Minutes of the

March 9, 2005
Item Action

Preliminary Discussion on Allocation Plan
Minutes of the Private Equity Investment Advisory Committee Meeting: March 9, 2005……………………………….1 MINUTES OF THE
Santa Fe, New Mexico
March 9, 2005

A regular meeting of the New Mexico Private Equity Investment Advisory Committee of the New Mexico State Investment Council was called to order on this date at approximately 9:05 a.m. in the State Investment Council conference room, 2055 S. Pacheco Street, Suite 100, Santa Fe, New Mexico. A quorum was present: Members Present:
Mr. Gary B. Bland, State Investment Officer Mr. Andrew Davis, NMSIC Member, Chairman [by telephone] Members Excused:
Legal Counsel Present:
Staff Present:
Guests Present:
Minutes of the Private Equity Investment Advisory Committee Meeting: March 9, 2005……………………………….2 Guests and Members introduced themselves. APPROVAL OF AGENDA
Mr. Enloe moved approval of the Agenda, as published. Mr. Bonafair
seconded the motion, which passed 5-0 by voice vote.

APPROVAL OF MINUTES: February 9, 2005
Mr. Giron moved approval of the February 9 Minutes, as submitted. Mr.
Bonafair seconded the motion and it passed 5-0 by voice vote.

