of its deal with LBMB.  Day was quick to point out that SRAM was financially sound and did not have to do the deal with LBMB or anyone.  However, he noted that if the deal fell through they could consider a new financial partner at some point in the future.

I expect that SRAM will wait until all of the dust settles and see where LBMB lands.  Expect the new owners of LBMB to be a private equity firm, which will make for a very interesting management dynamic (they will need Chinese walls for their Chinese walls).  At that point SRAM will determine if its in their best interest to close, assuming terms and conditions are still in tact.   However, as time goes on, those terms and conditions are likely to require amendment, which may scuttle the transaction.  There is a significant repricing of risk going on in the market as a result of the meltdown in the financial markets.  At some point LBMB will have to ask themselves does the deal still merit the valuation put on it previously.  There may be penalties if they walk away, but it doesn’t seem like it was that sort of deal.  If it does walk away that will have future implications (though walking away from deals has become a new pastime for the mega funds).  And what of the banks that are lending money into the deal, are they still in tact (this assumes this is a levered transaction, which it may not be)?  So many questions, so few answers.  It’s like the circle of life.  Either way SRAM will still be the best shifting system on the market…at least until Shimano electronic shifting is available for the masses.

Ride safe my brothers and sisters.

/bryan

As I have blogged about previously, conceiving of, developing and growing to profitability a consumer company is a different proposition than it was a decade ago.  In a variety of progressive consumer niches (namely natural products), the success of predecessors (e.g., Glaceau, Burt’s Bees, Izze, Tom’s of Maine, etc.) has breed a handful of “me toos”.  The proliferation of competing offerings (I counted 22 new energy drink companies at the last beverage show I attended) has created substantial noise in the channel.  If you have recently walked the isles of a Whole Foods Market, this is but one example, this would be readily evident to you.

As a result of the noise, consumer companies find themselves faced with a the need to spend more money on marketing and advertisement to differentiate themselves.  This can be problematic, as these things take money.  Long gone are the days of Nantucket Nectars where you could raise $250,000 from friends and family, make and overcome a litany of operational mistakes, right the ship and never look back for capital.  Today, it is not uncommon to see a company take in and spend $5 – $10 million generating its first $5 million in sales.  This has led to a sea change in the investment paradigm for consumer companies; namely it has brought angels into the funding equation.

It used to be angel investing was confined to the technology domain.  And while the majority of the 250,000 active angels continue to focus on technology investments, the percentage that consider consumer investments has grown exponentially.  This makes intuitive sense, as affluent individuals interact with products and develop an affinity, they become open to investing in other products within that category.   The exits that investors have experienced have also served to attract investor attention. More angel investing organizations have begun to incorporate non-technology investing into their opportunity evaluation.

Angel investing, like consumer capital needs, has also evolved.   The number of organized societies, groups of 10 – 250 accredited investors who belong to an organization that is responsible for generating deal flow, has grown from 10 in 1995 to over 300 in 2008.  These groups pool their resources to evaluate opportunities, perform due diligence and establish larger positions in companies.  Today Keiretsu Forum is the largest of these groups, possessing 750 accredited investors who have deployed $180 million in capital  in 200 companies since the groups inception in 2000.  Increasingly these organizations are getting cozy with venture firms who provide deal acumen and in return get a first look with respect to follow-on investments.

When I suggest angel organizations to entrepreneurs, I am generally hit with, in return for my free sage advice, a variety of preconceived notions.  A list of the common complaints is as follows:

> Forums do not provide me access to the types of investors I would value.  This view generally stems from a lack of knowledge about who they might get to invest through a forum process.   Most people want investors who are value add in some capacity.  Who wouldn’t?  What I have found is that, in an effort to get access to more consistent deal flow, successful business professionals with expertise in vertical markets, company development and governance can be found through forums and investment societies.  Often times I have run into venture capitalist who do their personal investing through forums.  At my last forum experience, I met a former Fortune 500 beverage CEO who was “looking for new beverages companies to invest in and help with distribution deals”.  If I were an emerging beverage company seeking money I would value that audience.  Having a conversation with the management organization of the forum or society can provide you insight into the background of its investor base.  From there one can make an educated decision.

> I shouldn’t have to pay to present.   Ultimately, time is money.  A one off angel investment process can be fruitful if you have strong connections within your local community.  However, every hour you spend not closing an investor, or closing an investor on a small amount of money, is an hour with a low ROI associated with it.   In contrast, the opportunity to close on many investors within that hour would generate a significant return relative to time invested.  Forums and societies provide you ROI well in excess of the processing cost.  The feedback you will get through the screening process will also be highly valuable in honing your pitch.  It is also worth noting that the fees associated with hiring someone to raise your angel round (success fee, warrant coverage, etc.) are egregious relative to what presenting at a society might cost you.

