Friday 16 November 2018

Dealmaker O'Callaghan rides out choppy credit markets

The publishing powerhouse EMPG is causing a storm, writes Joe Brennan

Nestled on top of an inactive volcano, the Cayman Islands, first discovered by Christopher Columbus over 500 years ago, are a haven for scuba-diving and snorkelling.

But in recent decades, the British colony's benign corporate regulatory regime has turned it into a top offshore financial centre.

Ugland House, a white and blue five-story villa in George Town, capital of Grand Cayman, is listed as the headquarters of subsidiaries of well-known names as Coca-Cola, General Motors, Procter & Gamble and Boeing.

In a town with a population of less than 30,000 people, this palm tree-fronted building is the base of some 13,000 companies. In recent times, it has also become the "brass plate" home to one Education Media & Publishing Group (EMPG).

EMPG is the name of a new publishing powerhouse formed by Corkman Barry O'Callaghan's $5bn merger of his Riverdeep e-learning company in late 2006 with US school textbook company Houghton Mifflin (HM) and their subsequent $4bn acquisition last year of Harcourt Education.

The group has become the biggest publisher of textbooks for kindergarten to 12th grade (K-12) pupils in the US, with an estimated market share of 51pc.

The deals put O'Callaghan, a former investment banker, behind two of the five largest transactions in Irish corporate history.

They have also left him running a group with an equity value of over $2.5bn -- but saddled with $7.1bn of debt.

"Barry stands out as the dealmaker of his generation. He has an incredibly strategic mind, but is also pretty opportunistic and quick on his feet," said a fund manager, who first met O'Callaghan when Riverdeep was publicly quoted. "But he's had more than his share of good luck."

But in these times of turmoil in the credit markets, has Ireland's arguably biggest "debt junkie" -- not yet 40 years old -- overstretched himself?

O'Callaghan joined Riverdeep in 1999 as chief executive from investment bank Credit Suisse First Boston, having been lured by Pat McDonagh, a former teacher and serial entrepreneur, to line up his fledgling education software company for a stock market flotation.


Riverdeep raised $150m in an initial public offering (IPO) before joining the Nasdaq in New York in early March 2000 -- just as the dotcom boom was peaking. There had never been a better time for a loss-making software company (it recorded a loss of $20m in the last six months of 1999) to raise money.

The five-year-old firm's value soared over 230pc in its first day of trading and soon reached the dizzy heights of $2bn. But within weeks, the technology bubble had burst, leaving Riverdeep's stock among the walking wounded, which also included other Irish Nasdaq-listed names such as Iona Technologies and SmartForce, as well as Baltimore Technology on the London bourse.

Adding to the stock's woes, Riverdeep attracted the attention of David Rocker, who headed up an aggressive US hedge fund Rocker Partners. Rocker Partners began to profit from the stock through a "short selling". That strategy involves market players borrowing shares and selling them. The aim is to then buy them back at a lower price, return them to the lender and make a profit on the price difference.

A bitter spat ensued, during which Rocker publicly called Riverdeep's accounting practices into question, while O'Callaghan accused his nemesis of being behind Chinese whispers and conspiracies.

O'Callaghan and McDonagh's response was to take the group off the market in 2003 in a $376.3m management buy out (MBO) -- to screams from many shareholders that they were acquiring the company on the cheap.

Shareholders that sold into the deal received $1.51 a share, less than half its IPO price, even though it was a much smaller business back in 2000.

"It was a very nasty time. The only ones that appeared to make any money out of the whole episode were the short sellers," said the fund manager.

Most institutional shareholders decided to cut their losses and sell out. However, the majority of smaller guys remained with the company as it went private.

Riverdeep could easily have found itself consigned to the hall of dotcom also-rans. But over the past 20 months, it has remodelled itself through two transformational deals.

As 2006 drew to a close, the company, best known for e-learning programmes such as 'Reader Rabbit' and 'Destination Math', completed the $5bn (€3.2bn) merger with HM, then the fourth-largest textbook publisher in America.

HM, which was founded in the early 1830s and was original publisher to Mark Twain, gave O'Callaghan 20pc of the US textbook market -- behind Pearson, McGraw-Hill and Reed Elsevier.

The deal was pitched to shareholders as providing the two companies with a way of cross-selling products in each other's markets.

HM's 500-strong sales staff in the US compared to Riverdeep's 50. It would also allow the combined group to cut $100m in annual costs.

Last July, this son of a Mitchelstown doctor pulled off his second mega-deal in less than a year, lining HM up to acquire Reed Elsevier's US education provider Harcourt for $4bn -- just weeks before the global credit markets went into a tailspin.

"That deal wouldn't have gotten away a month later," said a source close to the transaction.

"But it actually hit a wobble before the finish as the first signs [of the credit crisis] began to appear."

O'Callaghan's bankers -- Credit Suisse, Lehman Brothers and Citigroup -- suddenly baulked at supporting such a leveraged deal. Reed Elsevier was forced to take $500m off its original asking price and accept $300m of its payment in EMPG stock (11.8pc).

The group also committed to raise $235m in fresh equity to support the deal -- largely from institutional investors, according to sources, with O'Callaghan stumping up €40m and Davy's private clients arm underwriting a similar amount.

All told, the reconfigured structure of the transaction slashed over $1bn off what would have been EMPG's debt mountain.

