Is Tom Hicks Going Broke?

D Magazine, Jul 01, 2002 by McGraw, Dan

Private equity firms like Hicks Muse (the term "leveraged buyout business" is synonymous but lost favor in the 1990s because hostile takeovers gave it a bad connotation) are fairly simple businesses, at their core. They generally raise money for a fund from institutional investors to buy stakes in companies where they see upside potential. The private equity firm typically draws down on its commitments from investors for a five-year period, buying and investing as it goes. Generally, the goal is to cash out after 10 years. The private equity firm gets annual management fees of 1 to 2 percent, usually weighted more heavily in the first five years to "keep the lights on" while the firm hunts for target companies. The investors get a preferential rate of return, and, at the end of the fund's life, they get their money back plus the lion's share of the profits, with the equity firm getting 20 to 30 percent. If all goes well, partners like Tom Hicks make a lot of money on their expertise, and the investors get a higher rate of return than with other, more conservative investments. Being successful requires buying right and not overpaying for target companies.

The success or failure rate of these funds is difficult to gauge, because the firms themselves do not make return rates public and the long-term nature of the funds allows for turnarounds after bad starts. Nobody doubts however, that Hicks Muse had a golden touch during the early and mid-1990s. It certainly had a golden touch in attracting investors, quickly becoming one of the largest private equity firms in the nation.

Its first two funds performed well, with the right combination of food, manufacturing, and media plays. The third fund, started in 1996, has also done fairly well. By the late 1990s, though, the investment climate began to heat up. Investors leaped like lemmings into high-tech, and anyone who wanted some of their money had to jump ahead of them and pretend to be in the lead.

With its fourth fund, in 1998, Hicks Muse changed strategies. Out of a $4.1 billion pool, the firm placed $1.2 billion in telecom, buying minority stakes in public companies in a bid to become a major player.

Meanwhile, the New Economy siren song grew more and more enticing. Venture capital firms posted gigantic returns, and the pressure was on to match them. Hicks Muse jumped in by borrowing $200 million and investing in several Internet companies, with the thought of folding them into its next general fund. At the same time, it launched a $964 million Latin American fund with the idea of South exporting U.S. media expertise to the South American market.

As the Hicks Muse partners went out to peddle their fifth general fund, the New Economy turned ugly. The first to go down were the telecom investments. FourTeligent, ICG Communications, Viatel. and Rhythm NetConnections-would file for bankruptcy. ICG collapsed only six months after receiving a Hicks Muse infusion of $230 million. Analysts think the telecom plays will be nearly a total loss for the firm.