“Battle over Benihana Comes to a Boil with Dual Class Structure at Issue”

“We realized that management needed help,” said Cunningham, who managed the convertible securities division of Jefferies for 18 years. “Wall Street, over the past two years, has made it clear that their interests come before everyone else’s. The system is inherently conflicted when a bank represents both buyer and seller.” However, “we’re not saying Wall Street is broken, but it needs to be tweaked.”

He and Pritchard said they hope to reach out to a potential client as consultants soon after it decides to raise money through a debt or stock sale. At this point, they say, the competitive dynamics among banks are strongest, and companies planning a transaction are in the best position to question bankers and understand what an underwriter will do for the issuer.

“We have familiarity across the capital markets spectrum – equity, equity-linked high-yield and bank debt – and will consider the pros, cons and dynamics of each,” Cunningham said. The two executives say the fact that many banking firms have inherent conflicts makes the process of hiring one risky for inexperienced clients.

“The bottom line is that the customer is always right, but banks serve many customers. Our role will be to sit squarely on the side of management without allegiance to anybody,” said Pritchard.

Pritchard and Cunningham are their firm’s sole backers, though they would not reveal how much startup money they spent. The two rent office space at the headquarters of the private-equity firm Basso Capital Management. “Right now, we’re not a capital-intensive business,” Pritchard said. Aequitas aims to consult public companies with enterprise values of up to $2 billion, though Cunningham said: “We are agnostic about the size of the company, the industry, and the securities they want to issue. We don’t like to draw lines.”

Aequitas expects two-thirds to three-quarters of its advisory work to come from firms that want to raise capital through the sale of equity and debt. It also will help issuers plan convertible debt offerings.

“We are not about pushing back and saying ‘No.’ But we want to help companies avoid pitfalls,” Pritchard said.

Cunningham said many of his firm’s assignments could be related to corporate debt issuance. “Over the next two years, there will be much refinancing of debt,” and many businesses could sell stock for that purpose, he said.

Craig Stevenson, a 35-year shipping industry banker and the chairman and chief executive of Diamond S Shipping of Greenwich, Conn., was chairman and CEO of the oil-tanker owner OMI Corp. when he worked with Pritchard. In 2004, OMI hired Jefferies to price convertible senior notes at 2.875% in a private placement.

“When you start talking converts, Dave is one of the most knowledgeable guys I’ve come across,” Stevenson said. The note placement “gave us the opportunity to repurchase a substantial number of shares of our common stock at an attractive fixed price,” he said.

Aequitas has one client, which it would not identify. “If we have five or six engagements in our first year – and by engagements, we mean executed transactions – we’ll be successful in starting out,” Cunningham said.

Nicholas Kirk, a managing director at the New York advisory firm Hickory Group LLC, said Aequitas would be an ideal adviser for middle-market firms.

“There’s a need for thoughtful, intellectual advice that’s free of conflict. … A company that’s middle market, in the growth segment, needs the same advice [as a large corporation] and more. They’re fighting for market share, and they have a tougher challenge by the bent of their size,” said Kirk. “These folks need a much higher level of representation.”

Cunningham acknowledged the difficulties of hanging out a shingle in an industry rife with marquee names. “We’ll be up against internal dynamics, among other things,” he said. “We’ll have, for example, a CFO who has done business with certain bankers for years, saying, ‘Why do I have to hire this other firm?’ We could get derailed early by just that.”

He said Aequitas does not expect to expand its ranks beyond its two founders in the short term. “We could put 10 to 15 staffers in place immediately, but our fees would have to be higher, and our ability to tread water and grow the business right would get compromised.”

However, in the long term, it does intend to add staff as it builds clients and reinvests money into the business. “The type of people we would hire is someone comfortable with our client-centric focus,”said Cunningham, 48, who retired in 2008 from Jefferies, where was involved with the structuring, placement and trading of equity, equity-linked and debt transactions.

Before Jefferies, he was the head of equity and derivatives trading at Commonwealth Edison in Chicago. He is an elected trustee for the village of Pleasantville, N.Y., and once served as its deputy mayor.

In 1997, Cunningham hired Pritchard, now 45, as an institutional salesman at Jefferies. Pritchard was there for 10 years and rose to managing director and head of its convertible securities operation. He has also worked at Bear Stearns, the research and sales boutique Parallax Group and CIBC Capital Markets.

