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The Kings of Private EquityBy Graham SummersMonday, October 30, 2006 Tom McHale, Senior Vice President of Finance leans back in his chair and glances at the investor presentation on the computer terminal to his left. He’s skeptical of making the investment, remarking,
“At this point our percentage of closed deals has dropped to 1.4%. At our size we can be picky about what we choose to pursue.”
I’m sitting with McHale and the Director of Investor Relations for American Capital Strategies (ACAS), a leveraged buy-out (LBO) firm in Bethesda, Maryland.
McHale and his colleagues can afford to be picky. They’re among the world’s best investors… and only they only pull the LBO trigger when the cards are stacked heavily in their favor…
If you’re unfamiliar with LBO firms, you can you can think of them as activist investors that leverage their own capital to acquire a company outright. In a typical deal, the LBO firm pools its capital together with a company’s management to finance up to 25% of the company’s acquisition price.
Using the company’s assets as collateral on the loan, the LBO firm then borrows the rest of the money for the acquisition from banks, or issues high-yield bonds to extremely wealthy individual investors or institutions.
Once they’ve acquired the company and taken it private (hence the name “private equity”), company management and the LBO firm sell off various portions of the company to cut costs and streamline the business. The restructured company is then sold for a profit. You can think of it like looking through the attic and selling the valuable stuff that isn’t being utilized.
Typically, LBO firms shoot for mega-deals: Multi-billion buyouts.
Not American Capital.
Since going public in 1997, American Capital has focused almost exclusively on privately held middle market companies: Companies that generate $1 billion or less in annual revenue. It’s invested over $10 billion in 229 of these types of companies. These guys are so good at unlocking value, the returns are outright ridiculous.
Since 1997, American Capital has shown investors annualized returns of 22%. It’s paid out over $21 in dividends. And its current yield is 8%. If you’d invested $10,000 at American Capital’s IPO, with dividends reinvested you’d be sitting on over $49,000 today.
How do they generate these kinds of returns?
By being picky. By doing their homework. By doing the things every investor should being doing before making an investment.
In tomorrow’s Growth Stock Wire, Tom McHale will walk us through American Capital’s legendary approach to investing… and I’ll tell you how I’m using it myself…
Until tomorrow,
Graham
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Led by surging China Mobile and China Life, iShares China now up 52% in the past 52 weeks.
Volatility Index (VIX) still hovering around 2006 lows, indicating total investor complacency.
Earnings today: James River Coal and Verizon.
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