Tapping the equity markets: private equity funds take an interest in scrap and electronics recycling.

A funny thing has happened on the way to striving to become publicly traded: Some recycling companies are eschewing this approach, having seen the opportunities and advantages of using private capital markets to grow their businesses.

This trend toward private equity funds investing in recycling companies is not limited to smaller firms.

A BIG DEAL. Aleris International, a large consumer of aluminum scrap, recently announced that private equity firm Texas Pacific Group was acquiring it for roughly $3.3 billion. Aleris was the result of an earlier merger joining Commonwealth Aluminum and Inco Recycling.

Texas Pacific Group manages more than $1 billion in capital and is focused on funding and growing technology, biotechnology and consumer companies using various approaches.

Far from a small acquisition, Texas Pacific will acquire all of the outstanding stock of Aleris International for approximately $1.7 billion plus the assumption of or repayment of approximately $1.6 billion of debt.

While the deal for Aleris shows that there is private capital in all facets of the recycling industry, much of the recent news is showing that the greatest interest appears to be focused on electronics recycling. This segment is in its infancy compared to some of the more traditional metals recyclers.

The venture capital business, which is always chasing after the next "big" thing, is showing significant interest in electronics recyclers. In fact, as state legislation mandating recycling grows and interest in "green" technology moves from faddish to common business practice, more companies are looking to use their financial wherewithal to tap into these markets, and recycling companies are finding a receptive audience as they look for ways to grow their businesses.

GREENER ELECTRONICS, The electronics side of the recycling industry appears to be garnering the most attention from a variety of fund types, whether angel investors, venture capitalists or other private equity funds.

Several venture capitalists contacted for this story have said that the electronics recycling industry holds the best opportunities for investment groups because it is highly fragmented, meaning that there are no dominant companies as of yet.

Also, according to Brian Mikes, the San Francisco-based vice president of investment banking for the venture capital firm Canaccord Adams Inc., growth should be in excess of 20 percent per year for the next several years at least. This type of growth opportunity is one of the major reasons there is increased interest by the private equity side in becoming a more active participant in the market.

Canaccord Adams finds the potential within the recycling industry so promising that the company has dedicated staff focusing on developing and growing its portfolio of companies in this segment.

In a research report released this fall, Canaccord Adams notes, "We argue that the recycling industry is at a unique point in its history, benefiting from the confluence of numerous positive dynamics, including high prices for energy and metals, rising costs to extract limited natural resources and growing concerns over environmental pollution."

While the electronics recycling industry shows, on average, the best prospects, most investors stress the need for caution when choosing which companies to invest in. Mikes says that while companies need to have a well-organized business plan, his firm looks for companies with technology that will allow it to stand apart from any possible competition.

The Canaccord Adams report also looks at the prospects for e-scrap and finds huge opportunities, estimating that with the explosion in electronic equipment, the capacity to handle the material will grow by a factor of four to five times, with the key issue being the need to develop an efficient infrastructure for electronics recycling.

Reflecting the strong upside potential for the electronics side of the business, Newmarket IT, a computer refurbishing and recycling company based in Austin, Texas, recently announced that it has received $50 million in financing from Catterton Partners, a private investment group based in Greenwich, Conn. Jeff Ziegler, CEO of Newmarket, says there is a considerable amount of activity and interest in the electronics recycling segment.

When the investment firm was looking for a company in the electronics recycling industry, it chose Newmarket because of the market knowledge the company demonstrated and the heft of its contract base, according to Ziegler.

While the company has had success accessing the corporate side, the biggest challenge will undoubtedly be working with municipalities on electronics recycling programs.

Mike Farello, a partner with Catterton Partners, says that the company "tends to invest in sectors that have tail winds behind them. And, we see lots of tail winds in this [electronic scrap] business." Farello says that the electronics recycling industry is showing a 45 percent annual growth rate.

Farello says that before choosing to invest in Newmarket, Catterton Partners looked at eight companies for the better part of a year.

What intrigued Catterton about the model Newmarket IT demonstrated was the company's scalability, which he feels is most important, as well as its tight operating disciplines, substantial throughput and strong level of remanufacturing, he says.

"what we have found is that volume begets more volume," Farello adds.

SCALING UP. Chip Slack, with Intechra Holding Corp. of Jackson, Miss., which also has benefited from access to private equity funding, sees greater interest in electronics recycling from private equity firms. The company is demonstrating its drive toward size and scalability with the recent acquisition of Gold Circuit, Chandler, Ariz., which gives Intechra a more national footprint in terms of processing plants.

Slack indicates that the electronic scrap marketplace also shows strong growth prospects--greater than 20 percent for the foreseeable future.

Recognizing the greater interest in scale and service, Slack says the acquisition of Gold Circuit was done to increase Intechra's in-house recycling capabilities.

Chrysalis Ventures, a private equity firm that targets smaller growth companies in the Midwest and South, also has found a niche in electronic scrap.

The company, established 13 years ago, is headquartered in Louisville, Ky. Chrysalis has investments in 54 companies and $300 million in management, including a position with Intechra Holding. What the company likes about the electronics recycling business is that the volume of material is growing rapidly. And the additional specter of privacy protection could mean such companies will keep growing.

David Jones Jr., chairman and managing director for Chrysalis, says that with all the technology changes taking place, organic growth will be significant for many of these companies

In regard to the electronics recycling industry's fragmented nature, Jones says he feels that consolidation will continue throughout the next four to five years and that regionalization will still be a factor.

In boiling down the decision on where and with whom to invest private equity, most of the venture capitalists say that what they seek is a company providing a unique service that could give them a first-mover advantage.

VARIOUS FINANCIAL VEHICLES AVAILABLE

Tapping the private equity markets can be quite a Byzantine endeavor. The following are some of the commonly used devices that private companies may use when seeking financing:

* LEVERAGED BUYOUT FUND--Money raised through various institutions such as pension funds, universities, etc.

* VENTURE CAPITAL FUND--Managers raise a pool of money from institutions and wealthy individuals

* MEZZANINE FUND--Managers raise a pool of money largely from institutions. The money is invested in debt or alongside venture capital in companies. Mezzanine debts are debts that incorporate equity-based options, such as warrants, with a lower-priority debt. Mezzanine debt is actually closer to equity than debt, in that the debt is usually only of importance in the event of bankruptcy. Mezzanine debt is often used to finance acquisitions and buyouts, where it can be used to prioritize new owners ahead of existing owners in the event that a bankruptcy occurs.

* ANGEL INVESTOR--A wealthy person who invests in a company.

The author is senior and Internet editor of Recycling Today and can be reached at [e-mail].