Preliminary discussion on Allocation Plan Aldus Equity Partners representative Saul Meyer presented an update on the Addressing the next item on the agenda, Mr. Meyer stated that NGN Biomed, coupled with Silver Creek, comprises all of the venture capital Aldus plans to recommend for 2005, with NGN making up half of that allocation. He commented that Bioscience “makes a lot of sense for our portfolio because the management fees are lower and you can find higher quality groups that fit within our guidelines, whereas in venture it’s pretty tough to find groups that fit underneath the 2% management fee rule.” Mr. Davis commented that staff has obviously been very diligent in ensuring that the fees and expenses paid to these private equity firms are appropriate and no more than necessary, but wondered, “are we excluding any strong opportunities, in your mind, simply because the fees are too high? Or is the value proposition all that’s considered in this case?” Mr. Meyer responded that this was a difficult question; while the universe certainly expands when one goes above 2% in the venture area, Aldus is only looking for a couple of funds a year, so it is not a problem finding good venture funds. He added that this will become an issue, though, if the SIC decides in the future that it wants to ramp up the amount of venture it does. Mr. Davis asked, “So we’re not eliminating any candidates that you feel extraordinarily strongly about simply because of the fee structure?” Minutes of the Private Equity Investment Advisory Committee Meeting: March 9, 2005……………………………….3 Mr. Meyer responded absolutely not: “If I found one that I thought was amazing, that we just had to do, I would let you know, and I would try to get an exception for it.” DISCUSSION AND VOTE ON NGN BIOMED OPPORTUNITY, I, L.P.
Aldus Equity Partners representative Matt O’Reilly presented this report on NGN Biomed Opportunity, which has offices in New York and Heidelberg. He said this global presence offers a unique opportunity in terms of their deal sourcing and the way they execute and add value to their portfolio companies. Mr. O’Reilly said NGN has four managing partners, each with an extraordinary track record. He noted that one partner, Ken Abramowitz, was Investor of the Year on the publicly traded side for ten years running. Mr. O’Reilly said NGN looks at both public and private investments; and while they want to have the flexibility to do up to 20% in PIPES — which Aldus feels is very prudent — none of the six deals in their portfolio have been PIPES. Mr. O’Reilly noted an outstanding advisory board with most of the members being in the business, some of them scientists, who can help NGN generate deal-flow as well as execute on firms. Mr. O’Reilly said Aldus did its usual background check “and they came out very clean. Absolutely no issues with these guys on the background tests.” Mr. O’Reilly noted that venture capital typically has terms calling for a 2% management fee and no preference — so if they generate any gain, they get the 20% carry. He said NGN, on the other hand, has a 7-1/2% preference, which is very unusual in the venture capital area, so their terms are outstanding. He said the 50-50 transaction fee is still being negotiated and Aldus is hoping for something closer to 80-20. Mr. Meyer added that venture funds typically do not generate a lot of Mr. O’Reilly said a major strength of NGN is a five-year exit strategy, which they have executed historically. He said NGN focuses on late-stage healthcare; specifically, 60% in pharmaceuticals or biotech, 25% in medical devices, and 15% for other healthcare deals. Mr. O’Reilly commented that NGN’s global reach is exceptional in the biotech Minutes of the Private Equity Investment Advisory Committee Meeting: March 9, 2005……………………………….4 Mr. O’Reilly stated that NGN likes to invest in the late second phase of a company after FDA approvals are in. He noted that the six deals in NGN’s portfolio are either coming in as expected or above expectations. Mr. O’Reilly said NGN is raising $250 million for this fund, which Aldus is very comfortable with, since it is not an oversized fund. Mr. Meyer added that NGN came to the market with $150 million on their cover and subsequently raised their target to $250 million based on the amount of demand. Mr. O’Reilly noted that NGN is above the top quartile among their peer groups, with a very good IRR and a shorter multiple because of their quick exits. He also pointed out that NGN has had no write-offs, “which is unbelievable for a venture firm.” NGN managing partners Kenneth Abramowitz, William Gedale and Georg Nebgen came forward and distributed and presented slides. Mr. Abramowitz reviewed fund terms. He said NGN Biomed charges a 2% management fee, which then is reduced in Year 6 and beyond. He stated that NGN does not get its 20% return on the upside until it returns the SIC’s capital, fees and the 7.5% annual cumulative preferred return. He commented that the 7.5% mechanism is a way to reward the SIC and penalize NGN for not delivering what they say they can deliver. He stated that the investment period would legally be over a period of four years, although management will target three years for new investments, and there will be an eight-year fund term plus