The New Tycoons: Inside the Trillion Dollar Private Equity Industry That Owns Everything (Bloomberg)

by Jason Kelly

  Three days before we met in something close to the geographically dead center of Pennsylvania, her team, Clemson, got clobbered by Georgia Tech and she was, as they say in the South, still spittin’ mad. “I can’t even talk about it yet,” she said as we drove to lunch. Then she proceeded to talk about it extensively, and passionately, deconstructing her beloved Tigers’ loss and the implications for their now-faded national championship hopes. Later, when the talk turned back to her work at the private-equity firm TPG, she used a couple of football analogies to explain what she actually does.

  We chatted over sandwiches at Maria’s, a small sandwich shop in Bellefonte, Pennsylvania. Our waitress told us the special was a meatball sub, and Conklin, tempted for a few seconds, opted for the Italian sandwich on bread we were assured was homemade.

  “I just can’t bring myself to order meatball anything,” she said. Her mother’s meatballs are just too good, and it feels like a combination of disloyal and foolhardy to the younger Conklin to eat them anywhere but at home. Certainly everyone’s family history informs their own choices. Few more so than Conklin, whose career as an engineer and executive began with a life-changing accident. She was three years old, living in Ossining, New York, with her older brother and parents when her father dove into Conklin’s uncle’s pool and broke his neck, leaving her to watch as he was carted away in an ambulance. Doctors initially thought they wouldn’t save him at all, then told him he wouldn’t see 40 years old.

  The resulting paralysis changed the entire course of the Conklin family’s history and Deb’s own life. They left Ossining and moved across the Hudson River to New Jersey to live near her grandparents. They stayed there until Deb was seven, when a trip to South Carolina to visit her aunt and uncle over Easter prompted her parents to buy a house in Lancaster, South Carolina, near the North Carolina border and a short drive to Charlotte.

  Conklin became an apprentice of sorts to her wheelchair-bound father, an engineer who regained limited used of his arms and hands. They spent hours in the family’s carport, Deb following his instructions about which wrench to use for various projects.

  “I became his hands,” she’d told me a year before we met in Pennsylvania.

  I’d been introduced to Conklin originally as part of a Bloomberg Businessweek story on TPG’s “ops” group. In the intervening year, she’d finished up an assignment in San Diego with another portofolio company and now was on loan to another TPG-backed firm, plastic bag maker Hilex Poly. Milesburg, Pennsylvania is the site of the company’s second-biggest facility. Conklin is a member of the field operations group, a subset of the 60-person operations team inside TPG. She spends upwards of 45 weeks a year on the road, returning most weekends to her house on a lake in Charlotte. The Hilex Poly gig is a good one for several reasons. Initially seen as a “fly-by” assignment, she said, it morphed into her first COO role. Hilex’s headquarters are in Hartsville, South Carolina, a couple of hours from her folks’ house. That means most weeks she can head down on Sundays, stop in for dinner with her parents, and then on to Hartsville, and often she sees them on her way home on Thursdays. In October 2011, she attended her father’s seventieth birthday party.

  Once the money is deployed by a private-equity firm, it’s up to people like Conklin to put it work. What she and people like her do, at TPG and beyond, stands as one of the biggest shifts in the private-equity equation during the past decade. That time period has seen the rise of “ops” as crucial to getting the money to generate the returns private-equity managers have promised their investors. Conklin and her ilk, many of whom are honest-to-goodness engineers, stand in contrast to the so-called financial engineers that earned private equity a nastier reputation. Financial engineering involves using leverage and creative balance sheet work to generate a return. With less debt available and higher prices, private-equity firms are focusing on actually changing companies’ businesses to make money.

  With rings and watches left back in the office, we grabbed clear safety glasses and disposable earplugs from a dispenser just inside the door to the factory. I reminded Deb that when we went to Bay City, Texas, the previous November to take a tour of a Valerus Compression plant that was part of her assignment at that time, we needed hard hats and steel caps strapped on our shoes. “I’ve spent more than any other person alive on various safety equipment,” she said.

