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Responsible Private Equity Investors Revitalizing U.S. Manufacturing

Posted: 05/17/2012 10:57 am

Private equity firms and their investors from Taft-Hartley and state pension funds offered compelling accounts of their success in securing profitable returns on investment in U.S. manufacturing -- especially in the Midwest -- at the Heartland Capital Strategies fourth and final Responsible Investment Forum, organized in collaboration with the Blue Green Alliance.

Michael Psaros, a co-founder and managing principal of KPS Capital Partners, the world's leading turnaround private equity investor in the middle market, explained how KPS has achieved top decile investment returns among private equity firms globally by investing in manufacturing and industrial companies, while maintaining a constructive relationship with unions.

"When we raised our first institutional fund fifteen years ago, institutional investors were initially skeptical that superior investment returns could be achieved by investing in manufacturing. Further, investors were highly skeptical that unions could play a constructive role in the turnaround and subsequent growth of our companies.

"The industrial affiliates of the AFL-CIO did something magical at that time. They took reference calls for us reassuring potential investors in KPS of our firm's successful track record in turning around companies, and in the power of working constructively with unions."

As a result, KPS was able to raise $210 million for its first fund which closed in 1998. Almost fifteen years later, the firm has achieved truly world class investment returns, easily in the top decile globally according to investors, primarily by investing in manufacturing and industrial companies and mostly away from the coasts, thus proving, Psaros quipped, "that a labor-friendly fund with a card-check policy can invest and make more money than the union-hating investors."

Now, with almost $2.8 billion of assets under management, KPS' funds have been oversubscribed for years, with blue chip investors from eight countries.

PRI in Manufacturing

"A turnaround, at the end of the day, is about sheer force of will." Psaros said. He cited the case of HHI, a supplier of forged and machined steel automotive part components with sixteen plants in the Midwest. The company is today comprised of five formerly bankrupt firms that were facing liquidation, that KPS bought, turned around and integrated under new management, headed by Greek immigrant and University of Michigan graduate George Thanopoulos, who brought to the challenge a solid background in manufacturing from his experience at Mascotech Inc.

Six years later HHI, whose workers are variously represented by the United Steelworkers (USW), the United Auto Workers (UAW), and The Workers United "is the among the most profitable auto parts company in the world on a cash flow margin basis and was solidly profitable and cash flowing straight through the automotive crisis in 2008-2009," Psaros said. Equally important, he noted, 3,200 jobs were saved and another 1,000 will be hired over the next three years.

Pension Fund Allies

One of the Taft-Hartley pension plans that has invested in KPS funds is the International Association of Machinists (IAM), whose $9-billion pension fund is comprised of public funds, as well as single -- and multi-employer plans.

IAM Fund Director Steve Sleigh explained that all three of the union's forms of pension savings "operate under different regulatory regimes. We're highly regulated. So anything we do for social well being, if it doesn't pay off, we can't invest in it."

"Private markets," he said, "give us an opportunity to have relationships, which is a good thing," because it allows more direct oversight of developments in the investments in order to ensure that the union can readily meet its obligations to pay pension checks each month to its 83,000 plan participants.

"So what we look for is do-gooders [in the private market] who kick ass on returns," Sleigh said, in order to complement the union's commitments to Institutional Investors, whose "long-term interests are almost the same as workers' interests -- sustainability."

Public Sector Pensions Investing in Manufacturing

Public employee pension funds have a similar commitment to the sustainability of manufacturing and the manufacturing workforce, explained Bill Atwood, executive director of the Illinois State Board of Investment, which has $11.5 billion under management for 120,000 plan participants.

Ensuring the sustainability of manufacturing, Atwood said, "gives the economy greater stability. Manufacturing in the U.S. is crucial to the economy's long-term sustainability," he added, "and a preeminent principle of sustainability is workforce sustainability."

