Finance & Commerce, April 8, 2010
by Mark Anderson, Staff Writer

The Shefferts are raising money to invest in the companies it rebuilds

The Manchester Cos. has been helping build value in troubled businesses for more than 20 years — boosting sales, cutting expenses, streamlining business processes and generally creating a brighter outlook for shareholders and employees.

Now the Minneapolis-based turnaround specialist thinks it’s time to take a little greater share in the fruit of all that success.

The firm has launched an effort to invest directly in a few of its select turnaround clients. They’ll help recapitalize firms by providing a cash stake raised from private equity or hedge funds and high net worth individuals, investors who are looking for opportunities in the newly appealing distressed companies sector.

Manchester will take an equity share, too, based on its contributions as the operating partner in the assignment, said Chris Sheffert, who started his career with Manchester and returned last May after earning an MBA at Stanford and working with a Chicago private equity fund.

Sheffert came back as a partner to lead the investment initiative — a strategy that he had pitched to his father, Manchester’s founder and CEO Mark Sheffert, shortly before Chris left the firm in 2005.

“I had analyzed advisory situations where we had operating control in companies,” Chris Sheffert recalled.  “I calculated the market value increase that resulted from our engagements, and I looked at our advisory fees against that expanded value. Our fees didn’t reflect the value that we created.”

A pittance, at least when measured against the substantial gains that Manchester had been achieving for its client companies.  

Chris Sheffert’s analysis showed that when Manchester took operating control of a client company, its median EBITDA (earnings before interest, taxes, depreciation and amortization) increased by 250.2 percent in 10 months. In the two years following that, companies’ average EBITDA increase is over 1,000 percent.

“If you convert those gains into market value, everybody’s going to win,” Chris Sheffert said.

That’s the kind of story a growing part of the investment community is starting to look for from the distressed company sector, which means more attention — and more competition — for Manchester.

“A few years ago you could count on two hands the funds that were investing in distressed companies,” said Mark Sheffert, who formally launched Manchester in 1993. “There are at least three or four times that number now.”

Changing investment landscape

That investor migration is motivated by a handful of recent trends. Investors aren’t finding enough conventional merger and acquisition deals to absorb all the cash that they’ve been holding on the sideline. They’re gaining comfort with distressed companies, too, as more investment flows in and the sector gains prominence in the investment news.

And there is simply so much cash that managers need to deploy, Chris Sheffert said. A lot of money poured into equity funds that were opened in 2005-07, but their investment opportunities virtually stopped in 2008 and 2009. Now managers and investors want to put that money to work before their funds expire (usually within five years after opening), and they want it deployed in areas where above-average returns could help make up for recent losses.

Managers have one more incentive, Chris Sheffert notes: They won’t earn fees for money that isn’t invested by the time the fund ends.

It all adds up to an intriguing investment picture, but it hasn’t yet translated directly into Manchester investors.

The Shefferts and their team initially tried to launch their investment program by raising a captive private equity fund. Mark Sheffert said they gained commitments for about $80 million, but hurdles emerged. The biggest was the Obama administration’s decision that the new financial regulations should prohibit banks from investing in private equity firms, which frightened away the bank holding company that was Manchester’s largest committed partner.

And the Shefferts discovered that despite Manchester’s pedigree in the turnaround world, investors still saw them as a new kid on the block. “There’s nothing we can do to get around the fact that we’re a first time fund,” Mark Sheffert said. “Institutional investors haven’t really been interested in looking at new funds, the old ones were working so well, and they came back to managers and a record they knew.”  

But the investment landscape has changed, too. Many of those formerly strong performers are riddled with losses post-2008-09 and aren’t the formidable competitors they were.

Post-bubble investors are also vetting their partners more carefully, and Manchester believes its venerable record will be an advantage in that environment.

The company has 15 people on staff, most of them with decades of professional experience.  

But Manchester also prides itself on its “bench” of 25 to 30 contract executives, people like Elmer Baldwin, who helped manage a reorganization at Born Information Services and then joined the firm to help engineer its sale to Fujitsu.

That broad base of talent is another tool that Chris Sheffert believes will give Manchester an edge with investors looking for certain returns in an uncertain field.

“You look at most leveraged buyout firms today, and they’ll have very accomplished operating partners on staff. But usually that’s one person,” he said. “If you’re dealing with a $150 million company, and depending on half-time attention from one operating partner, you won’t see the revolutionary impact we can have when we go in as a team.”

That story has attracted groups of PE fund and wealthy individual investors who’ve backed two recent unsuccessful bids on companies, and who are ready to back several more deals that Manchester is exploring.  

And that deal-by-deal track record may eventually lead to the private equity fund that Mark Sheffert says he still hopes to establish.

That could shift Manchester’s efforts from advisory work to turnaround investments as more corporate problems unfold over the next four years, Sheffert said.  

“But I suspect this is going to be more evolutionary than revolutionary. And if it doesn’t work out that way, it’s OK.”