Cunningham expects “the vast majority” of clients to be publicly traded. Private companies or those owned by private-equity firms are “not our sweet spot,” he said. “It’s a harder sphere to break into.”

For Aequitas, named after the Roman goddess of fair trade, the biggest challenge is “how to get the story out that we have a pretty specialized set of skills,” Cunningham said. “We won’t succeed if we don’t add value. We need to have clients and prospective clients saying, ‘We’ve got to use this guy.’”

Some of these ex-regulators are high-profile professionals like former Federal Housing Finance Agency director and chairman James Lockhart, who signed on in August with WL Ross, Wilbur Ross’ private-equity firm. Some are professionals who have worked at the Federal Reserve for several decades. This may be a new twist to what is already a routine on Wall Street, where brokerages have lured specialists from the Securities and Exchange Commission for advice on legal issues or to serve on boards.

Just recently, a private-equity investor group composed of Parthenon Capital Partners, Lovell Minnick Partners and Continental Investors used the counsel of former regulators to acquire a controlling interest in Orlando-based Seaside National Bank & Trust. Ex-Philadelphia Fed bank examiner Paul Pilecki, now a partner at Winston & Strawn LLP, was one counselor who worked on the task.

Parthenon and Lovell Minnick led the investment in the nationally chartered commercial bank, which has $830 million worth of assets and 13 offices. The two each acquired roughly 23% stakes on the eve of Thanksgiving, investing $40 million in the bank, with Continental taking a 9.9% stake.

“The fact that some of the attorneys were ex-regulators made a tremendous difference,” says Brian Golson, a managing partner of Parthenon Capital Partners.

As Golson sees it, the former regulators were able to parse through concerns expressed by their counterparts at the Fed, the primary overseer of the Seaside deal. The task might sound simple enough, but regulators drew up a list of 29 different points to discuss with the investors, according to Golson.

“The level of knowledge they had about our transaction was immense. The regulators worked very constructively with us to make sure we were doing things by the book,” he says.

The consortium hashed out the concerns over two-and-a-half months, and ultimately invested in the bank through its holding company Three Shores Bancorporation.

“Bringing a regulator in creates confidence in respect to the team’s integrity – you bring some level of regulatory sensitivity and knowledge to the table and that makes you a better buyer,” says Edwin del Hierro, a partner at Kirkland & Ellis who led the legal advisory assignment for the Seaside investor group.

Robert Fiallo, the ex-chief executive of Washington’s Fidelity & Trust Bank, and other dealmakers believe that former regulators standing by your side is a key ingredient in the deal-approval recipe. Now that he’s completed the sale of Fidelity & Trust to Eagle Bancorp, Fiallo is ready for his next transaction and he plans on hiring an ex-regulator.

“The idea is to bring a former senior regulator on as our chief risk officer and a well-seasoned senior bank CEO that has successfully run a model predicated on quality acquisitions,” Fiallo says.

Fiallo is in talks with a number of different bank-holding companies with assets ranging from $300 million to $1 billion. Ideally, these would serve as a springboard for acquisitions of other banks, particularly troubled ones.

“There are firms out there that have brought on former bank regulators as part of their bank acquisition strategy. Getting a workable private-equity proposal through a regulatory review process can be a daunting task, and having people who have worked on this process from the other side can be very helpful,” says Charles Horn, a partner at Mayer Brown LLP.

Nick Kirk, a co-founder of the Hickory Group, a New York investment banking boutique, is helping Fiallo round up private-equity capital for the bank play.

“The template which has been successful for private equity is partnering with a management team that possesses both regulatory and operating experience. Without these two pieces, groups will be missing valuable process insight,” Kirk says.

Meanwhile, there are aspects to operating in the bank industry that may come as a surprise to some private-equity executives. Take, for example, the case of New York ‘s Herald National Bank, which is partly owned by a private-equity group.

When executives at Herald National were waiting to get regulatory clearance to open last year, a half dozen Federal Deposit Insurance Corp. officials showed up at the bank’s Fifth Avenue headquarters last fall like a regulatory version of a SWAT team. The group swarmed the private-equity backed bank’s offices, putting its business operations and computer systems through a battery of field tests – time-tested procedures that bank examiners have long carried out.

