Silver linings

H.I.G. Capital LLC calls it a stroke of good fortune. The Miami-based private equity firm's decision earlier this year to raise a $3 billion distressed debt fund, H.I.G. Bayside II, could not have been better timed. While opportunities to focus on underperforming and distressed companies have long drawn private equity money as cycles turn, H.I.G. is among the few that have made it part of their core activity from the start. Not only that, but the firm has the flexibility to invest up and down the capital structure, underwriting both equity and debt.

There's very little that the firm can't do when it comes to investing. The firm's roughly 200 professionals can undertake venture capital, growth equity, control buyouts, distressed debt and long-short public equity investments in small caps. The latest distressed debt fund, which closed in June, more than doubled its assets under management, to $7.5 billion-plus. Expectations are clearly running high that midmarket businesses will confront greater challenges amid tightened liquidity and economic pressures.

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H.I.G. founding partners Sami Mnaymneh, Tony Tamer and John Bolduc moved to Miami to set up the firm in 1993, initially concentrating on midmarket buyouts. As opportunities came their way, the range of capabilities expanded over time. The firm has resisted the pressure to climb up the food chain. "We've stuck to our knitting in terms of investment size," says Bolduc, who like Tamer hailed from management consulting firm Bain & Co.

The firm, which boasts an aggregate internal rate of return in excess of 30%, sought to replicate its model in Europe, where Mnaymneh, a former Blackstone Group LP executive, launched operations out of London last year. It now has a presence in Paris and Hamburg, adding to offices in Atlanta, Boston and San Francisco.

Recently, Bolduc spoke with The Deal's Vyvyan Tenorio to discuss the ramifications of the financial crisis as well as his firm's investing strategies.

The Deal: How would you assess the impact of the current crisis on your markets?

John Bolduc: It's a little hard to know exactly what's happening. I'm fairly confident that not all the pieces have stopped moving on the chessboard. It's clear that credit is going to be much tougher to come by, whether that's specifically in loans for leveraged buyouts or leasing companies who relied on the securitization market to provide leases on real estate or equipment. ... And that's absolutely going to have an effect on the middle market. History will probably show that it will have more of an effect on the middle market than on the larger market because of the risks associated with smaller companies. Usually, some of the larger companies continued to have access to capital, maybe not as much capital or as high a leverage, or at cheap rates as they had before. But typically, when institutions who extend credit start to pull back, they pull back in the riskier areas first, and that tends to be
the middle market.

In the short term, it's total chaos. The markets have disassociated themselves from fundamentals. If you wanted to get money today, I don't even know that the big companies can get it. The markets really have locked up, though I'm not sure if they've locked up for fundamental reasons or lack of confidence. Until the government puts a series of plans together to restore confidence here and in the worldwide markets, I don't think anything can happen immediately. Even if Congress had passed the package we were looking at, there'll be at least four to six weeks during which the financing markets will continue to be tepid.

And all this would have a ripple effect on companies' ability to get refinancing?

I think that's right. There's also a compounding effect. When a borrower defaults, typically lenders will step in and force -- or at least threaten -- a company to file for bankruptcy protection. This tactic works well when there is a functioning credit market to support the company both in bankruptcy and when it exits. A lot of times, people use foreclosure and bankruptcy as a way to create an end. That works well when there's something on the other side. If there's nothing on the other side because credit is tight or has pulled back, you may see fewer companies filing for bankruptcy and more doing out-of-court restructurings just to buy time, because they know that their best alternative is actually avoiding a knockout fight.

How are you deploying your capital?

We're fairly agnostic in that regard. We're really looking for the best risk-adjusted returns that we can get. We'll lend money to companies in certain situations. We do control buyouts, we will buy in the secondary debt markets and bonds. As you know, companies that are experiencing financial challenges are fairly complex. One solution doesn't fit all. Fortunately, we have a broad mandate from our limited partners, so we have a lot of flexibility on how we invest capital to achieve those returns. We've got a number of arrows in our quiver to attack problems to help solve that company's challenges and get to the other side.

Where have your efforts been concentrated in the past 12 to 18 months?

The credit crunch started more than a year ago in real estate. That part of the crisis didn't really affect us. But more recently, as you have seen, credit has tightened. We have seen our investment pace pick up in the last six months. We've seen it pick up quite meaningfully across the board in buyouts, as well as secondary debt trading.

Buyouts have picked up even when financing is tough to get?

