Joseph Rice isn't your everyday 80-year-old retiree. His physique, even camouflaged by a crisp oxford shirt and tan slacks, is manifestly sinewy like a cat's, kept toned by regular workouts at the gym and by tennis. His erect bearing evokes his long-ago stint in the Marines. His memory remains keen. Refreshingly free of the bluster and hubris that attach to other leveraged buyout nabobs, Rice plays down his own talents while exhibiting a serene pride in his body of work.
Rice, whose career wound up officially last month when he stepped down as chairman of the New York private equity firm Clayton, Dubilier & Rice LLC, is one of a generation of Wall Street entrepreneurs who pioneered debt-financed takeovers of businesses. A former M&A lawyer, Rice entered the buyout trade in 1966, a decade before Jerome Kohlberg, Henry Kravis and George Roberts formed what would become the industry's dominant power of the 1980s, Kohlberg Kravis Roberts & Co. LP. In 1969 he opened an LBO boutique with Ed Gibbons and Leonard Green, before teaming up in 1978 with Eugene Clayton, Martin Dubilier and Bill Welsh to start Clayton & Dubilier Inc., as the firm was then called.
Their new shop quickly established its own brand of dealmaking. Clayton, a turnaround specialist; Dubilier, an inventor and ex-ITT Corp. executive; and Welsh, a former Raytheon Co. manager, were skilled corporate operators. With Rice helming the financing side, the firm was the first major LBO shop to focus as much on rejuvenating businesses as on financial sleight of hand. It was an approach much of the rest of the industry would emulate only years later, after intensifying competition forced other players to seek a leg up.
(Clayton and Welsh left in the mid-1980s, and Dubilier died in 1991. The firm has continued to replenish its ranks with veteran operators from top companies such as PepsiCo Inc. and Emerson Electric Co. Longtime General Electric Co. chief Jack Welch; A.G. Lafley, who led Procter & Gamble Co.; and former Tesco plc chief Terry Leahy are senior advisers.)
All that operating savvy hasn't immunized CD&R from the occasional failure, though historically its successes far outnumber its busts.
Rice names Lexmark International Inc. as perhaps the firm's greatest triumph. A company CD&R created in 1991 to buy IBM Corp.'s moribund typewriter operation for $1.6 billion, Lexmark had none of the front- or back-office infrastructure or accounting systems of a standalone business. CD&R operating partner Chuck Ames, the ex-chief of Reliance Electric Co., and Lexmark CEO Marvin Mann helped transform the business into a world-class maker of ink-jet printers, earning CD&R a threefold net return on its investment. (After Rice announced his retirement in April, Mann and other Lexmark alums sent him a framed letter, which he showed this reporter, citing his "key role in the formation and success of our company.")
A nadir in the firm's history came in the late '90s, when three portfolio companies went belly-up: Acterna Corp., Fairchild Dornier GmbH and U.S. Office Products Co. CD&R's investors took more than $1.1 billion in losses. The debacle spawned a housecleaning at CD&R. Some operating partners were pink-slipped, and Jack Welch was recruited to help chart a course correction.
Now led by Donald Gogel, CD&R has fared relatively well in the meantime, even in the face of the financial crisis. It has taken no cash losses since 2002, and its latest PE fund that's fully invested -- a $4 billion vehicle raised in 2005 -- has posted about a 9% net annualized internal rate of return, sources say. Among its current holdings, CD&R shows about a 100% partly realized gain on its stake in car rental giant Hertz Corp., and more than a 250% gain in beauty products vendor Sally Beauty Holdings Inc. HD Supply Inc., a building products company pulverized by the housing downturn, is on the mend.
In recent years, Rice has quietly inserted himself into the public debate over private equity and its impact on the economy and on jobs -- a debate that has gotten heated with onetime Bain Capital LLC CEO Mitt Romney's emergence as the Republican presidential front-runner. He has done so by supporting academic studies, chiefly by Harvard Business School professor Josh Lerner, on PE's granular effects. Rice chaired a panel of PE practitioners advising Lerner and other researchers' studies released under the aegis of the World Economic Forum in 2008. The studies -- covered widely in the financial press -- indicate PE's overall impact on jobs is fairly minimal, and the failure rate for PE-backed companies is low.
