Barons of Buyout
In the midst of a giant shopping spree, Fort Worth’s Texas Pacific Group sets its sights on Internet airline ticketing.
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In the battle for leisure travelers’ dollars on the Internet, the Purple Demon is swooping in to give Star Trek’s Captain Kirk a run for his money. Project Purple Demon is the code name for Hotwire.com, a popular travel Web site that was officially launched in late October to offer discount airline tickets. It’s a frisky new competitor of Priceline.com’s, the Internet bidding service whose ads feature actor William Shatner. Like Priceline, Hotwire sells excess capacity—unsold seats—on flights. But unlike Priceline, where consumers make bids for discount fares and then wait to see whether their offer is rejected or accepted, there is no bidding on Hotwire. The customer plugs in dates and destinations, and within a minute the site comes up with a price. Hotwire’s founders—including six major airlines as partners—are betting that the site’s ease of use and bargains (recently a round-trip ticket from Dallas-Fort Worth International Airport to Chicago O’Hare, with a day’s notice, went for $236, a fraction of the retail price) will give it an edge over competitors. And they’ve got a lot riding on its success— $75 million, to be exact.
The company behind all this is a Fort Worth investment firm called Texas Pacific Group (TPG), run by a media-shy financier and founding partner named David Bonderman. Bonderman helped lead the buyout and turnaround of once-bankrupt Continental Airlines, and TPG is known for accomplishing the same thing with America West Airlines. Basically it buys troubled companies with the hope of selling them later for a profit (when debt is used to help finance such deals, they’re called leveraged buyouts, or LBOs). TPG cut its teeth doing LBOs of Old Economy companies, and its assets include well-known brands like Del Monte Foods, clothing retailer J. Crew, and luxury shoe retailer Bally; it recently sold Beringer Wine Estate Holdings to the Australian beverage company Foster’s Brewing Group for about $1.5 billion. LBOs, remember, were the rage in the takeover-crazy eighties. Buyout artists like Henry R. Kravis used them to gain control of corporate giants like RJR Nabisco. Financiers such as junk-bond king Michael Milken provided the leverage, or borrowed money—in the form of the risky, high-interest junk bonds—that fueled the buyout binge. When the bottom fell out of the junk-bond market in the late eighties, debt—which boosts returns for investors in LBOs—became harder to get and LBOs fell out of fashion. Meanwhile, the sexier venture capital business, with its high-tech highfliers, drew investment capital away, as did the stock market. As Old Economy companies lost their luster with investors, buyout firms too went looking for high-growth companies with higher returns.
But TPG never was a pure buyout firm nor is it typical of most of the companies in its industry. In the nineties, even while it was doing more- traditional deals, it was pioneering the art of using LBOs in high tech, an industry once widely shunned by the clubby, secretive buyout business as too unpredictable and risky. It has also recently been doing more and more straight equity investments, like Hotwire, where no borrowed money is used. The firm’s philosophy is different too. Bonderman and his cohorts see themselves as strategic partners with the companies they buy and invest in, not just dealmakers that buy in and cash out. “The market has changed,” says William Price, one of TPG’s three founding partners. “Buyout firms have had to focus more on growth companies and how to change them and add value after they own them. It’s not just a simple transaction approach anymore.”
The market has changed in other ways too. Now that the stock boom has subsided, and venture capital is no longer producing the returns it once did, institutional investors such as pension funds and insurance companies are pouring more cash into buyout firms’ funds. A recent Business Week article estimated that LBO funds are expected to raise a record $80 billion this year, a 60 percent increase from the $50 million they raised last year. TPG has profited from the trend; this past winter it easily rounded up $4 billion of new investment money in a mere three months—about 55 percent of the total moneys it had raised to date—for two new TPG funds, one of which was devoted to tech investments. That was a record for the firm, so Bonderman, who is known for his rock and roll parties, threw a private bash in March to celebrate, renting San Francisco City Hall and hiring the B-52’s rock band to entertain guests. About a third of the new fund already has been invested, mostly in high tech and in Europe, where the buyout frontier is less expensive and very active, as big companies streamline and shed unwanted divisions. High tech now accounts for about half the $7 billion that TPG manages. The company makes its money from fund management fees and by increasing the value of holdings. TPG won’t discuss its fee structure, but the industry norm is a 1 percent management fee and a 20 percent take of profits. Most of the tech companies the firm invests in are in telecommunications—especially wireless—semiconductors, networking, and storage technology. So far TPG hasn’t done any deals in Texas, although it’s been looking at companies in Austin and the Dallas area.
