Argyle Conversations
by Argyle Executive Forum
David McGovern, Managing Partner of Marlin Equity Partners, discussed private equity’s role in corporate divestures and the reasons why large companies are shedding non-core divisions.

Elizabeth Cooke: Can you start by telling us a bit about your background and your start in private equity?

David McGovern: I started off as a lawyer at Gibson, Dunn & Crutcher in Los Angeles doing M&A work for a couple of years before moving into investment banking. I began in private equity and principal-level investing in 1999 by doing complex operational transactions, primarily in the technology industry. This was during the dot.com boom when a lot of capital was chasing high growth, low revenue businesses and it created a very attractive opportunity to invest in more mature technology businesses including hardware, services and traditional license-maintenance model software companies.

During that period, I was able to do some interesting corporate divestiture transactions. For instance, I led the acquisition of the Learning Company from Mattel which was a very large extraction and restructuring. Mattel had paid $3.5 billion for the company and it was losing a million dollars a day. I also acquired Micron Electronics’ PC business and Verifone from Hewlett-Packard which were similarly complex carve-outs and restructurings. These divestiture transactions occurred in rapid succession and laid the groundwork for what has become a career in operational focused investing.

When I founded Marlin in 2005, I saw the opportunity to bring this model of investing to the middle market. Since then, we have raised over $1 billion of capital and have completed over 60 acquisitions, including nearly 20 corporate divestitures.

What was the opportunity that you saw in the market when you founded Marlin?

In 2005, the private equity industry was growing very rapidly and there was a significant amount of capital being raised at the upper end of the market by the Blackstones and TPGs of the world. It seemed like many private equity firms were pursuing larger funds and larger deals, which created a logical opportunity in the middle market for firms like Marlin.

When it comes to the Marlin style of operationally focused investing, there tend to be opportunities across market cycles, whether it’s an up market or down market. We decided to focus on divestiture opportunities that were not on the radar of the larger buyout funds, yet required a level of sophistication and complexity that many mid-market firms lacked the operational resources and depth to handle.

Marlin has been one of the most active acquirers of corporate divestures in the past few years. What differentiates you from other buyers in a divestiture process?

Yes, we have been very active and have completed close to 20 corporate divestiture transactions since 2008. We have acquired divisions from some leading corporations including Thomson Reuters, Illinois Tool Works, Tyco Electronics, Unisys and Reader’s Digest, to name a few. What makes us different – and what I think the corporate seller finds attractive – is that we have a dedicated in-house operations team. We’ve built a captive consulting group within Marlin that consists of more than 30 operating partners who help us with our due diligence and develop the post-closing operating plan. They typically work in concert with the divisional management team; that way we have the same team completing due diligence, developing a plan for how we’re going to extract the business and executing on that plan post-close.

That’s a benefit to the seller as well, because a lot of private equity firms outsource that work to transaction service providers and accounting firms, and once a deal is closed, it is a third party that’s helping them complete the difficult work of an extraction. Utilizing our in-house due diligence team allows us to have continuity from start to finish and ensures that we are focusing and executing on the specific objectives of the seller, while we’re putting together our go forward plan.

Also, when acquiring divisions that have overlapping customers with the parent’s core business, we work closely with the seller to be a good steward of the business and protect their long-term customer relationships. We spend a lot of time working out the specifics on how we’re going to treat customers post-closing to ensure that they will continue to look at the seller in a positive light. Often, they also need reassurance that we’re going to treat the employees well and continue the same corporate philosophy and culture that they’ve had in the past.

This mentality of being a solution provider in these complex transactions is what I think gives us a leg up on our competition, because it gives us the ability to provide the speed and certainty that sellers typically seek in a divestiture transaction.

What are some of the primary drivers that lead a corporation to divest a business?

In today’s market, where you have slow economic and revenue growth, companies are looking at their business lines to identify what is dragging down overall growth or performance, and focusing in on those areas where they can actually drive growth and improve margins. Many large corporations are public, so they want to find a way to improve their stock price. That’s why we tend to see companies consistently refocusing their efforts on their core strategy, exiting underperforming divisions and driving their own growth through acquisitions. Sometimes when a corporation makes a large acquisition they take on pieces of the puzzle that do not fit and may shed those non-core businesses. Also, in any market, good or bad, you tend to have turnover of management which will influence the strategic plan of a company; new management often wants to put their mark on a business and will decide to divest divisions that they do not believe fit with their objectives.

