Private Equity Fund and Butler Capital Partners Essay Example

in management buyouts and buy-ins, representing 46% of investment in France and over half of the amount invested in the UK. European buyout funds also posted the best returns in the 1990s, demonstrating 30% returns over the period. 5 However, with these trends, the main concern for the future was that the big increases in funds raised would result in “too much money chasing too few deals”—a trend that was already visible in the increased competition seen in the large end of the market, according to Butler. Walter Butler and Butler Capital Partners Walter Butler was born in Rio de Janeiro, Brazil in 1956 to an American father and a half-French, half-Brazilian mother.

After spending his early childhood in Brazil, Butler moved back to France with his mother after his parents divorced. In 1983, Butler graduated in the top five in his class at the prestigious Ecole Nationale d' Administration and went to work with the French Treasury as Inspecteur des Finances. In 1986, he became head of privatizations in the media sector for the French Government. In 1988, he left the Government to become an executive director in the investment banking division at Goldman, Sachs. Butler explained his move. McCurry, Patrick, and Andy Thomson. 1999.

Being French was not necessarily a plus and being a former civil servant was definitely not a plus. But this was where I learned everything, not only about finance, but also about business in general. Everything in life is possible, but you need to make the right moves to be successful. One day, while working on an M&A assignment, I was putting together a book on strategic alternatives for a European

company. As part of the presentation, we listed the various parties that could be interested in purchasing the client. In the end, we had a couple of strategic buyers and tons of U. S. inancial buyers of all types, but no European financial buyers. At that very moment, it struck me that this was a tremendous opportunity that I needed to pursue. Though the risk was significant, I felt that in 1989 I was able to handle it; ten years later I probably would not. With that in mind, I moved back to France to begin raising the fund. Initially the experience was a case of the extremes: it was much worse than my worst nightmares, but much more exciting than my wildest dreams. I had no team and no track record—I had a U. S. brand but initially there was just me and…me.

On the back of this success, Butler Capital Partners closed its second fund, French Private Equity II, in September 1998 at FF 1. 1 billion, becoming one of the largest independent funds in France. The new fund would focus on investments in France and would continue to make traditional capital investments similar to those from the first fund, but on a larger scale. Given the development of Butler Capital Partners, the roll-up envisioned in the Autodistribution transaction could be the perfect opportunity for the fund—at least under normal circumstances. In order to decide on the investment, we first need to get to get smart on the company and the industry…and in a hurry,” Butler instructed his team. Autodistribution: A Dominant Force in the European Auto Part After-market The European Automotive Part After-market

The four largest markets in Europe for automotive after-market supplies were Germany, France, the United Kingdom and Italy. 6 Every market was very fragmented, with no company holding a share of any significance.

Factors for growth included a growing number of cars in circulation, an aging car fleet, an increased technical complexity of car parts, new legislation requiring more frequent compulsory vehicle inspections, and deregulation to meet European standards. The French automotive parts market was organized around three main distribution channels—the car manufacturers channel, the independent wholesalers channel, and the “new distribution” channel.

Historically, legislation in France insulated car manufacturers from competition from independent wholesalers. Unlike the rest of Europe, the car manufacturers tied up car dealerships and agents with exclusivity deals that prohibited them from purchasing parts from independent wholesalers. Moreover, there were certain parts sold by car manufacturers that independent wholesalers were simply prohibited from selling. “AD can supply about 95% of the number of parts for a car,” explained Vedrines. “In the past, they could not sell body parts, but deregulation should change much of this in 2002. The main trend during the 1990s had been a boom in the “new distribution” channel comprised of new auto centers and fast-fit body shops.

These new distribution businesses saw a huge increase in market share during a seven year period through 1994 as they took business from gas stations, independent garages, and agents, while car manufacturers and independent wholesalers were able to retain market share. However, the boom seemed to end in the mid 1990s as market shares had remained steady throughout the industry since 1994 and their suppliers. The intent was to pool together a group

of independently owned wholesalers to gain purchasing power and price discounts through the volume generated by their aggregated purchase orders.

When Gerbois died in 1976, the son of one of the major affiliates, Pierre Farsy, assumed control of the buying unit and proved to be a dynamic and influential figure in the organization. By the early 1980s, AD had begun using the profits generated by the central buying unit to acquire wholesalers--not only affiliates, but unaffiliated companies as well. Many of these companies were financially or operationally troubled companies that AD was able to rehabilitate through its increasing financial power and industry expertise.

