RealMoney Silver - Insiders Tip Off Three Private-Equity Plays

Insiders Tip Off Three Private-Equity Plays
By Tim Melvin
RealMoney.com Contributor
5/13/2008 1:03 PM EDT

Private-equity firms are having a tough year. At least, that is what the headlines are saying. The ClearChannel (CCU) deal is tied up in court. Transaction volumes are down big, falling 68% so far this year. The size of the deals are down as well, with the average deal being done for only about $210 million compared to the megadeals we saw in years past. Major banks have balance sheets plagued by leveraged-buyout loans they cannot syndicate. Several banks have dumped private-equity loans at large losses just to get them off their balance sheet in recent months. Credit for deals has pretty much dried up, and it is difficult for the firms to obtain the type of leverage that enabled them to earn out size returns in the past few years.

The few publicly traded private-equity firms have seem their stocks pummeled, as the outlook is perceived as gloomy. Investors hate the group and think the prospects are fairly bleak going forward. One group of investors disagree, however, and are putting their money where their mouths -- and beliefs abut the direction of the stocks prices -- lie. Corporate insiders are buying at several of these private-equity and financing firms.

Blackstone

Shares of Blackstone (BX) are up from their lows, but still well short of the highs reached following their initial public offering last year. They have had several high-profile deals fall apart this year, most recently the $6.76 billion buyout of Alliance Data Systems (ADS) .

While I do not pay a lot of attention to the absolute level of analyst forecasts, there is a lot of research that shows that the direction of forecasts has predictive value. In the past 90 days, analyst forecasts for Blackstone's quarter and full year have plummeted. Director William Parrot would tend to disagree with the gloomy forecast, as he has been buying shares since November. Institutional shareholders appear more bullish than the forecasts as well, raising their holdings by three million shares in the latest quarter.

KKR Financial

Some of the largest insider buys have been at KKR Financial (KFN) . The REIT is an affiliate of private-equity giant Kohlberg Kravis and Roberts, and manages a credit opportunity fund, as well as making specialty loans. Like most of the specialty finance and commercial REITS, the company has a lot of debt to fund its operations, but in this case it appears to be manageable.

A little digging in the latest 10q shows that the outstanding debt is more than matched by the company's investment portfolio of debt and equity securities. The shares trade well below book value and pay a fat 12% dividend.

Since the first of the year, insiders, including CEO Saturnino Fanlo, have purchased over 800,000 shares in the open market. The company also sold 34 million shares in an offering in April to provide capital to get through the current operating environment and take advantage of emerging opportunities in the marketplace.

In the prospectus, management said that it viewed it as prudent to pay off its short term debt now. They also said that since many of its competitors had withdrawn form the marketplace, they will be well positioned to benefit from a better environment for debt investing and lending.

Apollo Investment

Apollo Investment (AIVN) is in pretty much the same business, although it is structured as a business-development company instead of a REIT. Apollo has less debt as a percentage of overall equity, and also pays a generous yield of over 12%. The company typically invests between $20 million and $150 million in its portfolio companies and is willing to invest all across the capital structure.

Since the first of the year, three insiders have purchased over 30,000 shares of the company, and institutions have bought an additional 9.7 million shares. Several brokerage firms have downgraded the stock this year, putting pressure on the share price, although it has bounced well off the annual lows.

Private-equity and specialty financing for takeovers and buyouts can provide enormous returns for patient investors. It is no secret that the operating environment for these companies has been terrible so far in 2008. Now, as share prices have fallen, we are seeing the corporate insiders start to build their positions in the stocks to take advantage of the eventual rebound.

While most of these firms use a lot more leverage than I am usually comfortable with in making a long-term investment, if my market forecast is correct and they are able to make investments at much lower prices, the returns going forward could be huge, and I think they will be worth the additional risk.

Because my outlook is generally bearish, I am not ready to start buying into private equity. Insiders tend to be very early, and given the high levels of leverage, I would rather wait for a general stock market selloff to get involved. However, given the proven record of all three companies, and the high historical returns of private equity following a bear market, they are near the top of my watch list.