When Bonderman and James Coulter—both former financial advisers to Fort Worth billionaire Robert Bass—along with Price, a former dealmaker at GE Capital Corporation, were forming TPG in 1993, they decided that they should go against conventional wisdom and invest in high-tech companies even though almost no other buyout firms were. They saw that the industry was maturing, and though cash flows and revenues still could be volatile, tech companies at that time were getting larger, and giants like AT&T and Motorola were shedding divisions. All offered opportunities. “We decided that sitting in 1993 and not investing in technology was akin to sitting in 1893 and saying, ‘We’re only going to invest in agriculture but not in railroads or autos,’” says Justin Chang, a TPG partner in the firm’s San Francisco office who handles high-tech acquisitions.
The right deal came along in 1996, when Lucent Technologies (an AT&T spin-off) put its Paradyne subsidiary up for sale. The unit made telecommunications equipment, like modems, and was, in TPG’s view, poorly run and an orphan within AT&T—but a company with interesting technology. TPG bought Paradyne with $52 million in equity and $123 million in debt, installed new management, and split the company into two separate businesses: Paradyne Networks, which makes equipment for the digital subscriber line technology (DSL) that allows high-speed Internet access from ordinary copper phone lines, and GlobeSpan, which makes the microchips used in DSL technology. DSL, of course, has emerged as an important technology for San Antonio-based SBC Communications and other telecommunications companies. Paradyne Networks and GlobeSpan went public last year, netting TPG and its investors a stunning $1 billion in profits thus far. “Both have been phenomenal investments for us in terms of dollar return,” Chang says. But TPG didn’t sell out; it still has a stake in both companies worth an estimated $2 billion. The firm holds its investments for an average of five to eight years. “Our view is that an initial public offering is a step along the way but not an end in itself,” Chang says. “In every single company we’ve taken public, we still own a meaningful share of the company.”
Other big high-tech LBOs have followed: Last year TPG used debt to acquire ON Semiconductor, formerly the semiconductor-components unit of Motorola, in a $1.6 billion buyout that at the time was the largest LBO of a high-tech company in the United States. This spring it announced a $2 billion deal to buy Seagate Technology, a disk-drive maker, in conjunction with Silver Lake Partners, a Silicon Valley fund. Still, TPG’s partners acknowledge that borrowing a lot of money to buy a tech-driven company can be dangerous. Too much debt can cripple a company that, to stay competitive, must keep plowing money into its lifeblood, research. According to Price, TPG will use leverage only if a company’s cash flow can support it. “As we’ve been doing more technology investing, that area has naturally become more volatile, so you use less leverage because you don’t want to burden the company,” he says. Other times, as in the case with Hotwire, a straight equity investment makes more sense. Early this year TPG made the largest private straight equity investment in Europe, plowing $500 million into Gemplus, a French company that is the world’s largest maker of the electronic “smart” cards used in mobile phones and computer security systems.
E-commerce is also on TPG’s radar screen these days, although the firm is leery of the kind of highfliers that were soaring on Wall Street but then crashed this year. “Our view is that a lot of the pure online companies will not survive,” Chang says. “It’s the existing companies that have products, brand names, customers, physical fulfillment, and distribution capabilities that will ultimately win as they take their business online.” For instance, when Texas Pacific acquired J. Crew, in 1997, the company had retail stores and a catalog business, plus a strong brand name and customer loyalty. But it had no online presence. The firm assigned one of its own managers to start jcrew.com; it now rings up more than $100 million annually in sales and is one of the largest apparel retailers on the Internet. “If you have a good brand, it can play over the Internet quite powerfully,” Price says. “We hope that over time, as we build the Bally brand, the Internet will be a key part of its strategy as well.”
It’s too soon to tell whether Bonderman will be throwing another big bash anytime soon to celebrate the returns on TPG’s latest investments, like Hotwire. Meanwhile, other LBO firms are jumping into the high-tech market. And more new investment funds are popping up to go after a piece of the high-tech action. “Five years from now every buyout firm will have a technology practice or will want to have one,” Chang predicts. But for now, it’s TPG’s party and, even without the B-52’s, there’s some serious rock and roll going on.