June 19, 2015

Searchlight Scans TMT and Beyond

By Chris Nolter

As featured on TheDeal.com

While John Malone-backed Charter Communications Inc. (CHTR) rolls up much of U.S. cable TV, another Malone outfit, Liberty Global plc (LBTYA), has consolidated the market in Puerto Rico.

Liberty Global has a market cap approaching $50 billion and has purchased cable operators from Eastern Europe to South America. Still, the company teamed with relatively new private equity firm Searchlight Capital Partners LP for the $272.5 million acquisition of Choice Cable TV in June, the second deal that the companies have completed in the territory.

Searchlight is a New York firm founded in 2010 by Erol Uzumeri, the former head of head of Private Equity for the Ontario Teachers’ Pension Plan; KKR & Co LP London partner Oliver Haarmann and Eric Zinterhofer, previously co-head of media and telecom for Apollo Global Management LP and the Chairman of Charter. Including the founders, all in their mid-40s, the investment group includes 14 professionals from firms such as Blackstone Group LP (BX), GTCR LLC, Bain Capital and Silver Lake Partners.

Transactions out of Searchlight’s debut $860 million fund in 2012 skew toward telecom, media and technology, but include other sectors. They range from Puerto Rican cable and Alaska telecom and pay TV operator General Communication Inc, to British footwear company Hunter Boot Ltd. and Canadian special foods purveyor M&M Meat Shops. The firm declined to comment, but reports and people familiar with the situation state that the firm is working on a substantially larger second fund.

Liberty Global acquired Swiss cable and broadband provider Cablecom Holdings AG for CHF 2.826 billion ($2.185 billion) from Apollo, Towerbrook Capital Partners and Goldman Sachs & Co. in 2005. Five years later, Apollo and BC Partners sold German operator Unitymedia GmbH to Liberty Global for €2 billion ($3 billion). “We’ve done a number of win-win deals,” Fries added. “That’s not always common in our space.”

Liberty and Searchlight partnered in 2012 to buy Puerto Rican cable operator OneLink Communications, which they are combining with Choice. The new owners have tweaked the TV model to better suit the market. The company dropped more expensive English-language programming in favor of Spanish-language content that is less expensive and more popular locally, and reduced the cost of the service.

“I’ve known Eric well over 10 years,” said Liberty Global CEO Mike Fries. “Eric has been a critical and valuable resource as we’ve made two acquisitions, consolidated the entire island and grown the business,” Fries added.

MUSIC INDUSTRY veteran Charles Goldstuck, who founded J Records with Clive Davis and was Chief Operating Officer of Bertelsmann Music Group, runs Searchlight portfolio company TouchTunes Interactive Networks Inc. The New York company operates a network of more than 71,000 smart jukeboxes in North America and Europe.

Goldstuck took over TouchTunes in 2009. “I was looking for a business to invest in that had a digital platform,” he said. “I was keen to embrace the technology side of the music equation, versus the development side and just working with artists.”

In 2011, the company raised $40 million (£24.5 million) from Britain’s 3i Group plc. “The company needed to be recapped and reoriented,” he said. About 15 months ago, Goldstuck said, he made a board presentation that led to the deal with Searchlight in April. “What I was looking for was a PE firm or sponsor that had a media and digital media sensibility, but had the muscle and the clout to help me drive this business globally,” he said.

The company hired Moelis & Co. and began talks with suitors. While many of the backers were “courting” TouchTunes, Goldstuck said, Searchlight was “debating” issues. “They got into a very healthy debate and dialog about the company and its future,” he said, “which could be risky if you’re talking to the wrong CEO who has different ideas.”

As in the old days, the company’s jukeboxes charge to play songs. TouchTunes’ devices also integrate mobile technology and advertising models. A mobile app allows users to buy songs without getting up from the bar and risking derision from patrons if they want to, say, play Hotel California five times in a row. “A lot of people are shy and they don’t want to get up from their seat because they don’t want to lose it,” Goldstuck said. The company sells songs and ads and the application has about 550,000 active monthly users. Those users drop virtual quarters into the jukeboxes’ virtual slots and, Goldstuck said, generate about 22% of gross revenue.

Over the next 12 months, TouchTunes expects to have about a million active mobile users who generate approximately 30% of music revenue.

The jukeboxes also serve as a “proximity network” that can send drink specials or other location-specific messages to mobile phones. “Our network is bigger than that of McDonald’s, Starbucks, Wal-Mart. You combine all of those and you can add a few more. Dunkin’ Donuts, Taco Bell and a two or three other chains, and our touchpoints are even broader than all of that combined,” Goldstuck said. “That’s why when you look at things like proximity, we think there is a huge opportunity and Searchlight got that in two seconds.”

Peter J. Solomon Co. banker Mark Boidman advised Searchlight on the TouchTunes investments. “It’s important to Searchlight that technology is going to be a friend of the industry,” Boidman said regarding Searchlight’s strategy. The firm also likes assets that can grow by taking market share, he added, even if the size of the market were to fluctuate. “Searchlight also likes consolidation opportunities where there is a platform for future growth,” Boidman said.

