NEW YORK - When it comes to raising and investing private equity funds, Castle Harlan Inc. has more in common with the Rust Belt than with the information superhighway.
The firm has raised millions from institutional investors to acquire everything from a furniture maker to a manufacturer of airport luggage carts.
Castle Harlan's institutional investor roster includes the Oregon Public Employes' Retirement Fund, Salem; the Amoco Corp. employee pension plan, Chicago; the San Francisco City & County Employees' Retirement System; the New Hampshire Retirement System, Concord; the Public School Retirement System of St. Louis; Orange County Employees Retirement System, Santa Ana, Calif.; United Technologies Corp., Hartford, Conn.; and the endowments of Brown University, Providence, R.I., and the Massachusetts Institute of Technology, Cambridge.
While other private equity funds concentrate on hot sectors such as biotechnology, banking and communications, the New York-based firm avoids sectors - particularly high-tech sectors - and seeks out traditional manufacturing businesses among companies with capitalizations ranging from $50 million to $800 million, according to its president, Leonard M. Harlan.
Its latest acquisition, which closed recently, is typical of what the firm looks for. Truck Components Inc., a manufacturer of components for heavy truck wheels based in Rockford, Ill., is a purely middle America company, explained Chairman John K. Castle. The company makes about 35% of all Class A truck wheels and brake drums in the United States and is experiencing good growth as a result of the increase in trucking activity caused by the upturn in manufacturing, he added. (Class A trucks are semitrailers and other heavy trucks.)
The company, valued at $170 million, had 1993 revenue of $265 million, has good cash generating potential, a well-defined market niche and its products show no signs of impending technological obsolescence, said Mr. Castle.
Castle Harlan avoids start-up situations, venture capital, industry bets and does not buy minority positions. It will not buy commodity companies, because there is no value added it can bring to them, said Mr. Harlan. In addition, it will not buy what he calls "high-tech, high-obsolescence, high-fashion businesses" because they tend to go out of favor with the next innovation.
What it does seek out is companies that have a dominant position in their fields. As an example, Mr. Harlan cites MAG Aerospace Industries Inc., Los Angeles, which it acquired last year. MAG Aerospace manufactures 60% of all the aircraft lavatories in the world and has just gotten a new contract to supply toilet systems for Amtrak trains.
The Truck Components acquisition was the fourth in five months for Castle Harlan's second private equity fund, Castle Harlan Partners II. Since closing in April 1993, it has acquired controlling interests in four companies valued at more than $500 million with total annual revenues of approximately $450 million, and invested approximately $60 million of the $255 million raised.
In December alone, Partners II acquired three companies worth $323 million within a two-week period. The new acquisitions include MAG Aerospace; INDSPEC Chemical Corp, Pittsburgh, a manufacturer of resorcinol, a compound used to bond tires; and Smarte Carte Inc., White Bear Lake, Minn., a manufacturer of airport luggage carts.
Messrs. Harlan and Castle had been colleagues at Donaldson Lufkin & Jenrette, New York, where Mr. Castle had started DLJ's private equity funds, now known as the Sprout Group, in the 1960s. In 1986, he resigned as president and chief executive officer of DLJ to form Castle Harlan along with his former colleague, who was then chairman of The Harlan Co., a real estate firm.
In 1987, the firm closed its first fund, Legend Capital L.P. with $125 million in commitments. It invested $118 million acquiring controlling interests in companies such as furniture manufacturer Ethan Allen Inc.; the seafood restaurant chain Long John Silver's, Inc.; Delaware Management Holdings, the Philadelphia money management company; and Quantum Restaurant Group, parent company of the Morton's of Chicago chain of steakhouses. So far, Legend has returned $77 million to investors, and Castle Harlan estimates the fair market value of the remaining investments at $124 million.
The firm started operating in November 1987, weeks after the Oct. 19 stock market crash. At that time, private transactions still were basking in the high profile created by megadeals engineered by takeover firms such as Kohlberg, Kravis and Roberts, said Mr. Harlan. But both Legend and Partners II operate differently from the buy-out specialists of the '80s, he added.
"I think the biggest difference that distinguished us from other people in the business at the time was that we did not promote ourselves as financial engineers that would take a company, split it into 20 million parts and sell them all off to different parties," said Mr. Harlan. "We have earned our money the old-fashioned way, by growing companies, instead of just playing with the balance sheet. At that time, we were one of the few folks in our business focused on that."
As an example, Mr. Harlan cites Delaware Management, which Castle Harlan was negotiating to buy at the time of the market crash. At the time the deal was closed in June of 1988, it had $16.5 billion under management, and today it has almost $27 billion. After the buy-out, Castle Harlan brought in Japanese insurer Tokio Marine as an investor, with a 10% stake in the company, as well as an asset management client and a partner in expanding its operations into Japan.
Castle Harlan also requires the companies' existing management purchase stock and make an investment along with the fund. Management tends to have a different attitude when their own money is involved than when they are handling other people's money, Mr. Harlan said.
For example, in the Truck Components deal, Partners II put down $17 million of the $163 million purchase price, company management put another $3 million and the remainder was raised through the debt market. Mr. Harlan added both he and Mr. Castle have invested their own money in their funds.
As a rule, Castle Harlan tries to close deals before they reach Wall Street, said Mr. Harlan; once the company has reached the market, it is already in an auction form and prices tend to be driven up, he said.
Once the transaction target has been identified, the company does an exhaustive due diligence process, said Mr. Castle. Castle Harlan management visits the facility, sometimes along with manufacturing specialists familiar with the industry, and accountants and investment banks pore over the company's finances.
After the acquisition, Castle Harlan's strategy is to provide the businesses with management advice and raise capital for expansion and diversification. For example, Mr. Harlan noted Smarte Carte was a family owned company whose owners had to personally guarantee all of its debt, which had kept a lid on expansion.
By acquiring the company, Castle Harlan is freeing it from that constraint and providing the financial wherewithal to expand where it couldn't before, he said.
That is one of Castle Harlan's selling points when seeking both potential investors and companies to acquire, according to its principals. Mr. Castle said he and Mr. Harlan have had a long established record investing in and managing growing companies, and that has built up their credibility in the business, which helps in their efforts.
The gunslinger image created by the megadeals of the '80s made it tougher to raise money for a while, particularly among pension funds concerned about the "Barbarians at the Gate" image of buy-out specialists making outrageous profits from their deals.
"It did create an unsettled feeling among a number of pension plans and made it that much more difficult to present ourselves," said Mr. Harlan. That feeling has eased in recent years, but lining up institutional investors is still a selling job.
With expectations of economic slow growth during the next decade, Mr. Harlan said money managers are expecting returns in other asset classes will be less and are pushing their clients to move assets to alternative classes.
That should help, but in the end, it's their reputation on the line, said Mr. Harlan.
"It's a people judgment ultimately. They get all the numbers in the world and mark them down, fill out the forms - whatever. But when all is said and done, you sit there and say 'I have confidence in these guys. They can deliver.'"