Betting on a Private Equity Comeback

03/30/2010 2:00 pm EST

Focus: STOCKS

Mark Skousen

Editor, Forecasts & Strategies, High-Income Alert

Mark Skousen, editor of Forecasts & Strategies, says a small private equity company is very well positioned to profit from improving capital markets and the US recovery.

Last month, I had dinner with a group of business leaders, hosted by Marty Edelston, long-time publisher of Boardroom Reports. One of the guests was a headhunter in Manhattan. She said that 2009 was the worst period ever in her firm’s history in [searches] for executive jobs. But 2010 is a different story, and new job opportunities are coming on strong.

This is just one of many indicators that the US and global economies are on the mend. Another factor is the credit markets, and the recovery in bank and insurance stocks.

Private equity companies that invest in private corporate debt were hit hard by the financial crisis of 2008, losing more than 80% of their market value when their credit lines were suddenly cut off.

Even good conservative companies like Gladstone Capital (Nasdaq: GLAD) were damaged, and actually fell below their book value. Now, they are making a big comeback, and this trend is just beginning, for two reasons.

First, private equity companies are successfully restructuring their credit lines and covenants with their bank lenders, or being merged with larger competitors.

Second, the private equity companies are profiting from the current stingy attitude that traditional banks have in making loans to small business. Small business is turning to non-traditional sources, such as business development companies like Gladstone.

Gladstone is making a huge comeback, and it’s only the beginning, in my judgment. Despite its run-up last month, it still is selling [slightly above] book value ($11.92). (The stock closed above $12 Monday—Editor.) And remember, most stocks sell for multiples above their book value.

Gladstone still is deeply undervalued; it sold for more than $20 a share before the financial crisis. Gladstone has other outstanding valuations, including a low price-to-earnings ratio of 13.4x. It also has grown revenues at a rate of 15.88% per year for the last five years.

According to chief executive officer and founder David Gladstone, the company is looking very strong coming out of this recession. Revenues are rising (to $10 million) and net income is now positive again ($6 million). Last year, Gladstone was forced to cut its dividend in half, currently seven cents a month, but now there’s talk of increasing it.

A little-known Wall Street firm downgraded Gladstone [last week], causing the stock to drop by a buck. Yet, at the same time, Gladstone announced an expansion of its credit line to $127 million. "This new credit line will let us become more active in the market and is the first step in growing our assets," stated Chip Stelljes III, president and [chief investment officer]. (The stock has since rallied substantially, closing above $12 Monday—Editor.)

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