By Pete Gallo
All indicators are that billionaire hedge fund manager John Paulson’s firm, Paulson & Co., isn’t letting up in its interest in the embattled financial sector. Paulson & Co. in April took a 13% stake in American Capital, the Bethesda, Maryland–based private equity and asset management firm that trades on the Nasdaq.
American Capital and its addition to Paulson & Co.’s portfolio of financial sector investments is interesting to watch. Why? Remember, Paulson himself was one of the earliest hedge fund managers to correctly call the residential real estate market bust led by the subprime mess. And his firm’s 13% stake in American Capital identifies a new theme the rest of us should be paying attention to.
These days, Paulson is prospecting upside opportunity by buying into financial companies, like American Capital, that have exposure to distressed investments.
Call it special-situations investing in asset managers exposed to distressed debt that desperately need to restructure and recapitalize to hit the next level. In American Capital’s case, in looking to restructure $2.4 billion in debt, the firm raised $295 million through a 58.3 million share offering, based on filings with the Securities and Exchange Commission. (The offering deal inflated overall shares by 20% to 339.2 million shares of outstanding common stock.)
On April 19, Paulson & Co. offered to buy the bulk of that offering, gobbling up some 43.7 million shares at $5.06 each, amounting to a hefty $221.1 investment. Shares priced at a 5% discount.
But that aside, the position has already been a winner for Paulson & Co.
American Capital stock rose in value to $6.45 per share on April 29, up from $5.60 on April 19—roughly a gain of 13.2%. Not bad, though part of that spike surely followed me-too investors trying to flood into a stock drawing commitment from a heavyweight like Paulson & Co.
But will American Capital’s debt restructuring pay off in long-term profits for Paulson & Co.? American Capital has been publicly traded since 1997, but the company was bumped out of the S&P 500 index in February 2009 as a credit crunch crimped its bottom line. (The stock was at an all-time low of 63 cents in March 2009.)
As with all asset managers with distressed and special-situations portfolios, the challenge for American Capital after restructuring debt will be to monetize previously stalled portfolio positions. On May 4, American reported $163 million in cash proceeds from market realizations for the first quarter of 2010 (with $114 million coming from loan sales and principal payments from portfolio companies), as compared with $476 million and $463 million for the two previous quarters, respectively, filings show.
Paulson & Co has reason to be optimistic. American Capital focuses on senior obligations as well as second liens, ABL loans and mezzanine financing. The company’s holdings are also fairly diversified, but its notable focus is in the energy sector, where American Capital has exposure to everything from oil, coal and natural gas to alternatives like solar and nuclear. Service companies, utilities and distribution companies are also in the mix, as are resource-gathering enterprises, including some exotic investments like uranium mining. (Information technology outfits and human resources investments targeting state and local governments are also part of the American Capital portfolio.)
Since the start of the year, Paulson & Co. has bulked up on other financial sector firms, according to filings with the SEC.
For instance, the firm took a 4.4 million-share stake in the CIT Group. (Other hedge fund investors include Icahn Capital and Greenlight Capital.) CIT Group traded at $40 per share on May 4, up from $25 at the start of the year.
Another new position in the Paulson & Co. portfolio at the start of the year was a 1 million-share stake in Northern Trust, which was trading at $53 per share on May 4, up from roughly $50 in early February.
The hedge fund shop also started the year with a new investment in Wells Fargo, 17.5 million shares. The stock hit $33 on May 4, up from a low of $21.50 in January.
Other portfolio positions in the sector are SunTrust Banks and Citigroup. Meanwhile, Bank of America remains one of the firm’s largest positions—some 164.8 million shares. On May 4, shares were worth $18, up from $15 at the start of 2010.
Will the financial sector bet continue to pay off?