More recently, Rice co-founded the nonprofit Private Capital Research Institute, which Lerner steers, to further Lerner's research. Rice, CD&R and the PCRI have no ties, financial or otherwise, to any PE industry lobbyists or other groups seeking to combat the popular image of PE firms as asset pillagers and job killers. The PCRI's mission, he says, is strictly to educate by focusing dispassionately on the facts.
Rice sat down in late June with The Deal magazine's David Carey to discuss his career, the evolution and future of the PE industry, his work with the PCRI and his retirement plans.
The Deal magazine: How did you get involved in private equity?
Joseph Rice: I was working at a large law firm, Sullivan & Cromwell, and one of my clients, Laird Inc., was doing what you and I would now call a leveraged buyout. I was so taken with the whole process, I decided it was what I wanted to do. [The target] was Ben Pearson Co., then headquartered in Pine Bluff, Ark., which made archery bows.
I got Laird to hire me in July 1966.
What fascinated me was the idea that you take a group of underperforming assets and make them perform better. It's a very creative and satisfying process that takes place over an extended period of time. You really do have the opportunity to mold the business and grow it in the way you think it ought to be grown.
I worked at Laird for two years, spent another year at McDonald & Co., a large Midwestern brokerage firm. Then I co-founded Gibbons, Green & Rice.
What was it like working in a fledgling industry? How did that compare to today?
When I started off, there were only two or three organizations engaged in this activity. KKR didn't exist until 1976. In 1968 or '69, there was Laird and there was Bear Stearns. AEA Investors was formed while I was at Laird. And that was about it.
The differences between that time and now are dramatic. I don't think any of us who were early in the development of the industry ever foresaw what it would become. It truly has been one of the great growth industries of the 20th century, and it may well turn out to be one of the great growth industries of the 21st.
The biggest change has been the size of the pools of capital that are dedicated to this effort, the size of the firms managing them, the size of the deals that are getting done.
Certainly, a tremendous change has been the role that institutional money [from pension funds and endowments] has come to play. You know, when we started off, we would do deals where maybe we needed $3 million in equity. And we'd just go out and talk to individuals who we knew were interested in doing this. We'd raise the money in pieces of $25,000 or $50,000. We had no fund.
Nowadays, everybody has a fund. And putting money together is no longer the challenge it was. Because institutions are the principal contributors of the money, that gives them a very important role in everything that goes on.
So that's a big change.
In contrast to Blackstone Group LP, KKR and Carlyle Group, CD&R never expanded into other product lines such as debt investing or hedge funds. You have remained a fairly lean and focused boutique. You manage $13 billion in total, a fraction of what the megafirms manage. Did you stay small and focused by design?
Well, the idea of not being a multiproduct organization was a very conscious decision. I understand the buyout business. I know what makes it tick. I know what you have to do to make good investments and what will produce bad investments. I don't understand hedge funds. I don't truly understand debt investing. All the other things that are being done, I don't know a lot about. And trying to do them without a sufficient knowledge base would make me very uncomfortable.
Organizationally, to invest a $10 billion fund is a tremendous task. It takes a lot of people to do it. And I believe organizations can attract only so many superior people at any point in time. We all want to get to the top of the heap, and in order to attract the really good people, you have to have an organization that makes them all feel like they're at the top. That's hard to do when you have lots and lots of people.
I've heard institutional investors say that as the big firms have ballooned in size, they become more focused on amassing fee-paying assets, and less dedicated to delivering solid returns for their clients. Do you agree?
I suspect that's not the fact. We all recognize that if we don't deliver the returns for our investors, they're going to take their money and go someplace else. I'm sure that Blackstone and KKR are just as focused on performance as we are.