Herald raised $62 million from an investor group that included Palladium Equity Partners, FrontPoint Partners and Carpenter & Co. last year. Its efforts at managing the regulatory aspects of the process were enhanced by the presence of its chief credit officer, Joseph Harpster, the former head credit officer at HSBC Bank USA. Harpster joined Herald last year after two decades at Republic National Bank.

He also worked for six years as a bank examiner in the Fed’s New York branch, working with small to large banks.

“It’s always helpful when you have someone on the team that’s a former bank examiner; the regulators like that. It helped us when we went out to raise capital,” says David Bagatelle, president and CEO of Herald National, a middle-market commercial bank.

Bagatelle and Harpster helped get the Office of the Comptroller of the Currency and the FDIC comfortable that Herald had all its ducks in a row – namely that its safety, soundness and operating procedures were in order. The bank secured conditional approval from the OCC in June, followed by conditional approval from the FDIC in July. It went through the aforementioned field test and subsequently opened three branches.

“They’re basically assessing the quality of the bank by looking at the quality of its assets, capital adequacy, earnings ability, liquidity and management [team],” says Harpster.

Herald, which has put out $300 million in commercial loans this year, isn’t done with the capital-raising process, either.

Meanwhile, as is often the case in finance, no new tactic is truly original. Consider the case of Deerfield , Ill. ‘s CenTrust Bank, which raised more than $20 million worth of private capital to launch its business in February 2006. Its staff included Carl Vander Wilt, a 33-year senior veteran of the Chicago Fed who led up CenTrust’s formation as its CEO.

That is, “if we don’t screw this up,” said CEO and co-founder Andy Krafsur.

Designed by a former aerospace engineer, the technology has been endorsed by Dick and Rick Hoyt and has even raised controversy over whether it was legal to wear in races like the Boston Marathon, given claims that it gives wearers an unfair advantage.

The El Paso, Texas-based company has been slowly and steadily growing since it began in 2000. It’s raised $8 million from angel investors to date and is seeking an additional $5 million from institutional investors as it expands the use of its technology into work boots, military footwear and other types of shoes. The company had $6.4 million in revenue last year and expects $7 to $7.5 million this year. Spira’s initial gross margins are 55%, which is higher than the industry average of 35%, Krafsur said.

Given its profitability at a small size, the business has attracted interest from both venture capital and private equity investors, Krafsur said. The firm is in “somewhat advanced” discussions with investors from both asset classes for cash infusions, and has received at least one letter of intent.

One atypical avenue the company is considering is a reverse merger with a publicly traded shell company. Krafsur said the benefits of such a deal could outweigh the costs and time that come along with public listings. Such a listing would raise the company’s profile, attract talent with options, offer existing shareholders an opportunity to invest more, and give the company currency to expand. Besides, he said, “We have 270 investors so we act like a public company already.”

Note: The Hickory Group, LLC is performing general financial advisory work for Spira Footwear, Inc.

It sounds like alphabet soup, but several SPACs and BDCs are discussing transactions, according to Michael Tew of research firm SPAC Partners.

And it does seem to make sense. BDCs, which provide financing to middle and lower middle market companies, use their balance sheets to maintain strict leverage ratios, which means that they really could use some liquidity. Moreover, BDC share prices have plummeted in recent months, at the very time when their product is in high demand.

Enter the SPACs. They have money. According to Tew, there are around 40 SPACs with about $9 billion in equity that have yet to announce a deal. Since many of them will meet their “invest or fold” deadlines within the next 12 months, they’re scrambling to find suitable targets and fighting for the same deals. The prospect of a recapitalization-type of transaction is beginning to pop up on their radars, Tew said. “The deal would look something like a pre-packaged bankruptcy would look, except the company would not go into bankruptcy,” he said.

But, I wondered, can a SPAC do that? I thought they had to do a reverse IPO transaction with a private company. I thought wrong. Apparently, a SPAC can do anything but buy bonds. This particular type of transaction would be structured like a merger, where the SPAC gets the majority stake.

However, it seems like it could be rife with unhappy parties – most notably the BDC and SPAC shareholders. SPACs have seen their proposed deals voted down one after another, as their hedge fund investors have no appetite for public securities.

