ONE CONSEQUENCE OF THE GLOBAL CREDIT AND BANKING crisis is
an ongoing lack of available capital for so-called
middle-market companies. Big banks dont lend to smaller
businesses as freely as they once did, and firms like CIT Group
have followed suit. Meanwhile, several hedge funds have pulled
back or moved into other markets. The hedge fund
community generally was once a serious provider of private
credit to these companies, says Robert Ladd, CIO of
Stellus Capital Management.
This retreat creates a huge opportunity for firms like
Ladds. Houston-based Stellus focuses on lending to
companies with annual earnings before interest, taxes,
depreciation and amortization of $5 million to
$50 million. The firm has two main investment strategies:
a middle-market direct lending business and private equity
financing for the energy sector. Stellus invests across the
corporate capital structure, through first- and second-lien
loans and mezzanine and convertible debt as well as preferred
and common equity.
Until January the 21-person Stellus team was part of D. E.
Shaw & Co. Three of the current five partners, including
Ladd, joined the New Yorkbased investment firm in 2004
from Duke Energy Corp. to launch its direct lending division;
the other two arrived the next year. Ladd, who holds an MBA
from the University of Texas at Austin, was worldwide managing
partner for Arthur Andersens corporate restructuring
practice in the U.S. before joining Duke, where he served as
president and CEO of private capital subsidiary Duke Capital
Stellus has $1.4 billion in assets under management,
part of a subadvisory agreement with its former parent.
Although its always had a diverse business,
$26 billion-in-assets D. E. Shaw is best known for its
quantitative and technology-driven investing and trading
strategies. An illiquid provider of bespoke loans to small
companies seemed to many like an unusual fit, even if it was an
uncorrelated source of returns for the firms hedge
In 2008, D. E. Shaw raised a separate fund for its direct
capital business. But like almost every other manager, the firm
as a whole struggled in that years economic collapse.
Since then D. E. Shaw has undergone a retrenchment that
included laying off 10 percent of its staff and getting out of
certain noncore businesses. The spin-off of Stellus was part of
Ladd and his team were also keen to strike out on their own.
Given the nature of their business, they were already largely
independent. We had been interested in starting our own
firm, Ladd says. We were able to do this with the
continued support of D. E. Shaw.
Louis Salkind, a member of the Executive Committee of the D.
E. Shaw group , points out that over its 24-year history his
firm has built several units that were spun off as stand-alone
businesses. For example, in 1996, D. E. Shaw launched Juno, an
Internet service and e-mail provider. A few years later the
firm decided to spin off Juno, which later merged with Internet
service provider NetZero. More recently, D. E. Shaw has
maintained a relationship with Meng (Leon) Liang, who ran its
Chinese private equity business from Hong Kong before leaving
last year to start his own firm, Ascendant Capital Partners.
The Stellus business occupies a great niche in the
middle-market direct capital sector, Salkind says.
Stellus likes what it sees in the energy industry. Ladd says
there are strong opportunities to invest in the equity of North
American junior energy companies using new forms of
technologies, such as fracking, to retrieve oil and gas from
existing deposits that were previously uneconomical to develop.
The risk-reward is more interesting on the equity side
than on the pure credit side, Ladd says of this space.
Knowing that the deposits are there makes investing less
speculative than, say, wildcatting for oil, and the companies
will sell equity at appealing prices to meet their capital
On the lending side, private equity sponsors looking to
finance middle-market buyouts have been an attractive source of
deals for Stellus. Ladd wont cite any recent transactions
where his firm has acted as lender. But he notes that almost
the entire private equity industry is looking for middle-market
deals which happen to be Stellus sweet spot.