Exclusive Interview: Jon Moulton

It gives me great pleasure to bring to our readers an interview with private equity legend Jon Moulton. Between 1997 and September 2009 Jon Moulton was the Managing Partner and founder of Alchemy Partners. Previously at CVC, from 1985 to 1994 Jon was the Managing Partner and founder of Schroder Ventures, where he focused on LBOs and venture capital. Between 1994 and 1997, Jon was the Director in charge of LBOs at Apax Partners. He has been involved in numerous turnaround deals since 1980.

In late 2009, Moulton launched Better Capital, a fund focused on the acquisition and operational turnaround of underperforming businesses. Moulton and Better Capital have been in the news recently with their purchase of Reader's Digest UK.

Jon Moulton will be speaking at the upcoming European Investing in Distressed Debt Forum. For all those that are interested, you can listen to the podcast as well as read the transcript, here:

And to all my readers: If you have any feedback or additional questions for Moulton, please contact enquire@iqpc.co.uk or +44(0)20 7368 9517.

Enjoy the interview!

Big Challenges, Extraordinary Opportunities and the Coming Wave

Jon, thanks for joining us. Now, firstly, can you give a little background on yourself and the founding of Better Capital?

Yes, I’m quite an elderly, private equity man. I’ve been around for thereabouts 30
years and greatly enjoy it. My previous firm was a mid-market private equity firm that really
didn’t want to focus on turnaround, so I left them and set up Better Capital last autumn. We
did it in a rather unique way. We set it up on the public markets. We’re now on the main
market of the London stock market. We raised £210m with a view to invest solely in
turnarounds of UK and Irish companies, hoping to basically make some money out of the grief
driven by the recession.

Jon, out of all the organisations that you’ve been a part of,
which experience did you find the most rewarding? And also, which deals stand out in your
mind as just incredible successes?

This is a really difficult question, because I’ve been around for an awful lot of
different deals with different characteristics. In terms of making money, probably the best deal
I ever did was one at £243 million, which was a deal with AG Stanley, a retailer we bought out
of. But in terms of deep satisfaction, probably Parker Pen is a deal that really stands out in my

Parker Pen was a business in Janesville, Wisconsin, though it was known all
over the world. Most people thought it was a British company. It was run terribly, losing £20m
a year, or thereabouts. It had all kinds of liabilities, nonsense, massive overheads.

We did something amazing: we bought the company quite cheaply, closed the head office in
the United States and put one of the subsidiaries, which was the English subsidiary, in charge
of the world. It had a delightful chief executive, Jacques Margry. And over the course of the
next seven years, with management working with us in a productive way, that was really
rather nice to do.

We took that to making £40m-odd of profit, and a hugely successful deal
with seven years of 72% IRR. And it was, by the standards of the industry, a fantastic deal.
And lovely people to work with, delightful company. Everything went in the right direction. The
only sad bit was actually it was sold to Gillette and two years later it was back in loss, which
shows the impact of not having the right management. But it was just an incredible success,
delightful people. It made a lot of money and it funded several very successful divorces.

Can you talk about another of your deals, Better
Capital’s acquisition of UK Reader’s Digest - what was your rationale for this purchase?

Right, well, UK Reader’s Digest was a very unusual deal. Reader’s Digest is a US
corporation, a big one. It had got itself into some difficulty with rather an unpleasant balance
sheet - too much debt and massive pension liabilities in both the US and the UK. The UK
operation was making a modest loss on sales in the sort of £60m-something range, but it had
an enormous pension liability. I don’t think we ever knew what it was, but something well in
excess of £100m. The company thought it had negotiated a deal with the UK pensions
authorities, the Pension Protection Fund. It was really startled, having thought it had agreed it
and sorted out its problems in the UK, to have the pensions regulator overrule the Pension
Protection Fund - something which we don’t think has ever happened before or since.

As a result, it had to put the UK into bankruptcy and to administration, which it did. And it w
ouldn’t buy it back, the US parent, without actually significant risk of the pension fund being
reassessed under the rather severe UK pension rules. So, the deal was very odd, because, of
course, the parent was actually letting one of its biggest subsidiaries lose its brand name, so
a very unusual deal.