According to Nicholas Kirk of financial advisory firm Hickory Group, SPACs are trying new techniques to get shareholder approval for their deals. One such technique is to strike a deal that’s lower than the equity value of the SPAC. This allows the shareholders to see some up-front cash upon the deal’s close. “It’s a way to sweeten the deal for the SPAC shareholders,” Kirk said. And as for BDC shareholders, they know how dire the situation is. “It’s either die or merge,” he said.

Falling purchase valuations and a dearth of financing options have created attractive acquisition opportunities for private equity investors.

“There are a number of properties moving very expeditiously towards an exit, and that’s being driven by succession but also by financial issues,” says Stephen Kuhn, a managing partner at the San Francisco private equity wine investment firm Vinum Capital Management. “The economy has only accelerated deal flow, and valuations are decreasing.”

Kuhn says wineries that once commanded purchase multiples of 12 times cash flow during the M&A boom now draw six times Ebitda or less.

Vinum, a San Francisco firm, launched fundraising for its $250 million wine-focused fund last year, targeting midsize premium and superpremium winemakers producing anywhere from 20,000 to 150,000 cases of wine annually. Although it hasn’t closed the investment vehicle, the firm has secured investor commitments, Kuhn says.

On Tuesday, Sapphire Wines of Franklin, Tenn., bought Carneros Creek and Wildhurst wines from Briarcliff Wine Group of Danville, Calif., for an undisclosed sum. Earlier this month Fidelity National Financial chairman Bill Foley bought Kuleto Estate Family Vineyards of St. Helena, Calif., which produces less than 8,000 cases annually, from the California restaurateur Pat Kuleto through Foley Family Wines of Lompoc, Calif. Foley purchased the ultraluxury cabernet maker Merus, as well as Sebastiani, last year.

Of course, it would be wrong to suggest that the traditionally recession-resistant wine industry isn’t feeling any effects of the economic downturn. Consumers have cut spending on costlier wines, and restaurants have reduced their inventories of high-end brands to meet customer demand for less expensive wine. It’s not quite a favorable development for the financiers that have plowed money into superpremium wines with a cult following, such as Screaming Eagle. Former CSI Capital Management president Charles Banks and Stanley Kroenke, the owner of basketball’s Denver Nuggets, purchased the popular brand in 2006.

“Private equity firms that bought into ultrapremium or superpremium wines face the drop-off in high-end onpremise [restaurant] volumes,” says John Fisher, head of Fisher & Co., a wine and spirits investment banking firm in Menlo Park, Calif. “Private equity firms that bought positions in premium winemakers face more modest declines in off-premise retail, but declines nevertheless,” he adds.

Sales of wines priced at more than $20 a bottle fell 8% through mid-December, according to Nielsen Co. Just how much the downturn in consumer spending will affect higher-end brands is unclear. Before the price decline, however, the superpremium category was attractive enough that the veteran buyout financier William Price, a cofounder of TPG, acquired a minority stake in Kistler Vineyards in January 2008.

Fisher & Co. brokered the sale of Kistler to Price, who established the Three Sticks Winery in 2002 and is seeking to make white-knight minority-stake investments or acquire majority stakes in ultrapremium vineyards, according to Fisher.

“He was a vineyard owner and grower years before he started doing these deals. That’s instrumental in his ability to find little gems and run businesses,” says Fisher. The Kistler sale came less than a year after GI Partners, a private equity firm in Menlo Park, bought a controlling stake in Duckhorn Wine Co., a premium vintner based in St. Helena.

The chance to tap into the sheer number of privately held wineries facing generational ownership changes and growth financing needs is what appeals to some private equity investors, particularly those that invest in familyheld businesses.

A survey last year by Silicon Valley Bank and Scion Advisors, a wine business advisory group in Napa, Calif.,found that 51% of wineries in the West, primarily in California, Oregon and Washington, will change ownership within the next decade. It also found that 75% of California wineries were controlled by their original founders, 88% of which were launched after 1975.

“There’s a wave of owners thinking about exits, and private equity would be one mechanism for an exit to occur,” says Deborah Steinthal, a founding partner of Scion, a firm that helps wine owners prepare their businesses for sale.

In other cases, executives of companies like Oriel Wines are simply assessing their strategic options (Hickory Group is advising Oriel) in light of financing opportunities.