Over time, the purchasing power of AD grew as it continued to increase the volume of the parts purchased through the CBU. While integrating affiliates and consolidating the group in France, Farsy also turned towards Europe and began developing an international brand through a subsidiary, AD International. Started by Gerbois in 1976 in Belgium, Farsy expanded the network to seven buying units in seven different countries, with each country’s network owning an equal share in ADI.

The increased purchasing volume generated by the international buying unit enabled each international affiliate to obtain an additional 2% to 3% discount off the prices negotiated locally, with such additional discounts distributed to the local buying units based on purchasing volume. After registering the AD brand in 1984, Autodistribution began incorporating it throughout the network of wholesalers and garages in France and the rest of Europe. By the end of 1998, Autodistribution had become the largest independent wholesaler in France, with a market share of 33% in the independent wholesaler segment and 10% overall.

It represented a group comprised of

58 subsidiary wholesalers and 99 affiliated wholesalers and negotiated with over 350 suppliers. The company-owned, subsidiary wholesalers accounted for approximately 50% of the purchases made by the CBU. The auto centers conducted AD’s business-to-consumer activities through Maxauto, a 75-store garage chain, and Axto, a 24-store exhaust and brake replacement shop. Since the unit was still early in the expansion phase, its FF 350 million in revenues placed each business well behind the industry leaders in each segment and the unit had yet to reach breakeven.

Moreover, the auto center business remained a small part of the operations, having accounted for less than 7% of AD’s sales. Why AD is for Sale: Deal History Strafor Facom was a leading industrial product manufacturer of specialized tools in France. The company had very close ties with Autodistribution, having been a long-time supplier of products to AD. Almost immediately after becoming CEO of SF in June 1998, Paul-Marie Chavanne began negotiations with AD about a potential merger.

Chavanne explained his career and interest in AD. I have always been interested in cars for as long as I can remember. I left Peugeot not because I wanted out of the automotive industry, but because I came to the realization that I was too much of an entrepreneur to stay at such a large corporation. I always had the feeling that I wanted to run an entrepreneurial organization but at the start of my career, I did not know for sure. Then, after a number of years at Peugeot, I found that I was acting more as an organizer than an entrepreneur.

Moreover, Peugeot was really a player in the French market only, and

I wanted to be a part of a business that had broader interests in an international context. I accepted the position at Strafor Facom because of the chance to lead an entrepreneurial organization that had a broader focus. I was interested in merging with AD, not only because of the automotive connection, but also because of the tremendous growth opportunities the company had throughout Europe. AD was not just a French company, but an entire international network that was built around the AD concept, the AD brand and the AD process.

Given the fragmentation in both the French and the European market, I believed there was a tremendous opportunity for growth given adequate access to capital and the right operating environment. The discussions with AD began in June of 1998 at the instigation of Rothschild, the French merchant bank and advisory firm. After a couple of meetings with AD, in which Farsy and Chavanne shared their views on the auto parts market, the two companies began discussions about a merger. Chavanne explained the nature of the discussions.

We shared very similar views on the direction of the auto parts market and the strategic direction of AD. The initial phase of growth for AD would be to purchase these independent affiliates to consolidate our position in France before tackling European expansion. SF not only had the capital to commit to this strategy, but was also publicly traded. Since many of the owners of AD were also the owners of the independent affiliates and were approaching retirement age, this was an important point. A merged entity created a vehicle where they could sell their independent businesses—the importance of which

was being dwarfed by their 5 800-224

Butler Capital Partners and Autodistribution: Putting Private Equity to Work in France interest in AD anyway—while creating liquidity for their AD holding by trading it in for SF shares. Most importantly, as the largest shareholder group post-merger with a 20% stake, they would retain effective control over the entire combined entity. At the end of February 1999, Strafor Facom entered into an agreement with Autodistribution's shareholders to purchase 100% of Autodistribution in 1999. However, soon afterward, publicly owned Fimalac, another diversified industrial products manufacturer, placed a hostile takeover bid on Strafor Facom's shares.

