THM News
NEW YORK (Dow Jones)--The phrases "hedge fund" and "microcap stocks" go together like a lit fuse bordering a vat of nitroglycerine in most people's minds. But portfolio manager David Grin says his hedge fund has found a relatively conservative way to invest in small, capital-challenged companies and still book hefty returns.
Grin, 37 years old, and his older brother Eugene, 48, run Laurus Capital Management, which uses its $1.3 billion of assets to finance growth at publicly traded microcap companies. Instead of buying shares, they purchase convertible bonds, warrants and other structured products collateralized by assets of the portfolio companies.
The high-interest bonds, most of which now pay about 10%, combine with collateral such as real estate to protect Laurus' principal investments and offer a dollop of return. The upside, though, is in the potential conversion of the bond into equity, which can translate into big profits.
"We are in the business of financing growth and letting the borrowers execute on their business plans," says David Grin. "When it works out with microcap and growth stocks, you have amazing returns. If it doesn't work or fails completely, they pay the loan or we have the assets."
To date, the New York-based fund's investment strategy appears to have worked. Since their launch in 2001, the company's two funds (one is offshore but makes the same investments as the U.S. fund) have never had a losing month, according to HedgeFund.net, a database of more than 5,000 hedge funds. Annual returns ranged from 31.1% in 2003 to 10.4% last year. The funds are up about 7.5% for the first half of 2006.
Average annual return since Laurus' inception is almost twice the 11.25% return of the HFN Hedge Fund Aggregate index in the same period.
Unlike many hedge funds that focus on quick trading gains, the Grins take no short positions, do little trading and develop close contacts with the funds' portfolio companies. More than half come back for repeat financings, Grin says.
Laurus' returns also are unusually stable for a hedge fund, with volatility about the same as that of the Standard & Poor's 500 stock index. But the Grins, whose family emigrated from Russia in 1979, have adopted typical hedge-fund pay standards. Laurus' management fees are 2% of fund assets, while incentive fees start at 20% of profits and rise above 30% after hitting preset targets.
Investors, though, were not the biggest hurdle to launching Laurus, Grin says. Skepticism came from chief financial officers of the microcap companies, who were wary of borrowing from a hedge fund as an alternative to banks and financing companies. Unlike banks, Laurus makes no money on loan spreads or fees and does not impose strict operating restraints.
"We didn't initially buy into it," says Alan Catherall, chief financial officer of Numerex Corp. (NMRX), an Atlanta-based wireless data company spun off from the former BellSouth in 1994. "But they have proven themselves, especially from a control standpoint. They are very much a hands-off investor, as long as you pay them."
Numerex has borrowed $16 million in three separate transactions from Laurus since 2004, including a $10 million financing last month that Catherall says was vetted by several investment banks. Under terms of that deal, signed when Numerex was trading at $7.06 a share, Laurus can convert its bond into stock if the share price reaches $7.91. Numerex, shares of which traded recently at $7, has an option to make Laurus retire the debt if the stock hits $8.70.
Laurus, which employs almost 70 people in research, legal, sales and operations, subjects each investment candidate to "full-blown due diligence," Grin says, and finances only about 5% of the companies it reviews. This year, it has invested about $397 million - much of it in roll-up companies that move into new business areas - and expects to have stakes in more than 200 public companies by year's end.
The markets, of late, have been tough for microcap stocks. Though Numerex is up 56.2%, others recently financed by Laurus include Thomas Equipment Inc. (THM), down 83% this year to about 62 cents; IWT Tesoro Corp. (IWTT), down 62.6% this year at about $1.01 a share; Pacific CMA Inc. (PAM), off about 9% to 60 cents; and Digital Recorders Inc. (TBUS), down 11.7% to $1.35. It doesn't take much, of course, to realize three and even four-figure gains if stocks trading at such low values rebound.
Laurus generally holds its investments for three years and structures debt it lends to be repaid in 18 months through monthly amortization payments. That allows investors, after a six-month lockup, to redeem their shares monthly.
Grin says Laurus diversifies its investments across 190 U.S. and Canadian companies in 24 industries and limits exposure in any one industry to 10%. Laurus avoids so-called Pink Sheet stocks whose shares are not listed on a centralized exchange but trade largely by phone or computer.
The minimum investment in Laurus' funds is $1 million. About 92% of the company's more than 300 investors are institutions such as pension funds and foundations. Individual investors are primarily friends and family, many of whom began investing with the Grin brothers in the 1980s and 1990s when they bought residential real estate and bankrupt savings-and-loan companies from the government.
(Jed Horowitz covers investment banks and brokers for Dow Jones Newswires.)
-By Jed Horowitz; Dow Jones Newswires; 201-938-4047; jed.horowitz@dowjones.com
(END) Dow Jones Newswires
07-14-06 1500ET
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