Marek's 2012 Review and 2013 Outlook Interview

I was recently intereviewed by AxialMarket for their 2012 Review and 2013 Outlook Report.  You can read the interview below and get the report here.

Tell me a little about yourself and Catalus.

“Catalus is an industry agnostic lending fund that invests throughout the capital structure, including mezzanine, second lien, and subordinated debt. We also offer ‘special situation’ senior debt, which includes alternative opportunities -- unique geographies, business models, industries, or just atypical circumstances. We typically write checks of $5 to $25 million and invest in the US, Canada, the Caribbean, and Europe.”

How did 2012 go for Catalus?

“Depending on how you look at it 2012 was both a great year and a difficult one. From a returns perspective, we're happy with our performance. We are making solid risk adjusted returns for our investors and are very happy with our current portfolio of businesses.”

“From the new capital invested perspective, 2012 has been more difficult. While we did make a few investments, it was fewer in number and smaller in size than desired. Since we are a lender, this was a result of interest rates continuing to compress and the increased flow of capital into debt markets. Debt has been performing well -- it is a very competitive environment.”

“Interest rates have continued to come down throughout the year. While this is good for borrowers, it is bad for lenders. The lowering of rates has gone against the lending community.”

How will interest rates change in 2013?

“It’s hard to say what will happen to interest rates in 2013, but the consensus is that the rates will stay low throughout the year. I still have the hope that the economy will improve and rates will start to rise, helping to normalize credit conditions.”

How did it go for the entire industry?

“M&A was pretty weak in 2012. There were a few glimpses of some larger transactions, but there was no sustained, frequent M&A activity.”

“On the other hand, the high yield credit markets were robust. But this poses a challenge -- how can credit be robust if there are no acquisitions? The answer is dividend recaps, refinancings, and a little M&A. You have this interesting dynamic of a very robust, almost record breaking credit market with an underwhelming M&A environment.”

“Interestingly, the amount of equity going into LBOs is definitely on the rise. PE firms are using less debt and relying on senior debt or unitranche facilities and less mezz or subordinated debt. In order to get that type of capital structure, the firms are relying heavily on high-yield and loan markets.”

Valuations to rise?

“The most recent data seems to suggest that valuations will actually come down in 2013. That could be a result of the uncertainty in economy and regulatory environment -- if you buy a business, you have to price in that risk.”

“In much larger transactions multiples remain high, but as you get into lower-middle market, the multiples are pretty reasonable -- we see a fair amount of deals 5x-7x EBITDA.”

How are you thinking about 2013?

“I don’t see 2013 as a big turning point for activity. However, I do think January will be very busy. After a significant holiday -- like the one this year -- there tends to be a spike in new activity. I think people will return in January to find many new deals and will be quick to jump on them.”

“I am less concerned by the uncertainty than others.  I believe that there will be some clarity in early 2013 -- the two parties cannot continue going back and forth for six months. Once some agreement is made, either positive or negative, activity will continue.”

What do you mean by positive and negative?

“A positive outcome, given the current situation of anemic growth, growing taxes, and high spending, would be the two parties meeting somewhere in the middle.”

“A negative outcome would be if the current stalemate continued and the immediate cuts came into play. The cuts would create a huge drag on the economy. Although, it could create some opportunities for people like us who are willing to look at distressed deals and be opportunistic.”

How will Europe fit into the equation?

“Europe is particularly interesting because there are fits and starts of panic. I think 2013 will see some repeat of the panic of 2012. It was like when Bear Stearns went down -- there was a quiet for six months and then Lehman went down.”

“While there hasn't been any real solution to the European problem, I believe Europe will make its way out of the current crisis. Their dedication to stick with the Euro has helped spur some markets and in 5 or 10 years, recovery will be evident.  They may lose a country or two out of the Euro in the process, but it will likely recover.”

How will Europe impact the US?

“Since we are such significant trading partners, there is definitely an impact, but it all depends on how problematic the situation becomes. There are several countries in recession now. If that spreads to other countries or worsens, it could have a significant impact on the US.”

