The 2001 European LBO season will probably be most remembered for two things – subdued dealflow and the £2.14bn buyout of British Telecom's directories business Yell. Judging by the number of awards this acquisition has already collected and the nice things both investors and financiers are saying about it, Yell would indeed appear to be something to shout about. But John Muse, co-founder of buyout firm Hicks, Muse, Tate & Furst that did the Yell deal alongside Apax Partners, does not seem a man who is in the business of shouting. Those who've found him sat across the table negotiating deal terms describe him as tough, but in general conversation the Texan comes across as soft-spoken, almost mellow.
Hicks, Muse has done a number of high-profile transactions in Europe since Muse moved his family to London in 1997 to set up the firm's European office, but Yell is arguably the transaction that has attracted most attention. According to Muse, it is also one that has many of the characteristics the firm likes to see in a deal, allowing it to apply the kind of approach that has made it one of the most successful buyout firms in the world.
The winning formula
?We've always made money by buying good businesses and making them bigger and better?, he says. ?I don't know how we came up with it, but we actually coined the phrase which many people now use: ?buy and build?.? The method, which Muse also refers to as ?business plan arbitrage?, is to add new acquisitions to a strong platform or grow earnings organically by introducing new product lines and moving into new markets in different parts of the world. The aim is also to maximise capital expenditure efficiency and inject a sense of entrepreneurial urgency into the business.
This is the formula currently being applied to Yell. A stable business with powerful brands and a dominant franchise in the UK, Yell has strong free cash flows and a management team with the ambition to grow a bigger business. It's also a media business, one of Hicks, Muse's three favourite sectors together with branded consumer goods and industrial manufacturing. Spun off by a parent desperate to raise cash, observers say it was bought cheap, but Muse insists it was bought right, pointing to the regulatory constraints on pricing landed on the company by the UK's Office of Fair Trading during the buyout process.
Meanwhile, that time-honoured buy and build principle is well under way at Yell. ?It's our objective to be the consolidator of one of the last niches of the media market. If you get there early with scale and modest leverage, you can be the consolidator, as long as you stay disciplined with the price you pay, and as long as you don't make any acquisition ahead of the capability of the management team to digest it properly,? says Muse. Earlier this year Yell bought US directories business McLeodUSA, which operates in an unregulated market and is therefore expected to provide the larger entity with a strong growth element.
Muse says there is more to come. ?I don't want to reveal any secrets, but we've talked to every significant operator in Western Europe. Right now we've got our plate pretty full with McLeod, but watch this space.?
If it works, it'll be the kind of strategy Hicks Muse has applied several times over, for example in the second half of the 1990s in the US radio industry where it built up Clear Channel, a $1.2bn consolidation play that grew into a business with a network of over 1,100 US radio stations.
?Tom is the most optimistic man I've ever known?
nother example, from Hicks, Muse's first fund, is Berg Electronics, a components connector business bought in 1993 off Dupont for $35m in equity capital and $330m in debt. It was one of the early deals that put the firm on the map as a major contender in large leveraged buyouts. Five years and eight acquisitions later, Berg was floated, and the firm proceeded to distribute a return from the deal of $479m to investors in Fund I.
Muse started the company together with Tom Hicks, who had already established a reputation in buyouts with his company Hicks & Haas. Muse had set some capital aside whilst working in investment banking for Prudential and was looking to get into ?the principal business, but I wasn't sure about private equity.?
Meanwhile Hicks was at odds with his partner Bobby Haas: Hicks was keen to institutionalise the firm and raise a larger fund, while Haas wanted to carry on raising money on a deal-by-deal basis. ?I'd known Tom for over ten years and sold him a bunch of businesses, and he approached me as I was thinking about getting out of banking?, says Muse. By then Muse was looking at Life Partners, a financial services business that looked like a suitable buyout target. The pair went on a skiing trip in Colorado, a deal was struck ?over a couple of beers and a sauna?, and Life Partners became the new company's first deal.
Muse says that what has followed has been a great deal more than he expected. ?Tom is the most optimistic man I've ever known and I think saw more clearly than I did how big this could be. When we started, Drexel Burnham had just gone out of business, LBO was a dirty word, and KKR's was probably the only billion dollar fund around. No one could have projected how much capital would flow into the industry. Today we are seeing a retrenchment from that.?
The firm's first fund raised $250m and Jack Tate and Charles Furst became partners. A New York office was opened and a second fund was raised with $800m to invest. Furst began looking at Latin America, Fund III raised $2.5bn, and by the time Fund IV closed on $4bn in 1997, the business ranked among the leading players in its field.
Today Dallas remains the hub, and after three years of living in London, Muse is now splitting his time between Texas and the UK. In the London office, he is the only American, and the firm's international make up and presence is something Muse is proud of. Asked whether there is still a Texan touch about the business that sets it apart from the competition he says that there isn't. But he does allow that Hicks, Muse may have a somewhat softer style than some of the hard-charging Wall Street houses. ?That doesn't always work to our advantage by the way. Some people think they've got to go to New York to find a financial partner. But a lot of people can be intimidated by that. We'll tell people very quickly what we can do and what we can't do, and I think that is a little bit different from some other firms.?
