ASG Partners' interview with Steven Beckett, Partner at Peninsula Capital Partners
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What characteristics does Peninsula Capital look for in businesses you invest in?
Peninsula is a somewhat unique mezzanine and structured equity investor. We are focused on non-sponsored transactions and the majority of situation we invest in do not involve equity groups. As a result, most of our investments are for strategic acquisitions, growth financings, recaps, partner buyouts and leveraged dividends rather than leveraged buyouts.
When we look at any business, the first thing we try to understand is why it is successful. Sometimes it’s a superior technology, strategy or product. Often it’s a management team who is simply doing a better job of basic blocking and tackling. Once you understand why a company is successful, you can ascertain the sustainability of that business strategy. Management is another key factor. No matter how good a company is, unless we feel the management team is strong, we won’t invest in the company. A final key point we look at is the industry. While we don’t mind investing in low-growth industries and companies, we don’t like industries that are going backwards or have significant risk of going backwards due to factors outside of the company’s control such as technology changes, migration overseas, or markets that are being artificially supported by governmental intervention such as tariffs or import limits.
We gravitate toward firms that have found and dominate a niche within their market. Many of the companies that we invest in are small (under $25 million in revenues), but nearly all are the number 1 or 2 player in the segment of the market in which they primarily compete. Granted, their market may be less than $50 million, but within that market, they are a clear leader.
In a typical year about how many opportunities does Peninsula look at? Of those, how many LOIs do you submit and how many do you close on?
Over the last ten years, the number of deals we have looked at each year has stayed fairly constant at around 500 (excluding opportunities that are non-starters where we don’t ask for the offering materials. If I included those, the number would probably more than double). Of the 500 potential transactions where we do receive materials, we probably take a hard look at around 10%-20%. By this, I mean we talk or meet with management, gather additional information and do some preliminary industry works. Of that 10%-20%, we usually end up issuing proposals on about half and close on about a third of the proposals we issue.
How have the current economic conditions changed your approach or criteria?
On a macro perspective, the current situation hasn’t changed our investment focus. On the micro level, we are concentrating more on industries that have a low Beta to the overall economy and staying away from more cyclical industries such as capital goods. However, this is more of a tactical move rather than a change in strategic direction. As to our investment criteria, we are largely reflecting changes in the financing market in regards to leverage, pricing and terms. The one thing we remain committed to is looking at storied deals. The best investments we have made were ones that, on a first look, most investors would take a quick pass. Only after digging in did we find that these companies were really much better than they first appeared.
What other changes in “the market” have you seen in the last 6-12 months?
Fortunately for us, the non-sponsored market remains strong, often because owners can’t sell their companies for prices that they feel are acceptable. So, instead they look at alternative transactions such as leveraged dividends or take advantage of low prices to buy a competitor or complimentary business. On those types of transactions in the lower middle market where we invest, clearly the biggest change has been the lack of availability of senior debt. Most banks appear to be topping out at 2x leverage or less, with little or no appetite for unsecured “air-ball” term debt. Total leverage is probably moved down below 4x with most deals at 3.5x or less. Pricing has gone up by 2%-4%, both on the senior and mezzanine debt tranches while equity returns are up by 3%-6%. The amazing thing has been the rapidity of change. The pricing increases, the reduction in leverage and the lack of senior debt all seemed to happen in less than 60 days, catching many investors off guard. Frankly, I have been investing for over 20 years and have never seen the market shift this dramatically or quickly.
What advice would you give business owners who would like to sell their companies now or are planning to sell in the next 5 years?
First and foremost, you have to have a transition plan in place. If the owner is key to running the business, they need to get successor management in place at least a year ahead of trying to sell their company. Even if the owner isn’t key, they still need to have a management team that a buyer feels comfortable with and will want to keep in place post-closing. If you don’t, it will make selling the company difficult if not impossible and will definitely cost the owner a turn or more on the selling price. Second, make sure your company is “institutionalized.” By that, I mean you have good reporting systems in place. Make sure that you can report audited numbers, that you are up to speed on regulatory and market issues, and, going back to my first point, that there is a management team who can run the business if you leave tomorrow
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