Enter the Private Investor

In the past several years, the catalog industry has become an attractive target for financial investors. These private equity firms and institutional investors differ significantly from strategic investors looking to build their own businesses.

When a cataloger like School Specialty buys 45 companies in the span of 10 years, its purpose is to build its own market share. Likewise, when Deluxe Corp. purchased New England Business Service last year. But it may be another scenario when an outside financial investor is the buyer. Such an investor may be in it only for the short-haul, to make money on the investment in three to five years, then sell it and move on to the next deal.

That’s not necessarily a bad thing. Oftentimes, financial investors have resources and expertise that catalogers wouldn’t have available to build the business themselves. Selling all or part of the company may be the only way for the cataloger to get to the next level of profitable operations.

It was about 10 years ago when the financial community started seriously looking at catalog acquisitions. Before that, catalogers were almost all independents, says Donald Libey, managing director at Libey-Concordia, Philadelphia-based investment bankers to the catalog industry. Libey notes several reasons financial investors have developed an interest in catalogs:

1. “Catalogs are formulaic. Private equity groups are [comprised of] numbers people, and with a catalog, it’s all spelled out in black and white,” Libey says. “So there’s very little risk knowing how the catalog will perform.”

2. Catalog sales are growing at 8 percent a year or more, “faster than any other industry except drug companies. This is a high growth, high margin, high return on investment business,” he notes.

3. A catalog is an integral part of a multichannel business. “For a company that wants to grow an Internet business, the catalog provides a leg up in multichannel marketing,” says Libey. “Plus, catalogers have a huge advantage in customer service levels over retailers.”

Brooke Ablon, partner in private equity firm the Riverside Co., New York, also believes the expansion of the Internet has played a role in the emerging trend of acquiring catalogs. “There’s been interest in direct marketing firms by the private equity community for a while,” Ablon recounts. “It started to accelerate over the last few years due to the effect of the Internet and online sales becoming more important to retailing. Catalogers typically have established a foothold in the Internet. And conversely, many Internet companies now have started catalogs. So there’s a natural synergy between the catalog and Internet businesses.”

Ablon notes that cataloging is a quantitative business, a feature that’s very much liked by the financial community.

He says the Lands’ End acquisition by Sears was a major event that “made a lot of the strategics sit up and begin looking at acquisitions in this industry, if they weren’t already doing so.”

Riverside has made a number of mid-size catalog acquisitions in the past five years, among them the 2000 purchase of Keepsake Quilting and the 2002 leveraged buyout of auto parts cataloger J.C. Whitney and Co. Both of those still are among Riverside’s holdings. Catalog Success spoke to former Keepsake Quilting owners Russ and Judy Sabanek about the changes that took place since their company was purchased by Riverside.

Keepsake Keeps True to Its Market

In 2000, the Sabaneks began to feel it was time to look for a buyer for their small but successful niche catalog. Recalls Russ Sabanek: “We had grown the business as far as we wanted to take it, but we knew there was more potential there. Our accountant had given us some ballpark ideas of the business’s worth. So we started to casually look around for a buyer.”

The couple worked with Libey-Concordia to zero in on Riverside Co. as being a private equity firm that fit its interests in a financial, rather than a strategic, investor. During the past four years, Riverside has further built the Keepsake business by using it as a platform for acquisitions in the quilting and knitting direct marketing industry. Keepsake already had 18 million domestic and international customers of its quilting business. In May 2002, Riverside expanded its holdings in the craft market by buying Patternworks, a New Hampshire-based supplier of knitting and crocheting products. Then in September of that year it purchased www.eknitting.com, a Berkeley, Calif.-based retail and online store.

Since buying Keepsake, Riverside has maintained a fairly hands-off approach as an owner, says Sabanek. “Keepsake has had essentially the same management with just oversight from Riverside,” he says. Until just a few months ago, Judy Sabanek retained the title and role as president. She is currently in the process of phasing out as a new president takes over the helm.

Regular monthly reporting and four board meetings a year have formed the basis of Riverside and Keepsake’s communication, says Russ Sabanek. “It’s been a very comfortable relationship. It was just what we were looking for [in an owner].”

Golfsmith Sold a Majority Stake and Grew Its Business

A few years ago, Golfsmith International, a multichannel supplier of golf equipment and accessories, recognized a tremendous opportunity in the golf market — one it was unable to tap into without additional resources.

In the United States alone, about 26 million golfers spend more than $5 billion each year on golf equipment, merchandise and accessories. “Our research indicates that we own about 5 percent of the market, which means we have the largest market share in golf retail,” says Jim Thompson, president and CEO of Austin, Texas-based Golfsmith.

Thompson was Golfsmith’s senior vice president of merchandising and retail before being promoted at the time of the acquisition. “Given that the golf retail market is highly fragmented and consolidating, we believed then — and still do today — that there’s an opportunity to create The Home Depot, Best Buy or Barnes & Noble of golf retail by garnering 30 percent or more of the market.”

