The Messier the better for firm that bought piece of FAO Inc.

IN the world of private buyout firms, Michael Fourticq Sr. of Hancock Park associates prefers small messy deals.

For years, Fourticq and partner Brian McDermott have had their eyes on Right Start Inc., a 34-chain toddler and infant toy store that was owned by FAO Inc. But the ailing toy retailer refused to sell.

In a case of serendipity, Hancock Park was invited early last year to join a small investor group and placed a modest bet on FAO itself as part of a pooled $30 million attempt to get the company out of its first bankruptcy.

When the toy retailer, formerly known as FAO Schwartz and based in King of Prussia, Pa., filed for bankruptcy a second time in December, Fourticq and McDermott jumped at the chance for another bite at Right Start.

"I don't think it was a sweetheart deal," said McDermott of the $1.7 million cash offer, which included the assumption of $3 million to $4 million of inventory. "But when you're buying something out of bankruptcy, you hope you're getting a deal, and that's the risk."

In fact, Hancock lost out on a $200,000 breakup fee when the bankruptcy judge ruled the firm was an "insider" in the deal.

Such are the challenges for private equity firms, which often get dragged into court and have to wait years before realizing major gains on the companies they buy.

Deals are difficult

While many private equity firms work with existing managers, Hancock prefers to install its own team, typically with its own principals.

McDermott, for example, is president and chief executive of Right Start, now based in Los Angeles. Other principals are running the firm's other portfolio companies, including Saleen, an Irvine maker of high-performance cars for Ford Motor Co., and FHI Inc., an operator of BusyBody Home Fitness stores that was purchased out of bankruptcy in 2001.

Many of the firm's investments have required larger infusions than initially planned, Fourticq admits. Early experiences, in fact, have led him to believe that most deals are difficult.

Back in 1988, Hancock paid roughly $17.5 million to buy Leslie's Poolmart of Chatsworth, a local pool supply company with 66 stores and $58 million in sales.

The two founders of Leslie's had a 50-50 share in the company.

When one founder wanted to sell his stake after getting a divorce, and the other refused, a court order forced the owners to sell to the highest bidder--Hancock Park.

Though Leslie's ended up as a success story for Hancock, it took a decade of building up the company, taking it public and then taking it private again in a 1999 restructuring with Leonard Green & Partners for roughly $109 million.

Fourticq spent five years at Brentwood Associates, a local firm that invests in early-stage high tech companies, before starling Hancock in 1986. He spent eight years at Stem Industries, a textile and floor-covering manufacturer, eventually ending up as chairman and chief executive. He also was president and chief operating officer of United Castle Coal Co., a mining company.

McDermott spent three years at Brentwood and formerly was director of acquisitions and divestitures at real estate firm Castle & Cooke Inc. He also spent time as a financial analyst at Morgan Stanley & Co.

Carving a niche

Fourticq believes a rise in mergers and acquisitions involving private equity firms is a sign that the industry has reached maturity.

"We have a whole new set of buyers right now because of the new private equity market that didn't exist 20 years ago," he said.

With six principals, Hancock is trying to carve out a niche by investing in small manufacturers or retailers that are too small to attract the attention of larger buyout firms or even larger competitors.

The firm raised its first institutional fund last year (the earlier funds were drawn from private investors) and has $107 million under management.

Fourticq isn't concerned about scrutiny of the industry.

Unlike many private equity firms, Hancock lists its portfolio companies and information about them on its web site. He blames criticism of the industry on the larger shenanigans that have existed in plain sight in corporations.

"There have been a lot of bad actors in corporate America--I'm appalled by this stuff," he said, referring to Enron Corp. "Things that are done in the dark generally are things you shouldn't be doing."

But McDermott sees another trend that has prompted more scrutiny--as larger private equity firms raise bigger pots of money from institutions, returns naturally have started to trail off.

"It's very hard to get a high return on large numbers," he said. "But there has been a lot of pressure from the investor and public-interest standpoint that it can't be a friendly little club. I think the institutions look at this class of investment and they're trying to get extraordinary returns, and there has been some additional scrutiny as a result of the whole dynamic."