Private equity investing is one of the hottest games in town, and Castle Harlan is one of its most respected players. The firm, founded by John Castle and Leonard Harlan in 1987, has acquired 47 companies with a total value of $8 billion, and generated realized gross returns for investors of more than 30% a year.
Asked to describe the game plan, Leonard Harlan says, "We buy dull companies in mundane industries. " If that doesn't get your pulse racing, you can turn to the company's Web site, where the most recent management letter describes deals done in the late 1990s, because it was written several years ago and no one has bothered to write a new one.
Promotion is not a high priority at Castle Harlan. Instead, the team of 11 managing directors focuses on taking positions in mid-size companies and working with managements to improve returns. They would never consider doing a hostile deal, because, as Mr. Harlan says, "We want to be viewed as positive people doing positive things." Often the original managements are brought in as equity participants. Mr. Harlan considers his role as that of "senior coach."
They have launched four funds, investing the $2.2 billion raised in companies with average EBITDA (earnings before interest, taxes, depreciation, and amortization) of about $20 million, and normally paying no more than seven times that figure. The firm has kept leverage low, with equity supplying typically 25% to 30% of the purchase price.
This traditional approach has worked so well that management decided to take the show on the road in 2000, and formed a partnership with the largest private equity shop in Australia. In a recent deal in that country, Castle Harlan Australian Mezzanine Partners sold a satellite TV company for seven times what it had paid a little more than two years ago. By any standard, that's a home run.
Essential to the company's success, according to Mr. Harlan, is choosing companies that meet its well-established criteria. These include solid, leading market positions that are not about to be displaced by some technological innovation. "Mostly we buy companies you've never heard of," explains Mr. Harlan. "We don't buy companies that are broken." The companies preferably have strong operating cash flows and high quality assets. They also offer an essential ingredient: an exit strategy.
A typical deal was Castle Harlan's purchase of US Synthetic Corporation in February 1997. The company was at the time the world's foremost manufacturer of synthetic diamonds used in oil and gas drill bits. A major owner was approaching retirement, and, seeking liquidity, sold his interest to Castle Harlan for $57.6 million, less than four times earnings. Two years later, the strengthened operation was sold to a new owner for $165 million.
In March 2005, Castle Harlan sold Charlie Brown's steakhouse chain for $140 million. It acquired the family owned restaurant group in 1997 for about $50 million. During its ownership, the company's revenues more than doubled.
Leonard Harlan did not start out in the private equity business. After earning an engineering degree from Cornell, Mr. Harlan went to Harvard Business School, where he ultimately acquired a Ph.D. before moving on to the financial services powerhouse Donaldson, Lufkin & Jenrette to work in the real estate area. Within four years, he ascended to rank of vice president and shareholder, and considered himself ready to strike out on his own.
In 1969 he founded a private equity firm, which had a great first year. And then the bottom fell out of the stock market, and his company. In a mild panic induced by the impending arrival of a first child, he harked back to his academic successes and reoriented his company toward providing advisory work in the real estate arena. Landing a couple of fortuitous contracts early on, the company took off. According to Mr. Harlan, those years prepared him well to deal with the issues that can confront managements whose companies sail into troubled waters.
Years later, his original partners left the firm, and the resulting Harlan Company was sold to Ernst & Young. In the meantime, Mr. Harlan had joined up with an associate from his DLJ days, John Castle, who practiced the private equity trade in the 1960s and was one of the first to sell institutional investors on the virtues of alternative investments. He subsequently became chief executive officer of DLJ.
In 1987 the newly formed Castle Harlan launched its first fund, raising $125 million. Early successes were impressive. Mr. Harlan explains, "We really try to get into the company's culture. We meet with the companies' management every month, and talk to them every week. We put very knowledgeable people on the boards that can counsel management." An example can be found in Castle Harlan's experience with Worldwide Flight Services, the foremost provider of ground services at major airports, bought in 1999. Castle Harlan asked Major General James E. McInerney, a retired Air Force operations whiz, Brad Stanius, the head of Smarte Carte who knew every airport in the world, and Albert Casey, the former head of American Airlines, to serve on the board. Needless to say, these advisers were valuable additions.
Over time the company has acquired a reputation for fair and honest dealing, which helps them find attractive deals even in this competitive era. That is no small dividend, given the enormous amount of money flowing into private equity coffers and the subsequent scrambling for properties.
Castle Harlan has kept a lid on borrowings, though Mr. Harlan acknowledges there is plenty of money available. "Buyers will pay what lenders will lend" is how he describes one of the reasons deal prices have shot up. Experience has taught them that leverage can mean the difference between success and failure.
And there have been failures. In 1990 the firm bought Sharon Steel, a specialty steel producer owned by Victor Posner, out of bankruptcy. Within months of completing the deal, the price of steel plummeted, taking the future of Sharon Steel with it. Castle Harlan lost its original investment of some $20 million to $25 million.
What's next for Castle Harlan? Possibly venturing into another region, though it will be tough to duplicate their success in Australia. That market offered them access to the growing economies of Asia as well as the security of operating in a country with well-established rule of law and a highly educated workforce.
Mr. Harlan believes there will always be opportunities to make companies stronger and more profitable with better financial management or marketing, and by taking firms to the proverbial next level. Should there be a period where suitors drive values to extremes, the company will be happy to sit out a round or two, as they did in the late 1990s.
With such profound good sense at the wheel, is there any doubt that Castle Harlan, too, will reach the next level?