The rise of thrill-seeking leisure spenders was just one reason why private equity house Duke Street invested in go-karting firm TeamSport, but what else did it take to get the relationship off to a racing start?
The process all started on a wintry Saturday afternoon with the kids, prompting Duke Street partner Jason Lawford to take his family to an 800 metre indoor north London karting track. Lawford was impressed by the customer experience and he knew leisure was a growth market, which TeamSport understood. Go-karting was not an obvious choice for the mid-market London-based private equity firm, which has invested €2.5 billion (£2.19 billion) in more than 50 companies.
However, conferring with colleague James Almond, they agreed TeamSport was a unique business, which did fit Duke Street’s leisure focus. The next steps would be to look at its mechanics to find out what underpinned its success so far and what its potential could be.
Duke Street concentrates on four sectors – consumer; healthcare; industrials and engineering; and services – and targets companies with an enterprise value up to £400 million. In the period since the financial crisis, the average deal performance has been a 2.3x multiple on invested capital and a 29% gross internal rate of return (IRR).
The company has a unique hybrid-funding model. It adopted a deal-by-deal funding strategy in 2012, subsequently raising committed capital to invest alongside its co-investment mandates. Duke Street itself invests substantially in each deal, ensuring maximum alignment with its investors and portfolio company management teams. Most of the deals closed (about 86%) are proprietary, meaning they are sourced outside competitive auctions.
In the traditional private equity fund model, investors commit capital to the fund on a blind-pool basis and depend on the fund’s investment team to identify and execute investment opportunities.
In a deal-by-deal fund, a dedicated deal-specific vehicle is created for the purposes of making an investment in a single target. Investors considering an investment in a deal sourced by Duke Street bring their capital through the co-investment vehicle. The remaining capital is provided by professionals from Duke Street, as well as the Cornerstone Fund, which is a discretionary fund similar to a traditional private equity fund. Therefore, co-investors in the deal, which provide close to half of the capital, have full transparency on the underlying investment and are able to perform their own ‘M&A-style’ due diligence on the investment.
"TeamSport operates in the UK leisure activities market, valued at £25 billion"
In addition to this due diligence, they also need to perform the traditional fund investment diligence to understand the expertise and track record of Duke Street’s investment team, as well as the capabilities of the operational team that will manage the investment going forward.
In terms of fees, Duke Street charges a one-off arrangement fee of 1% of the enterprise value at the time of the transaction, an annual fee of 1% of the invested equity capital from the portfolio company and a deal-by-deal carried interest of between 10% and 30% after a hurdle IRR return of 8% to 15% is passed.
When CEO Dominic Gaynor joined TeamSport in 2002 the business was loss-making with a turnover of less than £1.6 million per annum. Working alongside founder Paul Wrightman, Gaynor set about professionalising the business. By 2011, they had transformed TeamSport, successfully operating nine tracks across the UK and reaching a turnover of almost £8 million.
During 2012, Gaynor raised bank debt and private equity funding to support a management buyout of the business, which completed in February 2013. His strategy was straightforward: continue to grow the business, but at a faster rate, to reach 20 tracks over the subsequent five years.
With the opening of new tracks in 2017, Gaynor had successfully grown TeamSport to 23 tracks, way ahead of the original plan. He focused on the development of circuits with multi-level tracks, the introduction of top-of-the-range karts and the installation of great customer facilities. He also invested in online marketing and sales support. All tracks were profitable and the business delivered an average return on investment of 40%+ with an EBITDA margin of 20%, which is high for a multi-site leisure business.
Gaynor also implemented several new ways of incentivising employees but the business still faced risk, not least its seasonality. Good weather outside can leave tracks quiet, which makes investors nervous.
However, Duke Street’s industry analysis was positive: TeamSport operates in the UK leisure activities market, valued at circa £25 billion, which is made up of cinemas, museums, paintballing, trampoline parks and indoor bowling. The UK market has grown at 5% per year since 2010 and this growth is likely to be sustainable until 2020, according to consultants OC&C. Go karting is a small stable fraction of the market, but it uniquely offers two ingredients spenders are looking for most: competition and an adrenaline rush.
“TeamSport is in the midst of Duke Street’s growth strategy”
Inspired by his visit to the go-karting track, Lawford pursued the transaction seriously. In the summer of 2017, he and his team started discussions with Connection Capital, a private equity firm which specialises in small transactions with enterprise values of about £10 million. Connection Capital supported Gaynor’s management buyout in 2012. The business at the time was on track to reach a turnover in excess of £20 million during 2017.
Connection Capital started an auction process and five private equity sponsors provided an initial bid. However, Gaynor, who was the largest shareholder in the business with a 30% stake, decided to negotiate only with Duke Street and one other private equity firm. He liked that Duke Street had a very good experience with multi-site leisure businesses. Indeed, this experience helped Duke Street front-run the auction process and offer a deal before the other competing private equity firm managed to submit its final offer. This was possible because Duke Street was already familiar with the business. In the summer of 2016, Lawford was introduced to Gaynor and tried to buy the business. However, Gaynor wanted to open a few more tracks before considering a transaction.
In November 2017, Duke Street offered £42 million for the business, conditional on the completion of due diligence in three weeks. The business had a £19 million loan on its balance sheet and the fees to close the transaction were expected to be approximately £2.5 million. The accountants also mentioned in a discussion that the company would likely have about £700,000 in cash balance at the time of closing. After a couple of discussions with some debt providers, Lawford decided to fund the transaction with a unitranche loan of £12 million.
Gaynor was convinced by Duke Street’s determination to buy the business and understanding of the seasonal revenue variance. Together with Connection Capital, he accepted the deal. As part of the agreement, he cashed out 50% and rolled over the remaining 50% of his stake in the company.
Post-deal, Duke Street implemented several layers of operational and strategic changes, which range from cost-cutting and improving sales force effectiveness to roll-out strategies involving consolidations in fragmented sub-sectors and international expansion.
Today, TeamSport is in the midst of Duke Street’s growth strategy, which, with a revamped marketing and booking process, has three dimensions – open more tracks, at a rate of up to six a year until 2021; improve existing tracks (consultants have calculated that a £200,000 investment at certain sites can generate £100,000 of incremental earnings) and expand the UK success in the fragmented German and Dutch karting markets.
TeamSport has been through a rigorous process at Duke Street. The firm looks at 250 potential deals annually. Only 30 reach the nine-month long due diligence stage. Out of these, every year about seven deals are discussed in the investment committee with investments in a maximum of three deals, which are held typically for four years.
The ingredients are all there for TeamSport to be a success – Lawford and Almond’s team will support management, but ultimately it will be up to them to deliver on the firm’s potential.
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