Main Street: A Great Private Equity Play

by Jon Markman | April 11, 2012 6:30 am

Private equity has gotten a bad reputation lately due to its managers’ penchant for curbing costs by firing employees. But it’s largely a bum rap since most private equity firms play an important role in providing financing and advice to young or struggling small and midsize companies.

Most private equity firms are naturally private. But there are a few that operate through an investment vehicle known as a “business development company” and are traded just like regular stocks.

Main Street Capital (NYSE:MAIN[1]) has been one of my model’s favorites in this space for a long time, and it remains a solid  pick. Think of it is as an investment firm focused on providing debt and equity capital to small and midsize companies. Its cash injections are typically used to support management buyouts, recapitalizations, acquisitions and growth initiatives for companies with annual revenues of $10 million to $100 million.


MAIN has been public only since 2007, but its predecessor investment funds were founded in 1997 and previously purchased or financed more than 70 companies in a variety of industry segments.

The firm has more than $850 million in assets under management and is headquartered in Houston. Its portfolio includes 80 companies of exceptional diversity, including video-conferencing, medical billing, automotive repair, IT consulting and specialized printing. With an average investment of just $6.2 million, no single company investment represents more than 4.3% of the total portfolio value, creating even more diversity and reducing overall risk exposure.

What does MAIN look for in a new investment? Top criteria include positive historical free cash flow, proven management and niche or leadership market positions.

MAIN says it’s a self-sponsored “one-stop” financing solution, providing customized solutions to lower-middle-market business owners and entrepreneurs. The U.S. Small Business Administration estimates that there are more than 175,000 domestic businesses that fit this criteria. MAIN is focusing on this niche because it feels the segment is under-served by larger private equity firms.

According to an analyst at R.W. Baird who follows the sector, MAIN has a differentiated operating strategy that drives higher risk-adjusted returns relative to its peers. The company does not rely on outside sponsors to help generate investment opportunities, choosing instead to source all of its deal flow internally. This has resulted in better pricing and terms on its investments versus similar deals by peers.

The management team has more than 100 years of combined investment experience, and the core group has worked together since the formation of the Main Street Mezzanine Fund in 2002. Co-founder Vincent D. Foster has been MAIN’s chief executive since 2007.

The role of the traditional private equity firm is to achieve a return on investment greater than its cost of capital and to return excess gains back to shareholders — in MAIN’s case, in the form of a nice dividend.

MAIN switched from quarterly to monthly dividends in the fourth quarter of 2008, and shares are currently yielding 6.7% per year. The firm was able to grow 2011 investment income by 81% from a year ago and is averaging 32% annual growth the last five years.

MAIN is in great financial shape, with $163 million of cash, securities and idle funds available at the end of the last quarter. It expanded its credit facility from $155 million to $235 million.

It’s trading at just 13 times next year’s earnings, and shares have been on an incredible run, up 19.5% this year. In sum, MAIN provides an excellent opportunity for appreciation while also dishing out a monthly dividend.

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