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The Dealmakers

The Buyout Business Has Changed, and So Has Frederic Malek

By Terence O'Hara
Monday, October 25, 2004; Page E01

A seemingly small change was recorded last week at Thayer Capital Partners, one of the Washington region's biggest and best known corporate buyout firms. In its marketing brochure, Frederic V. Malek changed his title to "chairman and founder" from "managing partner," the title he has held since he formed Thayer in 1993.

The change represents some big changes at Thayer. The biggest is that Malek has stepped back from running the firm and will no longer lead the deals it makes.

Malek heads a local group expected to bid for Washington's Major League Baseball team. (Frank Johnston -- The Washington Post)

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"The partnership and I agreed that it would be best served by relieving me to do what I do best," Malek said last week. "I don't intend to just pursue a hobby as a baseball owner. I intend to be chairman and partner of Thayer for the rest of my life.

In recent years, Malek has been in the spotlight as leader of a local group bidding for Washington's Major League Baseball team. But for more than two decades, he has been a fixture in the District's business and political circles.

Malek's main business, and the source of much of his considerable wealth, has been corporate buyouts. In addition to leading many of the buyouts and corporate investments for Thayer Capital's funds, Malek led the group that acquired the Ritz-Carlton hotel chain and led the buyouts of Northwest Airlines and the CB Richard Ellis real estate company. He also owns one of the largest private hotel ownership groups in the country, Annapolis-based Thayer Lodging Group.

But, in recent months, Malek has passed management of Thayer on to a troika of seasoned veterans, two of whom joined the firm since 2001. After several unsuccessful investments in 1999 and 2000, seven managing partners left the firm.

To some extent, according to many involved with Thayer, Malek's withdrawal from Thayer's day-to-day work is less a reflection on him than it is of the changing corporate buyout business, in which companies use a little bit of their investors' cash and usually a lot of debt to buy companies, then sell them a few years later.

Malek was involved in some of Thayer's costly missteps. But the current Thayer partners laud Malek for recognizing as early as 1998 that the firm needed to change and for guiding the partnership through a difficult period.

This story is based on more than a dozen interviews with current and former Thayer associates as well as others outside the firm who have knowledge of Thayer's deals in recent years. Malek and managing partners Daniel M. Dickinson and Scott D. Rued agreed to speak on the record. The third managing partner, Jeffrey W. Goettman, could not be reached for comment. Others spoke only on the condition they remain anonymous because they don't want to be seen as critical of Malek, whom each said he respects and admires.

Success Got Harder

Malek has moved easily between the political and business world here, serving as deputy director of the White House Office of Management and Budget under President Richard M. Nixon, a member of President Ronald Reagan's Council on Cost Control, director of the 1988 Republican National Convention, and President George H.W. Bush's campaign manager in 1992.

In the 1980s, Malek was president of Marriott Hotels and Resorts. Before that he was a was a management consultant with McKinsey & Co. and co-founded a hand-tool manufacturing company. He is a director for several companies, including Fannie Mae.

Thayer made several successful investments. One major local home run was Saga Systems Inc., a Reston software company. Thayer bought Saga in 1997 from its German parent, Software AG, for $30 million. In 2001, when the German company bought back the firm, Thayer could record a gain of more than $250 million on its initial investment.

Dickinson arrived at Thayer in April 2001, the same month Thayer closed out its investment in Saga. It was the high point.

"Everything started to get a hell of a lot harder after that," Dickinson said.

Dickinson was recruited to Thayer by Goettman. The two had met at Duke University, where Dickinson was studying mechanical engineering and Goettman was working toward a computer science degree.

Dickinson in 2000 had quit his job as co-head of the global mergers-and-acquisitions practice at Merrill Lynch, the world's biggest investment bank. He wanted to get back into the more sanely paced private equity arena, and Goettman gave him a call. "After 15 years, I wanted to get off the train," he said. He lives with his family in a Chicago suburb, though he spends at least one day a week in Washington.

Goettman had joined Thayer in 1998 "to give us more experience in operating companies," Malek said.

"We needed people with operational skills beyond what Rick and I could bring to bear," Malek said, referring to Carl J. "Rick" Rickertsen, who was Thayer's chief operating partner and one of the firm's most visible executives in Washington until his departure last year.

