I got too cocky:
Overconfidence and Fast Money Mindset:
Chairman Joseph L. Rice III acknowledges that the firm faced a challenging period due to
overconfidence and a "fast-money mindset." The belief that they could do anything they
wanted led them to make strategic mistakes.
Investments in Unfamiliar Industries:
The firm made investments in industries it didn't fully understand, such as U.S. Office Products
Co. and Dynatech (later Acterna). These investments resulted in significant losses and
bankruptcy filings.
Operational Challenges and Leadership Issues:
U.S. Office Products Co. faced operational challenges, including a CEO departure and a slow
strategy implementation that led to stock devaluation and employee departures.
Charles P. Pieper, involved in various leadership roles across Clayton's portfolio companies,
faced challenges managing multiple responsibilities simultaneously.
Financial Losses and Bankruptcies:
The investments in U.S. Office Products Co., Acterna, and Fairchild Dornier Corp. resulted in
substantial financial losses and bankruptcy filings, causing setbacks for Clayton.
Response to Setbacks:
Clayton addressed its problems by restructuring its upper management, hiring experienced
executives like Jack Welch and George W. Tamke, and implementing quarterly reviews.
The firm shifted its focus to industries it knew well, avoiding those it didn't understand.
Change in Investment Strategy:
Clayton adopted a more cautious investment strategy, targeting companies that were already
leaders in their respective industries. The firm's new strategy aimed to avoid industries it lacked
expertise in, including real estate, oil and gas, retail, merchandising, entertainment, and
telecommunications.
Performance Improvement:
The changes in strategy and management resulted in improved business performance, with the
firm selling companies and achieving substantial returns for investors.
Ongoing Challenges and Caution:
Despite improvements, Clayton faces ongoing challenges, including struggling companies in
which it holds minority stakes, such as Sirva Inc.
The returns from the latest fund are impressive, but the full outcome will only be known when
investors can pull their money out of the 10-year fund.
Learning from Mistakes:
Joseph L. Rice III insists that Clayton has learned from its mistakes and is on the road to
recovery. The firm expresses a commitment to avoiding a recurrence of the issues faced in the
early 2000s.
Hopeful Outlook:
While acknowledging past difficulties, Rice expresses hope that the firm has fixed its problems
and emphasizes a commitment to avoiding similar challenges in the future.
White Knuckle Deal:
Background on the Private Equity Deal:
Three private equity firms, namely Bain Capital, Carlyle Group, and Clayton, Dubilier & Rice, bid
$10.3 billion to purchase Home Depot Inc.'s HD Supply business.
Banks (Lehman Brothers, JPMorgan Chase, and Merrill Lynch) agreed to provide a $4 billion loan
to finance the deal.
Shift in Financial Conditions:
In July, conditions in the financial markets changed rapidly due to the subprime mortgage crisis,
affecting the broader debt markets.
This shift posed particular risks for leveraged buyouts, as loose repayment terms on loans and
bonds had been a common financing approach.
Negotiations Under Pressure:
The private equity firms faced pressure from the banks to tighten the terms of the loans and
bonds just before Home Depot's board meeting to vote on the deal.
The negotiations were challenging, and the banks sought more financial protection.
Last-Minute Deal Rescue:
After hours of negotiations and compromise, an agreement was reached. The banks provided
financing with a reduced loan of $1 billion, Home Depot assumed the loan payments in case of
default, and the private equity firms increased their equity contribution, paid higher fees to the
banks, and granted Home Depot a 12.5% equity stake in HD Supply.
The final deal price was $8.5 billion.
Revealing Debt Terms:
The debt terms in the deal included "covenant-lite" loans and "payment-in-kind" bonds, which
had been favored in recent years but had come under scrutiny due to the credit market
changes.
Impact on the Private Equity Industry:
The successful rescue of the HD Supply deal provided insights into how other pending buyouts
could be saved through concessions from all parties involved.
The private equity industry had experienced rapid growth, with larger and more complex deals,
including ventures into unconventional industries.
The shift in financial conditions and the need for concessions revealed the potential risks
associated with high levels of debt in the industry.
Lessons from Past Challenges:
Clayton, Dubilier & Rice had learned from its past challenges, including the bankruptcy of U.S.
Office Products Co. due to onerous debt and poor management.
The firm had realized the importance of due diligence and cautious borrowing practices to
mitigate financial risk.
Future Challenges for the Private Equity Industry:
The private equity industry faced challenges as the banks were becoming less accommodating
in providing easy financing terms.
The balance between the desire to do deals and the risks associated with high levels of
borrowing was becoming a key consideration for private equity firms.
Emphasis on Caution:
Clayton Dubilier & Rice indicated a willingness to accept more operational risk if it meant taking
less financial risk in future deals.
The private equity industry was preparing to adapt to a changing financial landscape and a more
cautious approach to financing.
