Meritage is a private equity firm having raised just over $600 million in committed capital since formation. We typically make two to four new investments per year. At the start of 2010, we had a total of eleven portfolio companies. During the year, we sold three of our companies - Diveo, NuVox and NewPath - to strategic buyers. We were delighted with each of these transactions.
In the case of Diveo and NuVox, our exit was frankly overdue as our Fund I made its initial investments in these companies in 1999. In an ideal world, these companies would have been sold as early as 2007 and certainly by 2008, as both were strongly EBITDA positive with excellent growth. As we all know well, strategic buyers had limited appetite for acquisitions in the 2008-09 timeframe, and the timing of our 2010 exits was due in large part to the return of strategic buyers with pent-up demand to the marketplace.
Both NuVox and Diveo were formed in frothy markets where debt and equity funding was readily available for capital-intensive projects, and both companies had large, unwieldy investment syndicates. As these companies started to mature, they encountered perhaps the most difficult markets (both financial and operational) in the history of the communications industry. While many larger and better-known enterprises failed in this market, NuVox and Diveo survived by virtue of significant restructurings and excellent leadership. In the case of NuVox, Meritage partner David Solomon was the Chief Executive Officer and led the company not only through a significant restructuring, but also through two major acquisitions. Under David’s stewardship, NuVox grew from a few hundred thousand dollars in revenue in 1999 to well over $500 million in revenue at the time of its sale. Interestingly, there were investors in NuVox who chose not to participate in the restructuring, and therefore did not benefit from David’s work. In the case of Diveo, Bob Goad stepped in and provided the operational and strategic leadership necessary to build the company into a strongly EBITDA-positive entity following its restructuring.
NuVox was purchased by Windstream Communications in February for approximately $650 million, and Diveo was purchased by Universo Online in December for approximately $475 million. We at Meritage take great pleasure in having been part of building these two significant enterprises. Both companies were started in the best of times, and both weathering the worst of times. NuVox and Diveo are now in the hands of significantly larger enterprises where they will be important earnings contributors going forward.
The third company we sold in 2010 was NewPath Networks, a Fund III portfolio company. NewPath was an altogether different story, as the sale of this company occurred only 16 months from the date of our original investment. We invested in NewPath alongside Charterhouse Group in April of 2009, believing that the company’s distributed antenna system (“DAS”) networks represented the next generation in communications tower infrastructure for high-density markets. We also believed that NewPath’s management team, led by Mike Kavanagh, was the best management team in the sector. NewPath was the smallest of the three “pure play” DAS operators by size but had achieved strong market positioning as a result of its strategy of building systems with high lease-up potential.
When we participated in the company’s $30 million institutional financing, we believed NewPath had adequate capital to build a significant footprint and make needed operational gains. Shortly after the closing, however, the industry landscape changed dramatically. First, our largest competitor was purchased by a large private equity firm, which made available significant additional capital (rumored to be $150 million) to this competitor. Our second largest competitor responded by raising $128 million in a significant equity financing. All of a sudden, NewPath’s $30 million looked quite modest! We quickly initiated a financing effort to raise at least $75 million, despite our concerns about dilution. Soon after hiring an investment banker, NewPath was contacted by both of its pure-play DAS competitors as well as several major tower operators, all seeking to purchase NewPath rather than have us raise additional capital. The company’s pure-play DAS competitors had the most to gain from an acquisition but proved to be “flat footed” in the process, thus setting the stage for the ultimate acquirer, Crown Castle, to become the dominant force in the sector.
Crown Castle purchased NewPath in September 2010 in a transaction that valued the company at approximately $115 million. By combining its communications towers and capital with NewPath’s DAS capabilities and know-how, Crown is now extremely well positioned. Although we would have liked to have grown NewPath into a much larger company, we realized that given the limited resources of the NewPath investors and the enormous dilution that was in store if we proceeded to raise more capital, we were ultimately on a precarious path. Therefore, from a portfolio management perspective, this was an excellent transaction.
Our success in 2010 demonstrates that the strategic buyer is alive and well for services companies. Buyers are seeking scale and/or seeking to fill specific strategic needs. This means that there continues to be an enormous role for private equity investors to grow their portfolio companies both organically and inorganically to take advantage of the current appetite of strategic buyers. Of course, the downside of an improving market is the impact on pricing of new investments. As we have learned on more than one occasion during the past ten years, private equity investors must be disciplined from a valuation perspective in order to generate attractive returns.
In a recent conversation with one of our limited partners, we learned that their 2010 distributions exceeded their internal forecast by 2.5 times, illustrating that our strong 2010 liquidations was an industry-wide occurrence. While the volume of activity will likely not match the 2010 level, we at Meritage believe that 2011 will continue to offer a robust environment to sell strong, profitable and growing companies.