Dickinson, 43, and Goettman, 45, cut their teeth in the mergers and acquisition world of the 1990s, Dickinson at Merrill Lynch and Goettman at Wasserstein Perella and Robertson Stephens. Both worked mostly with manufacturing and light industrial clients. "Jeff and Dan were far more sector-focused," Malek said.

Until the late 1990s, most buyout firms were run by generalists like Malek. They looked for companies with an upside in a wide range of industries. Thayer's investments in its largest buyout fund, for instance, included Internet consulting firms and a residential heating and air conditioning company. Most buyout funds stick with established, cash-generating businesses. But Thayer's Fund IV also invested in promising start-up companies that had no earnings and relatively little revenue.

Fund IV closed to new investors after it raised $880 million, in March 1999. It had some successful investments such as IESI Holdings Inc., a solid-waste management firm that has been buying similar firms in the Northeast and South.

But a number of deals have done poorly, and some have been written off or written down substantially. Among them:

• Vigilinx, a New York computer data security firm started in 2001. It was sold for what sources said was far less than what the fund invested in the company. Thayer continues to have an equity interest in the company that bought Vigilinx. While the investment could still make money for Thayer, a meaningful return is considered a long shot.

• Iconixx Corp., an Internet consulting company. Thayer initially committed $80 million to Iconixx to help it buy other companies, though the amount eventually invested was far less. Iconixx tried to go public in 2000, but the stock market crash that year precluded that. Thayer, like many funds that invested in Internet consulting firms at that time, has written off much of its investment, though the company continues to operate.

• Primary Services was a residential heating and air conditioning company formed in a 50-50 partnership with Washington Gas Light Co. The deal had its genesis in Malek's relationship with Washington Gas chief executive James H. DeGraffenreidt Jr., according to Malek. "Poor execution," Malek said of Primary, which sought to roll up independently owned contractors in the Mid-Atlantic region. Primary's management, he said, was never able to make the combined companies work together effectively, a common problem in such efforts. It was written off by Washington Gas within two years of its 2000 founding.

• Pryor Resources Inc., a corporate training company, was bought in a 1999 partnership between Thayer and fellow buyout shop Patricof & Co. In 2001, it filed for Chapter 11 in an alleged accounting fraud. Thayer continues to try to recoup its investment in the firm from various parties. Many other buyout partnerships had similar problems after the 2000 stock market crash, when company valuations -- the lifeblood of the buyout business -- went into sharp decline. During that time, many, including Thayer, brought in partners with extensive operating experience in certain industry sectors, and then invested only in those sectors.

"In the early days of Thayer it worked to be a generalist," Malek said. "But as we got into the late 1990s, it took a lot more in-depth focus on a few key industries to have a competitive advantage."

Different Directions

By 2002, Thayer's partnership was divided into two camps: the generalists, led by Rickertsen, who had shepherded some of Thayer's biggest bets in Internet services, and the sector-focus partners, led by Dickinson and Goettman.

"Everybody needed to be rowing in the same direction, and we weren't," Dickinson said.

By the beginning of 2003, Dickinson said, the partners had decided to stop trying to raise money for its Fund V. The new fund was to be Thayer's biggest, up to $1 billion. But it raised only a third of that amount, partly because Fund IV had done badly and because institutional money for private equity funds was scarce after Sept. 11, 2001.

In the spring and summer of last year, Dickinson said, "we started to get serious about restructuring the team."

Thus began the departure of managing partners and directors that has only recently ended. Rickertsen quit, going on to form Pine Creek Partners, a buyout fund. Among other notable departures: Douglas H. Gilbert went to the buyout team at Marvin P. Bush's Winston Partners. Daniel A. Raskas recently took a job running acquisitions work for brothers Stephen M. and Mitchell P. Rales at their D.C.-based industrial conglomerate Danaher Corp. Jon Isaacson is now a principal at buyout financing firm American Capital Strategies in Bethesda.

Sources at Thayer at the time described the departures as difficult but amicable. Most agreed they were necessary, given the firm's direction. A former partner said too many of the partners until last year were "off on their own a bit. There was no clear agreement on the direction." Also, the former partner said, "we had title inflation."