“We have some industries that have are particularly strong in the US -- like energy and technology. The growth in those areas can help offset some of the pain that we feel from Europe.”

Why tech?

“The US has demonstrated global technology leadership for some time now. There are so many innovative companies just beneath the surface that will likely become immense successes. While not all are success -- i.e. Groupon -- there is undeniable innovation. Technology in the United States is almost perennially a bright spot.”

Anything else I should ask you?

“In any environment, it is an investors job to find opportunity. Whether there is a recession, a bubble, rapid growth, or a stable economy, it is our responsibility to find places where we can invest safely and generate strong risk-adjusted returns for our investors.”

“Our sweet spot is our ability to find unique opportunities that are either overlooked or avoided by the broader market.”

Catalus Capital Closes Four Investments in 2012 and Seeks New Opportunities

Catalus Capital is pleased to announce that the fund made four investments during the course of 2012 and continues to be active in the market. "We're enthusiastic about the companies that we invested in during the last year and about the partners that we are working with," commented Marek Olszewski, the firm's Managing Partner, "we have significant additional capital to deploy in 2013." Catalus benefits from a highly flexible fund mandate that allows it to be an effective alternative financing source.

We're Hiring!

Catalus is growing and we are seeking to add to our investment team. We would love to hear from you if you meet the profile below.

Private investment firm seeking Associate or Analyst to help support investment evaluation, deal sourcing, and other related tasks. The position reports directly to the head of the firm. Responsibilities include analyzing, summarizing, and presenting investment opportunities as well as assisting in deal sourcing, due diligence, and activities related to managing the firm. Experience in private equity, investment banking, bond/loan research, distressed investing, other investment research, or mezzanine/structured lending is required. An ability to work diligently in an unstructured/entrepreneurial environment is essential. The position will allow for significant responsibility in the deal evaluation and investment process. This is an opportunity to get in at the ground level of a growing fund with significant expansion potential.

· 1-4 years of experience evaluating leveraged buyout, growth capital and/or debt financing transactions.
· Ability to quickly and effectively evaluate, summarize and present investment opportunities, often with little direction or oversight.
· Strong analytical skills to evaluate businesses, market opportunities, industries, etc.
· Strong communication skills and keen attention to detail. Applicant will be required to draft investment memoranda, present ideas to the fund’s investment team and interact directly with senior management of potential investments as well as investment bankers and advisors.
· Strong modeling / deal structuring skills. Applicant will be required to evaluate multiple potential investment structures for each potential opportunity.
· Ability to work in a flexible and entrepreneurial environment.

Candidates can submit their resumes to marek@cataluscapital.com.

Europe, Take Three

Last month I went to Europe to meet our local contacts, build deal flow, and establish some new relationships.  I wasn't quite sure what to expect, but came back with some valuable insight.

Bank lending is very difficult to secure (even in the UK and smaller German deals), in business meetings the crisis is talked about constantly, and there is tremendous lack of faith in the governments to get the Continent on sound footing.  As opposed to a large hunger for capital, deal activity has essentially frozen.  Investment funds, and to a lesser extent strategic buyers, are waiting for some uncertainty to be resolved before deploying capital.

I was actually born in Europe (Poland) and have traveled there extensively.  The culture is quite a bit different, which holds true in business as well.  While the people I met with were appreciative of my visit, personal relationships hold more weight than in the US and local capital providers are inherently preferred.  I can appreciate this knowing execution risk is naturally higher with a foreign investor.  I also learned there are only a few hundred private equity firms focused on developed Europe, versus thousands in the US.  There are even less mezzanine and specialty lending funds.  European business owners are not as familiar or comfortable with the concept of subordinated debt that is more expensive than senior but cheaper than pure equity.

I recognize the turmoil abroad, but see the flight of capital as potential opportunity for Catalus.  We're excited to continue pursuing deals in Europe as well as the US, Canada, and the Caribbean.  We encourage you to reach out with any transactions fitting our investment profile.