> I need more money than a forum can provide.  Forums are effective for up to $5 million in capital for strong concepts.  Adina for Life and Earth Class Mail are examples of consumer companies that raise at least $5 million through the Keiretsu Forum.  As societies have opened multiple locations, it has made it possible for the best concepts in a given geography to do follow-on presentations in other attractive markets.  Generally speaking, most seed rounds should be serviceable by larger angel group.

I recently attended the Zino Society Zillionaire Forum where 30 companies presented to accredited investors with $150,000 also up for grabs in three categories (in addition to contributions directly from society members) through Zino’s dedicated investment fund.   Approximately 50% of the presenting companies were consumer in their orientation and the winner in the non-technology category, CHERRish, was also the winner of the “Best Overall Investment” (I voted for Byndoo).  Reaction to a number of the consumer deals was very strong.  I do believe that there is considerable pent up demand from angels for consumer deals.  With the technology IPO market closed and technology M&A multiples languishing, I expect more angels to jump over to, what used to be the dark side.  What will be interesting to watch is how the macro-economic climate impacts the pace of angel investing in 2009.

/bryan

On September 18th, 2008, Hammond, Kennedy, Whitney & Company, Inc. (HWK) a private equity firm, headquartered in Indianapolis, specializing in leveraged buyouts of privately owned businesses,  and Cardinal Equity Partners (Cardinal),  of pretty much the same ilk, acquired a majority interest in FURminator, Inc., a Fenton, Missouri based manufacturer and marketer of pet grooming products.  The FURminator’s products include small, medium, large, cat, and equine deshedding tools, shampoos and conditioners, treats, and dog food supplements. Terms of the deal were not disclosed.

FURminator was founded in 2002, by Anglea and David Porter, a husband and wife team.  Angela, or Angie as she is referred to on the company website, a professional groomer, and owner of Groomingdales’s, an upscale pet salon in south St. Louis, identified the need for a next generation deshedding and David (Top Dog by title) helped her run with the idea.  In 2004, the company generated sales of $700,000, which grew to $25.3 million in 2007.  Sales are projected to top $35 million in 2008.  FURminator ranked the highest among the top 50 St. Louis companies that made Inc. magazine’s list of the nation’s 5,000 fastest-growing private companies (see list here).

The FURminator product line was launched into the professional channel — groomers, veterinary offices, pet retail.  The price point was +/- $40.  The company was soon able to garner placement on QVC, creationg national awareness in a short period of time, and was then picked up by national retailers.  FURminator deShedding tools and products are available at national pet retails such as PetSmart and Petco, and at independent pet retailers, veterinarians, groomers and rescue organizations nationally.  Leveraging their brand in grooming products, the company has successful expanded into shampoos, treats and supplements.

The company was boot strapped by the founders since inception, financing growth with bankroll from David’s marketing day job and Groomingdale’s profits.  The company moved early to protect its intellectual property by patenting the product design.  Currently the company has four patents.

Hammond, Kennedy, Whitney & Company, Inc. was founded in 1903 by Paul Hammond as a merchant bank for wealthy families.  Since that date, it has evolved to be a generalist private equity firm focusing on the lower end of the middle market.  As a general rule their investments come with low risk of technological obsolescence. HKW focuses on management buy-outs of companies which have revenues between $20  – $200 million, EBITDA between $2 – $20 million, and enterprise values between $10 – $150 million.  The FURminator represents a departure for HWK in that it is their first investment in the pet space and it is much more consumer oriented than their previous investments, though they do list consumer discretionary as a focus area.

If I drew up a sketch of Cardinal, it would be much the same, only smaller, with slightly more exposure to the discretionary consumer market.