Oriel is a bit different from the traditional wine producers some buyout financiers are chasing. The company is smaller on the volume side only selling about 20,000 cases of wine a year, but its wines are produced from 24 regions in 10 countries and sold under the label Oriel.

“We have a very simple and clear opportunity to be the world’s leading fine-wine producer,” says John Hunt, founder of Oriel. “We are kind of a network of talented winemakers”, and “our model is not subject to the vagaries of the weather system.”

A serial entrepreneur, Hunt founded the Gran Clos winery in Spain’s Priorat region — which produces a uniquely flavored wine because of its slate-rich soil — and he is the chief executive of the $150 million special-purpose buyout company Overture Acquisition Corp. He is optimistic about the wine business.

“Wine has been growing faster than beer and liquor, and you’re starting to see interest from the beer companies in wine,” he says.

The opportunity to exchange distressed, non-investment grade securities-whether subordinated notes or junk bonds-for new debt is helping issuers relieve onerous obligations. By exchanging their debt, a portfolio company of a private equity firm can avoid bankruptcy and preserve the equity investment of its owner.

Take, for example, the recent debt exchange orchestrated by Harrah’s Entertainment and the Las Vegas casino company’s backers, Apollo Management and TPG. Harrah’s completed its $6 billion bond exchange in December, reducing its debt load by $1.2 billion and extending its maturity to 2015 from 2010 and 2011.

The exchange was one of 12 distressed exchange offers launched last year, including eight in the month of December, according to Standard & Poor’s.

Other exchange deals noted by S&P involved Cerberus Capital Management’s automotive financing business, GMAC Financial Services. The financing arm of General Motors issued $11.9 billion in new senior notes and $2.6 billion in cumulative preferred stock as part of its exchange offer and plans to be recognized as a bank holding company. GMAC also reduced $435 million in debt due next year, which combined with the other actions resulted in an $11.4 billion gain for the business in the fourth quarter.

Additionally, Lightyear Capital construction equipment rental portfolio company Neff exchanged $230 million in 10% senior unsecured notes in its distressed exchange offer.

“We are expecting there are going to be more distressed exchange offers,” says Diane Vazza, managing director at Standard & Poor’s. “It may be in some cases a smart business decision to negotiate a distressed exchange offer to potentially preserve more value,” she adds.

While S&P notes that the exchange offers may give issuers clear benefits such as delaying maturity payment, near-term liquidity, reduced interest expenses, and preventing covenants from being triggered, the credit rating agency still views exchanges of distressed debt as equivalent to default because the issuer hasn’t met its obligations as expected. After an issuer completes a distressed debt exchange, S&P assigns a new corporate credit rating of ‘SD’ (selective default) to the rated debt as well as a ‘D’ rating on affected instruments.

Distressed exchange offers have piqued the interest of more than just financial sponsors seeking to keep their equity investments from being wiped out in a bankruptcy.

New York investment bank Morgan Joseph has moved to help businesses arrange exchanges for billions of dollars of debt, hiring Drexel Burnham Lambert alum James Schneider to spearhead the effort. Schneider, a managing director at Morgan Joseph, says the investment bank isn’t just seeking to target troubled businesses.

“We will do probably an equal number of healthy and distressed [companies],” he says. “What’s happening is the healthy companies see that it is flu season, and they don’t want the flu to turn into pneumonia.”

Schneider says the chance to capitalize on debt-distressed companies is just beginning.

One benefit of exchange offers is the speed at which they can be executed. By taking advantage of an exemption in securities registration, an issuer is able to avoid a potentially lengthy review by the Securities and Exchange Commission.

The highly leveraged portfolio companies of private equity firms, along with publicly traded companies, are expected to fuel distressed debt exchanges this year.

According to Fitch, Freescale Semiconductor is one candidate with “the potential for a distressed debt exchange.”

Fitch lowered the Austin, Texas-based semiconductor maker’s default rating to ‘CCC’ from ‘B’ in January after it assessed the company was generating $700 million to $800 million in capital expenditure and interest expenses. A Blackstone Group-led consortium acquired Freescale for $17.6 billion of equity in 2006.

