Berkshire Partners, which h had extensive experience investing in the retail and manufacturing sectors, was initial ally drawn to o Carters because of the strong brand name night of the senior the co many had developed during d its 136 -year history y, as well ass for the street man augment team m. (See Exhibit 1 for a profile of Berkshire. ) TO o investigate the t option off a potential LOBO, Berkshire assembled d a five-member beer team, to b be led by managing directors Ross Joy ones and Bra Adele Bloom and senior associate Mice hall Occasion.
(See Exhibit bit 2 for biographical sketches. The tea am would have eve less than eight weeks to o move thro ugh all the stages of a Goldman Cash–led auction -?from initial research and due diligence to valuation and bid strategy. In addition to running the auction and thereby serve ins as Carter’s agent, Go Olden Caches (GAS) would d be offering g “staple-on” financing.
Under this arrangement, the he winning b bidder would d have the pop option to final once the deal the wrought a prep packaged capital structure proposed by Goldman Cash. L Carter’s ca arties was of mounded in 18 865 in Amended, Massage hugest.
Over the course o of 136 years in the highly y competitive apparel industry, the company became the largest branded d manufacturer Of toddler and baby apparel in thee United Estates and also a leading make Kerr of young ACH Alden’s clothing. Divide ding its mark et into five segments-?Ia eyeteeth (i.
E. , n newborn), baby sleepwear, baby play wear, young g children’s sleepwear, ND young children’s play. N. ‘ wear-?the com many sough HTH to outfit children for the first six yea ears of life, “fro mom birth to buy In the early 199 ass, the company found itself struggling g.
Owned at the time by in insurance com many Mute al Benefit Life and Wesley y Capital Corp.. , Carter’s h had developed unprofitable blew product line ones in swimwear and UN underwear, and d many of its more decorative features (zippers, cue UT bows, etc. ) were not well w received by b consumers. In 1 992, thee company installed a new w management NT team led by y CEO Frederick J. Row an, with the intention of “steering it back to its core niche off soft, comfortable 1 Moor gang Stanley had recently made a similar offering to the eventual b buyer of Dresser Equipment Grog pup-?underwriting SSL . Billion in debt financing after leading the he auction. While staple-on financing was not a typical practice, , it was becoming nag more common professor or Malcolm Baker and a Research Associate James Quinn, Global Research G Group, prepared this case. HOBS cases rare developed solely as the basis Orr class discussion. Cases are not intended to serve as endorsements, e so urges of primary data, or illustration’s of effective or ineffective management. Copyright get 0 2005, 2008, 2011 President and Fellows of Harvard College.
To rod deer copies or request permission to reproduce materials, call 1800-545–7685, write Harvard Business School Publishing, Boston n, MA 02163, or go to http://www. H hobs. Harvard. Due. No part of this pub publication m or by any mean may be reproduced, stored in a retrieval system, used in a SP broadsheet, or transmitted in any form ins-?electronic, mechanical, hotfoot opining, recording or o otherwise-?with hoot the permission n of Harvard Busing news School. This document is authorized for use only by Skylark Fang ([email protected] Com).
Copying or posting is an infringement of copyright. Please contact [email protected] Org or 800-988-0886 for additional copies. 205-058 Berkshire Partners: Bidding for Carter’s clothing. “2 Rowan arrived with 39 years of experience in the industry, most recently running the Bassett-Walker and Lee Jeans division of IF Corporation. Many members of his executive team were also former managers with IF Corporation. With a strategy of simplifying Carter’s products, Rowan and his team returned to producing what they called “high-volume, basic apparel. Product design remained relatively consistent from year to year: About two-thirds of the apparel was carried forward from season to season with the same fabric and construction, varying Only through color and artistic layout. Rowan and his team also focused on improving the capabilities of their supply chain while exploring offshore sourcing options. Throughout the compass history, it had relied on domestic manufacturing to produce its clothing. But amidst an increasingly global environment in which more and more U. S. Impasses were outsourcing production abroad, Rowan sought cost improvements and “manufacturing flexibility’ through manufacturing abroad. In 1 992, Carter’s closed two of its domestic sewing plants and made plans to close six additional sewing plants and its main textile mill. Central America and Mexico soon became the company’s first international production sites. By 1996, with operating and financial performance beginning to turn around, Carter’s was acquired in a leveraged buyout by Investor S. A. , the Bahrain-based firm est. known for its investments in Gucci Group, Asks Inc. And Tiffany & Co. Investor (see Exhibit 3 for profile) paid approximately $208 million. This included $56. 1 million in senior debt and $90 million in subordinated debt. The purchase was consistent with the firm’s philosophy of injecting “patient capital” into North American and European companies; this simply involved waiting for the business to improve before selling it or taking it public. At the time of the Investor LOBO, Carters was doing business with over 400 wholesale accounts, including department stores, national chains, and epically stores.
