Yesterday, I took the broad shotgun approach to reviewing Bain & Co.'s private equity report. Today, I want to break out the rifle and get a little more specific about using the report to generate solid investable ideas.
The report points out that private equity firms have become increasingly active in the middle market of U.S. companies. Private equity ownership of companies with an enterprise value of between $100 million and $500 million has grown substantially in the past 15 years. In 2000, private equity owned less than 10% of the companies in that size range, and today they own about 20% of middle-market companies. I expect that percentage to increase, as all that super-abundant capital continues to look for a place to find reasonable rates of return.
It is a simple matter to run a screen looking for middle-market companies that might attract the eye of private equity, or perform like private equity funds over the next seven years or so. I screened for companies that are between $100 million and $500 million in enterprise value and traded at an enterprise value-to-EBITDA ratio of 6 or less. That's about two-thirds of the current average deal multiple in the United States, according to Bain. The search produced an interesting list of companies that might be excellent opportunities for investors with a long-term private equity mindset.
Strattec Security (STRT) makes what it calls automotive access control products. This includes things like locks and keys, steering column and instrument panel ignition lock housings, power sliding door systems, power lift-gate systems, power deck lid systems and door handles. It is not a classic Tim Melvin deep-value stock, but it is not an expensive stock either.
The shares trade at an EV/EBITDA ratio of just 5 and 10.6x earnings. Earnings are up nicely over the past five years and have jumped ahead more than 60% so far this year, so business is pretty good. The return on equity for the company is 18% this year. Strattec has very little debt and a Z-score of over 5, so there is a margin of safety in the balance sheet. If I was running a private equity fund, this is exactly the type of business I would want to own.
Marlin Business Services (MRLN) has a pretty good business that looks attractive from a long-term perspective as well. It provides equipment financing solutions to small and midsized businesses. It finances about 100 types of equipment, including computers, copiers, security systems and software programs. In spite of strong earnings growth over the past five years, the stock trades at just 13x earnings, and the EV/EBITDA ratio is just 5 right now. You get paid a little to wait with this stock, as the shares yield 2.46%.
Marlin has only lost money one year in the past decade, and business quickly recovered after the horrible economic conditions of 2008. This is a good business at a decent price and should reward shareholders with a long-term private equity-like mindset.
Now that Kimball International (KBAL) has spun off the electronics contract manufacturing business, it is more a pure-play furniture company. It operates under three brands -- National Office Furniture, Kimball Office and Kimball Hospitality brands -- and business should be pretty good as markets such as hospitality and government continue to improve. The EV/EBITDA ratio is just 5.3 and I would not fall out of my chair if I got up one morning and the company had been bought by either a PE firm or strategic buyer at a premium to the current valuation. With no debt and a Z-score over 7, the balance sheet is strong.
RE/MAX Holdings (RMAX) is a franchisor for residential and commercial real estate brokerage services in the United States, and I am frankly surprised that it is still a public company. I would have thought that at some point in the past few years some private equity shop would have realized that real estate will recover at some point and this company will be something of a cash cow. The EBIT margin for the company is 49% and it produced EBITDA of almost $84 million in 2014. Real estate may not be recovering as fast as some had hoped, but it is going to get better over the next five to seven years. Trading with an EV/EBITDA ratio of just 3.8, these shares appear to be a private equity-mindset bargain.
Private equity is looking for middle-market companies that have a good business at a trading at a low EV/EBITDA ratio. It makes sense for us to do the same.
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