On this late August afternoon, every single member of private equity firm CAI is in its New York headquarters. They have gathered for a two-day strategic planning session, during which they will go through each one of the firm's portfolio companies, examine historical and projected financial information, valuation metrics, growth strategies, and original and revised investment theses.
“Here everybody's sitting face to face, and going through each one of the companies, and having everyone offer various suggestions and really focus in on them is helpful,” says Peter Gottsegen, one of CAI's founding partners. This includes all levels of the firm's hierarchy. “Somebody might have a better idea about doing something. There's no monopoly on good ideas.”
Gottsegen has been at CAI for nearly two decades now. He founded the firm with four others in 1990 after leaving a long career at Solomon Brothers. He had been a partner at the storied investment bank for eight years, and had risen to head of investment banking by the time he left in 1986.
Out on his own, he started doing deals with buyout veteran Les Daniels. Daniels had been investing on his own in the healthcare sector for about a decade by then, after leaving the venture capital and buyout firm he co-founded: Burdge, Daniels & Co.
A year later, the two joined up with Richard Schmeelk, who was retiring from his role as head of corporate finance at Solomon, and Peter Restler, who had been the head of Canadian operations at Shearson Lehman Brothers. One of the first deals the four men did together was the acquisition of a bankrupt generic drug maker in New Jersey, Zenith Laboratories. They would sell the business in 1995 and earn 30.3 times their initial capital investment.
In 1990, the four men found David Culver, who had been the chairman and chief executive of Canadian aluminum manufacturer Alcan. The group decided that Culver's prominence in the Canadian business community, along with Schmeelk's and Restler's extensive networks in that country, could be a powerful niche to build a fund around. Investors apparently agreed – by December of that year, they had raised $182 million for CAI's first fund.
Since then, the firm has raised two additional funds – $195 million in 1998 and $375 million in 2004 – and has made 22 investments. Including CAI's substantial co-investment program, the firm has deployed $1.3 billion in equity capital to date. Around 60 percent of these deals have been in Canada, and the rest in the US.
The firm has provided around $600 million in co-investment opportunities across its three funds, representing more than 85 percent of the capital deployed, says managing director Tracey McVicar.
“It's very useful when you're out looking and talking to people to be able to represent realistically that you can actually do a $2 billion equity deal or a $200 million equity deal,” she says. “Because in Canada there aren't that many firms that can, besides the big pension funds that invest directly, that can really bring that kind of money to the table.”
CAI generally looks to invest between $20 million and $75 million per deal, in industries in which its partners have some expertise, but the firm is fairly flexible in terms of sector and strategy. What matters most is that the deals CAI invest in be proprietary.
“We focus on relationships a fair amount,” Gottsegen says. “Of the 22 transactions that we've completed, about 70 percent of those were proprietary and were not the result of competitive auction situations. They come to us as a result of the relationships that we have.”
Since the founding of the firm, the partners have sought to support and extend that network. From the very beginning CAI has had a group of individual “special investors,” who are invited to invest in CAI's funds on the same terms as its larger limited partners. They include retired businessmen, former university presidents and politicians. Although they do not have a formal advisory role, these investors are often on multiple boards, and can serve as sounding boards on potential deals in various industries. They also occasionally bring deals to CAI.
Then there is CAI's network of professionals that serve as directors on the boards of its portfolio companies. Along with the special investors, the group totals around 60. Their function is similar to that of operating partners at any private equity firm, but CAI's relationship with them is unique.
“Our model is a little different than other firms, where they have operating partners who on the payroll of the private equity firm, and they are looking for a deal that the private equity firm will then invest in,” Gottsegen says. “In our case… the portfolio company pays what is a normal director's fee, so it's not a huge amount of money, and then we give options into the shares so that their interests are aligned with ours and those of our limited partners, in that they're helping to grow that company and make a little bit of money in the process.”