From the outset, CD&R emphasized financial engineering less than other buyout shops. Your operational bent really set you apart. How did that orientation come to pass?
I would say that most of the firms were started by people who had purely financial backgrounds. I can't tell you what their motivations were, but I can tell you what ours were.
When we started, Clayton, Dubilier and Welch had spent all their lives running businesses. The aura of our firm wasn't very financial. What we thought about was: How do you make this business perform? How do you meet your obligations to the creditors? And your obligations to the employees and all the other people involved in the business?
And I think that inherently we felt that if we did those things, we would make money. We saw other people making money in this business, and so we thought why not us?
For the first six or eight years, I was the only financial guy in the firm. The other three guys were out either working on one of our companies or working on somebody else's.
I wouldn't say I'm as facile financially as the young analysts we are hiring today. But you didn't need to be. The buyout business is not brain surgery. Although there isn't any question that you need to know what the financing sources are, and what they are willing and not willing to do, and what those sources feel is fair compensation for what they do -- well, after you've learned that and understand your market, you don't have to be amazingly adept at financial matters.
There now are people at [CD&R] who are far more financially proficient than I ever was. I think that's [a reflection of] the evolution of the industry and the passage of time.
Tell me more about your modus operandi in the early days.
It was very much like it is now.
If we could, we'd buy a company that had a management team that stayed with it. One of my three partners would in effect act as the chairman of the board and give the business guidance. If the management team proved not up to the task, our guy would go in and run the business day to day until we could fashion a new management team.
The first business we bought was a privately owned company called Kux Manufacturing. The second was a division of Mead Corp., the third a division of Inco and the fourth a division of Harris Corp.
So we did three carve-outs and one [outright] company purchase. That's roughly the ratio we've maintained over the years.
What have been the high points and low points of your tenure at CD&R? And what lessons did you learn from your failures?
Lexmark comes to mind as a great deal. Chuck Ames, Marvin Mann and Mann's successor as CEO, Paul Curlander, and the employees all did a wonderful job making that a great business. It was a tremendous tribute to the people who were in that organization, who came out of IBM. We had as good people in that business as I've ever seen.
The low point was the late '90s. That was a harrowing time. We're used to success, not failure. And when you fail in this business, it's hard on everyone.
But we learned from that experience. We [now] are more thoughtful about the characteristics of the businesses we buy. If you look at the businesses that we've bought over the last decade, they all share a set of characteristics: They have multiple suppliers, multiple customers, low technology and good market positions.
Lexmark certainly didn't fit that profile. Would you do that deal today?
You're right. We would never do that deal now. Too risky.
How is your current portfolio performing? There was a time when Hertz and HD Supply were struggling.
The recent performance has been great. Obviously, everybody struggled through a very significant downturn. But we were blessed with really good management teams that worked our companies hard and brought them though a difficult time in good shape. While the recovery has not been as strong as we would like and Europe is weak, if you look at our companies' numbers, Hertz, HD Supply, Sally Beauty, US Foods, among others, as well as most of our most recent investments, are all doing well.
Over time, other private equity houses have embraced the operations-focused style that CD&R pioneered. Has that made it harder to differentiate yourself from your rivals?
The answer is yes.
Now we think we do something different than anybody else. That starts with the role the operating partners play here. They are honest-to-goodness partners at our firm. They share in the decision process. They share in the rewards of the firm. They're entitled to a portion of the carry, without regard to whether or not they worked on a particular deal.
That's very different from most other firms, where the operating advisers aren't full partners.
Let's turn to how the public perceives private equity, and the myriad stories about PE's cutthroat treatment of workers and profiting when the businesses it owns collapse. Some of Romney's Republican primary rivals bashed him and Bain and PE. What do you think of these attacks?
It's a very emotional set of arguments. For someone who is interested in the private equity industry, you'd like to be less emotional and more factual.
