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July 1, 2008

FRESH EYES

Since 1995, Platinum Equity has demonstrated a knack for generating huge returns from corporate castoff businesses. Now, it's doing it again with two of the largest metals service centers, Ryerson and PNA.

To understand Ryerson Inc. and PNA Group today, it helps to know something about Jacob Kotzubei and Rob Archambault, partners of Platinum Equity LLC, the Beverly Hills, California, private equity firm that owns both big service center companies.

Archambault’s first chance to be a chief executive officer came in 1999, when he was all of 35 years old, just two years after he entered the private equity business, and a dozen years after he decided that life as a merchant marine third mate was not as worthwhile as he always thought it might be.

“There’s a lot of time spent at sea,” recalls Archambault, a New York State Maritime College graduate who is now 44 years old. “And the time that wasn’t spent at sea was spent, you know, in various other areas, drinking and things like that.”

Idyllic for some, perhaps, but not for the intensely motivated Archambault, who changed course and went into business. He found a niche in data distribution technology and, eventually, as a vice president of Pilot Software, he met Platinum’s leaders during buyout negotiations in 1997. It was “like” at first sight.

“They engaged our executives in talk about the issues and how we would fix them,” says Archambault of Platinum’s style. “They challenged our thoughts and our approach. Or if they embraced the approach, they challenged our timeline for getting it done. It was very refreshing.”

A year later, Archambault was invited to join Platinum’s transition group, the people who create stand-alone companies from acquired businesses that were previously part of much larger, established organizations. On behalf of Platinum, Archambault ran a company that provided telephone reservation services for American Airlines. Then he led a former unit of Dow Jones & Co. that provided in-depth, long-term data on stocks to individual investors. Later, he briefly ran a company that sold telephone systems and consulting services to medium-sized businesses while integrating that operation into other, similar Platinum properties.

Today, at this writing, Archambault is interim CEO of Ryerson, the second-largest North American operator of metals service centers (annual sales, $6 billion).

FAST TRACK

Kotzubei, a former lawyer with degrees from Wesleyan University and Columbia School of Law and a stint at the high-profile law firm Sullivan & Cromwell, seemed to have it made when he joined premier investment bank Goldman Sachs in 1998. But three years later, after negotiating with Tom Gores, Platinum’s founder, chairman and CEO, over the sale of a business shed by Motorola, he jumped ship and joined Platinum. “He has an incredible charismatic personality,” Kotzubei says of billionaire Gores, a 44-year-old Israeli whose Platinum Equity competes in the private equity arena with his older brother Alec’s company, The Gores Group LLC. “You just believe in him. He had a very powerful effect on me. I saw the model and the Platinum investing style, and I believed in it. You only get one chance to leave Goldman Sachs, and I decided to place that bet with Tom Gores.”

Today, at 39, Kotzubei is the Platinum partner who oversees the private equity firm’s investments in Ryerson and who served the same function with PNA (annual sales, nearly $2 billion), now sold to Reliance Steel & Aluminum with an expected closing date of Aug. 1.

Skeptics in the metals service center industry, some of them with many decades of experience, might question how two such young men with no metals industry experience have the chutzpah to believe they can improve outfits such as Ryerson and PNA. Or, more, how they’re able to generate rich, outsized returns from those companies.

Some see private equity operators such as Platinum Equity as nothing more than slick, heartless financial manipulators that squeeze blood from stones at the expense of the people, relationships and long-term health of otherwise strong metals industry properties.

There’s no question that Platinum is in it for the money, and sometimes for quick money. Kotzubei, for example, notes that Platinum has “generated phenomenal returns” from its investments in about 80 companies since Gores began the company in 1995. “We have had triple-digit IRRs [internal rates of return] over the last four years,” Kotzubei says. Private Equity Intelligence Ltd., the London-based analyst of private equity fund performance, says investors in Platinum’s first buyout fund, Platinum Equity Capital Partners Fund I of 2004, have realized a multiple of 2.68 on their money, compared with 1.28 for all U.S.-based buyout funds originated in that year. The fund’s IRR is rated at 73%, compared with 22% for all of its peer funds from 2004. Viewed another way, as of the end of the 2007 third quarter, every dollar of limited partner money invested from the fund by Platinum has generated $2.68 in returns.

