How Does Main Street Capital Make Its Money?

I have been writing about investing for a while, and even I find it difficult to read a company's entire 10-K or annual report. The information contained can often be overwhelming, and the ability to prioritize and parse this data is a learned skill. If you are so inclined, one great place to start is by examining how a company makes its money.

When it comes to business development company Main Street Capital (NYSE: MAIN  ) , the short answer is that it makes its money from investing in small and midsize companies. However, if we dive a little deeper and examine the company a little further, we can truly see where its money comes from.

In its own words
According to its recent 10-K, Main Street Capital is a "principal investment firm primarily focused on providing customized debt and equity financing to lower middle market (LMM) companies and debt capital to middle market companies." Per the company, its lower middle market companies generally have annual revenues between $10 million and $150 million, while its middle market companies have annual revenues between $150 million and $1.5 billion.

At the end of 2012, Main Street had investments with a fair value of $924.4 million in a total of 147 companies. Though the company is invested in more middle market companies, it's the lower middle market companies that make up the bulk of the value, as well as account for most of the current gains:

Portfolio

Companies

Fair Value

Total Cost Basis

Lower middle market

59

$510.3 million

$408.0 million

Middle market

85

$390.0 million

$385.5 million

Other investments

3

$24.1 million

$23.6 million

Total

147

$924.4 million

$817.1 million

Source: Company 10-K. 

Converting investment to revenue
With a business focused on providing debt and equity infusions to businesses, it is fairly easy to determine where Main Street makes its money. It receives interest payments from its investees on a regular basis per the terms of the specific contract, with most loans generally having terms of three to seven years, with monthly or quarterly payments and interest rates between 12% and 14%. It also receives dividend payments from any equity investments, as well as the occasional fee that it receives for providing business consulting services.

Beyond the cash payments that Main Street receives as both dividends and interest payments, it also has unrealized gains from many of its equity investments. Ultimately, the goal is to recoup the investment, and Main Street works with its portfolio companies in planning exit opportunities, be it a sale to another company or a simple redemption of the outstanding shares or warrants. 

What kinds of companies are represented?
Main Street seeks to diversify its holdings over many industries and throughout the United States. According to the company, they currently have investments in over 36 different industries, ranging from energy equipment and services to thrifts and mortgage finance. A quick look at the top five industries at the end of 2012 show a diverse group, and feature both the largest gain and second-largest decline from 2011: 

Industry

2012

2011

Change

Energy Equipment & Services

10.2%

9.8%

0.4%

Machinery

8.3%

7.7%

0.6%

Software

7.9%

4.8%

3.1%

Media

6.7%

7.1%

(0.4%)

Commercial Services & Supplies

6.1%

9%

(2.9%)

Source: Company 10-K; fair value of portfolio invested in industry.

As expected, when I took a further look at the 147 companies that Main Street invests in, I did not recognize many names. This is primarily a function of the majority of its investments going to smaller companies that tend to be private or regionally located. Nevertheless, there were a few companies that I recognized, like the formerly public Ancestry.com and movie studio Miramax Films. Otherwise, Main Street is able to identify small businesses that meet its standards for investment and make a decent return.

Where are the companies located?
The geographical breakdown of its investments shows that it has managed to expand outside of its Southwest base of Houston, Texas. The Southwest still represents the largest portion of its investments, but it is starting to lose ground to some other areas, with strong growth in the Midwest and the company's first investment outside the United States:

Region

2012

2011

Change

Southwest

31.3%

39.3%

(8%)

West

25.3%

23.6%

1.7%

Midwest

17%

13.4%

3.6%

Northeast

15.8%

14%

1.8%

Southeast

9.1%

9.7%

(0.6%)

Non-United States

1.5%

0%

1.5%

Source: Company 10-K; fair value of portfolio invested in region.

As Main Street continues to diversify its holdings, I would expect the regional breakdown will continue to change, which would open up new opportunities for the company. It would be able to capitalize on some fast growing parts of the country, as well as reduce its risk should the Southwest or other region experience a slowdown. If the change from 2011 to 2012 is any indication, we should see similar results when 2013 comes to an end.

Fulfilling a need
Traditionally, when a company needs capital, it usually goes to a bank or other financial group for funding. However, when these avenues are unavailable, a company like Main Street Capital can come in and offer similar funding, as well as provide business owners with hands-on advice on how to maximize their potential. There is definitely a need for Main Street, and as a shareholder, I hope it's something it can continue to do for a long time.

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