ELECTRONIC BILLBOARD operator Ocean Outdoor U.K. Ltd. is an example of a platform for acquisitions. The London company owns the Liverpool Media Wall, which is the largest full-motion electronic advertising screen in Europe, and the 1,734-square-meter installation near London’s Waterloo Station. Earlier this year the company collaborated with ad agency WCRS on an electronic billboard for a campaign to raise public consciousness of domestic violence. The display used facial recognition technology to gauge the number of people observing an image of an abuse victim. As more people looked on, the victim’s injuries would heal.

Originally backed by Smedvig Capital, Chairman Tom Goddard and CEO Tim Bleakley arranged a sale to Lloyds Banking Group’s middle market PE unit LDC in early 2012.

“We set about implementing a rollup plan and expanding across the U.K.,” Bleakley said. Last Summer, the company bought Signature Outdoor, the top digital out-of-home advertising company in Birmingham, the country’s second-largest city. LDC sought an exit. “For a variety of reasons they decided they wanted to hop off the bus,” Bleakley said. The company hired Wyvern Partners and Linklaters to look for new backers.

“We wanted to find a like-minded, similar investor to LDC, ideally slightly bigger and with a little more expertise beyond the U.K. territories,” he said. Ocean also wanted a firm that could turn a deal around quickly. “We started to engage in November. We were looking to get a deal done before Christmas,” Bleakley said, adding that the company made 19 management presentations over five days. Ocean engaged with Searchlight’s Oliver Haarmann and Darren Glatt, a former Apollo partner, Bleakley said. Searchlight acquired a controlling interest in December.

Ocean subsequently bought Manchester digital outdoor company MediaCo Outdoor in April. Bleakley said the company continues to grow in the U.K. and expand in other European countries where the digital outdoor advertising market is less developed. There could be partnerships or more acquisitions. “We’re not talking about telephone-number type acquisitions,” Bleakley said.

Educational and professional publisher Cengage Learning Inc. is another portfolio company. Searchlight and other creditors gained stakes in the Boston company during its 2014 exit from bankruptcy. Textbook publishing is not exactly adjacent to electornic jukeboxes and outdoor advertising. But like TouchTunes and Ocean Outdoor, Cengage is developing its digital business and applying technology to traditional media.

SEARCHLIGHT’S CABLE and telecom investments are geographically dispersed, but reflect the importance of broadband services and the consolidation in cable and fiber networks. While the strategy in Puerto Rico cable has involved changes to the TV package, video makes up less than 15% of revenues for Alaska portfolio company General Communication Inc. (GNCMA). Wireless and broadband are the sources of growth. Searchlight invested $75 million in an unsecured note in December 2014, as the company bought out wireless JV partner Alaska Communications System Group Inc. (ALSK) for $300 million.

For Searchlight portfolio company Integra Telecom Inc., the focus is on fiber networks. “Their initial thesis is still a huge part of our story,” CEO Bob Guth said of Searchlight’s investment. The company has fiber networks in Western cities such as Portland; Seattle; Salt Lake City, Utah; Boise,

Idaho; Phoenix, Arizona, and Sacramento, California.

“They saw assets that were pretty strong. A lot of fiber. A lot of really deep, dense networks throughout the Western U.S.,” Guth said. “They thought those networks weren’t being fully utilized and that there was an opportunity with a little more focus to push them further.”

Integra had fallen into distress on the heels of the 2007 purchase of Eschelon Telecom Inc., which closed as the economic crisis was taking shape. “It would probably be one that, if the company had a do-over, we wouldn’t do today,” CFO Jesse Selnick said of the acquisition. The company also raised $245 million from Warburg Pincus in 2007.

The company eventually reorganized out of court, and wound up with 10 to 15 institutional owners.

Searchlight purchased Goldman Sachs’ stake in the telecom networking company in December 2012. The firm is the largest shareholder, but does not control Integra. Tennenbaum Capital and Farallon Capital are the two other largest investors. “They got to know the other shareholders [and] got to know that the shareholdings was actually a strength instead of being scared of by the fact that they didn’t have voting control,” Selnick said.

“They are both patient and aggressive, which may sound a little bit like an oxymoron,” Guth said of Searchlight. The Integra CEO compares Integra to Charter, a formerly distressed company that has had a turnaround. “That’s been a long time in the making,” Guth said. “He’s been involved there for a long time and obviously its turned into quite a bit more than any of us could have predicted a few years ago.”

Without any exits, gauging the success of a PE firm can be a theoretical exercise.

“To make your name, you need to have completed deals.” said Boidman of Peter J. Solomon. Some firms don’t get deep into processes, he observed, or turn up at the right sales.

The size of Searchlight’s investment team suggest that the firm has plans to work on a larger scale than its first $860 million fund.

“They are a serious fund and judging by their present fundraising efforts I would imagine they are going to become one of the dominant funds in years to come,” said one media industry source.

The firm may have to rely less on partnerships, depending on how its future fundraisings play out.

Liberty Global CEO Fries is open to collaborating more with the firm. “We would be happy to do more deals with Searchlight. I consider them to be some of the smartest guys in the PE business, especially when it comes to media and communications” Fries said. “How that unfolds, I have no idea.”