A wolf in sheep's clothing?: Buyout firms acquire a taste for telecom

Hicks, Muse Tate & Furst; Kohlberg, Kravis Roberts & Co.; Thomas H. Lee Partners; Forstmann Little. These once-feared names of the leveraged buyout era now are investing large amounts of capital in telecom companies. But unlike the 1980s - when these private equity firms thrived on the financial thrill of buying troubled companies, gutting the management team and preparing them for sale, roll-up or even liquidation - today they claim to be strategic investors with a higher purpose.

With the windfall that has come to venture capital firms and public investors from early stakes in telecom and Internet companies, it's no surprise that these monied Wall Street veterans want some of the digital economy action. Despite these firms' reputation as takeover artists, telecom companies seem to welcome their cash infusions.

"We view them as very strong, supportive investors. They know the competitive landscape, and they bring us significant capital to accelerate our growth rate," said Whit Edwards, vice president of corporate development for MJD Communications, an integrated communications provider.

In January, Thomas H. Lee Partners and Kelso & Co. invested $445 million for a 43% stake in the privately held company. Continuing its interest in integrated service providers, Thomas H. Lee Partners agreed to invest up to $150 million in US LEC on Feb. 25.

The increasing demand for bandwidth lets competitive local exchange carriers (CLECs) offer competitively priced voice services and advanced data services, said Scott Sperling, managing director of Thomas H. Lee Partners, and that's why the firm finds CLECs a compelling investment. The firm looked at more than 60 opportunities in 12 months, measuring companies against the strength of the management team and the asset base.

Hicks, Muse Tate & Furst put more than $200 million each into Teligent and Rhythms NetConnections and is backing a joint venture by paging company Metrocall, Aether Systems and PSINet. Called Inciscent, the company aims to be the first "wired-to-wireless" application service provider. Hicks, Muse Tate & Furst brings a financial acumen and an existing network of tech investments that the venture can tap, said Tom Matthews, president of Inciscent. "They're bridging the difference from a pure financial investor to a strategic investor."

However, that probably won't happen overnight in most cases. The old modus operandi of these firms is still very different from the average denizen of Silicon Alley or Sand Hill Road. For one, they commit large dollar amounts; two, they almost always get at least one seat on the board of directors and a substantial ownership stake in return; and three, they seek later-stage companies with undervalued assets.

But the firms argue that they're a perfect fit as the telecom industry matures. When companies come onto these firms' radar screens, the value-add the companies are seeking is different from what they require at the VC stage, Sperling said.

In return for chunks of money to expand their maturing business, they get private equity investors experienced with larger enterprises. Thomas H. Lee Partners is not focusing on a roll-up strategy with its investments but instead will leave that to management, Sperling said.

Still, some leveraged buyout firms may be unable to resist learning some new tricks to get in on the gold rush earlier. For instance, KKR, recognizing its lack of experience in nurturing start-ups, recently signed deals with VC firms to co-invest in the Internet boom.

The firm recently announced a joint venture called European Digital Partners, which targets fledgling European Web outfits, and teamed with VC firm Accel Partners on Accel-KKR Internet, a firm that will advise U.S. companies on integrating their offline and online operations and activities.

"Accel-KKR combines Accel's outstanding track record of building Internet economies with KKR's track record of building offline businesses," said a KKR sp okeswoman. There's no reason to think similar partnerships won't arise to incubate early-stage telecom businesses.