That’s pretty heady stuff, but it’s only part of the Platinum Equity story. Like many private equity outfits, Platinum says its focus is operations, not financial manipulation. Such claims are often met by skeptics with raised eyebrows and scornful derision.

But Platinum is not just paying lip service. Platinum calls itself an M&A&O company—mergers, acquisitions and operations—and, in fact, it often acts more like a strategic buyer of its companies than a financial one. It invests, sometimes heavily, after the acquisition in additional businesses, equipment, people and facilities that give its holdings a stronger position for the long haul.

“We invested in our steel companies with a long-term view,” says Gores. “We … invest knowing the business models could survive in the long haul. These were businesses that, if you kept them healthy, you would find the times to thrive. We dug into the operations and found stable and competent businesses that we could enhance with our operating touch.”

Adds Kotzubei, “It’s not about financial engineering with us. It’s about operating the business better on a daily basis to bring value. When we buy a business, we ask ourselves, ‘Is this a company we want to own?’ It’s OK to make a good return, but for us, it is about investing in a business and creating leaders in that business.

 

Jacob Kotzubei, Maurice S. “Sandy” Nelson, Jr., Rob Archambault, and Stephen E. Makarewicz

photos by Edward Carreon

“Many of our [private equity] brethren fit the bad description. They are ‘break up the company, do whatever you can to make money right away’ type of people. But that’s just not who we are.”

Says longtime metals industry leader Maurice S. “Sandy” Nelson, Jr., CEO of PNA Group and former CEO of Earle M. Jorgensen Co., “Platinum Equity has been fantastic to work with. They are real smart people. They have made all the right moves. They are involved and active, and they have not asked us to do anything that is preposterous or silly or beyond what we could do. They want to see us create value, and we want to do that, too. We’re working hand in glove, and succeeding. There are distinct positives from private equity. The naysayers don’t know what they are talking about.”

FRESH PERSPECTIVE

Out of all those distinct positives, perhaps the most important is that Platinum brings fresh eyes to analysis of any business that it buys.

“From our perspective, it’s interesting coming in as a complete fresh face to the industry, not fully understanding everything and just asking some basic questions,” says Archambault. “Nine times out of 10, people look at you and say, ‘We already thought of that.’ But sometimes, people with a lot of experience get caught up in what they learned years ago and what they know. ‘This is how the company has always operated,’ they say. ‘We can’t operate it any differently.’”

Except sometimes they can. At Ryerson, purchased by Platinum for $2 billion in a transaction that closed in October 2007, an article of faith was that the business required continued use and focus on its old four-warehouse, 1.3-million-square-foot Chicago service center. About half the products shipped to that facility were reshipped to other Ryerson service centers as part of a determined centralization drive by previous management.

“The distribution business doesn’t suffer a lot of double handling, and that’s essentially what was going on there,” says Stephen E. Makarewicz, who was promoted by Platinum to become Ryerson’s president and chief operating officer. “With four buildings, if you are building a load, you’ve got to drive the truck from one building to the next. It just didn’t work very well.”

At the time Platinum did its due diligence on Ryerson, Makarewicz, then president of the Ryerson South operation, was on assignment in Chicago looking for ways to make the huge facility, a loser on an EBITDA basis, more efficient.

“It bothered me that we were getting product in and storing it in Chicago, and then more than half of it was going out to service centers as far away as Arizona or Los Angeles,” says Archambault. “I mean, you don’t have to be an industry expert to know that something just doesn’t make sense there. So we were digging into the numbers. I had a roomful of people, mainly from Ryerson, and we were going through their Chicago renewal program. So I had to ask the question, ‘What if you shut down Chicago?’ It was a very sacred topic at the time. Very emotional.”