Financing is an issue. It has clearly brought prices down. It has also caused us to look for companies with stronger asset bases underneath them. Markets have clearly pulled back. Rates are higher; terms are not as generous. That's affected valuations that businesses can get. As this crisis continues to unfold, I don't know how much longer [financing] will be available. But there are still some deals getting closed, and there are still a number of folks out there providing capital.

Any examples of investments with a strong asset base?

We just closed on a company called Shapes [Shapes/Arch Holdings LLC], a 300,000-ton aluminum extrusion business based in New Jersey. We bought that out of bankruptcy. Obviously, that has some assets associated with it. We also partnered with two other financial institutions for the reorganization of a call center business called PRC when the company emerged from bankruptcy in June.

Within the last six months, we also closed Pendum, the largest independent provider of services to ATMs in the country. That's not as asset-intensive as Shapes, but it does have five-year contracts with owners of ATMs that are stable. Earlier this year, we also bought AirNet, which runs an air cargo business with 100 airplanes. Last year, we acquired Flight Options, a private jet aviation company that operates a fleet of 130 luxury aircraft.

Recently, Gemini Air Cargo, which you acquired out of bankruptcy in 2006, went bankrupt again. What went wrong there, and how are your other aviation companies coping with the challenges?

As some of the distressed [businesses] roll through the economy, obviously fuel prices hurt the airline industry, material products businesses, transportation companies; we've been focused on areas where distress is showing up first. Gemini was hurt by fuel prices. In our other aviation-related investments, customers shoulder the fuel risk.

How are your other investments faring, given the economic environment?

So far, all of our investments are doing quite well, but it takes more work to make that happen. One advantage we have is that, unlike other midmarket firms, we've got almost 200 professionals worldwide. That's because we spend a lot of time with our portfolio companies, working with them to achieve the turnaround that's necessary. Some of these investments are still very early.

Any examples of a successful turnaround?

Last year we bought a company called Ready Pac, one of the largest providers of fresh fruit and vegetable packaging to supermarkets and restaurants. This was through an out-of court bankruptcy. They made numerous acquisitions through debt. But their business was significantly hurt by the series of E. coli scares in spinach, tomatoes and other produce, and they couldn't service their debt.

We went in and, among other things, supplemented the senior management team. We helped them right-size the business, refocus sales efforts and go out to acquire in areas that they didn't have to backfill the volumes they had lost. We've grown top-line revenue to about $200 million and doubled the profits. This is one where we invested in equity, senior and mezzanine debt.

Which companies have you acquired out of bankruptcy, and how are they doing?

We've done a number of out-of-court restructuring [transactions], including Beacon Industrial, which makes engineered products and systems for filtering liquids and gases. We bought Broad Point Communications out of bankruptcy. It owns cellular phone licenses in the Gulf of Mexico for the offshore oil and gas industries. It has built up the network; users are up.

We signed a number of contracts with oil firms to transmit their data back from the oil rigs on our cellular network. With oil prices going up, that's helped boost their business. The company was actually a casualty of Katrina in 2005, but we worked closely to bring it around and it's doing spectacularly well right now. We acquired it in 2005 and made two add-ons subsequently.

How much would you invest in equity?

We'd invest anywhere between $10 million and $80 million. Broad Point was within that range, but we don't disclose it typically.

Last year you exited Claymont Steel Holdings for something like a 460% return. What changes did you make?

That was one case where we were very involved with the company. We bought it from a foreign seller, then took it public. It wasn't distressed. We bought the business in 2005, then sold down about 50% of the business in two public offerings. The remaining piece was bought by the Evraz Group. Increasing plant utilization made a big difference. The steel plant's output was close to 400,000 tonnes a year, and we probably increased utilization by 25% or 30% ... where 20% increase is a meaningful rise for the business.

What are your returns expectations, given the state of the markets?

We have capital that investors have committed for 10 to 12 years. I'd like to think that the issues we have today will not be around, that we'll have solved or overcome them, and markets will be back to some level of normalcy. Generally speaking, what's going on today is very positive for our returns because we've got capital when others don't. Prices are lower now.

It's a tough economic time, but those are the types of things that we historically have done well -- helping companies manage through.

I actually think it's a great time if you've got capital and buy assets now. It's going to be a lot of work to be able to fix those assets and wait until values come back. I actually think this is a great time to put a lot of money to work and generate extraordinary returns, but it will take some time. It clearly won't be as easy as it has been in the last few years.

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