February 2, 2015
Interviewed by: David Snow
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Z Capital’s Unique Approach to Deal Sourcing

Z Capital Partners’ President and CEO Jim Zenni tells Privcap about the firm’s focus on value investing and its proprietary deal sourcing system for finding companies that have operational or financial issues. He also discusses what scenarios would lead to the firm not pursuing an acquisition and which factors in today’s market are affecting deal sourcing.


Z Capital Partners’ President and CEO Jim Zenni tells Privcap about the firm’s focus on value investing and its proprietary deal sourcing system for finding companies that have operational or financial issues. He also discusses what scenarios would lead to the firm not pursuing an acquisition and which factors in today’s market are affecting deal sourcing.


Z Capital’s Unique Approach to Deal Sourcing
With Jim Zenni of Z Capital Partners

David Snow, Privcap: We’re joined today by Jim Zenni of Z Capital Partners. Jim, welcome to Privcap. Thanks for being here.

Jim Zenni, Z Capital Partners: Thank you, David. Thanks for having me.

Snow: Your firm is well known for being a value investor, but I’m interested in understanding how you define value in the context of private equity investing. What does it mean at Z Capital?

Zenni: If you look at what we do, and it’s all within the middle-market space actually, we try to find high-quality companies that for whatever reason had some operational or financial issues. Yet it’s still a very good business at the end of the day and—either through operational or financial restructuring—it could be a much better business under a different ownership regime. More important, what really drives us as far as value is finding great businesses that have a real purpose in life. Real market share, real product development, real cash flows.

The other big issue for us is the acquisition price, the entry price, of when we buy a company.

Snow: In the cases where you find a company that’s underperforming, but you decide not to invest, what are the reasons? Is it typically because of cyclical forces outside the power of the management team or is it that the management team is hopelessly messed it up to the point that you don’t think there’s a chance to fix things?

Zenni: Again, it’s a great question. The answer is “yes, all of the above,” frankly. It’s not only management teams or maybe macro events. It’s also just poor owners at the end of the day. A lot of the companies that we will invest in, ultimately, were owned by other private equity firms. And if you look at the chain of events, it’s typically a traditional private equity firm that made an acquisition—maybe two or three acquisitions—and maybe there was a change of ownership to other, maybe it’s a daisy-chain transaction. But sometimes that last transaction didn’t go to well, and therefore, it’s an over-levered balance sheet or whatever the case may be.

But companies have to meet a certain criteria for us. We’re a control investor. We’re not minority investors. We want to own this business and we want to control it, and we have a very large investment team that includes operational partners to transform it to a better place and create value at the end of the day. But it’s got to be a good business that we can get our arms around and has defensible market share, and we can grow it.

Snow: What are some important ways you’re coming to have opportunities to invest in the kinds of businesses you want to back?

Zenni: It’s interesting—a lot of LPs who invested with us recognize our unique sourcing capabilities. We actually have spent a lot of time and money in building our own proprietary systems at Z Capital. And most of the elements of these systems are patented. We got it patented a couple years ago.

Snow: Systems for sourcing specifically?

Zenni: For sourcing. Yeah. We actually have the ability to identify companies within certain industries and certain size—various types of filters—of companies that are potential for an ownership change, a restructuring or an operational turnaround. Then, we actually have people on the ground—boots on the ground—calling on commercial banks and other counterparties to be proactive in our sourcing activities.

For a lot of GPs (maybe most GPs), it’s more reactive. They’re either sourcing things from trading desk on Wall Street—if it’s a distressed for control—or, in many cases, it’ll be from investment banking community. We do field investment banking community deal flow, but most of our activity that we pursue is situations where we do it directly. We can set our own agenda and our own timeline, if you will.

Snow: Talk about the kind of due diligence you would do when an opportunity becomes available. How is it distinct from the kind of due diligence—the regular way a private equity firm would conduct things?

Zenni: Our due-diligence process is pretty lengthy and we like doing it exclusively with counterparties. And when I say lengthy—it’s a combination of both the financial investment part of our team as well as the operational team. In many cases, it’ll be months.

When you have an auction, even in investment banking process, a banker is hired for the sale. There’s a process of identifying potential acquiring entities. Then, the books are sent out and there’s a timeline. Bids are due two months from now. It’s not a process we particularly like; we usually try to shy away from those. In many cases, frankly, we’ll say if the auction fails, let us know.

Snow: Talk about some important factors in the market right now that are affecting both your ability to source new opportunities and also the fortunes of the portfolio companies you already own. I’m going to guess the debt markets and the economy are looming large, but how does that affect your specific strategy?

Zenni: I’ve been around a while, and if you look at the common themes today, you’ve got forgiving credit markets, which have consequences of balance sheets that are forgiving to the owners. Meaning there’s no financial covenants in many of these transactions. In the senior debt, the maturities are very long, so it gives the owner of those companies a lot of latitude on timeline. And it’s pretty much extended and there’s a lot of the proverbial “kicking the can down the road,” even when those do get into some difficulties.

Then, you’ve got the overlay currently of commodity prices, specifically oil prices, which have a fairly large ripple effect, frankly, that is still being played out. I’m not sure the marketplace at large has really sorted out what the end result of that’s going to be, but I think you’re going to see default rates rise. In our particular case, it’s going to be more of the secondary companies, the middle market, that support some of the oil-related companies. But if you think about, it impacts retail spending. It impacts budget deficits and all those kinds of things.

Snow: I have a question for you about the way you add operating value to your portfolio companies. By definition, all the companies you invest in have some form of operational challenge that has put them at a disadvantage. And your firm helps them get back on their feet. What are the most important steps you take to help map out a path to improvement for these companies?

Zenni: At the outset, while we’re doing the due diligence for a potential acquisition, we identify two large groups or a group of items or issues that we’ll address. One is balance sheet, right? In many cases, the balance sheet needs to be resized, in the form of restructuring or an out-of-court restructuring—something along those lines. So it’s a balance-sheet fix. But, on the other hand, there are also always operational items that we can address, depending on the industry and on the type of company. That gets mapped out very early on in the due-diligence process. We have a very large team. Today, we’re a little under 60 people from an organization standpoint. Half the team is the investment team and half of that team are operators, former CFOs, CEOs, industry-specific expertise.

So, we attack an acquisition with five or six people on it who are on it fairly regularly—daily for many months—executing on the plan we’ve developed on the front end. We’re looking to optimize the business because, in every case, the company was operating with less than an optimal deck, so to speak. Maybe it’s in bankruptcy. Maybe it’s breaching its financial covenants. Maybe the owner has walked away from the situation. There really is a drift, if you will. And we come in and we optimize the operations. In many cases, we’ll change out management. And we’re very hands-on—executing on something we’ve created at the outset.

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