This deal interests me along many levels.  First, it is a pet deal and I follow the space.  Second, is that it’s a majority recapitalization.  A majority recapitalization involves purchasing more than 50% of the equity of the company, but more often 75% – 80%.  Given the decline in the credit environment we haven’t seen many of those lately, and as someone who is currently representing parties in those types of deals, I know how hard they can be to get done in today’s environment.  While financial terms were not disclosed insider knowledge (not mine, see source here),  says that the deal was north of $80 million and that HWK and Cardinal put up approximately $50 million with the balance coming from bank debt and a few smaller individual investors.  My gut (me now making up numbers) tells me that the deal likely penciled out at 3.0x TTM (trailing twelve months) sales, or ~ $90 million in enterprise value (that’s debt plus equity).  Assuming the company had a 35% – 40% EBITDA margins on $30ish million of TTM sales at the time of the deal that would imply they were able to garner 2.5x – 3.0x leverage, which in today’s environment is a solid out outcome.  I admit the potential to be underestimating their margin profile. In tighter economic times, debt capacity notwithstanding, I’ve found investors hesitant to provide such large cash outs to founders assuming they will be disincentivised to work for the larger payout.  One of the ways that I suspect this was overcome was the regional proximity of the key players — St. Louis and Indianapolis.  The physical proximity makes it easier to monitor the deal.  Finally, I’m interested in the deal because FURminator used a banker, The Fortune Group out of St. Louis.  What is unknown to me is whether FURminator was responding to inbound interest or running a process.  I’m guessing it was the former.

So why would investors pay such a healthy price for FURminator.   I’m hoping to talk to HWK to confirm, but I can devise a pretty solid rationale.  First, despite the gloom and doom in consumer discretionary, the pet vertical continues to perform and has a solid forward outlook.  The market is large and growing double digits.  Second, in a contracting consumer environment, people view grooming services as a place to cut back (ranked 3rd, 68% in a Fleishman-Hillard survey) and in fact grooming services at chain retail are leveling off as an expenditure.  In tough economic times we become a do-it-yourself society, in contrast to a do-it-for-me populous.  This bodes well for FURminator sales.  Lastly, I suspect there is an international angle to be accelerated.

I can already read the headline when they sell, “Private Equity Firms Shed FURminator”. Maybe I will get to play a role.

/bryan

To many of you, the World Triathlon Corporation (website here), a privately held company based in Tarpon Springs, Florida, is just another company better known by its acronym — WTC.  However, for those of you who participate in the sport of triathlon or even race Iroman branded triathlons (that is a 2.4 mile swim, 112 mile bike and a 26.2 mile run, consecutively), WTC is near and dear to your heart.  You see, every year WTC puts on the Ironman triathlons series (and it’s baby sister the 70.3 series), twenty-six races worldwide at last count, culminating in the World Championships in Kona, Hawaii, which enable everyone from the most seasoned endurance athlete to the everyday Joe and Jane, the opportunity to test their mettle in ways that are not so commonly available to your average weekend warrior.  I am one of those people, which is why this deal hits home for me.  Ironman is “the brand” in long distance triathlon.  Many a triathlon die hard, has inked the WTC trademark logo (the M dot above) somewhere on their body (I am not one of those people, however).

Ironman was born when U.S. Navy Commander John Collins, in an attempt to settle a score between the Mid-Pacific Road Runners and the Waikiki Swim Club, suggested that the debate should be resolved through a race combining the three existing long-distance competitions already on the island: the Waikiki Roughwater Swim (2.4 miles), the Around-Oahu Bike Race (115 miles; originally a two-day event) and the Honolulu Marathon (26.2 miles).  Collins calculated that, by shaving 3 miles off the course and riding counter-clockwise around the island, the bike leg could start at the finish of the Waikiki Rough Water and end at the Aloha Tower, the traditional start of the Honolulu Marathon.  The first Ironman Triathlon was held on February 18, 1978 in Honolulu, won Gordon Haller in a time of 11 hours, 46 minutes, and 58 seconds.

In 1979, fifty athletes joined the fray, and the first Ironwoman was crowned.   From there the sport grew by leaps and bounds, from fourteen athletes to more than fifteen hundred at Hawaii venue   In 1982, Valerie Silk moved the race to the Big Island and moved the race to its current October time slot.  The Ironman World Championship, as we know it today, was born.

Since its inception in 1978, there have been some memorable achievements and moments (which assumes  you’ve been paying attention) — the famous Julie Moss crawl to the finish (for accuracy sake the race was run twice in 1982, and this occurred during the February 1982 race), the “Ironwars” featuring Dave Scott and Mark Allen, the Luc Van Lierde record in 1996 of 8 hours, 4 minutes, and 8 seconds, Paula Newby Fraser’s 8 wins and Natascha Badmann’s 6 wins, and Tim Deboom’s kidney stone passing on the course in 2006   Countless human interest stories have also been woven into the Ironman fabric.  Races have also sprouted up in diverse locations including Lanzarota, South Africa and Malaysia.