  Part of TPG’s theory for people like Conklin is that her skills as an engineer and expertise in a corporate philosophy called Lean manufacturing are ultimately transferable, not only across manufacturing operations but even in service businesses. Conklin, before Valerus and Hilex, was a vice president embedded at Caesars, running around the world figuring out ways to improve everything from check-in times at hotels to the efficiency of a cook in the kitchen, then working as a part of the senior management team to push Lean initiatives through the company.

  Conklin led me through the creation of a plastic bag. There’s the extruder that shoots a cylinder of 450-degree plastic 15 feet up to the next floor, where machines turn slowly to create rolls of plastic. As we descended to see what happens next, I asked Conklin whether she knew anything about plastic bags before she got this job. Over the din, and through my earplugs came the reply: “Heck no!”

  TPG counts on the likes of Conklin to prove out the investment thesis here at Hilex and other companies where the firm has collectively decided they can somehow use their prowess around costs or revenue growth to make money. She and her cohorts take on senior roles inside the company, and are far from being occasional advisers. The ops component of TPG is overseen by Dick Boyce, a slight, serious looking fellow who came to the firm almost 15 years ago, recruited by Jim Coulter. The TPG founder had met Boyce a decade earlier when Coulter was a summer associate at consulting firm Bain & Co., where Boyce was a partner. Boyce went on to senior positions at companies including Pepsico, where he rose to oversee the soda giant’s operations. Coulter came calling in 1997, only a handful of years after TPG, then called Texas Pacific Group, was born. Coulter and co-founder David Bonderman, emboldened by the huge profits from selling a once-broken Continental for more than 10 times their investment, wanted to build an operations capability within the firm to replicate that success.

  Continental has emerged as one of the defining private-equity deals, by dint of its timing in the industry’s evolution, as well as what it gave rise to. Coulter and Bonderman, who’d met investing money for the Bass family in Fort Worth, Texas, decided Continental was worth buying and fixing. The birth of TPG was for that deal; the funds came later. Continental required the men to bring in operational experts from the top of the executive ladder through the organization.

  They were hooked, both on the tangible changes they could make, and on the financial rewards it could generate for them and their investors. The then 32-year-old Coulter, looking for ways to institutionalize an operations-centric approach, plumbed his network and came up with Boyce.

  Boyce brings a Mr. Spock-like intensity and logic to the TPG process and tends to use diagrams and charts to explain an issue. The soft-spoken Boyce is a relentless networker and his assistant maps his travel schedule to his Rolodex, scheduling catch-up coffees and dinners with former colleagues and partners to keep up to date. One TPG operating partner, Vincenzo Morelli, met Boyce when the two were in business school at Stanford and played in a standing Saturday morning soccer game. Two decades later, he went to work for Boyce in Europe.

  Boyce favors shirts with buttoned-down collars, and during one of our conversations at a partners meeting for the firm in New York, he made a point of showing me that he’s in fact wearing a tie from J. Crew, which at that time TPG was buying. Again.

  J. Crew, back in 1997, was one of the first deals Boyce worked on for TPG. The firm had bought the company for about $500 million from the family that had created it and quickly decided to fire the CEO before finding a suitable permanent replacement. Boyce, far from a fashionista, got the job and kept it until Coulter woo
ed Mickey Drexler, who runs the company to this day and who negotiated the second sale to TPG in 2011. The J. Crew deal, redux, brought TPG and private equity into a different sort of spotlight and triggered some uncomfortable questions from shareholders, some of whom sued over the buyout.

