A new model of investing

An industry once driven by speed and profit is now reprioritising its goals to get deals done. Just last month, LDC backed the £5.6m MBO of model retailer Modelzone, in a deal that saw the private equity firm work with management for a whopping 18 months prior to investing to operationally improve the business. This deal goes a way to proving how dramatically the market has shifted its focus.

While completion times are running longer these days, 18 months is an unusually long period of time for a private equity firm to invest its time and its resources in a deal that may not pay off.

"Many other private equity firms would have walked away from what was a very complicated deal, but we saw a real opportunity for the business to grow. An 18-month gestation period was never planned, but that is how long it took for us to achieve the desired end result in an increasingly difficult environment," says Miles Frost, investment manager on the transaction.

When Modelzone was first introduced to LDC in the first half of 2008, the outlook for the retail sector was bleak. By October, the team had concluded there were too many improvements required in the business to invest, barring any concrete evidence it could improve its operations. Consequently, the idea was to supplement management and allow them time to implement the identified changes to see them work pre-completion.

"We saw strong opportunities in the business, but there were also significant weaknesses. It was a family-run company that was under-exploited," says Peter Brooks, managing director of LDC in London.

The result? While sales of the company reached their low point before Christmas of 2008, the figures since January have been up 6% on a like-for-like basis. Frost believes this is a direct result of management implementing the actions devised with LDC, along with the external non-executive directors introduced to the team. These changes included new ways of merchandising and marketing; the roll-out of a new store to a new format; and the addition of four new individuals to the management team.

"This deal was a doer-upper, in the sense that it was like buying a house that needed fixing first. The company needed resources - not only financial, but managerial as well to realise its full potential," explains Tony Nash, investment director at LDC, who worked on the deal.

According to Brooks, the asking price was slightly high when LDC was first introduced to the company, but as the business began to improve, the price of acquisition (3.8x LTM EBITDA) became fair. The private equity house also made a point of replacing the bank debt in the deal structure with its own money, to ensure there were no controlling covenants, so as to de-risk the deal as much as possible.

"This investment speaks volumes about why we are entering a period of great private equity investing. If this deal had been done two years ago, the risk profile in comparison is much lower now. Now we're transacting a fair price - we have low gearing, full visibility and have gained an actual insight into the business," comments Brooks.

He continues: "While retail is a difficult sector, we looked at the company on its own merits. The business wasn't any old retailer - it had a loyal customer base. We did what any sensible investor would do. It is old-school investing, where you're not being run around by an investment bank, but you are given real time to consider the deal."

The LDC deal is a testament to how far the market has come: two years ago, buyout houses spent all their time processing a transaction rather than investigating it. LDC's willingness to work with management teams in difficult situations could be attributed to the firm's relative success in this market. It has completed 11 deals to date this year, the latest being the MBO of financial and education benefits firm JPMorgan Invest from its parent JPMorgan Asset Management (see page 46).

"No business on people's desks right now is all positive in terms of earnings and sales forecasts. We're not afraid to look at those that have been struggling. We realise we have to work with management and package the deal accordingly," adds Nash.

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