From where we sat, it was a company that was really rather heavy with costs in the UK. Its
offices were in Canary Wharf, which seemed unnecessarily luxurious. The combination of rent
and its pension liability meant that the company started off at about -£8m before it started to
work, in a year. So, we’ve taken out all that cost, made some management changes, started
putting in some new IT systems, and we’ve seen an enormous benefit. The company is
trading far, far better now and we’re pretty optimistic about the future.

The business is an unusual one. Most people think it’s just the magazine; the magazine is
actually only about 15% of their revenues. Realistically, they’re a very effective direct mailer
that sells lots of books, DVDs, CDs, and financial services. It’s going well. Our rationale for
the purchase was quite straightforward: we could buy it reasonably cheaply. By turning it into
substantial profit, we would hope to make a lot of money.

Now, moving on to the economic crisis, which is
obviously still a key topic, you were quite prescient in your predictions for the economic
malaise that we find ourselves in today. I understand that you’re also quite negative on the
economic prospects for the future in the UK and Europe. Now, how does that shape your view
of the future of turnaround and distressed investing?

This is the toughest question, I think, you could reasonably ask me. What is very
clear at the moment is that the only certainty is uncertainty. The European and UK economies
are full of issues - too much debt, too much sovereign debt, large deficits, the effects of
pulling back those deficits, pulling in public sector spending, weak demand. Today we’re
looking at stock markets falling all over Europe.

The future of the economy, though, looks to me to be fairly bleak. We’re in the middle of a
bombed bubble with very, very low interest rates. Those will reverse. When they reverse, we’ll
see the economy is going through a terrible shape, and the opportunities for distressed
investing will become very large.

At the moment, our basic approach is we’re only going to do really rather special and
attractive situations, and we’ve got to wait for the inevitable tidal wave of bad deals to come
hurtling towards us when interest rates rise and when the economic prospects become more
clearly adverse, both of which I sadly expect some time over the next year or two. I could
easily be wrong, but that’s certainly the basis we’re going for: no rush, wait for a wall to come.

How do you distinguish
between a business with a possibility of a turnaround versus a business in a permanent
secular decline? In either type of situation, how much does valuation come into play, versus
the possibility of getting your hands dirty in the business to improve operating results?

Right, okay. So, let’s start off. Businesses are in permanent secular demand. Say,
UK coal mining, you can make money out of it, because there’s cash flows. The companies
will generate more cash than they can handle. So, you have to buy them very cheaply. Those
kinds of opportunities still work. What you mustn’t do is buy a pretty-well dead business,
something which is just simply declining very rapidly, and no matter how quickly you cut the
costs and chopper the business, you never end up with much in the way of a positive cash
flow, and eventually the closure costs absorb everything you put in.

So, what we try and do - well, mostly actually - is buy companies which are not first division
companies, but they’re not the ones doomed to relegation, from the bottom division. The sort
of middle-of-the-road companies with modest growth possibilities, which, because of m
ismanagement, because of silly strategy, perhaps just because of ill luck with the litigation
or something, are in serious trouble. And these we can then buy at a reasonable price,
because nobody knows how to price loss-making companies, turn them into profits and make
some money out of it.

Now, the process of taking a company from loss to profit is sometimes really easy. Most of
the time it’s moderately difficult and it involves a number of steps. The more steps that you
need to take, the more difficult the steps are that you have to take, the riskier turnaround
becomes. So, I typically prefer shorter turnaround. It’s one which, I’m afraid, involves lots of
negative actions: closing things, stopping selling products. Just taking cost out, because that’s
predictable, controllable, whereas doing a turnaround which relies on increasing sales or
margins, that’s not so controllable; that’s much harder to predict.

The more you have to do, the cheaper the deal has to become, because obviously time is
money, and the more really difficult cases we take on, the less we can do. We’ve got to
the pile of money we have and the people we have to do it. So yes, it’s a trade-off,
sometimes a very difficult trade-off to estimate, because one of the other things about
turnaround companies is that typically they come with mediocre or even bad information, poor
financial controls, poor understanding and poor basis for us to understand it. You can make a
lot of money in all kinds of deals if you just keep your eyes open.

What do you look for in a management team? How do you find the
particular CEO that can turn a certain business around?

Well, the whole thing at the moment is that this is probably the easiest part of our
business. We know a very large number of turnaround chief executives, many of whom have
done somewhere between one and a half a dozen turnarounds before. And there aren’t as
many deals around as there are CEOs, so finding one is quite easy. What do you look for in a
turnaround management team? Well, you look for somewhat different characteristics than you
would in a stable business. First of all, you need a highly decisive management team. Better t
hat they take 100 decisions and get 80 right, than they take 20 decisions and get 20 right.