In 1990, WTC acquired the rights to Ironman from Silk and the true business of Ironman was born.  WTC grew the sport and it’s underlying revenues by adding venues, attracting sponsorship and advertising, and licensing it’s brand to a host of product manufacturer.   In 2005, WTC launched. the 70.3 series (1.2 mile swim, 56 mile bike, 13.1 mile run) and a 70.3 Championship in Clearwater, Florida.  Additionally, the company developed Ironmanlive.com a way for you to follow a race and your favorite athlete online.  WTC had taken a cottage operation and grown it into a brand, providing standardization along the way for sponsors, host communities, and competitors alike.

Providence Equity, WTC’s new owner, is a well known private equity investor headquartered in Providence, Rhode Island (shocker).  The firm became well known in the media and telecomm space, having made successful investments in Voicestream Wireless, Metro-Goldwyn-Mayer, Warner Music Group, AT&T Canada, CDW and a host of others including recent deals Clear Channel Communications and BCE, Canada’s largest communications company.   Since it’s inception in 1991, the firm has garnered $21 billion in equity commitments and invested in more than 100 companies operating in over 20 countries.  Providence Equity Partners VI, closed on $12 billion in 2007.

The relationship between Providence Equity and WTC developed over time.   Apparently, discussions have been had on and off for several years between the two entities.  Notably, a number of Providence Equity partners are endurance athletes and a board member has participated in an Ironman.   I suspect that it took time for WTC to grow to be the size of a Providence target company and ultimately it decided to bend the rules for an interesting brand that has an undermined media angle (rumors place the deal between $40 – $60 million, whereas Providence targets deals where they can put to work a minimum of $250 million in equity).

So the question now becomes how does Providence make money on its ownership stake in WTC.  As a triathlete, I can see there is still growth in the participation format, especially the 70.3 series, which is easier to take to smaller venues.  This will result in more sponsorship deals and better race day economics.  However, based on what I know about race promotion, it can be a thin margin game.  Most race directors that put on independent events do it for the love of the sport, not the money.  Even it WTC has perfected a portable process, it’s margins cannot be that much more substantial.  Raising entry fees is a possibility as demand far outstrips supply.  However, at some point there has to be a lash back, even from the faithful.  Liscencing may see some improvements through better tie-ups, but there are only so many areas where the brand truly creates sell through (Ironman branded mattresses anyone?)

My gut says they have to build the brand by broadening media coverage and capitalizing on the value of the community.  Providence is reasonably well situated to do the former, however triathlon can be a bore to watch on television, absent the extended outtakes and human interest stories;afterall we are talking about events that take place over a 4.5 – 8.5 hour time frame for the pros, depending on the distances.  Further, the majority of middle America is going to have a tough time identifying with the athletes who, save for a few notable exceptions, tend to be humble pie, better known for their run splits and pre-race meals then their media outtakes.

Expect to see value creation through tie-ups between WTC and other Providence Equity companies.   The most likely relations are with Hulu, streaming media, and potentially the Yankee Sports Network, broadcast media.

The final question is what is the available exit strategy.  Ultimately, what WTC has is niche content that appeals to a very attractive demographic.  I suspect this will be viewed as desirable to a diversified media company who wants to milk the cash cow once the risk of platform expansion is managed away and the content library has proven itself to be valuable.

The question is can triathlon become the next mixed-martial arts league, with product linkages and true devout followers who will tune in in Tour De France like numbers.  Ultimately to earn a threshold internal rate of return of 30%, WTC will need to grow 400% over 5 years.

Just because said it was cool, does not necessarily mean it will be a home run.  That’s why I’m a banker and not a PE professional.

/bryan

I’m too old for Las Vegas, or at least that is what I keep telling myself.   But when the opportunity to attend WWPIA Superzoo 2008 (show website here) at the Mandalay Bay Hotel for free availed itself through my wife’s business, I knew I had to put my Vegas issues aside.  Superzoo is the third largest show of its kind in North America, and its exhibitors and attendees list is steadily growing.  The show falls at an ideal time for retailers, who are now beginning to turn their attention to stocking their shelves for the holiday season.  What I like about Superzoo is that the show is an ideal size to be an observer, large enough to attract many of the top retailers and small enough to be able to walk the show multiple times a day.

For me Superzoo was about meeting, but also about observing and learning.  I set a modest goal for myself to meet five companies from the extended Pacific Northwest and five interesting brands outside the region.  My central category focus was on alternative food, given the projected growth in the sector and the developing brands in the space and their lateral mobility into treats.  I also wanted to hear from boutique retailers how they were feeling about the industry and the prospects for their business given the challenging macro economic climate.  Finally, I wanted to see what the buyers were into by watching the traffic flow into the single product company booths.

Based on my two days of walking the floor, here are some summary observations.