“Part of what makes [Platinum] good is that they continue to challenge us in positive ways,” says Makarewicz. “If we earned as a public company what we earned in the first quarter of this year, everybody would have been delighted. But the fact is, we missed the plan by a couple of million dollars, and that is just unacceptable. And the fact is, this is bigtime change. We understand that there is going to be enormous pressure to deliver on plans that we jointly agreed to. I haven’t in my career seen change of this magnitude, where the company was just so totally aligned with the strategy.”

On the other hand, Kotzubei says Ryerson’s selling, general and administrative expenses in the first quarter were $21 million lower than in the first quarter of 2007, or $84 million to the good annually. The first quarter was not just bad news, in other words (See “Ryerson Reverses Course”).

METALS WORK

So, other than fresh eyes, what does Platinum Equity bring to the table?

For one thing, the company has a very keen sense of why the metals industry is a good investment for the long haul. Kotzubei says Platinum looks for a set of business characteristics, “and if we find them, we’re going to be very interested in the business, irrespective of the sector.” Those characteristics, which demonstrate the risk-averse nature of an operating company, include:

  • The business must have recurring revenue. “As part of our due diligence, we look at historical buying patterns and get comfortable with the idea that the customers will be coming back. The business won’t collapse under us,” Kotzubei says.
  • The business must have “hard, monetizable assets, working capital, real estate,” says Kotzubei—all “things that can give you some protection in case an investment doesn’t go well.” Ryerson, for example, cost about $2 billion, but had about $1.6 billion in working capital and $300 million in real estate, providing substantial downside protection. Ample collateral is good.
  • The business must be “scalable,” which to Platinum doesn’t mean the ability to grow as much as it does the equal ability to shrink in bad times. “We want to be comfortable that if the business is shrinking that we can react to that and can continue to have cash flow and profitability even in a shrinking environment” Kotzubei says.

Unlike the stereotypical private equity investor, Platinum doesn’t invest on the assumption that the business will grow 15% or 20% a year. “Many of our investments do, in fact, grow rapidly, but we don’t invest on the idea that the way we’re going to make money is through growth,” says Kotzubei. “The way we invest is to focus on downside protection. Can we survive very bad times? We believe that if we build a portfolio of companies where we think we can survive, then we’ve got an opportunity to grow operationally and be successful. As often is the case, the bad times don’t materialize, and you make a great deal on the investment. But our focus is, can we get comfortable?”

Platinum first learned about the metals industry through its acquisition in December 2005 of ESM Group, which provides hot metal desulfurization equipment and services to steel producers. Platinum found ESM, a non-core business of former owner Degussa AG, starved of financial and intellectual capital. Kotzubei encouraged ESM’s management to explore its dormant plans to launch a secondary use for its technology in defense applications. ESM did so successfully, and Platinum sold the expanded business to SKW Metallurgie in October 2007. “We made roughly 3.5 times on our money,” says Kotzubei.

Platinum also learned from its ESM experience that more steel is used in North America than is made here. That led to an interest in the whole metals sector and the eventual purchase, in May 2006, of PNA Group Inc. from TUI AG of Germany for $375 million. At the time, PNA consisted of Feralloy, the Chicago provider of flat rolled steel products; Delta Steel, a Houston-based service center for steel structural beams, channels, tubes, plate and related products; and Infra-Metals of Atlanta, a specialist in steel structural products.

Kotzubei boils down Platinum’s research on and confidence in the metals industry into the “4 Cs” of costs, currency, consolidation and China.

  • COSTS. Platinum concluded it could not predict with any reliable accuracy the likely costs for energy or raw materials required to make metals. “But what you can get very comfortable with is that over the long term, those costs are going to move up,” he says. Global consumption of raw materials was certain to increase, pressuring supplies and forcing costs upwards, which Platinum regarded as a long-term positive trend.
  • CURRENCY. Although the outlook for the dollar was also uncertain, “there were already signs that the dollar was not going to surge anytime soon. We had no clarity that it would drop as much as it has, but we believed it would not strengthen,” Kotzubei says. A net positive, in other words, for U.S. exports and manufacturers.
  • CONSOLIDATION. Steel industry consolidation had heavily concentrated production with three or four companies. “That produced a sea change in behavior,” says Kotzubei. “Rather than a general manager at a steel mill getting a pat on the back for producing more tons that week, they got a pat on the back for producing the best profits. Steel mills were run by profit-oriented, rational managers with the discipline to take capacity off line if a supply/demand imbalance occurred.”