It's a relatively misunderstood industry. For that reason, it's very easy to paint it in any number of ways. The Obama camp has every interest in painting it in the most unattractive way. And Romney's people are interested in painting it in a very attractive fashion. But most importantly, it's a discussion that is almost totally uninformed.
The truth, I suspect, lies somewhere in between. Look, this is a high-risk business, no question about it. No firm is without a performance failure. That goes for everyone.
But people aren't hearing the full story. The overall failure rate for leveraged buyouts is tiny, around 1.2% on average annually, according to recent studies. When the press does these stories, they're finding the 1.2% out there, and ignoring the 98.8%.
That brings us to your work with Harvard's Josh Lerner. Tell me about that.
All we're trying to get is the facts out about private equity.
Josh and the other academics did some really great work that was presented at the World Economic Forum. He's extending that research at the Private Capital Research Institute.
My role is basically to try to encourage Josh to press on. To do what needs to be done, you have to assemble a database -- one that ideally reflects every transaction that had been done in every fund that has been active in private equity. And the only way to do that is to go out to the private equity firms and ask them to make available data that is highly secret and proprietary in nature. Josh has been extraordinarily successful at that. He has gotten 15 or more of the most prominent firms in the U.S. to furnish the information.
So we've started. The idea is to have an absolutely unimpeachable database from which people can do research on the impact of private equity on the economy and jobs and so on.
Today you have people who are absolutely sold on private equity and say it's the greatest thing. And then you have people who absolutely hate it. But they don't have any common fact base for an informed, intelligent discussion. That's what Josh and the PCRI will try to provide.
Earlier, you said that private equity may well turn out to be one of the great growth industries of this century. Given that PE has lost a lot of steam since the start of the financial crisis, and a great many firms have performed poorly and may not survive, what makes you so optimistic?
A couple of reasons.
First, the buyout industry exists because it performs a very necessary function. Mature businesses in a competitive world need to constantly reinvent themselves. That means they have to invest in new businesses and at the same time discard older businesses. And private equity plays a tremendous role in facilitating that whole process. We give the seller money he can use to reinvest in his business, and we take the business he has discarded and try to make it into a viable, ongoing business on its own.
The other thing is that there is more and more institutional money being dedicated to alternative assets and private equity. That's because the only way for institutional investors to achieve the returns they need to meet their [pension] obligations is by investing in assets that return more than the public market in stocks and bonds. So that drives institutions to alternative investments.
At the same time, I do believe there will be a shakeout in the industry. The institutional investor has gotten very sophisticated and has clear ideas about what he wants and how he wants to get it. I'd be surprised and disappointed if all the firms that received funding the last time around got funded again.
So you'll have more capital dedicated to private equity but fewer firms. That means the remaining firms will have more capital available to them.
What is the next frontier for PE?
I think in terms of product, I think the large firms that have proliferated new products have probably hit all possibilities they can. I don't think you're going to see another new, new thing.
The new, new things are going to be geographical. There is still a lot of geography where private equity can make a contribution. All the developing countries can use the kinds of creative and entrepreneurial things we do. They have a place through all of South America. And obviously in Asia, where there have been some very serious efforts to establish this activity, but you can't say they have accomplished very much there.
You think about all the countries in the world that don't have mature economies -- those are all economies that could use the kind of creativity that private equity offers.
What about the next frontier for Joe Rice?
My wife [Debevoise & Plimpton LLP private equity lawyer Franci Blassberg] and I are going to take a house in Telluride, Colo., for the winter, and we're going to go skiing. If we feel like skiing for a month, we'll ski for a month. If we feel like skiing for two months, we'll ski for two months. Of course, Franci is a hard-working lawyer, and I don't expect she's going to be there the whole time.
I'd like to visit Africa, and Israel.
So I've managed to create a little room for myself. On the other hand, I suspect I'll be in the office at least once a week. You know, after you've been involved in an organization as long as I've been involved in this one, it's hard to just put it down. You may carve out a little more time for yourself, but you never truly leave.