Gottsegen and McVicar both stress these directors' independence from CAI. The firm doesn't like to fill a board with its own people. Usually there will be just one or two CAI partners on a given board, the rest of the directors will be drawn from CAI's network, or they will be directors the portfolio company has requested.
“For the size of companies that we have, we have very interesting, independent directors who are in very meaningful roles on the boards,” McVicar says. “Because you can't really attract really good independent directors if you're not going to really let them be independent and be directors in the true sense of the word.”
CAI has recently begun to assemble a special group of several former executives from the utilities and energy industries, as the firm intends to start focusing on suppliers to utilities.
“If a group of people comes with a great business that could really use doors open for them at big utilities, we hope that we can provide some turbo power to the business plan to make things happen faster, as well as serve as a sort of intelligence gathering unit,” McVicar says.
Striking out for the West
CAI started out in New York and Montreal, cities where its founding partners had established networks. In 2001 the firm opened an office in Toronto, in order to be in closer contact with the significant portion of the Canadian financial community that resides there. In 2002, the firm opened its fourth office in Vancouver, and brought on McVicar as a managing director to lead the effort.
Back in 2002, Western Canada was not a particularly popular destination for private equity. But founder Peter Restler had lived in the region for a year, and had an extensive network of contacts there. The availability of McVicar also helped spur CAI to formally set up shop in Vancouver, Gottsegen says.
“Our two biggest investors are in BC and Alberta, and they had always encouraged a physical presence out there,” McVicar notes. “But the catalyst really had to be the idea that there was a lot of business to be done. And it was a place that we serviced primarily just fly in fly out. We thought and hoped that there was enough business to be done to justify a presence out there.”
This dual presence is unique among Canadian firms, she says, and it has turned out to be a powerful asset for CAI.
“There are a lot of people that just do Western Canada and there are a lot of people are based in Toronto and fly in, but to my knowledge there is nobody with that dual presence, and I think that's really effective,” McVicar says. “That helps us: when there are no deals to be done in the east, there's still business to be done in the west. During the time I was ramping this up, those guys were doing their deals. Out east there was a much better environment for doing business. So we have a really good balance. You don't get discouraged as a firm when times are tough because somewhere they're always good.”
Opportunities and threats
Currently there are two major themes in the North American marketplace on which the CAI team hopes to capitalize. The first is the relationship between the US dollar and the Canadian dollar.
“The weakening of the US dollar has contracted the margins at the portfolio companies,” Patterson says. “So we do all the things that you do to try to mitigate against that, buying forwards, putting your debt into US dollars, trying to get as many of the inputs to the manufacturing process in US dollars, to try to provide natural hedges, cost-cutting programs and try to make the operations as efficient as possible.”
That trend has recently reversed, and the Canadian dollar has weakened somewhat relative to the US dollar. CAI is benefitting from that as well, because the firm is able to buy forward at an exchange rate that is lower than the rate CAI budgeted for. The firm can also take advantage of the chance to buy companies in the US at relatively lower valuations.
Another major regulatory change was the Canadian government's decision two years ago to eliminate the income trust structure by 2010, McVicar says.
“From the early part of 2004, that [structure] was our biggest competition as private equity investors,” she says. “The public market through this structure could pay eight or nine or ten times EBITDA for businesses that we wanted to pay three, four, five, six times. So it was part of the reason why it was really tough to do any deals in the early part of this decade.”
Because of this structure, many companies in Canada went public because they could, not necessarily because they should have. Now that the economy has entered a downturn, cash flows are down, investors are unhappy, and going private is starting to look like “a very viable and interesting alternative” for many of these CEOs and boards, McVicar says.
Last November, CAI partnered with Goldman Sachs Capital Partners, Kelso & Co, and Vestar Capital Partners to take private CCS Income Trust – an oil field waste management company with an enterprise value of $3.5 billion. McVicar estimates that there are around 160 such businesses that would benefit from going private, and in the coming months CAI will be working to choose targets from their ranks.