The banks, meanwhile, tried and failed late last year to sell down EMPG's $7.1bn debt pile as credit market turmoil continued. However, a letter O'Callaghan has sent out to shareholders this week shows Credit Suisse, the lead banker, has syndicated the group's $4.35bn senior debt to investors across the US, Europe and Middle East.

It is understood the banks sold the debt at a discounted price, though the extent of this is not known.

A further $600m of senior debt was shaved following the recent sale of its college textbook division. The banks are also making headway selling down EMPG's €1.7bn second-lien loan, which ranks behind a traditional senior credit facility in terms of security.

"We expect this tranche to be fully syndicated by the end of the summer," said O'Callaghan.

"We are confident of [the group's] ability to repay all obligations under its financing arrangements, to meet all covenant requirements and to remain comfortably within its revolving credit facilities."


With an annual cash interest bill in the region of $550m and capital expenditure and product development costs of about €350m, Davy analyst Barry Dixon's €830m earnings before tax, depreciation and amortisation (EBITDA) forecast for the group would leave it with negative cash flow this year.

That's before the synergies from combining HM and Harcourt kick in.

"We estimate that EBITDA, including synergies, will be over $1bn this year and $1.15bn in 2009," said Dixon.

O'Callaghan said synergies -- "the fundamental deal driver for us in entering into the Harcourt transaction" -- are already ahead of expectations. EMPG has upped its synergies forecast from $110m to $140m for this year.

"The full synergy savings will accrue over a three-year period and will total between $320m and $340m of annual EBITDA savings and $100m of [product development] savings by year three, making a total cash synergy of approximately $420m to $430m," he said.

While O'Callaghan takes care of the big figures, his old pal Tony Lucki, previously president and chief executive of HM, has free rein to run the day-to-day operations out of Boston. When Lucki manages to scrape out the last of the cost savings, they will be left with a business in a mature industry in America where earnings will grow by a high single digit percentage, at best.

But the real kicker could be EMPG's fledgling international arm, EMPGi, which is targeting opportunities in the Middle East, China and India.

"You're basically talking about transferring existing intellectual property into other markets -- the upside is enormous," said Dixon.

With the equity component of the Harcourt deal raised priced at $10 a share, O'Callaghan has come good for the small shareholders who backed the 'take private' five years ago.

Davy believes investors who stumped up for the new stock "could potentially double their investment over the next two years", while Credit Suisse is understood to have recently valued the group at between $18 to $20 a share.

Although there is a relatively inactive grey market in the stock, many investors are keen to cash in their chips.

Dixon said exit strategies could include an IPO in the US in two to five years or a trade sale -- "likely to be a deal with a large international publishing company such as Newscorp or Viacom".

The analyst believes a debt refinancing to allow investors take money off the table is the least likely option, given the current state of the credit markets and EMPG's relatively high gearing.

But could O'Callaghan really stomach heading up a public company again?

"It's possible he could use an IPO to sell down his stake and move on," said an observer. "The one big difference between the old [publicly quoted] Riverdeep and the entity it is now is that he has got a much broader and stronger management team."

O'Callaghan's 38pc stake in EMPG is currently worth about $950m (€600m). But Davy and Credit Suisse valuation scenarios would propel him into Ireland's exclusive club of billionaires.

If he used an IPO or sale to take his money off the table, he might have time to check out the touristic charms of EMPG's new tropical home. People who know him say he'd only use the break to plot his next audacious move.

The leader of a generation of business movers and shakers

A year shy of his 40th birthday, O'Callaghan counts among a new generation of movers and shakers making their mark in business circles in Ireland.

Young, loaded and well connected, the young gun got his first big break in 1990 when he landed a job in the mergers and acquisitions business of Morgan Stanley in London.

Barely in the door of the bank, he bumped into two fellow Irish graduate trainees, Niall McFadden and Jim Barry, and persuaded the duo to give him a place in their bachelor pad. They too have become legendary dealmakers in their own right.

Fast forward to 2003 and McFadden scooped €1.6m for advising O'Callaghan on the $376.3m management buyout (MBO) of Riverdeep. McFadden (41) was also central to the MBO of retailer Arnotts around the same time and used his fees to establish his Boundary Capital investment firm, which he floated on Dublin's junior market, IEX, in May of last year.

Boundary's notable investments include stakes in Arnotts, Veris, a quoted property management company, and Siteserve, a quoted construction site services company.

Jim Barry (41) is chief executive at NTR, the acquisitive infrastructure conglomerate. NTR has been involved in €3.7bn worth of transactions over the past 15 months alone, including the sales of a controlling stake in wind farm group Airtricity and its controversial West-Link toll bridge. The group has been spending heavily in waste management, solar energy, wind power and ethanol.

Financier Domhnal Slattery (41) is another member of O'Callaghan's gang. Aside from sitting on EMPG's board, the Co Clare-born businessman behind investment group Claret Capital has been known to present his friend with investment opportunities.

But O'Callaghan's main investment focus has always been Riverdeep. Ahead of the 2003 MBO, the group's founder Pat McDonagh decided to pool his 21pc stake with the 5pc held by his protege and split the shares evenly.

Following the MBO, backed by private equity firms Alchemy and MSD Capital, the pair owned 21pc each. Within 10 months, the private equity houses had been bought out and O'Callaghan subsequently went on to acquire his mentor's holding -- leaving him with a 65pc stake. The HM deal in 2006 watered his stake down to 47pc, while the Harcourt transaction has diluted it to 38pc -- albeit in an exponentially bigger group.

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