News Column

Is Markstone on verge of insolvency?

April 28, 2014

By Shai Shalev and Lital Istamati, Globes, Tel Aviv, Israel

April 28--Could the loans at grey market terms taken by private equity firm Markstone Capital Partners Group LLC drive it into insolvency? In the past few years, Markstone, which previously raised almost $700 million from US and Israeli investment institutions, borrowed huge sums at high interest from outside parties to cover the heavy debts of some of its portfolio companies.

The significance of the extraordinary loans taken by Markstone, run by managing partner Ron Lubash, is that not only are portfolio companies such as bookseller Steimatzky Group and Amfic liable to become insolvent, but the fund itself, which has mortgaged its main holdings to creditors, could face the same situation.

Legal sources told "Globes" that it is rare and abnormal for a private equity fund to assume debts (even if they are subsequently loaded on the portfolio companies), and this is evidence of unusual conduct by management. They said that cross-mortgages and deals between a fund's portfolio companies (such as the loan by Magnolia Silver Jewelry Ltd. to Steimatzky) are extraordinary.

Market sources estimate that Markstone took a huge debt of NIS 250 million from Deutsche Bank, which it dispersed among its portfolio companies that had cash flow problems, beginning with Steimatzky and Amfic (formerly Prisma Investment House).

Markstone mortgaged various holdings against the Deutsche Bank loan, not necessarily the companies which received the loans (cross mortgaging). This is an unusual step that is not normal in the private equity industry. NIS 70 million of the Deutsche Bank loan went to Steimatzky, which is now being sold to Keter Publishing House Ltd. and office supplies retailer Kravitz Ltd. for NIS 40 million.

As part of the sale, Markstone will assume Deutsche Bank's loan to Steimatzky, as well as a NIS 200 million owner's loan that it granted to Steimatzky, and an additional loan (of NIS 16 million) given to Steimatzky from Magnolia, another Markstone portfolio company.

7 companies left, 5 of them failures

Theoretically, Lubash has several options for dealing with Markstone's debts, including bringing in a new partner, calling for more money from its investors, and selling portfolio companies at a profit. But in practice, none of these options are realistic because of Markstone's dismal condition. To date, it has repaid investors only $365 million, about half of the $657 million raised ten years ago.

Markstone has seven remaining holdings, five of which are failed investments, which probably not even part can be recovered. They include all-terrain vehicle maker Tomcar Ltd., soil stabilization solutions company PRS (Mediterranean) Ltd., Elran Real Estate Ltd. of cousins Gadi and Dori Dankner, Amfic, and Steimatzky -- an adventure that has cost Markstone more than NIS 200 million in lost investment and a similar amount in loans taken over the years.

The only investments that may yield Markstone a profit are its 100% stake in Magnolia and 20% stake in nylons manufacturer Nilit Ltd. However, over the years, Markstone mortgaged the shares in these two companies as its cash flow problems worsened. There are reportedly several liens to different parties on each of these assets.

Last week, "Globes" revealed that Markstone mortgaged Magnolia's shares to private equity fund Fortissimo Capital in exchange for a NIS 40 million loan (a subordinate lien, after a lien given to Mizrahi Tefahot Bank (TASE:MZTF) for a NIS 50 million debt). Markstone's holding in Nilit, in which it invested $73 million (and which it estimates is worth $110 million) is also mortgaged to several parties. For example, in exchange for a NIS 140 million loan to Steimatzky, Bank Hapoalim (TASE: POLI) received liens on Nilit and Netafim Ltd. (which Markstone later sold).

The biggest problem: Amfic

Markstone's holdings in Steimatzky and Magnolia are the current focus of attention, but its biggest and most problematic investment is Amfic, which owns 23% of Psagot Investment House Ltd., Israel's largest investment house. Amfic's debts are estimated at NIS 500 million, the result of Prisma's collapse in 2009. Most of the debt, about NIS 400 million, is to the banks, and the remaining NIS 90 million is to the bondholders of subsidiary Phenomenal Holdings, which is insolvent. Markstone invested $260 million in Prisma, which, like the investment in Steimatzky, is liable to go down the drain.

Amfic's debts were worsened by Markstone's rejection of Apax Partners' offer in 2010 to buy out Amfic's stake for NIS 600 million. In retrospect, this was a huge mistake by Markstone's managers, Lubash and the late Amir Kess. Since that refusal, Markstone has had to inject $60 million into Amfic because of its heavy debts to the banks and bondholders.

Markstone acquired the stake in Psagot following the sale of Prisma's provident funds to Psagot. In March, Phenomenal (via which, as mentioned, the shares in Psagot are held), became insolvent, after again failing to make a NIS 15 million bond payment.

Until recently, Markstone also owned 50% of Excellence Mutual Funds Ltd. In September 2013, it sold the holding to Excellence Investments Ltd. (TASE: EXCE) for NIS 64 million, an amount that was quickly swallowed to cover debts.

Markstone's investors (among them Israeli institutional investors), which have kept their distance from the firm since the bribery scandal involving Markstone's founding partner Elliot Broidy in 2009, will face a write-off of a large part of their investment. The investors have kept quiet so far and are not demanding explanations, even though it is clear that the previous valuations given by Markstone for its holdings are utterly unrealistic, and that reports about its conduct are partial at best and even misleading. It cannot be ruled out that the reason is that these institutional investors do not want to be associated with the failed investment, and wish to avoid explaining why they ignored the warning signs.

Markstone declined to comment on the report.

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(c)2014 the Globes (Tel Aviv, Israel)

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Source: Globes (Tel Aviv)