This bid was rejected both by Strafor Facom's management board and by Autodistribution's shareholders. Strafor Facom tried first to find an industrial company or a financial investor willing to place a counter takeover bid against Fimalac. Chavanne recounted the experience. Since we had already made a deal with AD and since AD shareholders would then be the largest shareholder of SF, we needed to get approval for any Fimalac proposal from AD shareholders, which effectively meant we needed approval from Pierre Farsy.

Even though AD was a broadly held organization, Pierre had run the organization for a number of years, was the owner of an independent himself, and more or less had the complete trust of all of the shareholders. His influence was significant. In the Fimalac proposal, Pierre knew that Fimalac would not have the resources to develop both the combined Fimalac/SF business and the AD business at the same time. In fact, the offer to include AD was more of an afterthought for Fimalac when they placed the hostile bid for SF.

As a result, we needed

to either find a white knight for the entire SF organization including AD or we needed to find a separate buyer for AD that could guarantee its development and implement a build-up strategy. Our initial attempts focused on finding a white knight for the entire business, but this proved too difficult due, at least in part, to the time constraints imposed by the closing of the AD transaction. As a result, we turned our attention to finding a separate buyer for Autodistribution. That is when we became aware of Butler Capital Partners.

Rolling it up: Autodistribution’s Strategy There were four key elements to AD’s strategy going forward under Chavanne. The first element of the strategy was to pursue an aggressive acquisition program to build up the organization set in two stages. Stage one focused on opportunities within France, with the goal to acquire around FF 1 billion of turnover each year. Around half of these acquisitions would be AD affiliates, on many of which AD had a right of first refusal, and half independent wholesalers not affiliated with AD.

After approximately three years, most of the acquisition opportunities in France would be exhausted, so the company would focus on acquisitions outside of France. The first targets here would be European wholesalers affiliated with the ADI network. The second element of the AD strategy was to increase efficiency within the organization’s existing subsidiaries. “About one third of the subsidiaries were highly profitable,” said Chavanne, “one third were of average or adequate profitability and one third were under-performing or loss making subsidiaries. We need to take measures to ensure the last two categories increase their efficiency.

These include everything that

goes from the implementation of best practices to the re-evaluation of management. ” The third element of the AD strategy was to improve the central organization through the elimination of back-office expenses and through better coordination of logistics. “At the time of the AD purchase by SF,” explained Chavanne, “there was very little centralization of the administrative aspects of the business. In addition, we needed an investment in logistics of approximately FF 50 million to centralize the control of the inventory flows throughout the organization. The final element of the strategy was to increase the purchasing power of the CBU. Part of this would be accomplished through the increased demand garnered through the acquisitions described above. Another method would be to increase the percentage of purchases affiliates and subsidiaries made 6 Butler Capital Partners and Autodistribution: Putting Private Equity to Work in France 800-224 through the CBU. “Since we assumed our market share in the existing business would remain stable and since we expected the market to grow at two to three percent over the near term,” Chavanne explained, “ we needed to find ncremental growth in the existing business. Therefore we wanted to get the subsidiaries to increase their purchases from 65% to 70% over the subsequent three to four years. ” Another method by which the management expected to increase the CBU purchasing power was through increasing the supplier base. “Currently, most of our suppliers are in France,” Chavanne said.

“By expanding throughout Europe, we also expected an enlargement of our supplier base that would allow us to arbitrage automotive part prices in other markets. Through these four strategic elements, Chavanne and AD management

expected to make Autodistribution a powerful presence not only in France, but in the broader European market as well. And Along Comes Butler Capital Partners History of Involvement In early April, Butler Capital Partners first approached Lehman Brothers about the Autodistribution opportunity. Karin Jacquemart-Pernod of Butler Capital Partners explained the initial development of the deal. Walter had contact with Lehman on April 1, 1999 when the Fimalac offer became public.

Lehman was looking for a white knight to fend off the hostile takeover attempt of SF. Our discussion at first centered on a Butler Capital Partners buyout of the entire entity, but after two to three weeks, the discussion shifted to a buyout of Autodistribution alone. Aside from getting a brief overview of the market, the company and the opportunity, we really received little information from Lehman. Then, for three or four weeks, we heard nothing at all from them but continued working on the deal by studying AD and the related businesses from an outside perspective.

