While the private-equity market is starting to recover, the process is likely to take a few years. It's still difficult to get financing, and there is a focus on trying to get liquidity on existing deals. But the fact remains that private-equity firms are sitting on over $500 billion in capital. To generate fees on this hefty amount, deal-makers need to, well, do deals.This means we are going to see some creative approaches, such as buildups.
In fact, this week KKR announced just such a deal -- a new partnership called Weld North LLC. The financial details were not disclosed, but it's likely that the capital involved is in the range of a few hundred million dollars.
Anatomy of a Buildup
A buildup is when a private-equity firm identifies a market opportunity and finds a talented management team to create a company through acquisitions. Interestingly enough, KKR has had lots of experience with buildups, going back to the early 1990s, another bust period for the private-equity business.
With a buildup, there is not much of a need for debt financing. Plus, it's a good strategy when valuations are low and companies are looking for liquidity or access to capital.
The Investment Thesis
In theory, buildups make sense, but they can be tough to pull off. Keep in mind that KKR has had challenges with the structure, as seen with its Primedia deal. Launched by KKR in 1989, Primedia focused on buying up media properties like magazines and trade journals. Then after going public in 1997, the company jumped into the Internet sector, making deals that included buying About.com at the height of the market. But with a heavy debt load and losses, the company had to unload assets and now has a market value of only $120 million.
For the most part, a buildup first requires a clear investment thesis. Often, this means focusing on an industry sector that is underperforming, undercapitalized and fragmented. The theory is that by scaling up a company, it should gain a stronger competitive advantage through market power and economies of scale.
In the case of Weld North, the investment publicly released thesis is fuzzy: Apparently, the firm intents to focus on "consumer services, education, media, personal services and marketing sectors, among others."
Yikes! Hopefully, this is not the internal game plan. Rather, it's a good bet that Weld North has a clear investment thesis on how to achieve growth and a strong market position. And over time, we'll get a sense of this through the deals it makes.
Next, a buildup needs a proven management team that understands M&A, integration and operations. Needless to say, these skill sets are hard to find.
But KKR seems to have found a superstar to lead Weld North: Jonathan Grayer. Back in 1991, he started his career at a small test prep company, Kaplan. It was part of the media empire of The Washington Post.
Before he turned 30, Grayer became the CEO of Kaplan, and grew the operation through a blend of acquisitions and organic strategies. Now, the company represents 58% of the Washington Post Co.'s (WPO) revenues, and its growth has offset the damage from the deteriorating newspaper business.
To get an indication of the importance of Grayer to the company's fortunes, take a look at his separation agreement when he left Kaplan in November 2008. He received a cool $46 million. Moreover, he had to sign a noncompete agreement, which expires in November 2011. If he doesn't uphold his end of the agreement, he'll miss out on $30 million.
Grayer will be tasked with aggressively buying companies and then improving their performance. It's a juggling act, and one that will take time -- something he no doubt recalls from his long expansion of Kaplan. When it works, the results for investors can be substantial. It doesn't always work, as the Primedia example illustrates. But KKR will certainly give Grayer the resources to build another great company, and to get another big payday if he can make it a success.
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