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The Kings of Private Equity

By Stansberry Research Interview Series
Monday, 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




Recent Articles
Market Notes
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.
 
In The News: U.S. growth slows to lowest in three years.
Market Watch
Symbol Price
Change
52-Wk
S&P 500 1221.53 +1.3% +10.1%
Oil 38.31 +1.4% -0.6%
Gold 138.07 +2.1% +16.3%
Silver 28.60 +2.4% +53.6%
US-Dollar 80.67 -0.8% +8.1%
Euro 1.32 +0.6% -12.1%
Volatility 18.01 -7.1% -19.8%
Gold Stocks 581.56 +3.0% +17.0%
10-Year Yield 3.02 +0.7% -10.7%

World ETFs
Symbol Price
Change
52-Wk
USA 122.89 +0.3% +11.3%
Canada 30.50 +0.2% +16.2%
Russia 21.94 +1.4% +18.1%
India 37.85 +0.3% +22.3%
Israel 16.69 +1.3% +10.8%
Japan 10.64 +0.6% +6.5%
Singapore 13.73 -1.1% +18.8%
Taiwan 14.78 +0.4% +19.2%
S. Korea 57.31 +1.3% +23.4%
S. Africa 71.87 +1.4% +28.2%
China 44.42 -1.4% -0.6%
Lat.America 53.17 +0.7% +8.4%

Sector ETFs
Symbol Price
Change
52-Wk
Oil Service 137.59 +1.0% +18.9%
Big Pharma 64.14 +0.0% -3.2%
Internet 72.07 -0.1% +23.4%
Semis 16.22 +1.2% +29.4%
Utilities 31.28 +0.2% +1.5%
Defense 18.52 +0.1% +10.6%
Nanotech 10.03 +0.4% +1.6%
Alt. Energy 10.08 +1.3% -3.3%
Water 18.49 +1.0% +14.5%
Insurance 16.14 +0.4% +21.1%
Biotech 20.54 -0.2% +28.1%
Retail 19.70 +0.3% +30.2%
Software 24.79 +0.8% +25.9%
Big Tech 53.87 +0.3% +22.7%
Construction 13.10 +0.9% +15.7%
Media 13.64 +0.5% +26.0%
Consumer Svcs 67.39 +0.2% +24.5%
Financials 55.04 +0.3% +7.4%
Health Care 64.30 +0.1% +2.0%
Industrials 63.54 +0.5% +21.0%
Basic Mat 74.35 +1.1% +25.3%
Real Estate 55.32 +0.1% +25.0%
Transportation 91.77 +0.7% +26.9%
Telecom 22.59 +0.5% +17.8%