  At issue was who knew what and when. Coulter had remained on the J. Crew board, even after TPG sold most of its investment after taking the company public in 2006, and he remained close to Drexler. According to public and court filings, Coulter approached Drexler about a new deal to buy J. Crew, noting the company’s depressed share price. Drexler’s delay in notifying the board caused shareholders to accuse him of trying to keep anyone from competing with TPG to buy the company. J. Crew ultimately settled the lawsuit, agreeing to pay the shareholders $16 million. The total value of the buyout was $3 billion.1 Why buy the same company all over again? Coulter and Boyce said TPG has a whole series of things it can do, in concert with Drexler, to grow J. Crew in a new way, both geographically and through new products and brands. In the years since it bought and sold J. Crew the first time, TPG has pushed deep into emerging markets, especially China, a market where J. Crew had virtually no presence.

  There are more and more Deb Conklins springing up around the world of leveraged buyouts, as private-equity managers, in the wake of the financial crisis, scramble to prove their operating bona fides. Showcasing a team dedicated to ops or a slate of proven managers from the corporate world became de rigueur in any investor and public presentations, and pitches to journalists, as buyout firms sought to burnish their image.

  “It’s completely, radically changed,” Blackstone’s Steve Schwarzman said. “It’s no longer enough to buy a company and see how it does.”

  Firms like TPG, Clayton Dubilier & Rice, and Bain Capital all trace their lineage in operations back to their firms’ inceptions. KKR has bulked up its Capstone unit (an internal consulting business that works with deal partners in the due diligence process as well as after the company is purchased) since its creation in 2000. Carlyle early on tapped what it originally called senior advisers—former executives of big companies brought in to help seal deals and consult—and now calls operating executives. Regardless of how they came to be, it’s a key talking point for any firm trying to pitch an investor, or a target company.

  The importance of operational expertise, and just the fact that it’s talked about as much as it is, is revealing about the industry—those who have a stake in what private equity are demanding to unpack what’s inside the black box. Investors especially are unwilling to settle for the bare minimum information about what the private-equity firms are actually doing with their money, and how they’re getting to the profits they eventually distribute. A variation on that is true for another key constituency: the workers at the companies bought by private equity and, in some cases, the labor unions that represent them. Spooked by stories of massive job cuts and factory closures, they’re demanding insights into what buyout firms do after the deal closes.

  Another reason operations have come to the fore is due to what can generously be called enlightened self interest for buyout firms; simply leveraging up a balance sheet and flipping it rarely works anymore.

  That’s mainly because of the simple mechanics of any market, especially in modern times. The early private equity industry thrived in part because of imperfect information. That is, a firm could make a lot of money by buying something cheap, putting leverage on it, and selling it to someone else without doing much to it. In an age where there are few secrets, especially when it comes to companies that might be for sale, finding that unwanted, undervalued, and unknown company to buy is exceedingly difficult.

  This gets to the heart of a private-equity fallacy, what in investment banker-speak is known as a “proprietary deal.” Buyout managers, especially when they’re pitching investors, love to talk about proprietary deals, and their ability to find them. A deal that no one outside of the interested parties knows about until the deal is closed is at best endangered. Any investment banker involved in a sale, or any executive running a company, is going to do their best to ensure they attract the best price from the market. Given the amount of money in private equity alone chasing deals—the total “dry powder,” or committed, unspent capital in all types of private-equity funds was close to a trillion dollars in 2011, with about 41 percent of that held in leveraged buyout funds2—stiff competition for almost anything is a foregone conclusion.

  How each of the big firms approaches operations ties back to their own roots. TPG’s Coulter, trained as an engineer, and Boyce, a veteran of Pepsi and Bain, speak in reverent tones of this combination of consulting and, in Coulter’s words, “academy companies,” where executives get high-quality operations training and experience.

  The management consulting thread runs strong through the industry, nowhere more so than Bain Capital, which was born of that business. Mitt Romney, has been well-documented during his U.S. presidential run, was charged with taking the management consulting playbook—dropping into a company and working with management to fix what was broken—and turning it into an investment business.

  Amid all the hubbub around Romney’s candidacy, I talked with Mark Nunnelly, a long-time Bain partner about the specific business of applying those methods in the investment world. He pointed to Bain’s investment in Domino’s Pizza, a deal Romney has cited as one that turned out well for everyone involved.