Humanization of Pets Movement is Maturing.  A lot has been said, written and posted about the humanization of pets movement.   The history of the phrase (or at least based on what I have found) dates back to 2005, when Pet Channel published an article about a the growing trend of pet insurance.   In that article, Pet Channel noted that we were “treating our cats and dogs more like children than ever before.”  The movement was validated in 2006 when the head of Del Monte’s food and pet division was quoted saying that “the humanization of pets is the single biggest trend driving our business”.  In 2007, Packaged Facts, a leading market research organization, published a projection that non-food sales, relating to the humanization of pet, would grow to be a $15 billion by 2011.

Despite the definition advanced by Pet Channel, the first wave of pet humanization was largely perceived as simply pampering your pet, a willingness to do more for and spend more on them as a means of communicating to others their importance in your “pack”.  Based on what I observed at Superzoo, that definition has morphed to be more sophisticated, eliciting a symbiotic contrast between pet and owner — what I do for me, I do for my pet.  To me this is true humanization.

Superzoo featured a bevy of product and service companies facilitating this symbiosis.  Pet related OTC health products are proliferating.  A number of new vitamin and supplement companies have emerged. Lotions and potions have also come a way, with products now available to treat skin conditions, style hair and mitigate smells.  Their packaging increasingly sophisticated and marketing draws human parallels.  Alternative food companies, many of them who have been making formulas for some time are gaining market traction, due in part to the pet food recall, but also in part due to this maturing of the humanization movement.  Many of their booths featured pictures of the human ingredients including in their products. Treat companies, incorporating nutrients and human foods were well trafficked by buyers at the show.

The Alternative Food and Treat World is Merging Into One.  The pet food recall of 2007 served to open up the pet food market to alternative and organic food brands who were otherwise idling in relative obscurity, serving a defined “hardcore” niche.  The headlines caused by the supply chain failures of much larger brands, allowed them to emerge from the shadows and enter the spot light as consumers sought clarity with respect to the ingredients underlying the products they were feeding their pets.  According to Packaged Facts, 14% of consumers switched food brands as a result of the recall. The alternative food category was a key beneficiary, buoyed by the fact that a cross section of these brands had been operating for decades and they had control over their own sourcing and production.  As a result, these brands developed affinity in the market relatively quickly, capturing enhanced distribution through secondary retail and the natural foods channels.

In an attempt to leverage their momentum, these producers arrived at Superzoo with treat lines to augment their core food offerings.  Hoping to benefit from their brand attachment with consumers they are expanding into the lucrative treat space.  Most producers told me that the product sales velocity in the space coupled with the enhanced margin profile for treats made it an easy decision for most.   In return, Dogswell, a premium player in the better-for-you treat world, introduced their own wet food and biscuit treat lines.   The two worlds are clearly converging.   This makes complete sense given the the fungiblity of a brand across these two product categories.  What will be interesting to watch is who has the greater brand pull across categories.  While Dogswell is a major treat player, I suspect it will be more challenged relative to Primal Pet Foods, Steve’s Real Food, Evanger’s, etc.  TBD.

Mass Pet Retail is About to Undergo a Second Evolution.  Given the current economic climate, consumers are looking for one-stop-shopping.  Consider that trips to the pet store will fall nearly 3.0% in 2008, after falling nearly 2.0% in 2007 (again thank you Packaged Facts).  Further consider that the mass pet retail market made a heavy push into grooming services, which is in the top three list of things consumers view as highly discretionary in a turbulent economy.  In a contracting services world, the major pet retailers appear to be trying to find ways to nibble at the edges of the boutique world, seeking out premium products.   They will augment this by adding additional services, including co-branding pet insurance to leverage their brand and add additional convenience to the pet consumers shopping experience.

The question is whether we will see store-within-a-store concept,s trying to siphon off high end customers who continue to utilize larger store formats to augment their purchases or to acquire food from major brand players not otherwise carried by their boutique retailer.  Clearly they will have to raise the service bar to do so.

On the outside looking in is Amazon.com.  E-commerce offerings in the pet space are underwhelming, to say the least.  Given, again, variable service levels at mass pet retail, their ability to create a sizable dent in the marketplace is without question.  However, while they have identified the opportunity they have done little to date to organize themselves effectively, which is a daunting task.  That said, I see Amazon Fresh as a potentially big vehicle for deliver of alternative food products and over time I expect Amazon.com to become a sizeable part of the delivery supply chain.

All in Superzoo was a great experience.  I expect to encapsulate all my learning’s into an updated market presentation shortly after year end.  On a side note, if you are ever looking for a great meal in Las Vegas outside all the hubbub, Lotus of Siam (see review here) should be on your agenda.

/bryan

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