two one-year extensions. Mr. Bland asked if the SIC’s participation in this Fund will include the investments already made by NGN, and Mr. Abramowitz responded yes, the SIC will retroactively invest in NGN’s investments at the prices NGN invested in them. He said NGN asks for a 7.5% interest charge in return on the called capital for coming in late, because the other investors came in almost a year ago. He added that NGN has had two capital calls on the first $98 million, at 20% and 23%, or about $40 million. Mr. Kulka clarified that it is normal procedure to pay interest for coming in late. He added that the interest is distributed back to the LPs and is not kept at the GP levels. Mr. Kulka also stated that the 7.5% is a fee outside of the commitment, and Mr. Meyer added that usually it is LIBOR+ or Prime+, and 7.5% is in the range of what Aldus is seeing in the market. Mr. Meyer added that the advantage in this case is “we were able to underwrite a third of the deals we’re going to see in the Fund. To me, it’s more comfortable.” Minutes of the Private Equity Investment Advisory Committee Meeting: March 9, 2005……………………………….5 Dr. Nebgen said NGN will have $210 million on commitments if the PEIAC/SIC approves the $20 million investment being recommended today. He added that another $80 million has been soft-circled. Mr. Davis commented that the regulatory and political environment in the world of big pharma has significantly deteriorated over the last year or so, and asked how NGN plans to deal with that; for instance, does that affect their exit strategies. Mr. Abramowitz responded, “I would say it’s 33% bad news and 67% good news. The 33% is that we also are investing in pharmaceuticals that will also have the extra scrutiny of the FDA; the 67% is that the big pharma companies are desperate beyond belief to either license or to buy our companies — not right now because we have to nourish them for the next three to five years, but when these companies develop their drugs to Phase 3, and some of them we even think will get to the market — the big drug companies pay $300 million [to] $800 million when something’s obvious. When it’s half obvious — when we invest — they don’t pay half price; they’re not even interested. We invest when it’s $50 million when it’s half obvious, and we sell it when it’s completely obvious… for five, six, seven, eight times our investment.” Dr. Nebgen said there were two additional aspects to this. He said the first was when the CEO of Merck overreacted and pulled Vioxx off the market without consulting the FDA or its subcommittee, only to have the drug returned to the market later. He said that, in retrospect, Merck should have gone to the FDA first, gotten a stronger label, and continued selling the drug for the benefit of its many users. Dr. Nebgen said the other aspect is that Pfizer, for instance, wants 50% of its drugs to come from external resources; and in general, the need by pharmaceuticals to buy drugs from the biotech industry is the highest in history. He pointed out that the key difference between NGN and other groups is that NGN’s model doesn’t rely exclusively on public markets: “They only invest in companies that are private and public with a five year exit. If an IPO happens, that’s nice, but any exit must do the same in a private deal. Why are we so happy to have that strategy? Because if the weather is bad, and we have a $500 million drug and this is an $800 million to billion-dollar market, we know that the company will pay that privately independent of the market. If there is a good market and we can IPO this company, we will, but we do not rely on that in our investment strategy because we put 70% of our money late stage with one round to exit or profitability.” Adding to his earlier point, Mr. Davis said there seems to be a sea change in the world of pharmaceuticals — while a good deal of wrongdoing has been uncovered, no doubt the resulting closer scrutiny has resulted in “a lot of babies Minutes of the Private Equity Investment Advisory Committee Meeting: March 9, 2005……………………………….6 being thrown out with the bathwater,” along with, it would appear, a tendency by CEOs to err on the side of conservatism by pulling drugs rather than face questions of why they didn’t. He commented that it would seem to be more expensive in this new environment to bring drugs to market, and asked if NGN has factored that into their five-year exit strategy and money making plans. Mr. Gedale commented that the regulatory environment goes in cycles, and so far he has seen five, three in the painkiller industry alone in the last 25 years. He speculated that the atmosphere of fear around pharmaceutical issues may have reached its zenith at this point. Dr. Nebgen added that he doubted there would be more pharmaceuticals pulling drugs off the market, as happened with Vioxx and Celebrex, without consulting the FDA first. He said he thought the industry had learned from these two experiences. Mr. Enloe moved approval of a recommendation to commit $20 million
from the National Private Equity Program to NGN Biomed Opportunity I, L.P.,
subject to negotiation of final terms and conditions and completion of
appropriate paperwork. Mr. Giron seconded the motion and it passed 5-0 by
voice vote.

