Apollo Global Management (
co-founder Joshua Harris was on a losing streak.
The firm's $430 millioninvestment in big-box retailer Linens
N' Things went south when the company filed forbankruptcy .
Investments in Claire's retail stores,
Realogy Holdings (
, and Harrah's Entertainment all came under pressure as the
globalcredit crisis hit. Apollo was forced to shut offcash
interest payments to investors and toissue moredebt .
But Harris didn't let a little bad luck stop him. He and his
partners kept making deals.
In a classiccontrarian move, he purchased moreshares of
LyondellBasell Industries (
, even as the company was sliding toward bankruptcy.
The result? By 2013, the firm's initial $2 billion investment
had turned a $9.6 billionprofit , the largestgain ever on
aprivate equity investment.
Apollo Management was a private equity firm until itsIPO in
2011. And even though Apollo is an excellent company, it's the
idea of private equity I would like to talk about today.
If you're a regular StreetAuthority reader, you may have heard
of business development companies (BDCs). BDCs allow you to
invest in private equity firms on theopen market . And their
structure gives stockholders several unique advantages.
Because business development companies target underserved
firms, they typically can charge higher interest rates onloans ,
helping to compensate for any additional risk. In addition,
BDCswill often take anequity stake in the companies they finance
-- if these small private firms go public, theBDC scores a
Even better, theyoffer tremendous tax advantages. The federal
government wants to encourage investment in small businesses --
according to the U.S. Small Business Administration (SBA), small
companies hire more than half the U.S. private-sector workforce
and have accounted for 60% to 80% of all new U.S. jobs over the
past decade. Therefore, BDCs are a special type of organization
exempt from federal taxation.
To qualify, a company must meet certain specific criteria.
First, it must pay out 90% of itsincome to shareholders as
dividends. Not all of this cash must be paid out immediately --
some can be carried forward to smooth out dividends over time,
but the cash must be paid or the BDC facestaxes on part of
itsearnings . This is why most BDCs offer high dividend yields,
approaching 20% in some cases.
And because the companies they invest in are considered
riskier, the government also requires BDCs retain relatively
Business development companies must have $1 in equity for
every $1 borrowed -- theirdebt-to-equity ratio cannot exceed 1.0.
Thus, your average BDC has far less debt than an average bank of
But thanks to the law, even if some of a BDC's investments go
south because of a weak economic environment, it doesn't have
huge fixed charges in the form of debt repayments to worry
Even the worst markets can offer great opportunities for BDCs.
When credit markets dry up and banks are unwilling to take on
risky lending, BDCs are one of the few sources of financing for
many small companies. This gives them the opportunity to extract
particularly favorableterms for their investments.
StreetAuthority expertanalyst Amy Calistri has had incredible
success with BDCs in her
portfolio. When she recommended
Hercules Technology (
in February 2010, thestock was trading for a little more than $10
Today, HTGC is trading near $15 a share. A 50% gain in three
years isn't too shabby -- but let's not forget the rich 7%yield
that Hercules has been paying out over that same time. By
reinvesting her dividends, Amy (and the subscribers who took her
advice) is enjoying a total gain of 104% on her position.
And here's the thing: At today's prices, Hercules is still a
Hercules makesmoney by providing finance to tech companies at
all stages of development -- from startups to mature companies
looking for growth.
These companies are major players across the tech spectrum.
From Achronix Semiconductors to Zoom Media Group, Hercules'
investments include companies that operate in communications and
telecom infrastructure, computing and storage infrastructure,
digital media and consumer Internet, e-commerce, security and
Over the past two years, HGTC has been on a remarkable
But despite a 35% rise in share price thisyear , the stock
still trades at a forward price-to-earnings (P/E ) ratio of 11
and a price-to-book (P/B ) ratio of 1.5.
As mentioned, HGTC'sdividend yield is 7%. And that's on the
low end for Hercules: Thanks to the dividend-friendly BDC
structure, the company has paid annual yields ranging from 7% to
16% over the past five years.
For context on Hercules' attractive share price compared with
its yield, consider this: The average company in the S&P 500
currently yields 2% and trades at a P/E of 19 and a P/B of
Amy made a smart move when she added Hercules to her portfolio
in 2010, and she's been smart to keep the company in her
portfolio. If you haven't already, you might be smart to add
Hercules to your portfolio today.
Risks to Consider:
BDC dividends are taxed asordinary income rather than the
lower 15%dividend rate. So it is preferable to hold BDCs in a
tax-advantaged account. BDCs are sensitive to interest rates, and
a sharp rise could make dividends and share prices volatile.
Action to Take -->
HTGC is a strong buy for income-oriented investors at today's
© Copyright 2001-2010 StreetAuthority, LLC. All Rights Reserved.