    Platinum had expected the magnitude of price swings to decline. That didn’t happen—prices have skyrocketed—but that misjudgment has worked to the company’s advantage, because distribution profitability increases as prices rise.

  • CHINA. China is problematic because “if it stumbles meaningfully, it will have a dramatically negative impact on this industry,” Kotzubei says. “But our view was that even if they do have a hiccup, it will be short term and will not reverse the long-term growth trend.”

SOLID GROUND

As for PNA, it had all the required business characteristics: a solid history, loyal customers, “fantastic asset coverage” and strong management. “We were very well protected on the down side,” Kotzubei says. “And as it turns out, we have done extremely well” (See “PNA Expands Nationally”).

Platinum further improved its PNA comfort level by adding Sandy Nelson as CEO in January 2007. Since then, Platinum has invested another $150 million in PNA acquisitions and $50 million for plant expansions and Greenfield construction, while withdrawing dividends of $150 million. This left PNA “prudently levered,” says Kotzubei. “Done right and done well, there is room to both make money and invest in the business,” he says. “We invested in PNA with a 15-year horizon in mind. I’m convinced we will do extremely well.”

The time horizon may have been 15 years, but when opportunity strikes, Platinum doesn’t hesitate to sell its properties. Reliance, which announced its deal to buy PNA in June, paid $1.1 billion for the company, or 2 1/2 times Platinum’s net investment in the purchase and facilities expansion during the last two years.

“What we did with PNA was take a very good company, and through concentrating on operational reforms and organic and acquisition-oriented growth, created a company that was unique for the space, with a leading market position for its products and locations,” says Kotzubei. “That made it an extremely attractive candidate for Reliance. And Reliance has a reputation for buying the very best companies and paying fair value for them.”

“We like the business and have known and respect the managers of the different businesses,” says David H. Hannah, chairman and chief executive officer of Los Angeles-based Reliance. “Platinum supported the growth of the business through acquisitions and capital expenditures. [PNA’s] different businesses fit very well with us, add to our diversification of products and customers, and expand our geographic footprint.”

Because of its record of substantial returns on its investments, Platinum is closing on a second buyout fund—the first, in 2004, raised $700 million—that observers say will be substantially oversubscribed at more than $2.5 billion, compared with the target of $1.5 billion. Times remain good for Platinum and its business of building outstanding returns on the basis of stronger businesses.

“The days of easy money, where you could buy undervalued assets and restructure them and not worry about much else, are long gone,” says Dr. Colin C. Blaydon, dean emeritus of the Tuck School of Business at Dartmouth College and director of its Center for Private Equity and Entrepreneurship. “But because of the way that private equity shares with the management team, and because of the increases in value created by improving the company, there’s a very strong incentive. And if they succeed, it’s a very attractive payoff for them.”

 

REYERSON REVERSES COURSE

Just as all businesses tend to experience some degree of cyclicality, business organizational styles are cyclical as well, shifting between centralized, decentralized and sometimes hybrid models.

At Ryerson Inc., (sales, $6 billion from 105 North American service centers plus 20 in India and four in China; 2007 EBITDA, $210 million) a determined march toward industry-leading levels of centralization abruptly ended in October, replaced by a decentralized structure and costreduction business plan.

Under the pre-Platinum management, Ryerson tried to achieve major economies of scale with suppliers, building purchases by requiring all of its service centers to carry the same basic stock of largely commodity items. The company was installing an SAP AG enterprise resource planning system—notoriously difficult to implement in a metals industry environment—and it ran nearly all purchasing, credit and other business functions from Chicago. To lock in customers, Ryerson had a heavy reliance on long-term contracts, a practice that leads to problems during periods of rising prices.

