June, 2007

By Paul Ziobro
Dow Jones - LBO Wire

When TSG Consumer Partners started raising its most recent fund, it was besieged by hungry investors.

Existing limited partners, like Colorado Public Employees' Retirement Association, Michigan State Bureau of Investment and the New York State Teachers' Retirement System, all wanted to increase their allocations. Would-be new LPs beat a path to the firm's door. Demand ultimately reached close to $2 billion -- about four times the size of the firm's previous partnership.

In the end, the consumer-focused firm settled on about $900 million for TSG5 LP, which closed in December. Existing investors increased their commitments, with only a couple of new investors allowed in.

“We wanted to make sure that cash doesn't burn a hole in our pocket,” said TSG Chief Executive and co-founder Charles “Chuck” Esserman.

TSG's popularity shows just how strong limited partners' appetite for industry-focused funds is right now. On top of that, there are few firms, even within the industry-focused space, with a track record like TSG's. The firm's funds have yielded a compound annual internal rate of return of about 59% since its inception, with not a single unprofitable deal among them.

TSG, which was founded as the Shansby Group in 1987, attributes its winning record in part to being a trailblazer in a lot of sectors. The San Francisco-based firm says it was the first buyout investor to test the waters in such spaces as ethnic and organic foods, orphaned brands and super-premium personal care companies. Successes like its natural foods platform, which it sold to the Hain Food Group in 1998 for an aggregate IRR of 47%, led to copycat plays from competitors, it claims.

Almost as important as blazing a trail, however, is knowing which sectors to avoid. As the low-carb diet craze swept the nation several years back, TSG looked at -- and passed on -- a number of products riding on that bandwagon, guessing that it was just one in a long line of fad diets.

“We need to separate fads from trends,” Esserman said. “We believed at the time that low-carb was a fad.”

Distinguishing between the two can be difficult, but TSG's laser-like focus on the consumer space has resulted in a deep well of proprietary market research that helps its partners to develop expertise on the subject. They've used the research to keep the firm's eyes squarely on companies whose products are not cyclical, have low research and development costs and, of course, have great brands. Brands that TSG has backed like Mauna Loa Macadamia Nut Co., Terra Chips and enhanced water company Energy Brands Inc. all fit that description – “Great products that are different, and great products that make a difference,” Esserman said.

TSG likes to sell its companies to strategic buyers, which can often offer premiums to what buyout firms can pay. To that end, it has only occasionally tapped the debt markets for dividend recapitalizations, preferring instead to pump free cash flow back into companies for marketing initiatives and the like.

“The dividend recap doesn't really at the end of the day add value to the company,” Esserman says.“It creates more financial risk.”

That may run counter to the strategies of many other buyout firms. But when you're building a brand into a household name, you can't afford such short-term luxuries, TSG says.

“We're building value by building a much larger and more attractive business,” TSG Managing Director Alexander S. Panos said. “And you can only do that, in our mind, by investing in the brand.”

Locations: Headquarters are in San Francisco; recently expanded New York office

Key Personnel: Managing Directors M. Hadley Mullin, James L. O'Hara, Alexander S. Panos and Yasser U. Toor

Deals: Over 45 deals total since inception. Ten portfolio companies currently, with two exits pending. Its three most recent exits, from Energy Brands Inc., Smart Balance maker GFA Brands Inc. and high-end shampoo maker PureOlogy Research LLC, have returned an average of 10 times equity.