In 1994 the private-equity firm Forstmann Little & Co. acquired Ziff Davis Publishing for $1.5 billion. At the time, Ziff was a tech-publishing powerhouse, approaching $1 billion in revenue.

Nonetheless, observers at the time thought Forstmann Little paid too much. A FOLIO: report from the time put it this way:

Has Teddy Forstmann overpaid for properties whose best days are past, and when his tolerance for lower-than-expected growth is exhausted, will the cutting begin in earnest? “Teddy Forstmann paid more than people who knew the industry more intimately were willing to do,” says a former Ziff executive. “Does this mean he is smarter, that he sees things no one else sees?”

Forstmann’s response, FOLIO: reported, was this: Ziff possessed the three characteristics the investment firm looked for in an acquisition—a dominant position in a market where demand is relatively recession-proof, significant growth potential; and top-flight management. Sale price came fourth.

Now, 12 years later, Forstmann seems to have been prophetic. First, he clearly did not overpay. The company was sold by Forstmann Little to Softbank a year later for about $2.1 billion (Softbank broke up the company and sold it in pieces later in the nineties. The magazine group went to another private-equity firm, Willis Stein & Partners for $780 million.)

More than that, Forstmann Little understood before most the value of magazine media to private equity. There’s no doubt that private-equity gets it now. In what might be the hottest deal market ever, private-equity firms are fueling most of the competition and doing most of the buying. Consider this comparison: In 2000, there were 102 deals, according to DeSilva & Phillips, in a year that firm characterized as “A Year to Remember.” Of those, 29 involved private-equity firms. By contrast, in January to June of this year, there have already been 73 deals, of which 41 had a private-equity participant, mostly on the buyer side. So in 2000, 28 percent of the deals had PE participants, and so far this year, 56 percent, or double, involved private equity.

What’s more, Jordan, Edmiston Group’s Scott Peters says there are dozens of private-equity firms now interested in buying into the industry, and more than 100 when the industry is defined more broadly as consumer or business media.

All of this adds up to an extraordinary transformation in the magazine industry—a new form of capital structure has emerged in an industry that when viewed in terms of the number of companies, is still largely privately owned and entrepreneurial. So where once there were three forms of ownership—private entrepreneur, conglomerate (Time Inc., VNU, Reed) and public company (Penton Media, McGraw-Hill)—now there are four.

Naturally, then, questions come up: Why does the magazine industry appeal to private-equity firms? How has the presence of private equity changed the creation of magazines? Has the impact been good, bad or neither? In the reports on the 12 pages that follow, FOLIO: looks at the phenomenon from a number of perspectives.

The modern relationship between private equity and the magazine industry tracks back two decades. When 90-year-old Billboard Publications Inc. went on the block in 1984, the group publisher, Jerry Hobbs, teamed up with a group of managers and the investment firm Boston Ventures to buy the company for $40 million. That started an extraordinary chain of events for Hobbs and the renamed BPI, in which he and Boston Ventures first sold the company and then bought it back before finally selling it to VNU in 1994 for $220 million. (Earlier this year, VNU, a Dutch public company, sold itself to a consortium of several private-equity firms.)

Shortly after the Ziff deal came two other significant early transactions: The $237 million acquisition by Hellman & Friedman Capital Partners of Advanstar Communications in 1996 and the $440 million purchase that same year of Petersen Publishing by Willis Stein and a trio of publishing managers including Neal Vitale, Claeys Bahrenburg and Jim Dunning. Both of those deals were home runs for their investors, with Advanstar selling to DLJ Merchant Banking Partners in 2000 for $900 million and Petersen to Emap in 1999 for $1.2 billion.

“I think what we’re seeing is the third generation of private equity,” says Dan McCarthy, CEO of Network Communications Inc. and a veteran of private-equity deals. “The first was characterized by the early investors, including Veronis & Suhler and KKR [which created Primedia] and others. They were able to change the industry by accessing the debt markets and doing a series of rollups.”

The second generation, McCarthy says, became much more competitive. It includes such firms as Kelso & Partners, which acquired Cygnus in 1997, the Wicks Group, which created Wicks Business Information in 1999 and ABRY Partners, which acquired Cygnus in 2000 and invested in Penton Media in 2002. It also included Primedia, which remained acquisitive throughout the nineties. “The second generation was people who could do deals,” McCarthy says. “They were the best dealmakers.”

The third generation, he suggests, needs to bring something more fundamental to the table. “The market has been so carefully picked over,” he says. “The third generation is going to have to be people who have the vision to operate a business. You can’t count on rising with an overall tide. Because of the uncertainty of the model, you have to have a sense of where you think the opportunity is.”

For their part, private-equity firms are pretty straightforward on where they see value, and they usually echo what Ted Forstmann said in 1994. Says Walter Florence, managing director at The Frontenac Company, which owns part of Aspire Media and recently sold 101communications, “Whether it is a magazine or a Web site, we believe the delivery of relevant and quality content is a good business to be in.”