It had also established a major domestic presence with its outlet stores: The company operated roughly 150 retail outlet stores across the country. Consumers could purchase Carter’s merchandise through these outlets stores at a deep discount, with the outlet stores offering new products, holdovers from excess inventory, as well as assorted Carters brand accessories and licensed products. Beginning in 2000, Carters launched a new brand called Tykes. A departure from its two mainstay brands, Carter’s and Carter’s Classics, the Tykes brand was aimed at the discount channel.
Its introduction coincided with a series of conversations with executives from Target, an emerging general merchandise retailer. Target was interested in expanding the store’s offerings in baby and children’s “lifestyle” clothing. With the assurance that Carters could keep its shelves “automatically replenished,” the companies struck a long-term deal in which the Tykes brand was made immediately available at all 972 Target stores across the country. By the summer of 2001, Rowan seemed to have Carters on a path of operational and financial SUccess. From 1992 to 2000, the company increased venue at a compound annual growth rate of 9. %, with earnings before income, taxes, depreciation, and amortization (EBITDA) increasing 22. 1%. (See Exhibit 4 for selected financial. ) Analysts attributed much of the comma NYSE growth to improved brand recognition, a lower cost structure, expansion into the discount channel, and the movement of some manufacturing operations offshore-?while recognizing Investor as an able and willing partner in managing the growth. 2 Chris Rough, “Investment Bank Buys Morrows William Carter Co. ,” The Atlanta Journal-Constitution, November 1, 1996. ([email protected] Com). Copying or posting is an infringement of copyright.
Please contact [email protected] Org or Up for Sale In mid-2000, having watched over the growth of its investment in Carters, Investor decided it was time to sell its stake in the company. Investor typically looked at a range of exit options, but at the time the initial public offering (PIP) market was at a near standstill. In Joneses view: “Investor might have been able to take this company public in 2001. But they were at the end of a five-year period, and they wanted liquidity. So to sit there, take another year or two to work their way out of a public stock was not something they wanted. He added: “They’ve [Investor] got a network of investors that fund them, but if you don’t have good returns coming out to keep talking about, it makes it harder to raise money. So in the normal course they were looking to generate a win through the sale of Carters. ” Amidst rumors that a handful of potential strategic buyers had passed on the deal, including apparel companies Jones Apparel and SSH Gosh Bog’s, Investor initiated an auction among financial buyers. Christopher O’Brien, a ember of Investor’s management committee, added: “The nature of this company’s business is that it is not particularly related to economic swings.
We thought it was a company that financial buyers would find attractive in this marketplace. “3 Berkshire Partners Berkshire Partners was founded in the mid-sass by five individuals committed to creating a private equity firm “based on successful relationships, hard work, analysis, and the open decision making of all individuals. “4 By 2001 , the firm comprised roughly 10 managing directors, 4 principals, 12 investment staff (associate level), and 2 advising directors. In a given year, the firm reviewed some 1,200 potential deals, with the intention of whittling the pool down to five to six closed deals.
Jones estimated the number of times per year the firm completed full due diligence and submitted a final bid at about 12: “Our batting average is pretty good-?we tend to go all the way on things we think we have pretty good odds of winning. So we’re not making a run at 40 things and getting five. We’re doing it on 10-15, and we might get almost there on another handful. ” For each deal under serious consideration, Berkshire formed a deal team comprising our to five people. A managing director served as lead partner for each team. A team would typically contain an additional managing director, a principal, and one or two investment staff.
According to Jones, “As a firm, our work is very inclusive and collaborative in our efforts to uncover all the key information. ” While the deal team took responsibility for “making a recommendation and then doing due diligence and bringing back an investment package,” ultimate investment decisions rested with the firm as a whole. In analyzing a potential deal, Berkshire relied largely on its internal staff to array out the analysis and would “use a Pain and McKinney to help us answer or flush out a couple of issues that we just don’t have the resources to do. Beyond that, the firm relied on leading Boston law firms to carry out due diligence on contracts, leases, patents, and trademarks. Ernst & Young (E&Y) handled the firm’s accounting due diligence, which principally involved looking at quality of earnings. According to Occasion, getting the capital structure right was “an art, not a science. ” He added: “There are a lot of factors that go into determining the right financing structure. To start, there’s arches price-?dollars needed to ultimately buy the company. And, of course, there are your 3 Kelly Holman, “Berkshire Buys William Carter Co. ” The Daily Deal, July 17, 2001. 4 Berkshire Partners Web site, “Our partnership,” http://www. Breathlessness. Com/l_o_partnership. SHTML, accessed December 1, 2004. 3 returns. Obviously, if I hold purchase price steady, and increase my leverage, my equity returns will increase, and so on. ” Berkshire managers believed the equity portion of the capital structure at the time needed to be at least 25% in order to achieve the desired ratings outcome and demonstrate to the lending ease that Berkshire Was making a serious commitment.