"In any small partnership, when you make changes it's difficult," Dickinson said. "But you have to be very disciplined in your approach, and it became clear to everyone that [the new direction] was where we were making our bets."

As the new strategy and partnership were gelling, Thayer stayed in virtual stealth mode. While past Thayer investments were well-publicized by the firm's partners, no press releases were issued to tout the other deals. One of the reasons for the low profile, one source said, was the embarrassing involvement Thayer had with former Connecticut state treasurer Paul J. Silvester.

In August, Malek and Thayer settled SEC charges that the firm had paid a consultant $374,500 for "no meaningful work" at the behest of Silvester, who had pledged some $75 million of Connecticut state pension money to Thayer's Fund IV. The consultant was a political ally of Silvester. The SEC alleged Malek and the firm broke securities laws by not notifying investors in Connecticut's pension fund of the unusual arrangement. Silvester pleaded guilty in 1999 to federal bribery charges that he solicited kickbacks from investment firms that were given to friends and relatives.

Thayer hired the consultant with the expectation that he could be helpful in dealing with a new Democratic state treasurer after Silvester, a Republican, lost the post in late 1998, according to Barry E. Johnson, Thayer's chief financial officer . Thayer "would never hire anyone with the expectation they weren't going to do any work," Johnson told The Post this year. He said the firm is "happy to have this matter come to a closure and behind us."

Thayer agreed to cooperate with the SEC's investigation. Malek and the other partners declined to comment on the matter beyond Johnson's statements.

Thayer and Malek did not admit or deny wrongdoing as part of the settlement. Malek paid a $100,000 civil penalty. The firm paid a $150,000 penalty.

New Leadership

Thayer's new regime was sealed when Dickinson recruited Scott Rued, 48, early last year. Rued was a founder of Hidden Creek Industries, a Minneapolis buyout firm that focused mostly on automotive parts manufacturers. Rued had developed eight companies in the manufacturing sector that ultimately bought 55 companies. Much of Hidden Creek's investments were sold in public stock offerings in recent years. Hidden Creek is widely considered to be one of the most successful sector-focused buyout funds.

Rued said that when he met with Malek in the spring of 2003, he told Malek that he wanted to run the partnership with Dickinson and Goettman.

"I told Fred, 'If you still want to run this firm, then I'm not the guy you want,'" he said.

Malek agreed. Since Rued's arrival, Malek has played largely an advisory role at Thayer. "My job is not to tell my partners what to do," Malek said.

Under Dickinson, Goettman and Rued, Thayer has funneled money into a number of new investments, including Brown Corp., a Michigan-based maker of complex welded components used in car manufacturing, and Heckethorn Manufacturing Co., a Tennessee automotive components supplier. Other investments include Associated Asphalt Inc., a Roanoke firm; TEAC Aerospace Technologies, which produces digital video devices for the military and in-flight entertainment systems for airliners; and Mistras Holdings Group, a New Jersey maker of nondestructive testing devices -- things you use when, for example, you want to test how much weight a bridge can hold without actually putting the weight on it.

Thayer also has brought in two senior "operating partners," former chief executives who can work closely with portfolio companies. One is James J. Forese, the retired chief executive of IKON Office Solutions Inc., who became Thayer's chief operating officer last year. Richard A. Snell, former chief executive of auto-parts maker Federal-Mogul Corp., also joined last year as an operating partner.

Malek also beefed up Thayer's advisory board, the group of industry heavyweights that private equity groups use to help identify and vet portfolio investments. Thayer's board now includes Nicholas D. Chabraja, chief executive of General Dynamics Corp.; Norman R. Augustine, retired chairman of Lockheed Martin Corp., and Robert J. Eaton, former chief executive of Chrysler Corp.

Malek still probably has one of the most formidable Rolodexes in Washington. Both Dickinson and Rued said they expect him to stay with the firm indefinitely.

"I hope he's here for a long time," Rued said.

Malek said Thayer will probably start raising Fund VI next spring or summer, and he'll probably be involved in that effort.

To some extent, the fundraising will hinge on how much Thayer can recover for investors in Fund IV and how much money it can make for Fund V.

"In the final analysis, we're there to make money for our institutional investors," Malek said. "Not excuses."

Terence O'Hara's e-mail address is oharat@washpost.com.

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