Lehman’s bankers were trying to get authorization to release more information, but I suppose they were really just focusing everyone’s efforts on trying to sell the entire business. For a while there, we thought we were out of the running and then, all of a rd sudden, we were allowed access to a data room on April 23 for our first look at AD’s internal th numbers. On April 29 , we had a second shot at the data room and a second meeting with Lehman, where they provided a much more thorough presentation of the management’s plans for the business.

From that meeting, we could see that we were in

the running, but we only had a little over two weeks to finalize a bid if we decided to make one. Based on the information gathered in the data room and from the meetings with Lehman Brothers, there were some concerns that developed due to the constraints of the deal that were put on potential investors. Aside from the constraint created by the short evaluation period, the absolute valuation seemed in line with the market for the industry. However, compared to the prices paid in Butler Capital Partners’ other investments, the valuation looked rather “fully priced. As a result, the team needed to make sure they could justify the valuation as reasonable for this particular transaction. Also, there was limited information available in the data room. This was not only a concern for Butler Capital Partners’ in-house investment decision, but also for the evaluation of financing by the banks. However, the information they did receive was quite useful, as the numbers had been audited only two months prior in connection with the original Autodistribution acquisition by SF. Finally, there were the potential liabilities associated with the company.

While Butler Capital Partners would receive the same representations and warranties as SF and could review all SF due diligence reports available in the data room, the team had a limited ability to investigate the company's liabilities due to the lack of time and information. 7 800-224 Butler Capital Partners and Autodistribution: Putting Private Equity to Work in France In light of the numerous constraints put on Butler Capital Partners, the one area in which they felt had some flexibility was the capital structure. Since the price of the

transaction was already determined, the one source of value for the fund was in structuring the deal.

Butler commented on his fund’s approach to structuring the transaction. When thinking about the deal structure, the first thing that we must be cognizant of is the nature of the business. Since AD is pursuing a build-up strategy, we want to build as much flexibility into the capital structure as possible in an effort to avoid limiting AD’s ability to pursue their strategy. That being said, we want to ensure we are able to achieve an equity return that is commensurate with the risk and our objectives in the fund.

Since we can not negotiate on price, the only way to enhance the return is through the different levels of financing—especially debt—in the capital structure. Our capital structure needed to reflect a balance between these two goals. Another consideration was the amount of capital Butler Capital Partners could, or wanted, to put in the deal. Butler Capital Partners’ covenants required that they put no more than 20% of the FF 1,100 million into any one deal. In order to complete the deal, the fund needed to find alternative sources of equity capital outside of the fund.

One potential source was management; this provided the additional benefit of aligning incentives. For example, the equity stake the CEO had in the company could provide a significant incentive. 7 But management could only contribute so much cash toward the offering and Butler could not afford to give away free equity—for a variety of reasons. Another source was other private equity funds. But this source was also limited, as these funds faced even sterner timing

issues for diligence than Butler since they would come into the deal even later than Butler Capital Partners.

A final source of capital came from the existing AD shareholders who would exchange one third of their existing stock for stock in the new entity. When Butler developed the proposal for the capital structure, the composition of this group and their objectives needed to be taken into consideration. Pierre Farsy had significant influence over the group, but even he had limited persuasion power. Even with this flexibility, the complex developments of the deal history unveiled some additional constraints. Since we were brought into the deal at such a late point in the process,” explained Pierre Costes of Butler Capital Partners, “the availability of financing had become quite tight. When the various interests put together their proposals for the transaction between SF and AD, they made sure they secured financing for the deal. In the process of doing so, they conflicted many potential sources of debt and mezzanine financing. Thus, four out of the six major French banks were effectively eliminated from providing us with financing. One potential source of financing was from a French bank with which Butler Capital Partners had worked before—Banque Nationale de Paris. Although they had not yet guaranteed funding, BNP did give Butler Capital Partners a term sheet that outlined their indicative pricing levels and amounts. Although the team was pleased to find a bank that was not conflicted, there were still some serious issues over the terms of the financing. Butler explained his concerns. There were several elements to the original term sheet that concerned us.