The idea of swapping old debt for new debt or sometimes equity isn’t a new concept. Buying up tranches of deeply discounted debt or preferred shares of a company involved in a restructuring and exchanging debt for a majority equity stake has been done for years. Apollo was an early pioneer and other firms like KPS Capital Partners followed suit in acquiring and turning around troubled businesses.

Nicholas Kirk, a managing director at New York investment banking boutique The Hickory Group,
says that in certain instances owning a portion of debt makes sense. “It provides the holder with definable covenants and related performance terms to enforce and utilize.”
If the latest debt exchanges offer any indication, the attractiveness of debt as an investment option isn’t going to fade soon.

At a time when the credit crunch and economic downturn have derailed more than one leveraged acquisition, a New York court is set to determine whether Credit Suisse and Deutsche Bank should proceed with financing Hexion Specialty Chemical’s $10.6 billion buyout of Huntsman. Specifically, the two banks may be forced to fund $9.4 billion in senior secured debt and $5.9 billion in senior secured second-lien bridge loans for the acquisition by Hexion, a portfolio holding of Apollo Management.

The implications for Credit Suisse and Deutsche Bank are obvious: the pair of banks face the prospect of a large markdown on the debt arranged prior to the credit crunch. But, the outcome for the leveraged buyout business could be more far-reaching, say investment bankers and private equity executives alike.

“If the courts force the financing it will cause banks to become more selective and more disciplined in their lending, and drive up the cost of capital,” says Nicholas Kirk, a managing director at The Hickory Group, a New York investment banking boutique. “This is a very significant step and something that banks have feared for a number of years,” he adds.

John Jonge Poerink, managing partner of New York private equity firm Linley Capital, agrees on the significance of the case.

“Private equity firms and all parties involved in a deal will be much more specific about when you can step out of a transaction.”

The trial for determining whether the two banks will be required to finance more than $15 billion of debt for Huntsman’s purchase is scheduled for Jan. 8, 2009.

Credit Suisse and Deutsche Bank’s financing commitment letter expired on Nov. 1. While Hexion had sought to extend the expiration date for the banks’ financing commitment, a judge declined the company’s request and Credit Suisse and Deutsche Bank responded by issuing a joint statement on Halloween: “We’re gratified by this decision and we’ll continue to defend ourselves vigorously.”

The banks, says one private equity attorney who agreed to speak on the condition of anonymity, will likely argue the issue of solvency.

Credit Suisse and Deutsche Bank have questioned the validity of the solvency opinion and solvency certificate submitted by Hexion and Huntsman, respectively, over the combined entity’s solvency.

But, Hexion disputed the argument by the banks and filed suit against Credit Suisse and Deutsche Bank on Oct. 29 in New York, alleging the two banks breached their obligations to fund the deal’s closing.

As a result of the legal logjam between Hexion and Huntsman, banks are closely evaluating their financing commitment letters, says the attorney. For now, the issuance of such letters where one or more banks express their willingness to finance a merger has pretty much stopped.

Meanwhile, New York-based Apollo is on the hook to pay more than the $325 million termination fee in the merger agreement. A Delaware court has decided that Columbus, Ohio-based adhesive resin maker Hexion will face uncapped damages.

Additionally, Apollo is facing another payout if a suit lodged by Woodlands, Texas-based chemical company Huntsman comes to fruition. Huntsman’s $3 billion suit against Apollo and firm executives Leon Black and Joshua Harris is scheduled for trial in Texas on Feb. 9, 2009.

Apollo, meanwhile, has already taken another step to commit additional equity to support the buyout. In late October, it increased the size of its equity investment by $210 million, boosting its total commitment to the transaction to $750 million. It also took the unusual step of deferring a $100 million transaction fee and portfolio monitoring fees for the next three years. Additionally, Huntsman shareholders Citadel Investment Group, D.E. Shaw and MatlinPatterson Global Opportunities and the Huntsman family have committed an additional $416 million in financing.

The most likely outcome for the $28-per-share deal is that it will be settled with a revised purchase price. That’s how Bain Capital Partners and Thomas H. Lee Partners settled their purchase of San Antonio, Texasbased radio company Clear Channel with a syndicate of Wall Street banks.

Last Thursday, Huntsman issued its third-quarter results. It posted adjusted Ebitda of $193.9 million on $2.7 billion of revenues.