Wall Street is abuzz with talk of private equity shops going public, but some investors are saying been there, done that.
Talk is that big private-equity offerings will give mom and pop investors an opportunity to piggyback on the outsize gains that private equity firms have rung up over the past several decades. Last month, Blackstone Group filed for a $4 billion initial public offering. This week, chatter emerged that another titan of the private equity business, Leon Black's Apollo management, is considering an IPO.
But Malon Wilkus, CEO of alternative asset management firm
American Capital Strategies
, says there's nothing novel about investment companies tapping the public markets for the purpose of taking over or investing in other companies.
"The public markets provide a fabulous source of capital to fund buyout transactions," Wilkus says, though he adds, "It's a lot of work to be a public company."
It can also be a lot of work being an investor in these companies, what with all their complex transactions and arcane strategies. Taking a look at American Capital offers some interesting insights into what might lie ahead with the private equity IPOs.
So-called business development companies like American Capital invest in hundreds of small to midsize companies, at times taking controlling stakes. These entities operate as regulated investment companies and, similar to real estate investment trusts, must distribute at least 90% of their taxable income to shareholders every year. The company's debt must not exceed its equity, but the trade-off is that income generally isn't taxed.
Such BDCs function in the same ways that venture capitalists and private equity shops such as Blackstone do. The difference is that being public, BDCs don't have to go on time-intensive capital-raising campaigns to build up a war chest.
Wilkus founded Bethesda, Md.-based American Capital, a buyout and mezzanine fund, out of his two-bedroom condominium in 1986 and took it public a little over a decade later.
American Capital has invested in companies such as Nashville-based Gibson Guitar and baby products firm Evenflo. Last March, it helped Fort Washington, Pa.-based Cottman Transmission acquire Philadelphia-based Aamco Transmissions. The combined entity, which will boast 1,100 stores nationwide, will keep the Aamco moniker.
Its $6.8 billion market capitalization puts American Capital just behind $11.5 billion
, which earlier this year became the first hedge fund to offer shares to the public. Fortress' shares doubled in their first day of trading on the
New York Stock Exchange
American Capital started more slowly but has grown steadily. It hit the market more than 10 years ago with a modest $155 million IPO led by Friedman Billings Ramsey, but it has since had 26 additional campaigns. American Capital, since going public, has raised some $15 billion in debt and equity, using a variety of underwriters including J.P. Morgan Chase, Citigroup and Wachovia.
The universe of similar publicly traded alternative investment vehicles is small. It includes
, with a market cap of $4.2 billion.
Thus far, American Capital's performance has been stellar. It has generated internal rates of return of 24% since it was launched -- a number that compares favorably with PE shops and hedge funds, which usually aim for returns in the 15% to 20% neighborhood.
"As an operating company, we're one of the best performing operating companies," boasts Wilkus.
The company has drawn its share of scrutiny, though.
The Securities and Exchange Commission
conducted an inquiry of American Capital four years ago tied to short selling and valuations of the companies that it acquires. American declined to comment on specifics of that matter and since the investigation was informal, it's unclear if anything ever came of it.
But part of the SEC scrutiny might be tied to the company's debt-to-equity ratio, which has meant the company has had to be mindful of its public offerings.
American Capital regularly uses so-called equity forwards -- essentially agreements in which the underwriter shorts the issuing company's shares and distributes proceeds at a designated price as it needs funds and the issuing company covers any loss the underwriter incurs, explains an underwriter for American Capital at a Manhattan-based investment bank, who declined to be identified.
The forward serves as a credit line for the company and allows it to maintain its regulated limits, Wilkus notes. "We're never going to play the market. We're just trying to fund our next investment," he says. "To the extent we've had a short position it's been entirely because of the equity short program."
These BDCs also have been the target of short-sellers, mostly hedge funds who have sought to profit from borrowing shares and then trying to talk down the company's share price.
About 70% of the American Capital's outstanding shares are owned by retail investors, notes Wilkus. He says short sellers "were basically saying that we weren't capable of producing the kind of returns that we have historically produced." He declined to elaborate further.
The shareholder base appears supportive, however.
"We've been big shareholders since the original IPO. ... These are high-quality long-term
investment managers who have done a terrific job with their business. They're not high rollers, they're not flashy," says John Lewis, president of Chadds Ford, Pa.-based investment manager Gardner Lewis Asset Management, the largest American Capital shareholder.
Washington-based Allied Capital also has had its own short-selling fracas. David Einhorn's Greenlight Capital has been a big short-seller. Einhorn has said he believes Allied's managers knew about an alleged fraud at its subsidiary Business Loan Express. A former executive there, Patrick J. Harrington, was indicted in January by a federal grand jury for fraud.
Allied has since received a subpoena from the U.S. attorney's office for the District of Columbia tied to phone records fraudulently obtained on Einhorn.
Allied declined to comment via a spokesman, as did Greenlight.
Short sellers' involvement aside, the BDC market is expected to grow, notes David Chiaverini, research analyst at
BMO Capital Markets
in New York, who tracks the BDCs.
"Driving that is the underlying growth of M&A activity. We're seeing some $200 billion of money being raised by PE funds within the past couple of years ... that's going to drive deal flow for BDCs as well," he notes.
Some of the most recent entrants include
, which back in December sold $216.5 million worth of shares via Lehman Brothers and Merrill Lynch, and
( GNV), which raised $109 million with lead underwriters Citi, J.P. Morgan and Wachovia. BMO also acted as co-managers on both offerings and is an active BDC underwriter.
American Capital has its own growth plans in sight. It hopes to take its show international and has opened offices in Frankfurt, Germany as well as Paris. It also hopes to soon enter the Asian markets, Wilkus says.
As its business has expanded, it also has become more sophisticated. American Capital plans on becoming a manager of collateralized loan obligations (a package of loans structured and sold off in pieces to investors), which will allow it to offload some of the debt it originates in its buyouts while also collecting management fees. Recently, it debuted a roughly $400 million CLO. Similarly, it has a number of investment funds, from which it collects management fees, Wilkus notes.
Despite the expectation that a wave of private equity shops might be entering the public market, Chiaverini notes that firms such as Blackstone and KKR exist in another stratosphere, targeting much larger buyout prey. That means they are unlikely to be in direct competition.
The next goal for the BDCs? Broader market billing.
Lewis of Gardner Lewis is hoping that American Capital, as it grows, gets into the
. "We've committed new capital
in American Capital over the last month," he says.