Dwayne Hyzak is chief executive officer at Main Street Capital, a publicly traded Business Development Company (BDC) providing debt and equity capital to lower mid-market businesses in the form of minority recapitalizations and other investments.
In contrast to private equity firms, Main Street can hold investments longer and doesn’t seek third-party lenders to obtain debt financing. Hyzak, who joined the firm almost two decades ago, breaks down the effect of covid-19 on the portfolio and expectations ahead.
How have deal structures changed in this market downturn?
Types of transactions that we have been executing since the onset of covid-19 have been consistent with what we have done historically, but if there’s a difference, it’s that both we and the targets are probably taking a little bit more of a conservative approach.
We are still buying a similar amount of equity ownership; we’re just putting less debt on the business and, hence, their take-home proceeds are going to be more conservative than pre-covid.
For example, if a business generating $5 million of EBITDA or cash flow could have had the opportunity to get $20 million of liquidity, where $15 million was through a loan – 3x EBITDA – and $5 million was through our equity investment, then that number today might be $15 or $17.5 million because we will likely not put as much debt on the business day-one. And as a result, there’s less cash for them to take out of that transaction.
According to Dealogic, 52 percent of deals announced globally were add-ons YTD – a higher figure than any given year since 2015. Would you say it’s easier to do add-ons in this environment versus platform deals? If so, why?
I don’t know if I’d say it’s been easier, but I do think it’s been more attractive or viable.
Companies that have performed well during the covid environment have likely become more interested in acquisitions because they see the opportunities to acquire businesses in their industry that have not performed as well.
For a lot of our portfolio companies, the opportunity set has improved and that’s really what’s driven them to look at acquisitions more consistently or favorably.
Also, the valuation that they would execute a transaction at has improved, largely because of how covid-19 impacted some of their peers that may not have the same conservative capital structure that they have.
What impact do you see on valuations broadly speaking?
For companies that not only navigated covid-19 well but outperformed, they can command a valuation consistent with pre-pandemic, or maybe even higher, because their performance through a difficult time period has proven the strength and resiliency of their business.
For instance, if it’s an SaaS business, they not only retained customers and revenues, but their software solution became more valuable during the pandemic. That’s where you see outperformance and the valuation expectations for that business improve as opposed to being flat or down.
That’s one extreme.
But if you look at businesses that have navigated covid-19 well but didn’t really outperform, they could still find attractive opportunities, but would likely be looking at valuations lower than pre-pandemic scenario.
What do you think the top priorities of a Biden administration should be from a PE perspective?
We are very much focused on domestic US businesses. From a size standpoint, they’re on the smaller end in comparison to a lot of other companies and the broader economy. So, we would hope that the agenda would include continuing support to the smaller businesses.
Having a pro US-focused [administration] is going to be a positive. You can look at that from a lot of different perspectives. It can be tax policies or regulations. But initiatives that are pro US business would be a positive for the companies that we look at and invest in.
In general, though, there’s an expectation that there will be some changes from a tax standpoint. That will result in increased taxes, whether it’s on primary income or capital gains, but I think it remains to be seen how that plays out.
As the second covid wave arrives in the US and a new administration gets in place, how will the partnership strategy change for Main Street Capital? Are there certain sectors that will be focus areas?
We’ve been executing our core strategy for almost 20 years through multiple different administrations, which is to partner with individuals that operate businesses on a day-to-day basis. Going forward it’s key for us to find ways to be focused on the alignment with these individuals than on anything else.
We always found anything that focuses around infrastructure attractive. For example, repair maintenance or services around critical infrastructure such as electric utility, pipeline or road infrastructure. And we continue to find that an attractive area for us to focus on today.
I think it’s something critical to the US economy and if you look at some of the commentary coming out of the administration, I do expect that focus on infrastructure to be part of the agenda. They are looking at ways to invest in roads, bridges or other infrastructure.
Edited for length and clarity.