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DEALMAKERS

CapitalSource's Especially Warm Reception

By Terence O'Hara
Monday, October 11, 2004; Page E01

Investor conferences put on by public companies tend to be upbeat affairs. That was indeed the case at CapitalSource Inc.'s annual presentation to research analysts. About 125 people -- mostly the youngish, mathy types who follow financial service companies for Wall Street -- were crammed into the Fairmont hotel in Foggy Bottom to listen to a procession of crisp, data-laden speeches about CapitalSource.

In four years, chief executive John K. Delaney and his handpicked team of money men have built a company that is worth twice as much as Washington Gas Light and has more loans than Riggs Bank. Trading at more than 23 times its annualized earnings, CapitalSource's stock price is among the most amply priced commercial finance stocks in the country.

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When I asked why the stock price was so high, one analyst at the meeting referred not to the numbers in the inch-thick graph-o-rama provided by CapitalSource's investor relations people. He pointed to the front of the room at Delaney.

Delaney founded HealthCare Financial Partners Inc. in 1993 with Ethan Leder, whom he met at Georgetown Law Center. The two took HealthCare Financial public in 1996 and sold it for $500 million in 1999. HealthCare's third founder, Edward Nordberg, now runs Medical Office Properties Inc., a real estate investment trust in Chevy Chase.

Delaney founded CapitalSource a year after he sold HealthCare Financial. Leder has formed two companies since HealthCare Financial was sold. Their ventures have enjoyed the backing of hundreds of millions of dollars from private equity funds.

Leder stayed in the health care field. He formed US Bioservices in 2002. It was built through a few key acquisitions, funded primarily with $60 million in venture financing from Connecticut's Whitney & Co. a private equity firm. Leder and partner Mark P. Clein, a venture industry veteran, designed US Bioservices as a distributor of highly specialized, and expensive, drugs for chronically ill patients. He sold it to AmerisourceBergen Corp. last year for $160 million, only eight months after it was formed.

Soon after that sale, Leder formed United BioSource Corp. with $153 million in funding. It was one of the largest venture-financed start-ups in the Washington area in years. Investors were Whitney, Baltimore's Grotech Capital Group and Connecticut's Oak Investment Partners. The idea behind United BioSource is what is known these days as a "build up" (and what used to be called a "roll up" before that business model took on negative connotations). A build up is an acquisition strategy focused on consolidating a diversified, fragmented industry. United BioSource is buying companies that provide services used by pharmaceutical and biotechnology companies to test treatments and implement trials as they bring products to market. Bethesda-based United BioSource has bought four companies, and Leder said a fifth deal should be completed this month.

"I think the message of the company is resounding out there in the marketplace," Leder said. "The industry is ready for what we have to offer."

He said the firm should have revenue of about $50 million after the fifth acquisition. Leder said he has two-thirds of the original capital left to buy more firms.

Delaney's CapitalSource is about a mile south of United BioSource's headquarters. His 12-floor office looks across Wisconsin Avenue at the building where HealthCare Financial's offices were.

"I'm a creature of habit," Delaney said. Indeed, when he left HealthCare Financial, he stuck to what he did best: lending and dealmaking.

CapitalSource had about $3.3 billion of loans on June 30, $900 million of them made in the first six months of the year, in three lines of business.

Its biggest business is corporate finance, mostly leveraged-buyout lending, acquisition financing and recapitalization. CapitalSource can lend up to $50 million, and can syndicate loans up to $100 million. That puts it squarely in the middle-market, helping mid-size buyout firms do mid-size deals, exactly the niche that has been abandoned by many big lenders, such as commercial banks. Corporate finance has driven much of CapitalSource's growth.

The company's health care financing business is much like that of HealthCare Financial's: making loans to mid-size health care providers such as assisted living facilities, hospitals, doctors practices and the like.

CapitalSource's structured finance group makes a variety of loans in special situations, including time-share financing, commercial mortgage financing and lending to the security alarm industry.

Each business requires a high level of customization. Much of it is also based on cash-flow -- the ability of a business to generate enough cash to service the debt -- and not hard assets such as real estate. Delaney said banks, which have gotten bigger and more standardized in their approache to commercial lending, tend to shun credits that require the high-touch work CapitalSource does. Banks, for regulatory reasons, also prefer to do asset-based lending, not building a credit around cash flow or the imputed value of a firm.

"The middle-market business has become much more sophisticated and has a lot of complex, diverse capital requirements," Delaney said.

The result is that CapitalSource can charge higher fees and interest rates for its commercial credit.

Like Leder's United BioSource, CapitalSource was formed with money from private equity investors. Farallon Capital Management and Madison Dearborn Partners LLC led an investor group that put up $540 million to capitalize the company in September 2000. Other initial investors were Wachovia Capital Partners, Friedman Fleischer & Lowe LLC, Highfields Capital Management LP, Och-Ziff Capital Management and Rosewood Venture Group.

Farallon is the company's biggest owner with about 24 million shares, worth more than half a billion dollars. Delaney's personal stake is worth nearly $160 million. Many of the initial backers sold about a fifth of their shares in a secondary offering in February. Delaney sold 18 percent of his shares in the secondary.

Delaney founded the firm with former Farallon partner Jason Fish, who is president. The management team is made up of a dozen people, most of whom in one way or another worked with Delaney at HealthCare Financial. Bryan Corsini, chief credit officer, is a former Fleet Capital Corp. lender who lent money to HealthCare Financial. Managing directors Dean Graham and Joseph Kenary and Chief Technology Officer Chris Woods all worked for HealthCare Financial under Delaney.

Delaney said the company will mostly stick to what it's doing now, but it may add a business buying and managing distressed debt and could start an operation in Europe.

Together Delaney and Leder have created $3.3 billion in value since 1999, based on the money generated from the sale of their companies and CapitalSource's market value. Both are in their early forties.

"Here's to guys who went out and hit home runs, then they stepped right back up to the plate and hit grand slams," said Perry W. Steiner of buyout firm Arlington Capital Partners. Steiner is a friend of Leder, and Arlington Capital is a CapitalSource client.

Terence O'Hara's e-mail address is oharat@washpost.com. Dealmakers appears every other Monday in Washington Business.


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