Those are the common catalysts for corporate divestitures, but during the downturn, you also had over-leveraged businesses that were selling companies, whether performing or not, to raise cash to pay down debt. We also saw money-losing businesses that were being divested because the parent was faced with funding losses and a significant time and attention drain. As you can tell, there are a number of different drivers, so we try to listen closely to what the seller is trying to accomplish in order to provide a positive outcome.

How do you typically interact with corporate development teams?

Each corporation is unique. You will find that some have corporate development teams that are very active from an M&A perspective in terms of driving strategy, and will work closely with their boards to evaluate which businesses should be divested. Others tend to defer to the specific business units within their organization, and at the corporate development level, they tend to act more as investment bankers in facilitating transactions. So it all depends on the setup; if they’re more operational-focused, we’re dealing with them from an operational perspective; if they’re more of an M&A-focused team, we’re dealing with them more from a transactional perspective.

At Marlin, we have investment professionals and operational professionals who are former CEOs who have run large businesses. We also have specific line function people who are focused purely on HR, IT, facilities and leases. Additionally, we have finance, diligence and tax professionals who are focused on those specific areas. Early in the process, we work collaboratively with the specific corporate line function personnel to make sure that we are all on the same page and then we maintain an ongoing dialogue as we develop a comprehensive strategic plan.

Are there any particular industries that you focus on at Marlin or do you consider yourself a generalist?

We do consider ourselves generalists, but we have had a lot of success in technology over the years. We have also done a significant number of deals in the services, manufacturing, consumer and healthcare sectors. We want to find businesses that we can grow or improve through operations. Ultimately, our job is to drive returns for investors, so we focus on businesses, across a number of industries, where we see opportunities to create value.

Finalizing and completing an actual divestiture can be one of the more challenging areas of M&A. Can you talk a little bit about some of the pitfalls you’ve seen as a buyer when you’re trying to complete a divestiture transaction?

The biggest pitfall in a divestiture transaction is typically a poorly defined transition services agreement. Every business is different in terms of the level of integration that’s occurred. Sometimes you are buying a product line or division that lacks a standalone infrastructure or occasionally it’s a more straightforward carve-out. In almost every situation, you need to consider key shared services like ERP systems, finance and accounting. We spend a lot of time evaluating what it’s going to take on the front end of the sale process to stand the business up on its own.

The transition services agreement is really an operational document, but we have been in situations where people view it as similar to a purchase agreement negotiation and try to drive value through it. That’s probably not a smart way to go. The biggest issues have come from not having constant communication regarding the TSA, so we try to setup a daily communication protocol. At Marlin, we have specific line function people who are responsible for each of the various elements that might be at play in a TSA, so the corporate seller benefits from working with us and having that direct line of communication. I think some other firms may not be equipped to have that level of communication throughout a divestiture process.

If you look at traditional private equity firms versus Marlin, what are some of the ways you may differ in your sourcing strategy?

The secret sauce is really never a big secret. It’s a relationship-driven business and it’s about staying in front of people and making sure that they understand what you bring to the table. It’s doing what you say you are going to do and having strong references. Our customer is a corporate seller, so we try to be a good corporate citizen and show that we can be a trusted partner in the divestiture process. We try to stay in front of all the large corporations out there that may be divesting businesses to tell them our story and what we are – and more importantly, what we’re not – capable of.

Can you walk us through a successful divestiture that Marlin has completed?

Yes, we have a few. One in particular that captures a number of the elements that we see in corporate divestitures is a business we bought out of Tyco Electronics back in 2009. We had worked with Tyco on another deal that they had sold through an auction process that unfortunately we didn’t win, but they enjoyed working with us and gave us an opportunity to buy a lithium-ion battery business that we rebranded Palladium Energy. It was a fully integrated business within Tyco, with various legal entities across multiple countries. It also had no back-office function, nor one for IT, telecom, finance, treasury, HR, legal, purchasing; you name it, they didn’t have a standalone function. On top of that, they didn’t have a full management team. They had a general manager for the business, but everything else was shared with Tyco. We had to build out the entire management team, and outside of Brazil it was an asset purchase, so we had to set up new legal entities globally, including in China. From a carve-out perspective, it was as complex as it gets.