First of all, the pricing levels were

quite high. The spread levels were at least 25 basis points too high across the board. Second, BNP required that most of the fees to them were due even if our bid was not selected. That is something that was simply unheard of. Third, BNP required that a formal working capital facility be put in place. AD already has a working capital facility in 7 Chavanne’s last salary at SF was FF 3 million. 8 Butler Capital Partners and Autodistribution: Putting Private Equity to Work in France 800-224 place, just not a formal one.

By making the facility a formal arrangement, AD would incur a fee that was unnecessary. Finally, the term sheet required that all the equity would be paid up front, even though about 3% of the equity would not be purchased until 2001. 8 Not only would we rather delay that equity infusion, but we would also like to use the cash flow from operations to finance the transaction if AD is ahead of budget. Although none of these elements pleased us, we were in somewhat of a bind. There was very little time available to us before we needed to submit our proposal, and we could not negotiate on all of these issues.

Moreover, there did not seem to be many other alternatives outside of BNP available to us; because of the dynamics of the deal, only a couple of banks could possibly finance this. As a result, we had to prioritize our concerns carefully and decide which elements we could accept, which elements we could renegotiate at a later date, and which elements were deal breakers. To Invest or Not to Invest?

Despite all of the constraints caused by the dynamics of the transaction and the deal history, Butler and his investment team believed there was an investment case for an AD buy-out and buildup.

Vedrines believed that the market throughout Europe was ripe for consolidation. “I am quite sure the auto parts market will consolidate,” he said. The driver of the industry is securing the best purchase price. Before, the buying associations similar to the original structure of AD were sufficient for that and were the only practical way of organizing the industry. Logistically, it was impossible to consolidate in an efficient manner, as the dynamics of the business did not allow for much in the way of eliminating costs. For example, take inventory control.

The dynamics of the business required that a particular wholesaler needed to have a part in his hands within as little as 1/2 an hour for many parts in order to serve the needs of repair garages in his environment. Often the mechanic wants to keep the car on the lift while getting a part he had not anticipated needing; by definition, there would be a significant amount of inventory overlap as the market drove this requirement. But with the recent changes that have come forth in information technology and logistics, there are ways to fix this problem. For instance, we can now identify highturnover parts and low-turnover parts very quickly.

The former will be stored close to final customers. The latter will be stored in central storage. And we can reassign parts to different storage locations very speedily. It is these changes in information technology that will bring about the opportunity to see

margin improvements through consolidation and will bring about the opportunity for a pan-European market to develop. Butler Capital Partners also believed AD had several other attractive attributes that warranted consideration.

As his team put together a financial model for the transaction, Walter Butler was able to better quantify the investment opportunity. “We thought we had one edge over the competitors,” Butler recollected. “That was a vision of the opportunities e-business could bring to the industry. These e-commerce opportunities could greatly increase the value at exit. ” Also, the internal growth opportunities presented by the acquisition of the independent affiliates could also help grow sales.

Not only would AD get the affiliate’s revenues but the CBU would stand to benefit as well; independent affiliates made 55% of parts purchases through the CBU compared to 65% for AD-owned subsidiaries. Externally, the purchase of other nonaffiliated wholesalers would continue, but the acquisition 8 For tax reasons, certain shareholders could not close the transaction before 2001. 9 800-224 Butler Capital Partners and Autodistribution: Putting Private Equity to Work in France opportunities in France, both internally and externally, would really run out after two to three years.

Therefore the acquisition opportunities in the fragmented European markets were very attractive. Finally, potential margin improvements were significant. For an acquisition of an affiliate representing 10% of revenues, the group’s gross margin increased by 1 percentage point and the operating margin by 0. 2 percent. The acquisition of independent wholesalers could bring even greater margin improvement. However, there were risks involved in the deal that were significant.

First, there was the fact that no one at AD had had any real international experience except for Chavanne even

though most AD managers were internationally aware thanks to the ADI network. After the transaction there would be a new AD with European ambitions, but with limited experience in that market aside from this experience with ADI. This brought about the more important concern: execution risk. There was definitely an opportunity in AD, but that was because the firm lacked structure. It was a loosely organized, entrepreneurial business run by men and women who were entrepreneurs.

This entrepreneurial spirit had been a key to the success of the enterprise, but there was a dire need to centralize control for the LBO to be viable and to produce the 30% IRR Butler’s fund would require. The key to success was to change the culture of the company from one of an association to one of a corporation without destroying the organization in the process. Chavanne shared Butler’s concerns on the cultural challenges facing AD going forward. The biggest surprise I had when acquiring AD was how old the management was. Pierre was a dynamic personality in the organization, but he was in his 70s.