"The demise of the U.S. manufacturing sector is a myth," Atwood averred, an assertion echoed by Michael Psaros, who insisted that "we are still the world's biggest manufacturing power."

In his management of the Illinois funds, Atwood said that he does not make tactical decisions about public equities, but rather leans heavily toward indexed funds.

Where private equity is concerned, he looks for prudent, successful firms that have "an enlightened view toward workers." He noted that "there is a natural inertia in the private equity world to invest on the coasts." Atwood is attracted to Midwestern investments in manufacturing, in part, "because we need to geographically diversify."

A more pressing concern with regard to sustainability, he offered, is the preservation of a secure defined-benefit pension system. "We first and foremost need to determine the long-term viability of Defined Benefit plans. If we continue to let them go away, this discussion about sustainability becomes a fiction."

DB Pensions Crucial to Sustainability

Michael Musuraca, managing director of Blue Wolf Capital Management, drew on his earlier experience as the designated trustee to the $40 billion New York City Employees Retirement System (NYCERS) to urge that ESG funds learn how to scale up to make it possible for Institutional Investors to meet their obligations and the needs of their retirees.

BlueWolf is a private equity firm that looks at companies in some distress where there is government and labor involvement. "Government," he explained, "is a good client to have and labor union's have an interest in ensuring the long term viability of a company.

"Institutional Investors now realize," Musuraca said, "that they need to call the tune. These pension funds in the long run will not be healthy unless there is a healthy economy."

He added that the decline in Defined-Benefit pensions is making it harder to aggregate investment capital.

Energy Efficiency Matters

Bob Baugh, Executive Director of the AFL-CIO's Industrial Union Council, offered that energy issues are crucial to manufacturing, thus the importance of climate change.

"CO2 is a problem," he acknowledged. "The question is, how do you address it smartly and strategically. How do you establish policies that are both about jobs and environment."

A strategy for achieving industrial energy efficiency would be a significant step in the right direction, he suggested, one that has been taken by ArcelorMittal, the world's largest steel making company, in cooperation with the United Steelworkers.

USW Ohio Director David McCall explained how the union had worked with ArcelorMittal to winnow the entrenched thicket of workplace job classifications as a means of improving productivity while respecting the contribution of the workforce and its acquired knowledge of production processes.

"We had to take a huge, long-term view of sustainability," McCall said

The changes achieved by through these collaborative efforts have reduced man hours incurred in the production of a ton of steel from as much as 2.9 to as little as 1.6. These reductions have massive and profound implications for energy consumption and efficiency. A similar awakening has occurred in the auto industry, where restructuring induced by the government bailout of General Motors and Chrysler has led to some radical restructuring of both work and investment policy, according to Brad Markell, an International Representative in the UAW Research Department.

Under the policies development through federal involvement, "You can now capitalize engineering instead of paying for it out of cash flow. We now have an industrial policy that says, 'Get green, and we will help you get there,'" an approach that helps reduce the financial and technical risks of green renovation.

"R&D and engineering are not precursers to manufacturing," Markell made clear.

"Manufacturing actually pulls the R&D and engineering in." As a result, GM is now the number one company in applying for green patents.

The Recovery Act resulted in $2 billion in grants that Markell suggested would have near-term impacts on innovation. "By 2016, we will have 40 percent of lithium battery production in the U.S." he concluded.

"We want to anchor capital in our communities," Baugh added. "We also want to anchor innovation in communities."

Sustaining America's Workforce

Michael Peck, chairman of Isofoton North America, a 60-year-old Spanish solar firm investing in solar facilities in western Ohio, asserted that having a truly sustainable economy guided by ESG principles means changing how the culture views workers.

"Labor is not a commodity," he declared. "Labor is sovereign, and capital, while important, is subordinate to labor. If all we're going to do with the green economy is perpetuate the follies of the past with a green term, then we're not accomplishing anything.

"Putting workers first is profitable," he concluded. "It feels so good when you get through the looking glass to the other side."

 
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