That required a collaborative project management approach with Tyco where we had to coordinate cross-functional carve-out activities, both from a pre-closing perspective and a post-closing perspective. The carve-out was completed within three months of closing, which is very fast for a situation as complex as this, especially considering that we had to get the Chinese and Brazilian approvals that were required. We took the division and stood up a new ERP system for three manufacturing plants, built out a data center to house IT and telecom equipment, put in payroll systems and benefits incentives, aligned the company’s management and employees with our interests and brought in back-office teams for IT, telecom, finance and treasury.

From a legal perspective, we had to set up tax-efficient legal structures including all of the licensing required in China and Brazil, establish bank accounts, a credit facility and then ultimately rebrand the company. All of that happened between signing and the three months after closing. It was a great experience for Tyco and got us into a fantastic business in Palladium. When we bought the company it was primarily a single-purpose business selling battery packs for cell phones. We have since expanded into new markets for everything from phones to GPS devices to medical devices to handheld POS devices. We created a diversified business that is stronger for the customers and our employees, and we have seen revenue and profits grow every year. That is a good poster child for what we do, not just from a corporate seller’s perspective, but from an employee and management team perspective as well.

What is your approach to leverage in some of these transactions?

We are generally low users of leverage and I wouldn’t classify us as a leveraged buyout firm. Often complex transactions are difficult to leverage because they may not have historical standalone financials that a lender can get comfortable with. In some cases, we are able to get leverage based on our historical experience with lenders and our pro-forma numbers, but overall it’s a low amount of leverage. Occasionally, some of our deals have no leverage at close.

What we want to do is give the business a chance to succeed without being tied down with significant cash flow drains at the outset. It’s all about making sure that the business has enough free cash flow to get stabilized after the extraction has been completed.

In closing, it would be helpful to learn more about Marlin’s geographic focus given that corporations are divesting worldwide.

We are primarily focused on investing in North America and Europe, but we have the ability to invest worldwide. Many of our portfolio companies are multinational in scope, such as Palladium which has meaningful operations in both Brazil and China.

BIOS:
David McGovern
David McGovern founded Marlin Equity Partners in 2005 and has been a private equity investor since 1999. He is Managing Partner of the firm and Chairman of the firm’s Executive Committee and Investment Committee. Marlin specializes in acquiring non-core divisions of Global 1000 corporations and has extensive experience structuring customized solutions to meet a corporate seller’s objectives, including complex carve-outs and structured partnerships. Since 2005, Marlin has completed over 60 acquisitions, including nearly 20 corporate divestitures. Mr. McGovern has significant expertise in the mergers and acquisitions process, corporate strategy, turnarounds and acquisition integration. He has been involved in all aspects of acquiring and managing investments, including deal sourcing and qualification, transaction execution, portfolio oversight as both a director and officer, and realizations through sales, public offerings and recapitalizations. Mr. McGovern has served as an officer and/or a member of the Board of Directors for numerous highly successful businesses, including Emptoris, Solarsoft, Aldon and Intuitive Manufacturing Systems, among others. Prior to his private equity career, Mr. McGovern was a senior investment banker at CIBC and an attorney at Gibson, Dunn & Crutcher. He earned a J.D. from Georgetown University Law Center where he was an editor of The Georgetown Law Journal (law review) and a B.S. in Finance from Louisiana State University (Beta Gamma Sigma).

Elizabeth Cooke
Elizabeth Cooke is a member of Argyle Executive Forum’s content team. Argyle Executive Forum is a professional services firm that convenes and connects business leaders from highly targeted business-to-business communities for strategic collaboration and business development. More than 25,000 executives participate in one or several of Argyle Executive Forum’s communities, with more than 200 new members joining every month. Prior to joining Argyle Executive Forum, Elizabeth worked as a senior search consultant for a boutique executive recruiting firm covering the investment banking and private equity markets. Additionally, she was a senior sales executive at the New York Stock Exchange, calling on C-suite executives and venture capital firms. She holds a Bachelor of Science degree from the University of Colorado at Boulder.