It became clear that this was really the end of the founder generation. While the founders might be considered irreplaceable, there was a definite need to reinforce each level of the organization with new blood without losing the spirit of the company. The greatness of the organization was that it was an open-minded organization; an organization of free men who felt free to put forth new ideas and to level criticism. But it was tough to run. The key would be to convince people to decide to change and to implement those changes. It

would be a delicate and slow process.

Walter Butler was also concerned about the due-diligence process. A problem was that his firm was somewhat late in the game. There had been several funds that had more time to perform due diligence on the company and, more importantly, to allow AD and the fund to get comfortable with each other on a personal level. In fact, Butler was aware of one group, led by BC Partners, which had been in the process from the very start and had produced a much more aggressive proposal. At the same time, BC Partners’ build-up strategy was more limited than the one proposed by Butler’s team.

Butler knew that BC Partners was a serious contender. As Walter Butler walked out of his beautiful “art nouveau” office building along the River Seine, he looked up at the Eiffel Tower in the distance rising above the cafes that lined the street in front of him. With cars full of AD parts whizzing past him, he knew Autodistribution could have the potential to become a power in the French and European markets. At the same time, he thought that an investment of this scale could represent a considerable amount of risk for his new fund, even though the business was counter-cyclical.

From 1986 to 1988, he was in charge of privatization in the media sector, within the French Government. He had previously held, from 1983 to 1986, the function of Inspecteur des Finances for the French Treasury, after graduating from ENA in 1983. Walter Butler has been the chairman of the French Venture Association since 1997. Pierre Costes, 30 — Pierre Costes, chartered accountant, joined Butler

Capital Partners in 1998, having spent the previous seven years at Arthur Andersen where he was director in the Acquisition and Special Operations department.

He graduated from Ecole Superieure des Sciences Economiques et Commerciales. Karin Jacquemart-Pernod, 31 — Karin Jacquemart-Pernod joined Butler Capital Partners in 1991, having spent the previous three years at Goldman Sachs, as an analyst in the Corporate Finance Department. She graduated from Ecole des Hautes Etudes Commerciale. Laurent Parquet, 33 — Laurent Parquet joined Butler Capital Partners in 1997, having spent the previous six years at Andersen Consulting where he was director in the Media and Communication Group.

He graduated from Ecole Superieure des Sciences Economiques et Commerciales. Michel Vedrines, 53 — Michel Vedrines joined Butler Capital Partners in 1991, having spent the previous three years as the chief executive of a medium-sized manufacturing company. From 1983 to 1988, he worked at the Institut de Developpement Industriel, a French investment company. He spent the previous 17 years at a subsidiary of Elf Aquitaine. He graduated from "Ecole Superieure de Chimie de Marseille" and obtained an MBA from ISA in 1983.

Jean-Pierre Pipaud, 47 - Chief Financial Officer — Jean-Pierre Pipaud joined Butler Capital Partners in 1999, having spent the previous two years as chief operating officer of NatWest Markets in France. From 1990 to 1996 he was financial controller of SBC Warburg in France, where he managed the internal Financial Control Service. He spent the previous 13 years at Credit Agricole. Jean-Pierre Pipaud holds a master degree in business law. Source: Butler Capital Partners. 13 800-224 -14- Exhibit 5 Investments from Fund I

Exhibit 6 ! Overview of the Major European Markets In Germany, the

car manufacturers’ channel is very strong with a reported market share of 60%. The “nothing but the best” German philosophy has led car users to often have their car serviced at the main dealer, expecting premium quality and premium products. As a result, there are fewer auto-centers or fast-fits than in other European countries. AD’s German counterpart is the firm CARAT which has recently integrated with the ADI network for its auto parts distribution activity.

The British market’s structure resembles that of France: significant position held by car manufacturers and strong development of the “New” distribution channel. Great Britain used to have many small traditional wholesalers, which were about half the size of their French counterparts. But many of the smaller wholesalers have disappeared and have been replaced by so-called “super factors” such as Partco , Finelist or the successful buying group FSG. Spain seems to mirror French distribution trends, but is still 15 years behind.