EV/EBITDA versus PE

An excited hedge fund trader recently emailed me about a “cheap stock” trading at a significantly lower PE ratio (price to earnings) than its competitors.  The Wall Street analysts were recommending it based on valuation and he was a fan of the industry to boot.

It seemed interesting so I looked into it.  Unfortunately, I found another example of oversimplification of valuation leading to erroneous conclusions.  PE is the market value of the company's equity divided by its net income.  It excludes any debt the company has and includes all of the vagaries of net income (as opposed to cash flow).  For every dollar of equity market capitalization this company had there were seven of debt.  Debt included, it turned out to be one of the most expensive stocks in its industry – something Wall Street research had somehow overlooked.

It seems like stock analysts and popular media focus on PE while the bond/debt markets use EV/EBITDA.  I would love to understand why Wall Street leans so much on PE when I’ve found it close to irrelevant in real fundamental analysis (seriously, if you know why or have any ideas, please email me).

There is no one catch-all metric to look at when investing.  One of several I use is EV/EBITDA (EV = enterprise value = equity market cap + debt - cash), (EBITDA = earnings before interest, taxes, depreciation and amortization).  The most important indicator of long-term corporate value is cash flow.  EBITDA is one proxy for cash flow, operating cash flow is another, but neither are perfect.  You also have to look at CAPEX (capital expenditures), working capital requirements, and other impacts.  EBITDA tries to zero in on the health of the underlying cash flow of the business and eliminate irrelevant 'noise' or accounting gimmicks.  Interest is removed because it is the result of how management has decided to capitalize the business and the interest rate environment (if you're using EV it’s not as relevant to the health of the operating business).  Taxes are a consequence of the jurisdiction, any one time tax breaks, and other factors that can be distorted in the short term.  Depreciation and amortization are not cash items and can be the result of a number of factors unimportant to the underlying business (for example, high amortization of intangible after an acquisition).

I’ll leave you with one example.  Take a company that has a market cap of $100, a debt of $1,000, and generates $50 of net income.  Sure, your PE is 2, but this company will likely file for bankruptcy and the equity will be wiped out.  While most cases are not as obvious, just remember when you're buying a stock you're buying both the equity and assuming the debt liabilities, aka EV.

Catalus Capital Partners with Top Investment Funds to Finance Aerospace and Defense Acquisition

Catalus Capital is pleased to announce its investment in GroupAero, a portfolio company of Corinthian Capital Group ("Corinthian"), to support a strategic acquisition.  Catalus collaborated with existing investor Brookside Mezzanine to facilitate the multifaceted capital structure. Headquartered in Los Angeles, CA, GroupAero is a leading designer and manufacturer of precision machined parts, flight-critical fabricated components, and tooling for the commercial aerospace and defense markets.  The company has developed an outstanding reputation among a wide range of commercial and military customers for producing cost-efficient, precision engineered solutions for tooling, assemblies and components.

Marek's 11 Things to Worry about... Revisited

On January 4, 2011, I sent out a document titled, “Marek’s 11 Things to Worry about in 2011.” It was a list I created for myself of what to consider while investing, and I wanted to share it with friends and colleagues. Over the course of the past year, while the awareness of the issues has heightened significantly, the actual list itself hasn’t changed much for 2012. Below is the original document with today’s commentary (in bold). I think this year it’s important to remain mindful of the risks, but also identify opportunities driven by other investors’ fear.

Marek’s 11 Things to Worry about in 2011

1. Europe – Greece and Ireland are struggling. Portugal, Spain, and Italy are next. The problem is solvency, not liquidity. More bailouts? Restructuring? Changes in the Euro-zone? This, of course, ended up dominating the headlines for most of the year and continues to be a major concern.

2. Commodity Prices – Many commodities have appreciated tremendously in 2010, including corn, oil, and sugar. This will have its effect on the global economy eventually. They didn’t get many headlines, but commodities were one of the worst performing assets classes in 2011. While oil and gold performed well, the Dow Jones-UBS Commodities Index was down 13%. As for the impact on the world economy, it must be a factor but I haven’t seen much data on the details.

