The tragic death in a traffic accident last Thursday of Amir Kess, a co-founder and managing director of the Markstone Capital Group private equity fund, left those who work in the capital markets stunned. Kess was bicycling on Route 40 near the city of Hod Sharon when he was killed in an accident involving a truck and a passenger car.
Markstone is among the country’s oldest private equity firms. Founded in 2004 by Kess, along with his close friend Ron Lubash and the American Jewish businessman Elliott Broidy, it has since raised more than $786 million. Kess, 52, had a law degree from Tel Aviv University and was a prominent figure in the Israeli local financial scene. Before coming to Markstone, he was the CEO of Poalim-M&A, a joint venture with Bank Hapoalim’s Poalim Capital Markets, and executive vice president of Arison Holdings, the investment vehicle of Bank Hapoalim owner Shari Arison.
Kess’ professional career was closely intertwined with Markstone, which has been responsible for some of the most successful and most problematic private equity investments in Israel over the past decade. Markstone raised about $250 million in its first round of funding mostly from the New York State Employee Retirement Fund and other American institutional and private investors. (Israeli investors at the time, included Phoenix, Clal Insurance, Meitav and Mivtahim.)
Markstone’s founders mostly had finance backgrounds, but chose to invest the fund's assets in non-financial arms of traditional and well-established businesses. The initial investments included the Golden Pages business directory, engineering firm PRS Mediterranean, agro-engineering company Zeraim Gedera, nylon fiber-maker Nilit, the Steimatzky’s bookstore chain, drip irrigation company Netafim and at a later stage, the jewelry retailer Magnolia.
In 2005, following the release of recommendations by an official commission that advocated barring banks from managing provident funds, Markstone’s leadership broke from its main focus and assembled an American-style investment fund dubbed Prisma from a slew of acquisitions. Markstone bought two mutual fund management companies from Bank Hapoalim for about a billion shekels ($288 million at current exchange rates) and spent about a billion shekels more for provident and continuing-education funds (“kranot hishtalmut”) sold by Bank Hapoalim. The fund used its own capital for about half the purchases and financed the rest with bank loans that it has yet to fully repay.
Spending money to lose money
During most of its existence, Prisma lost sizeable amounts of money, mostly due to problematic management and the high price Markstone paid for its assets. Within three years, the fund was required to make large payouts to its backers, and its value plummeted. Its fate was sealed at the beginning of 2008, when provident funds faced losses of more than 8%. When it then turned out that an investment manager had engaged in risky options trading with Prisma account holders’ savings, a public firestorm erupted. The account holders were reimbursed and Markstone’s losses deepened.
In early 2009, at the height of the global financial crisis, the decision was made to close Prisma. The provident funds were sold to the Psagot investment house, and other funds went to Excellence Investment House, both in exchange for stock in the buyer. About six months ago, apparently due to a need to raise cash, Markstone sold its interest in Excellence for the relatively paltry sum of 70 million shekels ($20 million).
The Prisma debacle was a prelude to larger scandal, when later that year the New York state attorney general found that Broidy, Markstone's chairman, had bribed officials at the New York State Employees’ Retirement Fund to ensure they put capital into the fund when it was set up. The attorney general cleared Kess and Lubash of any involvement. Broidy’s ties with Markstone were severed, and Dan Gillerman, Israel’s former ambassador to the United Nations and a veteran businessman, replaced him as chairman. In a settlement, Broidy paid the New York fund about $18 million.
The case undermined investor confidence in Markstone, which had already been compromised by the problems at Prisma. Some of Markstone's Israeli institutional investors asked the fund to halt new investment activity. In the interim, however, the fund managed to get mired in another problematic investment, this time in Elran Real Estate. In 2007, Markstone acquired a 24% stake in the property firm for 83 million shekels ($24 million) and became part of its controlling-shareholder group. But four years later, Elran was forced to reschedule its obligations to bondholders after a series of problem investments. It was trading at the time at a market capitalization of just 9 million shekels ($2.6 million).
Markstone made another failed investment of roughly $30 million in the off-road vehicle company Tomcar. Within three years, the fund was forced to write off almost all of its 80% stake in the company, and in 2011, it transferred control of Tomcar to an Indian motor vehicle firm, Maini, for no money and a 20% share of a joint company that the two parties set up.
Some ups and more downs
Nearly half of Markstone’s investment in PRS Mediterranean, the engineering firm, has also been written off. But on the other hand, the fund has chalked up some major successes with exits that have generated tens of millions of dollars. Among them are its 75% stake in Golden Pages, which it acquired in 2005 for $55 million and sold two years later for $93 million. Markstone’s stake in Zeraim Gedera, acquired in 2005 for $52 million, was sold in 2009 for $95 million. Its 13% stake in the Netafim drip irrigation company, bought in 2005 for $25 million, was sold to the UK-based Permira private equity fund for $110 million in 2011. Most of the proceeds from these sales were distributed as dividends.
Markstone recently disclosed plans for an initial public offering of 50% of Magnolia, the jewelry retailer, at a value of 300 million shekels. That would give Markstone a 100% return on its investment if the IPO goes through. Markstone’s investments in the Nilit fiber company and Steimatzky’s are also regarded as particularly successful, although the fund has yet to exit form either of them.
In recent months, Markstone has again garnered negative headlines with the news that Phenomenal Holdings, through which it holds its stake in Psagot, informed investors that Markstone was delaying payment of 15 million in principal and interest to institutional investors and banks that hold its bonds. In recent weeks, however, Markstone has entered into talks with the institutional investors over rescheduling repayments on the approximately 100 million shekels in the bonds it issued in 2007 to finance its Prisma-related acquisitions. The private equity fund also recently retained Poalim Capital Markets to identify potential buyers for its shares of Psagot, which would enable it to service bank and bond debt of as much as 500 million shekels.
The losses and controversies that Markstone has encountered over the years have not done it well. Its financial reports show that over the past decade, it has provided meager nominal returns of around 3%, not enough to even keep pace with inflation. In the past 10 years, Markstone has returned some $360 million to its investors, which amounts to about half of what they put into it. It is important to note that the assets it still holds are likely to be worth less than what it says on the books, in which case Markstone’s investors will be saddled with losses.
In contrast with investors, executives at Markstone have received tens of millions of dollars in compensation over the years. As is the practice with funds of its kind, the compensation is based on two variables — the value of assets managed and the profits generated. As far as is known, Lubash and Kess received management fees of $70 million to $80 million over the years.
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