March 6, 2013
Interviewed by: David Snow
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Private Equity in the Lower-Middle Market

Kirk Griswold, Founding Partner of Wayne, Pennsylvania-based Argosy Capital, describes the state of the deal market in 2012 and looks ahead to today’s pricing dynamics. He offers his views on the booming energy sector in the US, describes what he likes about the lower end of the middle market, and discusses his firm’s real estate investment business.

Kirk Griswold, Founding Partner of Wayne, Pennsylvania-based Argosy Capital, describes the state of the deal market in 2012 and looks ahead to today’s pricing dynamics. He offers his views on the booming energy sector in the US, describes what he likes about the lower end of the middle market, and discusses his firm’s real estate investment business.

Privcap: What current trends are influencing your investment approach?

Kirk Griswold, Argosy: You know, 2012 has been a very interesting year. It seems like the first half of the year was getting a little bit back to normal, although still a lot fewer transactions were done than were done in the peak year of 2007. I think about 150 lower middle market companies are getting done per quarter this year, compared to 220 to 230 in 2007. But what’s interesting is that the prices that are being paid and the size of those companies that are transacting tend to be higher.

They tend to be very high quality companies. And I think the reason for that is that when you look at the companies that actually survived the recession and survived it by not losing a lot of revenue, they were sort of steady-Eddie through the recession, those are the companies that buyers are looking at now and saying, “You know what? They made it through the recession. They must be very good companies. They must be very well run. Their customers must really need those products.” And secondly, the sellers are looking at that and saying, “This is a company that has not been hammered by the recession. Their numbers are still up.” So therefore, when we’re looking at a multiple, it’s a multiple of a decent earnings so that those companies can still transact. So I think there’s a pricing element that’s going on right now. And I think that it’s the higher quality companies that are transacting and selling today.

Privcap: What about opportunities in energy?

Kirk Griswold: So one of the interesting trends that we have seen, really over the last 24 months, is explosive growth in the number of transactions we’ve seen in oil and gas. Oil and gas in the United States has really taken off recently, in part because of fracking. And with the advent of fracking and being able to produce natural gas and oil from what were previously dead wells or areas that could not produce, there’s been a huge increase in the revenue and earnings of lots of small service companies; lots of companies that provide industrial parts, and valves and pipes and everything else to that industry. We have seen an unprecedented number of deals in that space. And it’s interesting to us that in the middle of every boom it’s very difficult to figure out that it’s actually a boom. But this is a huge boom. It’s hard to see why it’s not going to continue. It seems like it will continue. Certainly the reserves that they’re finding are massive.

Certainly they’re going to have to produce the gas and the oil because it has tremendous value. But the number of companies that have come to market, are sort of indicative of the people that have been in that space for a long time, are now sellers. And they’re selling their companies at what are record revenues, and record EBITDA. And the question is what happens from here. We’ve invested in that space. We like a lot of the stories about Marcellus and some of the other huge areas of resources. And it’ll be interesting over the next five years to see how those trends continue.

Privcap: You manage both both real estate and private equity funds. What sectors does Argosy focus on in PE?

Kirk Griswold: Argosy invests primarily in niche manufacturing companies and business-to-business service companies. And we are big fans of the lower middle market. We think that the best returns-, and if you look at any studies that have been done by a lot of the major companies that do studies, lower middle market returns, particularly in buyout beat mid and beat large cap. And we’re believers in that. So in our market there are about 140,000 companies that fit our criteria.  And that’s about ten times as many companies as there are in the mid and the mega size. So we focus in that area, lower middle market. And in terms of subsectors within manufacturing and within business services, we particularly like, and have really good experience in industrial parts and services, electronics, aviation services and franchising. So those are all subsectors where we’ve done at least five transactions in each of the subsectors, had very good experience.

We feel like we can generate the kind of returns that we’re looking for there. And with regard to returns, we’re generally looking for companies that have the opportunity to double in size in five years. So double revenue and double EBITDA. And there are a number of criteria that we look for initially to do that. But we find that those subsectors tend to meet those criteria many times. And as you know, once you do a transaction in a particular subsector, you’re at the trade shows, you know the managers that you can call and ask about certain companies. You tend to see more transactions. So we’ve built up some experience there. And certainly now we have 90 portfolio company CEOs that we can call on and ask about companies.

Privcap: How does the real estate business operate, and what do you focus on?

The real estate is really a separate fund group from the private equity. The real estate, although private equity and real estate have similar philosophies, in that we both focus on the lower middle market, smaller transactions, where we think there’s more value, you really have to be an expert in real estate to be successful there. So we have a separate team that manages our real estate. On the real estate side we focus primarily on investing five to ten million dollars in equity, in office projects, apartments, strip shopping centers, as well as residential land. So it’s really a separate focus. It’s a separate team. And we do have the same back office. We have the same fund administration. We have a few investors that are crossover investors.  But in general it’s a separate team, separate organization. And they really need to be experts in what they’re doing full time.

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