  Romney was deeply involved in winning over Domino’s, which was based in Michigan, where he grew up. Romney and Nunnelly were among those invited to pitch founder Thomas Monaghan, who had made it clear to his advisers that he wanted to sell the company and get out of the business, not find a partner to keep growing the pizza chain with him at the helm. Monaghan’s strategy had the implicit endorsement of none other than the Pope. A devout Roman Catholic, Monaghan was challenged by the Pontiff to do something to change the world. He realized the only thing worth enough to fund his quest was the pizza company he’d created with his brother.

  Monaghan was a tough man to court, and Romney’s attempt to bond over a shared Michigan lineage flopped when it turned out Romney’s brother was running for office against one of Monaghan’s close friends. As the clock on one of their meetings ran down, Romney noted a model of a 1957 Chevy on Monaghan’s desk. The ice was finally broken as the men bonded over a love of cars. Bain eventually won the deal, paying $1.1 billion for Domino’s.

  With Monaghan out (he’s gone on to devote the majority of his time to Catholic charities, including a new university), Nunnelly stepped in as the temporary CEO. More than a dozen Bain executives, split among deal guys and operating specialists, took on everything from uniforms to new products and promotions to pricing and expansion. They recruited a new CEO and revamped what had been a “siloed” management strategy, Nunnelly said. They reversed an effort overseas geared toward putting a small number of outlets in dozens of countries to focus on building bigger businesses and more substantial presences in six or seven key overseas markets.

  Ultimately, Domino’s doubled its sales across the chain and international sales increased by five times, Nunnelly said. The company went public in 2004 and has a market cap of about $2.4 billion. Through dividends and selling stock, Bain ultimately made about five times its money on Domino’s over a 12-year period. “It demonstrated the full arsenal of our tools,” he said.

  Take as a given that very little is going to come empirically cheap and that these guys actually have to do something with the company. A private-equity manager few outside the business have ever heard of saw this in the late 1980s and was among the first to do something about it.

  The view from Jay Jordan’s office is actually better than Henry Kravis’s down the street. He sits on the 48th floor of the General Motors building, the tower that’s at the southeast corner of Central Park, across the street from the Plaza Hotel. Its first floor is home to FAO Schwartz—where Tom Hanks danced on the piano in the movie “Big”—and th
e CBS Early Show. The Fifth Avenue Apple Store plunges into the building’s plaza, designated by a massive glass box with the lit Apple logo.

  Tourists with Christmas lists were pouring into the Apple cube on a chilly afternoon when I met Jordan, who was dressed in a blue and white striped shirt and worsted wool slacks. Prompted by my comment about his view being superior to KKR’s, he glanced in 9 West’s direction and started talking about how KKR, specifically “Jerry and Henry,” turned him on to the “bootstrap” business.

  Jordan, working at investment bank Carl Marks in the late 1970s, heard through a friend about what Kohlberg and his young associates were doing in their post-Bear Stearns life so he convinced his bosses to let him do something similar. In 1982, he left and started his own firm, called The Jordan Company. Like KKR, he found insurance companies and pensions hungry for returns that would outdo the public markets. “There was definitely a market there,” he said.

  Like most entrepreneurs, he was insistent on doing things a certain way. To this day, the firm focuses its hiring almost exclusively on associates to ensure that employees learn the ways of the firm at an early stage of their career.

  Jordan made an exception in 1988 when he saw that he needed to do something radically different with the business. There was a limited number of things to buy and growing competition. The returns he and his handful of competitors had achieved weren’t going to last on this business model. “The whole industry was financial engineering,” Jordan said. “I always thought the music would stop.”

  He called his former roommate at Notre Dame, Thomas Quinn, who at the time was an executive at the health care company Baxter International. Jordan convinced him to join the firm to run a new unit, the operations management group, or OMG. The underlying theory was relatively simple: a sharp focus on cutting costs to drive the bottom line through programs like streamlining factories, organic growth for the top line, and intense strategic planning to make smart acquisitions that built the business.