Golfsmith was looking for the right financial partner to help it grow its operations and achieve its goal of dominating the $5 billion U.S. golf retail market. Golfsmith met with several potential partners before founders Carl and Frank Paul sold a majority stake, 80 percent of the company. In 2002, private investment firm First Atlantic Capital, New York, working through its private equity fund Atlantic Equity Partners III, acquired a majority stake in Golfsmith. (The Pauls continue to consult and are members of Golfsmith’s board of directors.)

Noel Wilens, managing director of First Atlantic Capital, says what made Golfsmith an attractive target for acquisition by First Atlantic was that it was a multichannel business and a quality company that still had the potential for further growth. “Certainly, we look at operations,” Wilens notes. “We look at the industry and the direction the market is headed.” With Golfsmith, he says, “We knew the market was moving to more of a multichannel environment, so it was good that Golfsmith already had all three elements of that — retail, catalog and Internet — working and in place. We liked the whole business model.”

Since the acquisition in October 2002, Golfsmith has been on an aggressive, focused plan to expand its operations, its leadership team and its offerings. For example, it has nearly doubled the number of golf superstores it operates to 46, with a nationwide footprint that spans from New York to California. The growth has been both organic and through acquisition. Key additions to the management team were made to help grow the multichannel retail operations, build the brand and strengthen the company’s position in the golf retail market, says Thompson. Golfsmith recently hired executives away from The Bombay Company, The Home Depot, Circuit City and Top Flite.

Overall, Thompson says, the relationship with First Atlantic has been a productive one. “First Atlantic, as well as our board of directors, shares Golfsmith’s goal of developing the dominant retailer in the consolidating golf retail market. The equity firm has been instrumental to our progress over the past two years.”

Pros and Cons of Private Equity Money

As executives at both Golfsmith and Keepsake Quilting catalogs can attest, an influx of private equity money can be a good thing for a business that’s poised for growth. Ablon suggests that a host of changes potentially are in store for a company once acquired. “On the positive side, we like to think we offer a company a variety of benefits,” says Ablon. He offers several examples:

1. Specific funds can be earmarked for growth, more so than normally would be available in a regular company environment.

2. Funding is available for other acquisitions, where they’d be appropriate and strategically helpful to the company’s cause.

3. Funding is available to improve the cataloger’s infrastructure, including internal systems, Internet site development, fulfillment and operations.

4. The investor can bring in other expertise to the catalog, whether it’s using personnel from the investment group or hiring executives from the industry to fill in knowledge gaps.

5. Investors can help catalogers build a five-year plan and say, “This is where we should be.” Ablon notes, “Sometimes a smaller company, or one that’s run by its founders, is too close to the business to make that kind of critical self-assessment.”

Of course, selling all or part of your business to a non-catalog investor brings new challenges, too:

1. Says Ablon, “There are financial owners, and there are operational owners. If you’re the cataloger, you need to know which it is you’re getting involved with. Neither is inherently bad, but a mismatch of expectations would be a major pitfall.”

2. The investment community is oriented to bottom-line results. “You and the financial investors may agree on expectations for the business — and they have to be met. Accountability will be important to the investors. For us as investors, the value of the business is driven by its profitability.”

3. If there’s something investors need to know about your business and how it operates — such as how you calculate customer lifetime value — make sure they know it and that you agree on a definition up front, says Ablon.

Timing

It’s essential for all parties involved in a private equity deal to recognize the financial investors’ interests in the catalog businesses they hold. Says Wilens, “Private equity firms usually hold their investment properties three to five years, depending on the company. But that’s the typical timeframe for looking for an exit strategy.”

Says Ablon: “When we buy a company, we have an idea, a strategic plan and timeframe. It’s not set in stone, but typically the hold period for an acquisition is, broadly speaking, three to seven years.”

For Riverside, the internal rate of return on investments currently averages 20 to 25 percent. “Of course, we’d always like to do better,” says Ablon. “But that’s about the industry average at present, so that’s where we’re going to look to be for our underwriting.”

Long-term Implications for the Catalog Industry

If the current level of acquisitions continues, and more catalogers get absorbed — both by other catalogers and through the process of financial acquisitions — what will the industry look like in 10 or 15 years? “More large consolidations could lead to the Wal-Martization of the catalog industry,” says Libey. “And that’s not good.”

How could such a scenario take place? Libey offers an example: Suppose a $10 million catalog is bought by a private equity firm, and during a seven-year period turned into a $50 million firm. The investor sells the $50 million catalog to a $100 million catalog company. If that scenario repeats across different catalog industry segments and an extreme consolidation takes place, you’re left with a few very large catalog houses controlling the entire industry, says Libey.

The downside, of course, is that consumers would be left with little choice. “This industry has been built on service. When it becomes about price and only price — and comparison price-shopping is the norm — then we’ve lost the soul of the catalog industry,” Libey says.

How to avoid the potential Wal-Mart effect on the catalog industry? Controlled growth by people and companies that know and understand the business, he says. “If you’re thinking about selling your catalog, pick an investment group that understands the catalog industry,” Libey advises. “Associate with solid investment groups that add value back to the companies before putting them back up for sale.”

Alicia Orr Suman is a Philadelphia-area freelance writer and the founding editor of Catalog Success magazine.