And Royce Yudkoff, co-founder of ABRY partners, which acquired F+W Publications last year and is in the process of selling both Penton and Cygnus, says, “We like the high barriers in the business as a result of unique content, we like the predictable cashflows, and the opportunity to increase cashflows by repurposing content through electronic media.”

Mike Hannon, a partner at JP Morgan Partners, owner of Hanley Wood and Ascend Media, updates that sentiment for the e-media age. “Magazines in a traditional sense are not appealing,” he says. “But what magazines represent, the delivery of content to a specific audience, is a great place to sit because you are at the nexus of information transfer. It has to evolve to the Internet and all sorts of e-media.”

ABRY’s Yudkoff rhetorically asks how an investment in a media company can miss. “These businesses are going to grow more profitable not only because the base business is stable but also because you have the opportunity to grow through electronic media,” he says. “You shed the cost of physical distribution, and add the ability to deliver custom information.”

From the magazine-company side, the emergence of private equity is seen as a mixed bag, although few executives are willing to go on the record with their observations. Generally, the complaints are these:

• Private-equity firms take the focus of executives off creating great products and put it on financial performance.
• PE has a short time-horizon—usually three to five years—and thus causes executives also to think in a near-term context.
• If a PE firm overpays for a company, the firm then has no money left to invest and the company is so debt-laden it can’t invest in growth.
• In the second half of an investment period, PE firms are focused on EBITDA, as are key executives, and that may create a conflict of interest. In some cases, the thinking goes, a company under pressure to deliver bottom-line performance may opt not to fill open positions, or it may forego a circulation effort, or it may choose a less expensive paper stock. And so on. The point is that the short-term horizon and pressure to perform may warp decisions.
• PE firms make buying decisions based on aggressive forecasts, sometimes not grounded enough in reality.
• Because of all these factors, companies that have been bought and sold multiple times by private-equity firms are often dried-out husks of what they once were, sapped of their vitality because of multiple changes in ownership, each of whom was focused on financial performance, not investment for growth.

As a rule, the private-equity model combines an equity infusion with borrowed money, in effect minimizing the amount of equity contributed in order to maximize the return. (PE firms typically look for a 30-percent or better internal rate of return on their investments on an annual basis, and borrowing allows them to do that.) But borrowing also means debt. “Leverage leaves very little breathing room,” says one executive who asked to remain anonymous. “I lived it on a daily basis. You actually feel as if you can’t breathe.

“Typically,” this executive continues, “if you are hitting the plan (the plan the bank liked when they approved the loan and which is generally very aggressive) you will be okay. But if there is even a hiccup, the situation can be impossible—most of these loans have escalating principal payments going forward—so it is a lethal combination if you begin missing revenue figures that were a wild guess three years earlier.”

Adds a b-to-b CEO familiar with private-equity firms, “The reality is that private equity is a buy-and-build model. It does not support a launch-and-develop strategy. Those kinds of investments would hurt their model. You can’t for a second believe that someone like [FOLIO: founder Joe Hanson] would survive in a private-equity firm. I wonder if they’ve stolen a little of the entrepreneurial spirit that existed in a lot of companies.”

What happens instead, this CEO says, is that you spend the first year after an acquisition getting the business established, the next three years building, often through more acquisitions, and the final year preparing to liquidate. “Companies like Hanley Wood are well managed and made investments, but those that don’t have the same management strength, or strategic vision, or quality equity partner, will starve their business and be hurt.”

Meanwhile, this same CEO notes, many deals these days have more than one PE investment company, a fact that creates new challenges. Every PE firm, he says, has its own reporting and performance requirements, and because they have a fiduciary responsibility to their investors, none is in a position to compromise those requirements.

“You become a slave to multiple masters,” the executive says. “It is going to be impossible for these managers to get anything done. When there are differing standards, all standards get fulfilled.”

Still, most publishing operators, albeit those affiliated with private equity, think PE firms have been a positive addition to the magazine industry. “The most important thing they have done is create liquidity in the market,” notes Bob Krakoff, CEO of a one-man company backed by an equity firm and on the prowl for an acquisition. “There are a lot more opportunities to find a buyer or multiple buyers. That creates a real marketplace and that is good.”

Second, Krakoff says, the fact is that when strategic buyers make an acquisition, they always change management. But when a PE firm buys a company, it is often buying the existing management, lending continuity. Third, he says, private-equity firms are very performance oriented, “and that is good during all parts of the cycle. They will act as opposed to letting things drift along,” Krakoff says. “Nothing gets buried.”

What’s more, Krakoff says, in almost every example you can think of, when a private-equity firm sells, it has almost always sold for more than it paid.

In the end, many operating executives say, private-equity has driven a slow transition in the business from being one of largely family-owned companies to a new form of ownership structure, something that is neither good nor bad, just different. “The industry has become more disciplined, much more focused on margins and growth,” says Tom Kemp, a managing director at Veronis Suhler Stevenson.

But will PE help provide that elusive characteristic called vision? Responses from one equity-firm executive suggest the answer. ABRY’s Yudkoff says, “It is complicated to navigate through the transition from print to e-media, but I think it is going to be a great business.”