LMM Deal Digest: October 2023
It goes without saying that since the COVID-19 crisis, no investment firm — regardless of type, size, or vintage — is going about business as usual. We checked in with Griffin Horter and Max Katzenstein, founders of independent sponsor Kaho Partners, to see how their firm is faring in the current climate and how their portfolio companies are coping with the consequences of coronavirus.
The pair founded Kaho Partners in April 2019, after working in investment banking, private equity, and hedge funds. “At that point we were ten years into a bull market. We knew it was very likely that over the next few years we were going to hit a recession. I don’t think anyone, least of all us, would have predicted a pandemic would start it. Nevertheless we envisioned Kaho from the start as focusing on acquiring recession-resistant businesses — what we call ‘antifragile’ businesses — whose fundamentals would continue to be strong in a downturn, and on minimizing the amount of debt we put on those businesses,” says Horter.
Finding great businesses is extremely hard. Finding great businesses and paying reasonable prices for them is even harder. So, when we find the right opportunity, we want to be able to own that company for as long as possible in order to grow our investment alongside the earnings of that business.
Our impetus for starting Kaho was really to own high quality companies, look at markets where we could pay more reasonable prices, and compound our capital and our investors’ capital at high rates for the long term. If you look at the last 12 months of data — and obviously things will change given COVID-19 — but up until now the average buyout has been done at 11 or 12x EBITDA, which means there’s very little wiggle room for error and that buyers must use a lot of leverage in order to generate good returns for their investors. We are disciplined on price and use significantly more equity than is typical because we want to make sure our businesses are safe for the long term.
Typically, we look for businesses that are owned by founders or families — businesses that are already doing very well under their current ownership, but are looking to bring in an outside partner to provide capital, resources, and/or a liquidity event for the owners. These companies are focused on protecting their legacy, brand, corporate culture, and employees. They don’t want to go through a sales process again in three to five years or burden their companies with too much debt, and they really care who buys their business. We offer an alternative to a middle market buyout firm because we can partner with these businesses for the long term.
At our previous jobs, we both saw how having a mandate to deploy committed capital could incentivize investors to pay too much for businesses. Funds were paying double digit multiples for companies that were flat or declining. We’ve opted to raise capital on a deal by deal basis so we don’t have misaligned incentives to deploy capital.
We acquired North American Manufacturing in October 2019. The company is a military contract manufacturing firm that supplies rugged field equipment to all branches of the U.S. armed forces as well as federal agencies like FEMA. It was founded in 1976 and had been a 2nd generation family business. While the owner had decided he was ready to step back from day-to-day management, he was still very concerned about the company’s legacy, making sure his employees were taken care of, and staying in Scranton, PA where they were based.
Last month, we acquired Kenny’s Great Pies, a premium pie manufacturer based outside of Atlanta. It’s another family business started 30 years ago in the founder’s apartment, but today the company has a dominant brand in a niche space.
What we’ve seen in the last few weeks with both companies really supports our general aversion to putting too much leverage on a business. We used well below the average amount of debt on both acquisitions because while we didn’t know when, we assumed a recession was eventually going to hit.
Of course, we recognize that there’s always an element of luck too. The nature of this crisis is that it was entirely unprecedented, and a lot of really terrific investors are having to deal with consequences they never dreamed of. You could be the greatest hospitality or restaurant investor in the entire world, but the nature of your industry right now means you’re going to have a really, really hard time and that’s not necessarily your fault.
But looking beyond that, we do think that our preference to look for these antifragile businesses has positioned us well for the current situation. North American Manufacturing has had some of the largest order volumes in the company’s history over the past few weeks as we look to help both the government and health systems respond to the crisis.
Obviously, a premium pie company is very different from a military-focused manufacturer, but Kenny’s Great Pies is also quite recession-resistant. If you look at the historical capacity utilization in the food processing industry vs. other manufacturing businesses, it tends to be significantly more stable during recessions. Kenny’s is diversified across products, branded vs. private label, and customer channels, including both grocery stores and restaurants. Large national grocery chains and smaller regional chains are the majority of our business.
We closed this acquisition right before the outbreak of COVID-19 in the United States. Again, we used a pretty conservative capital structure, which will help us weather any short-term headwinds, but the good news for Kenny’s Great Pies is that people stuck at home still need to eat and they’re still going to the grocery store. And if you can’t do most of the things you used to enjoy doing, having a little bit of pie in your fridge goes a long way.
For both companies, our number one priority during the past few weeks has been making sure that our employees are safe and that we can continue to deliver great products and services to our customers. But we’re also continuing to be aggressive and on the lookout for new opportunities amidst the chaos. We know we’re lucky to be coming from a position of relative strength here.
It’s a mixed bag. We’ve spent a lot of time speaking with business owners, intermediaries, investors, and lenders and we’re seeing that M&A is pretty much grinding to a halt as buyers are nervous,sellers are more focused on making sure their companies don’t go under, and lenders are tightening credit. But we’re reassuring intermediaries that we’re still here, and that our partners, who tend to be high-net worth individuals and large family offices, still want to deploy cash. We anticipate that we’ll see some opportunities to step into broken processes that were perhaps at the LOI or management presentation stage. Deals may be falling apart, but that provides opportunities for people like us who can be flexible and opportunistic.