Aldus Equity Partners representative Saul Meyer presented this report on Capital Point Partners, a first-time mezzanine fund where the principals and the primary mezzanine investors in the fund have been investing together for almost 20 years. He stated that the firm is based in Houston and Philadelphia. Mr. Meyer stated that, because this is a first time fund, Aldus looked at team cohesion, the track record, track record of the principals working together, and the processes they have in place. Addressing team cohesion, Mr. Meyer said principals Jeff Sangalis and Don Rice have worked together for almost 20 years, have team members who have been working with them for some time, and in addition, they have added two principals to broaden the deal flow network. In reviewing Capital Point’s track record, Mr. Meyer noted one “hiccup” with RSTW Partners III (1997), a fund dedicated not just to making mezzanine investments, but also doing equity, which proved to be a mistake. Mr. Meyer said the current fund is limited solely to mezzanine, and what Aldus has underwritten is their mezzanine track record. He said Aldus has stipulated that CPP will not be permitted to make equity investments in the new fund. Minutes of the Private Equity Investment Advisory Committee Meeting: March 9, 2005……………………………….7 Reviewing the rest of the track record, Mr. Meyer noted that Capital Point has invested $670 million across 60 mezzanine transactions and generated a 19% IRR. He also noted an extremely good dispersion of returns in all of their funds, with the single exception of RSTW Partners III. Mr. Meyer also pointed out that, pre-fund, Capital Point outperformed mezzanine and performed almost to the top quartile of buyout; and in the 1992 fund, they outperformed over top quartile regardless of whether it was mezzanine or buyout; and they performed the same way in Fund 2. Mr. Meyer said their new strategy in Fund 3 — as previously discussed, a mezzanine-equity style strategy — resulted in lower performance than expected. Mr. Meyer said, “One of the reasons we sought out a group like Capital Point is that a lot of the funds we would have been investing with used to be in this market space, where they were raising the $350 million to $500 million mezzanine funds, but they’ve all been successful and they’ve all moved up market, and this presents a real problem, because the further up market you move in mezzanine, the more aggressive the primary debt market’s become, the more available the high yield market becomes; and as such, it’s more competitive, they get lower coupons, terms aren’t quite as good, they don’t have as great a position in the capital structure, and at the end of the day, they also don’t have the same amount of protection they would in a less-efficient market, which is one of the reason we struggle to continue to find mezzanine funds that we feel comfortable with in this market space.” Capital Point Partners Don Rice, Jeff Sangalis and Darl Petty appeared before Responding to questioning from Mr. Bonafair on what kind of presence Capital Point maintains in its companies, Mr. Petty said they are present at every meeting of the board and are actively involved in planning strategy and keeping the company on course. He said their documents give them many rights and remedies as a lender to do that. Mr. Sangalis added that Capital Point has the right to go through a company’s books at any time they wish. In one instance, he said, they uncovered some improper expenditures and other problems, and the CEO was fired after they brought that to the company’s attention. He said Capital then brought in an interim management team that remained there for six months until a new CEO was hired. Mr. Sangalis acknowledged that Capital Point has significant influence but doesn’t have equity representation, so can’t actually have a person fired, for example. Minutes of the Private Equity Investment Advisory Committee Meeting: March 9, 2005……………………………….8 Mr. Bonafair commented, “You can be persuasive and you can be involved and still be presiding over a disaster.” He said Capital Point was able to influence the board in the instance just described, where financial misconduct was involved and firing the CEO was the logical choice. He added, though, that he has seen difficulties in these arrangements, “when things have to be changed and you have to have some kind of firepower to make the change.” He asked Capital Point if they have had a situation in the last five years where they couldn’t make a change. Mr. Rice responded that he couldn’t think of a situation where Capital Point insisted someone had to leave and the firm refused. Mr. Bonafair asked if there have been problems where a firm has balked over certain terms, and Mr. Rice stated that they produce a term sheet early on in the process that lays everything out on the table early so they don’t spend weeks on a deal that doesn’t materialize. He remarked that this is in contrast to “a lot of people in our business who put in a one-page term sheet and just try to get the business.” Mr. Rice added that, in their due diligence process, it is very important for Capital Point to understand who the control group is, what their history is, and do they stand behind a deal: “We have to be very comfortable that this is a group that’s going to work with us. We’ve sat on 72 company boards, so we’ve got a lot of history and a lot of experience that we bring to the table, and they see that quickly. So you’re right; once rational minds get together, the right thing usually gets done.” Mr. Meyer clarified that Capital Point works in the sponsored end of the mezzanine market, which limits rights with regard to what they can actually physically get in there and do (unlike a Levine-Leichtman) so they have to rely much more heavily on the buyout sponsor to exercise control. Mr. Bonafair said he understood that, and commented that Aldus’ investigation has proven that they’ve had a good track record in that arena. Mr. Davis commented that some people see the mezzanine space as “pretty frothy,” and suggested Capital Point spend some time defending that and how they plan to avoid “being drawn into that kind of froth again.” Mr. Sangalis responded, “As you know, we’ve been through any number of cycles. We’ve seen this before; you name it, we’ve seen it. The key for us to generate good deals is strong deal flow. And one of the reasons we have a diversified deal sourcing is that right now, frankly, a half buyout, half growth, we’d probably be doing more growth where we can work directly with management teams on a referral basis than we will with equity sponsors. So it may be shorter for some period of time until that market lightens up for us. There has been a lot of discussion about the hedge funds and their getting into our business and all, and Minutes of the Private Equity Investment Advisory Committee Meeting: March 9, 2005……………………………….9 for the most part they’re doing larger transactions, and we think some of them may stumble, too, as the cycle continues, and we’ll be there to help them get out of those transactions. But the key point for us is strong marketing and aggressive marketing and a diversified flow.” Mr. Giron moved approval of a recommendation to commit $30 million
from the National Private Equity Program to Capital Point Partners, L.P.,
subject to negotiation of final terms and conditions and completion of
appropriate paperwork. Mr. Enloe seconded the motion and it passed 5-0 by
voice vote.