At the time, investment banks were willing to lend at a rate of roughly four to five times EBITDA, with the multiple determined largely by market conditions. Occasion continued, ‘This is coupled with the challenge of asking yourself: Is this the appropriate amount of leverage for a business of this type; what do the ratings look like; how difficult will it be to get the financing completed; and what does that mean in terms of your total financing costs? These are all the variables that you play with to try to figure out the optimal capital structure for the business.
After taking an equity position in a private business, Berkshire saw its role as supporting management in a variety of ways, including a) helping to prioritize key objectives, b) reviewing organizational design, c) helping to “build the bench” of key managers, and d) even leading the integration process in the event of a subsequent acquisition. Jones added: would say that we’ve done a lot of work over the last several years to be more thoughtful about how to address opportunities for companies up front and align strategically with management.
So in thinking about how we add value, it is important to look t the work we do in due diligence not only as critical to making a smart investment decision, but also a critical foundation to operate from during the life of the investment. At any given time, Berkshire held a portfolio of roughly 25 investments. About half of these businesses required very little of Berkshires management attention-?the firm “was on top of these businesses” and fully expected to exit them in due course.
About one-quarter of the businesses required a moderate level of attention, and another one- quarter required Berkshire to be “very focused on them. ” Businesses earning the largest amount of attention did so “because it’s the early stages, or we could still have a meaningful impact and they’re very important to our firm’s success. ” Berkshires typical exit strategy was sale of the company, rather than an PIP, by a ratio of about four to one. The firm’s conditions for exiting via an PIP were threefold: 1) a strong brand, 2) strong growth potential, and 3) a dramatic need for capital.
Unlike many other private equity firms that often used an PIP to close out their ownership stake, Berkshire was more likely to initiate an PIP in the middle of its ownership with the intention f staying involved with the management and helping the company to grow. In many cases, a follow-on offer would ensue. Berkshires Bid for Carter’s When Berkshire Partners received an invitation to participate in the auction for Carter’s, the investment team was initially optimistic about a potential match between the two organizations.
The firm had developed a focus on “building strong, growth-oriented companies in conjunction with strong, equity-incanted management teams. “5 Berkshire viewed Carter’s not simply as an apparel company in the retail space, but more as a consumer products company. According to Jones, Carter’s being “a really Strong brand that could be leveraged across multiple channels” was something that “we found very appealing, and in general find appealing. ” 5 Berkshire Partners Web site, “Press Releases,” http:// www. Irrationalness. Com/5_1 _ 17_press. SHTML, accessed September 1, 2004. 4 ([email protected] Com). Copying or posting is an infringement Of copyright Please contact [email protected] Org or Initial Meeting On the first Tuesday of May, Berkshires five-member team traveled to New York to meet with Carter’s management. The Carter team included the CEO, resident of marketing, executive vice president of operations, executive vice president of global sourcing, and SCOFF.
The meeting provided an opportunity for the respective managers to get to know one another, to discuss the ground rules for the auction, and to begin a dialogue about the future growth strategy for Carters. To a person, the Berkshire executives were very impressed with the Carter team, acknowledging their experience, commitment, and “confidence in their five-year plan. ” (See Exhibit 5 for four elements of growth strategy. ) The initial meeting also opened lines of communication between Berkshire ND Goldman Cash, which Carter’s had engaged to run the auction process.
In the early weeks of May, Berkshires team had a number of discussions with Goldman Cash. The deal was being shown to a limited number of financial buyers (“more than 2, less than 10”), and not all potential buyers would be given the opportunity Berkshire had been given to meet with the management team prior to submitting a preliminary bid. In addition to running the auction, Goldman Cash was providing staple-on financing for the deal, although the buyers were not limited to the Goldman financing Truckee and could choose to submit a bid that would be financed by other sources. (See Exhibit 6 for proposed capital structure. Members of the Berkshire team acknowledged that a staple-on financing structure, if not actually compared against competing offers in the market, could create a conflict Of interest for an investment bank. A bank’s dual role of auctioneer and financier, if unchecked, could pressure a buyer to accept inferior financing terms in order to win the bid. Occasion stated: There were a lot of tensions inherent in the new staple-on structure. The investment banks ere concerned externally about how it would affect their reputations, and the private equity guys weren’t that excited about it.
They felt it limited their ability to get an edge in the bidding process by bringing more creative financing to deals. What the staple-on did provide, however, was generally a more expedited financing process. Nevertheless, the Berkshire team came away from the meeting in New York eager to look carefully into the deal. In the ensuing days, Goldman furnished Berkshire with a summary of financial projections put together by Carter’s management (see Exhibits AAA, b, and c). GAS also indicated that the process required potential buyers to submit equity bids of at least $130 million to be considered.