The problem was that “service centers are pretty much a local business in the end,” says Stephen E. Makarewicz, Ryerson’s president and chief operating officer. “You can’t run a service center in Los Angeles effectively out of Chicago. You have got to be in that market. You have to understand the customers, the supply chain in that market, and you have to give your local people the flexibility to stock what they need to stock to effectively serve their market. Yet we were trying to build this highly centralized, everything-done-out-of-Chicago business that proved to be problematic.”

Further, he says, the underlying purchasing theory didn’t prove to be true.

“To build volume to leverage our suppliers, we took business that probably wasn’t good business for us,” says Makarewicz. “We got the tons, and in theory that should have given us more leverage. But there’s a point in our industry where scale just doesn’t seem to matter as much as some people might think. The top-tier distributors pretty much get the same deals from suppliers, and maybe you can squeeze out a little bit more here or there on a product, but the ability to lever the buy side wasn’t quite what some people thought would happen. It’s counterintuitive, but a lot of these mom-and-pop shops do a pretty good job of competing with the big boys.”

So centralization has been shelved in favor of speed and local responsibility to respond to the needs of local markets. Headquarters-based vice presidents have been replaced by six regional presidents who are dispersed into their territories, with complete responsibility for all business functions in their areas.

“Our reorganization has set the tone for our business expectations and speed to market,” says Kevin Richardson, previously a regional vice president under the centralized structure and now president for the Southeast. “We used to have this huge corporate structure, with shared resources for purchasing, credit, marketing and, to some extent, operations. What that meant is that you had people in Chicago responsible for the entire country and not connected to any business plan or unit.”

Under the new structure, Richardson has his own purchasing, credit, marketing and operations responsibility, as well as revenue and profit goals. Mills that used to ignore him and his warehouse network now call on his purchasing executives to tout their products. Credit issues are resolved immediately by regional credit managers, who now have the time to visit with customers and warehouse managers to discuss problems. “Information in this business is key,” says Richardson.

For example, Ryerson sold 21 loads of tubing to a South Carolina fabricator, sourcing the material from a regional tube producer and completing the order in just an hour. Under the old system, the regional office would not have been permitted to buy from the regional supplier, and it would have taken days to secure a quote from Chicago. The deal likely would have been lost.

In another instance, a good customer—a manufacturer of agriculture equipment—confronted with difficult credit arrangements because of the protracted subprime mortgage fallout, quickly obtained a seven-figure credit extension from Ryerson. A similar solution would have been difficult under the old organization, Richardson says.

Decentralization is only one of a number of steps taken by Ryerson to energize the business, which has been a laggard in recent years. Working with Ryerson executives, owner Platinum Equity set $150 million as a first-year cost reduction goal, which Makarewicz says will be completely achieved. Among steps taken to reduce costs:

  • The Chicago warehouse will be closed with all functions transferred elsewhere by the end of the year.
  • Decentralization itself saves about $45 million in improved efficiencies.
  • The SAP ERP project has been halted.
  • Slow-moving items are removed from inventory at local discretion.
  • Ryerson cut employment by 5% across the board.“No one complained, so we knew it was the right thing to do,” says Makarewicz.
  • An 80/20 process to reduce inventory and focus on the best and most profitable products has been put in place and segmented by market size to recognize product mix characteristics.
  • Multiple facilities have been or will be consolidated in Richmond, Charlotte, Jacksonville, Orlando, Los Angeles and Pittsburgh, among other places.
  • The corporate staff has been cut in half.

In addition, Ryerson is looking at potential acquisitions once again. “We have essentially the same debt-to-equity ratio as we had when we acquired Integris [Metals Inc., in January 2005 for $410 million, plus assumption of $234 million in Integris debt],” says Makarewicz. “We have plenty of liquidity.”

And now, plenty of momentum. “There is a significant opportunity at Ryerson,” says Rob Archambault, the Platinum Equity partner who has been serving as the interim CEO. “Some of it has to do with the magnitude of the costs that we felt could come out of the company by refocusing it. But just as much of it has to do with how excited people are about operating in a decentralized organization, how they have embraced that. To be able to make decisions for what’s going on in their region, to be accountable for that, means a lot.”