?The fact is there hadn't been an impediment at all?
Where he says Hicks, Muse does not differ from the competition is in the difficulties it got itself into in 1999 and 2000 at the height of the technology boom. People close to the firm say it put together a plan to build a global broadband business. As Muse comments, the firm turned to technology ?because we couldn't find things that were reasonably priced in our space?. The firm ended up committing around 20 per cent of Fund IV to telecom and Internet investments – and came up short. Problems also occurred with the firm's exposure to Latin America, particularly Argentina. As a result, the fund is now extremely unlikely to match the performance of its predecessors, although it is still expected to finish up with an internal rate of return in the mid-teens according to one investor in the fund.
Muse now refers to the firm's strategy in those technology obsessed days as being ?offmessage?, a phrase he uses several times during the conversation, insisting that almost every other house ended up getting into similar difficulties, some more so than others. He makes no attempt though at playing down the frustration limited partners felt at Hicks, Muse's failure to deliver what these investors thought they had bought, i.e. exposure to a buyout strategy in the firm's core sectors. ?We made some mistakes, and we apologised. We did a mea culpa with our investors at a conference 18 months ago.? Part of the partners' apology was the unusual step of offering a guaranteed return on $200m worth of internet-related investments.
The firm also took measures to address the problems that going off message had caused in the portfolio. As part of what people in- and outside the firm have described as a back-to-basics campaign, resources were moved and the headcount reduced. More importantly, investors were given assurances that in terms of investment strategy the firm would return to its original forte and stick with it.
Nevertheless, when the firm launched Fund V with a target of £4.5bn last year, clearly not everyone wanted to participate. ?There was more of a wait-and-see attitude with some of our new investors in Fund IV who were disappointed?, says Muse. One such investor, who says they passed on the fifth fund for capacity reasons, says that if they had money to invest, they would have looked at investing, but would have started their due diligence from scratch with a particular focus on Hicks Muse's investment strategy and personnel.
Back to basics
Muse argues that the decision to close the fund early in 2002 at $1.6bn – far short of the target total – was mainly driven by the fact that institutional investors had little capital to allocate. ?People who had been invested in us for a long time all came back, because they had made very nice returns. But their budgets had been slashed dramatically, often by 50 per cent. Our timing was terrible.? He also says that Fund V, which alongside the firm's €1.5bn European fund invested in the Yell deal, was large enough for the firm to do what it wanted to do: ?We've got enough capital to play in the larger deals in our space. All it means is we might be coming back to the market sooner than we might have done otherwise.?
Was Yell a deal that helped take the back-to-basics message to the market place? Muse says it wasn't. ?The media and some of our competitors have been calling into question our access to capital or our ability to function. But the investment banks and executives who we are dealing with don't pay any attention to that. The fact is there hadn't been an impediment at all.?
Hicks Muse personnel have not done a great deal of talking to the press during the past 12 months, and Muse says the firm wants to talk about the press as little as possible too. But he does admit to being irritated by the way in which recent media coverage of the company has still been focusing on the IT problems it ran into: ?When we exited our investment in Microtune [in December 2001], we made more than 3.5 times our money. We didn't even announce it, but the press got hold of the story, and the coverage was: ?Big hit for Hicks Muse. However this is the same firm that in 2000?' – it's just so yesterday's news.? Such irritations aside, Muse is as keen as ever on being involved in the firm. A second generation of dealmakers has been brought on board, there are eight partners now, and the founding partners are less close to the firing lines when it comes to getting deals done. The Yell deal for instance was led by Lyndon Lea, a young London-based partner who negotiated the terms, with Muse and Hicks getting involved in board-level meeting at BT, developing the relationship with Apax and helping to decide on the capital structure and which banks should be called in to do the financing.
Muse says the younger partners are running the firm on a day-to-day basis, and that there will be a time when the firm's management committee, which handles all the key decision, will entirely comprise of second-generation managers. It matters to him that most of the future drivers of the business were all grown in-house rather than poached from rival firms. ?Only when we set up in Europe did we have to bend this rule slightly?, he laughs. London-based buyout practitioners say the firm's done a good job in terms of staffing the European office.
Muse says the transcontinental travelling can be a drag, and that he has thought about ?simplifying? his life. But he is nevertheless determined to ?stay involved in this firm for a long time.? Part of this motivation, as is often the case with practitioners who became financially independent a long time ago, is the idea of eventually leaving behind a firm that has his name on it. Another part may be an ambition to prove that Hicks Muse can stage a full comeback and erase any memory of that off-message excursion into IT.
But, on a more basic level, there is also still a significant appetite for building businesses. Asked about Mumm and Perrier-Jouet, the champagne makers Hicks Muse bought in 1999 and sold 19 months later to Allied Domecq for four times its money, he calls the episode ?bitter-sweet?, sweet because Allied's offer was too good to be rejected, but bitter because he had had plans to do a great deal more with the investment before selling out. ?This was a fun business to be involved in, and I would have liked to held on to it a bit longer.?