Mr. Kulka informed the Committee that, in May 2003, the SIC committed $15 million from the New Mexico Program to the Ventana TGB 2 Fund, but the closing was delayed because of problems with Pacific Corporate Group and the time it took to bring a new advisor on board. He said staff has been working with them since then in an attempt to close this deal, and now Ventana has come up with an exit in their portfolio and is not interested in the SIC’s participation. Mr. Kulka stated that the State Investment Office has indicated to Ventana that the SIC is no longer interested in TGB 2, which is essentially fully invested, and asked them to come back with TGB 3 when they begin fundraising. Mr. Birk commented, “We burned a lot of midnight oil to get this done in a reasonably fast time period in order to have the final terms and conditions ready for their annual meeting on November 2. The annual meeting came and went, time dragged on…. and then out of the blue, they said they had been caught completely off guard by a surprise offer to buy one of their portfolio companies by Pfizer, and the transaction closed in about two weeks’ time.” Mr. Birk commented that he has done a lot of work with big pharma companies and is very familiar with Pfizer, and knows that transactions in that arena take far longer than two weeks, so there may be an issue with respect to good faith negotiations. Mr. Enloe asked how this affects the SIC’s portfolio stratification, and Mr. Kulka responded that this essentially throws $15 million back into the pot, and the SIO will be looking at three or four funds at the end of March as candidates for the New Mexico Program. Mr. Birk reported that he is tracking a total of ten firms at the current time. Minutes of the Private Equity Investment Advisory Committee Meeting: March 9, 2005……………………………….10 NEW BUSINESS
Mr. Bland reported that audit results are in, and the auditors have asked the SIO to improve its valuation checking in the National and New Mexico Private Equity programs. In conjunction with that, he said, Aldus has an improved program that the auditors are very pleased with, so the SIO will be negotiating sometime today to get that program up and running, which will provide additional outside verification of the valuations on these portfolios and portfolio companies. Mr. Davis asked if this could be viewed in some circles as a potential conflict, since that would amount to “putting the people who are recommending the deals in charge of also valuating the deals for us.” Mr. Bland responded that staff did discuss that issue. He explained that this would be the third valuation check, which is what the auditors wanted, and the auditors were satisfied with this choice. Mr. Bland said the first two valuation methods are 1) the audited statements on the individual companies in the portfolio, and 2) the outside audit report of the valuation of the partnership by the CPA firm involved. Mr. Meyer said the method Aldus plans to utilize for checking valuations takes into account broader portfolios than solely the New Mexico portfolios, so when there are multiple GPs involved with a transaction, Aldus know if they’re carrying them at different values. He said third parties will be entering data, and those are reconciled against the cash flows that the SIO is already taking internally. He commented, “I think that’s the best check and balance system you’re possibly going to get in this business.” Mr. Kulka noted that, prior to this arrangement, all of the SIC’s consultants also did the administrative work for the SIO, so they would send a report with values in them, and staff would just plug them into the in-house system. Mr. Meyer stressed that under no circumstances would Aldus mark things up beyond what a GP is marking them to. Further, he said, Aldus can’t force a GP to actually mark up an investment. NEXT MEETING DATE: WEDNESDAY, APRIL 20 2005, IN CINCINNATI
AT 9:00 A.M.
Minutes of the Private Equity Investment Advisory Committee Meeting: March 9, 2005……………………………….11 Its business completed, the Private Equity Investment Advisory Committee adjourned the meeting at approximately 10:45 a.m. Judith S. Beatty, Committee Reporter

Minutes of the Private Equity Investment Advisory Committee Meeting: March 9, 2005……………………………….12

Source: http://www.sic.state.nm.us/PDF%20files/PEIAC%203-9-05.pdf


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