3. US Government Balance Sheet – Federal debt is high and continues to grow despite rock bottom interest rates, while taxes are being cut. Many municipalities, states, and cities are struggling to remain solvent due to high debt and declining tax rolls. At some point this irresponsible behavior will catch up to the US. Federal balance sheet and budget problems surfaced on several occasions and will continue to do so- this problem isn’t going away anytime soon. On the other hand, municipalities held up much better than many had prognosticated, including Meredith Whitney who had a well-publicized blunder.

4. US Unemployment – Unemployment remains stubbornly high and there is little sign of material improvements coming anytime soon. This impacts consumer spending, economic growth, and government benefit spending. Unemployment stayed over 9% for the majority of the year, and only very recently dipped a bit. The labor participation rate, the number of people employed relative to the population, and other related metrics, all show a population that is shifting towards permanent unemployment (which isn’t captured in the headline rate).

5. China – People are in awe of China, its growth, and its prospects. But historically China has had its booms and busts, and it hasn’t always delivered on its potential. The biggest concerns are a possible real estate bubble and inflation. “Housing prices in the U.S. peaked at 6.4 times average annual earnings this decade. In Beijing, the figure is 22 times.”*. Given the recent global focus on China, a major correction in its real estate market will likely be felt by investors everywhere. Inflation is soaring and the government is raising interest rates, but will likely need to take more drastic action. China was one of the worst performing equity markets in the world last year, down around 20%. Economic challenges are getting more attention and 2012 will tell whether the government can engineer a "soft landing."

6. Japan – Japanese debt now stands at 200% of GDP**. Japan has an aging population, and growth is nonexistent. Judgment day is coming.

7. Interest Rates – They have nowhere to go but up. It is unclear how the markets and the economy will respond once the process of raising rates begins. Investors have piled into government, corporate, and high yield bonds in 2010 and enjoyed substantial gains. These gains will be pressured when rates start to rise, which will likely impact other markets. I was blatantly wrong on this one. Rates went down and then down some more on treasuries and mortgages. I’ll go out on a limb and repeat my assertion that rates have nowhere to go but up at this point.

8. US Housing – Mortgage rates are rising (most recently from 4.2% to 4.8%), foreclosure inventory is high and rising, prices are dropping (1.3% in October alone), unemployment is high, and many homeowners are underwater. Nothing good to say here other than some markets are starting to look cheap. Last year was a difficult year in housing and several of the major builders are under heavy debt. However, things are starting to turn in the market and this may be one of the big positive surprises in 2012.

9. Economic Growth – Troubles in Europe and cuts in government spending will negatively impact European growth, which will in turn hurt the rest of the world. This one held true, in retrospect was obvious, and will continue.

10. Banks – Unclear whether the banking crisis is really over. Financial results of the banks are lackluster, and every time things look up there is a new issue, like the mortgage “robo-signing”. Financials were one of the worst performing sectors in the US and abroad last year. This also might be an area of positive surprise in 2012. I believe the US banks are much better positioned than anytime in the past decade with leverage ratios the lowest in 20 years*** and very conservative lending criteria. In addition, financial stocks are very cheap, mostly trading at a large discount to tangible book value. On the other hand, European banks might continue to suffer for a while. Nevertheless, as you may have read, Catalus recently announced expansion to the Continent.

11. War – The Koreas aren’t playing nice. Iran is a wildcard. Russia has been aggressive in places like Georgia. Any decent sized war or attack will have its implications globally. Nothing major in 2011, but rumblings in the Middle East are growing and the risks remain.

Bonus! The Unknown – Who knew that AIG was selling naked CDS en-mass in the 2000’s? I didn’t, I thought it was an insurance company. You don’t know what you don’t know. We’ll see what we don’t know in 2011. My favorite!

* Wall Street Journal, ** Central Intelligence Agency (CIA), *** Goldman Sachs