The company needs to turnaround quickly, stop losing, stop haemorrhaging. So, somebody
with a bias towards action; somebody prepared to tackle radical things; somebody prepared
to basically absorb the shock of the unexpected, because turnarounds are littered with those.
These characteristics are fine for taking a company from loss to profit; they’re typically not the
characteristics you want in somebody to run a stable business. So, turnaround managers,
quite often a couple of years out, you don’t need them and don’t want them. You want
somebody more stable, and the good turnaround managers know that too.

Which investors do you admire? Which investors have shaped
the way that you approach deals, Jon?

In the UK, I’m afraid, the field of potential investors in turnaround is really very
small. What have we got? We’ve got Endless, Rutland - those are the two largest names in
the marketplace besides us. It’s a very small field. In terms of which investors I admire,
people like Wilbur Ross from the US are far, they’ve done far more than anybody in the UK
has done in turnaround. You definitely have to give them their degree of admiration for doing
it. They’ve tackled some very, very difficult companies, and made an enormous amount of
money out of it. You see the same with people like the Gores group in the United States. The
scale of the turnaround market in the US is so much bigger than it is here. The heroes, I’m
afraid, are still at the other side of the Atlantic. If interest rates rise, if the banks discharge
their loads, then perhaps we’ll see some real heroes appear here.

Now, talking of the US, a significant amount of capital has obviously been raised
by private equity and distressed debt hedge funds to effectively pick up assets on the cheap. W
ould you say that this phenomenon is occurring in the UK and Europe in general, and
do you approach deals more cautiously in these types of environments?

Right. Several questions, really, underlying that. First of all, in terms of people
raising money for distressed debt investing, hedge funds, some of the giant international
players in distressed debt, like Oaktree, are here in very substantial volume. There’s no
shortage of buyers for distressed debt. And, as we speak, actually the pricing of distressed
debt looks pretty unattractive. There’s not much reward for quite a bit of risk. There’s no
shortage of money in the distressed debt area.

Private equity funds playing in turnaround on distressed in Europe in the UK, they’re much
thinner than the United States. There are less of us. And at the moment there needs to be
less of us, because the banks aren’t releasing assets in volume and the very low interest
rates mean that lots of really quite financially stretched, poorly run businesses can chug along
a little longer before the reality eventually bites on them.

So, does it mean that I approach deals more cautiously? No, not at all. They really don’t bear
on me. The private equity world is lowly competitive at the moment in turnaround. We’re really
not a distressed debt fund; we don’t just buy debt because we think it should be priced at 80
and it’s trading at 60. That’s a perfectly good way to make a living, but it’s not what we do. We
buy control of companies that need an operating turnaround, and there isn’t an excess of
competition at the moment; not like a mid-market private equity firm, where at the moment
there are 85 or so competitors in the London market alone.

Finally, we’re know you are speaking at the
European Investing in Distressed Debt Forum. One of the topics that you’ll be covering is ‘big
challenges, extraordinary opportunities, and the coming wave’. What key talking points do you
expect to come from this discussion panel?

Well, I’ll probably lead it off by talking about something which is really very
startling. We’ve just been through the biggest recession since World War II. Liquidations in
the UK are at a 30-year low, which is an incredible coincidence. You have to analyse why,
and it’s low interest rates, government support, through not collecting overdue taxes, and
banks because they’re either unwilling to recognise losses or prepared to really postpone
them into the future. All of those things mean that at the moment you can actually make a
rather unpopular argument that there’s an unhealthily low level of corporate failure, and that
the problems are being stacked up both in the economy and in the banks. That eventually will
break, and when it breaks it will be rather dam-like. The volume of deals to come forward will
be very large indeed; whether that comes in six weeks, six months, or a couple of years, I
don’t know, and that’ll probably be the subject of some animated debate. But those are
among the big issues.

Thanks very much for your time today, Jon. It’s been great to hear
your points and hear about how you operate at Better Capital!



hunter [at] distressed-debt-investing [dot] com

About Me

I have spent the majority of my career as a value investor. For the past 8 years, I have worked on the buy side as a distressed debt and high yield investor.