Delaware unit execs in the buyout deal’s driver’s seat

The managers of Delaware International Advisors Ltd. teamed up with private equity firm Hellman & Friedman LLC earlier this month to buy out DIAL from parent Delaware Investments, winning their independence and avoiding the embrace of strategic investors such as Putnam Investments Inc., investment bankers say.

The determination of London-based DIAL's managers to gain control of the company — and the willingness of sophisticated financiers such as Hellman & Friedman to accommodate them — might be the beginning of a trend, according to industry watchers.

The owners of the biggest financial stakes too often don't include the people who actually run the business, said Kevin Quirk, a principal at Darien, Conn.-based vendor consultant Casey, Quirk & Acito LLC. He predicts a wave of "regurgitation" as more people conclude that that "long-term alignment is a critical part of the success of money management companies."

The deal announced May 5 called for DIAL and Hellman & Friedman to pay roughly $200 million to buy DIAL's equity from Delaware Investments and its parent, Lincoln National Corp., both of Philadelphia.

Some investment bankers said the deal was unusual both for its size — the buyout will create an independent investment house with assets under management of $19 billion — as well as for the degree to which DIAL's management team, as opposed to its owners, appeared to be driving the process.

One investment banker, who declined to be named, said the process was a messy one, with Lincoln and its investment banker, Merrill Lynch & Co., New York, looking for a strategic buyer of Lincoln's stake in DIAL at the same time DIAL's management was seeking a financial investor that would leave management with a controlling stake.

Clive Gilmore, deputy managing director at DIAL, said management held discussions with Lincoln on the best means of realizing value from a deal, "but for us, we came to the conclusion that a management buyout, plus a partner, was the best option."

DIAL executives said they went about pursuing that option in a disciplined way, issuing a request for proposals to a number of potential private equity partners.

"We have to send so many RFPs out for institutional clients. We thought we'd turn the tables," said David Tilles, DIAL's managing director and chief investment officer.

Management's strong desire to gain control of the company is clear from even a cursory reading of that RFP form, which had queries such as": "Please provide an insight into your general attitude to taking non-controlling minority positions," and "Have you ever arranged lending to management to help them buy additional equity exposure?"

The RFP that management eventually sent to three finalists (from the eight candidates initially identified) left open the possibility that the private equity partner would demand a controlling stake — a nod to prevailing wisdom that it's rare in an MBO for management to have control to begin with, conceded Mr. Tilles.

But Hellman & Friedman "just understood" where DIAL's management was coming from, he said.

The San Francisco-based private equity house won the bidding on the strength of its flexibility and "creativity at meeting the requirements that we had" in gaining control and ultimate ownership, said Mr. Gilmore.

Hellman & Friedman agreed to take a "large minority stake" that wasn't so big that DIAL's management team couldn't "buy us out over time," said Matthew Barger, a managing partner at the private equity firm. "If the pie is big, there's plenty for everybody."

No details of the deal were disclosed, but Mr. Gilmore said the partnership with Hellman & Friedman gives the management team "the potential to ratchet up" its stake in the company "if we meet certain targets in year four onward."

Casey, Quirk & Acito's Mr. Quirk said such arrangements could become the rule, rather than the exception. Hellman & Friedman are "very smart investors," and the announced deal has "terrific alignment" of their interests and management's interests. In fact, he said, private equity firms might become leery of financing a management team that doesn't have a majority stake.

"We prefer to have our partners own more equity than we own…it's the ultimate in alignment," said Hellman & Friedman's Mr. Barger.

Mr. Tilles said management felt ownership and control was crucial to taking the company's success — DIAL's assets under management surged from $2 billion when Lincoln acquired parent Delaware Investments in 1995 to roughly $19 billion today — to the next level.

Lincoln had put in place a plan that gave management exposure to 14% of DIAL's equity, but with 19 directors and senior portfolio managers in their 40s, and a next generation of investment professionals in their 30s and 20s that "we want to keep and motivate," management felt it needed access to a bigger chunk of the equity.

Officials at DIAL, Delaware and Lincoln all said the decision to sever the ownership ties was an amicable one, and, pending approvals from various boards and shareholders, the newly independent firm will continue to manage money for Delaware and Lincoln on a subadvisory basis.

But some industry watchers say the $200 million price tag for a fast-growing, highly thought-of company such as Dial leaves room to conclude there were some sharp-edged negotiations going on beneath the surface.

The investment banker, who didn't wish to be named, called that price tag "a bargain basement price" for DIAL.

A lot of factors might have come into play, such as contractual obligations and non-compete clauses, and the ability of DIAL to inherit its performance record in its new corporate guise, but it appears "there was a game of guts poker" and management won, he said.

The New York-based president of another major asset management house agreed: The price paid for DIAL could easily have been two or three times $200 million, he said. But some industry players said $200 million isn't necessarily beyond the pale.

The investment banker said Putnam was the strategic buyer with the inside track on purchasing DIAL, and it had been close to closing the deal. Putnam's chief executive officer, Charles E. "Ed" Haldeman, had previously run Delaware Investments. Moreover, Putnam's own international equity product has seen billions of dollars hemorrhage away after evidence emerged last October that senior portfolio managers had market timed their own funds. Goldman Sachs & Co., New York, was advising Putnam on the deal.

Mr. Haldeman was not available for comment, and John Brown, the head of Putnam's institutional business, said Putnam doesn't comment on its corporate development activity. DIAL's Mr. Tilles declined to comment.

Mr. Tilles and Mr. Gilmore said they've been explaining the deal to plan sponsors and consultants and have gotten a good reception so far. Joe Dear, executive director of the $52 billion Washington State Investment Board, Olympia, said, "We think it's a good thing. The MBO puts them in charge of their own destiny and gives them greater incentive to perform."

DIAL invests $937 million in international developed market value equities for the Washington board.