Is Full Circle Capital Running On Full Cylinders?

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This article provides an analysis of Full Circle Capital (FULL). FULL is a business development company (BDC) that invests in asset-based senior secured loans issued by smaller and lower middle-market companies, with a particular emphasis on companies within the communications, business services and media industries.

Getting back to the question posed in the title, the answer is a resounding no. As highlighted in this article, troubled portfolio companies, a poor dividend payout ratio, and stock issuance below net asset value are reasons for this response.

Overall Portfolio Health

FULL's portfolio has a total cost of $104M and a current fair value of $100M, so the overall portfolio is valued at about 97 cents on the dollar. However, of the total fair value, $25M is invested in U.S. treasuries. We are evaluating FULL on its investing acumen; any Joe Shmoe can invest in U.S. treasuries. Thus, when U.S. treasuries are removed from the mix, the overall portfolio valuation drops to about 95 cents on the dollar. To put this number in perspective, the overall valuation is much better than the worst-in-class BDC Gladstone Capital (NASDAQ:GLAD) as discussed here, but a bit worse than Prospect Capital's (NASDAQ:PSEC) portfolio valuation as discussed here.

The subsequent portfolio analysis will be broken down into two parts - those companies that are on non-accrual status (i.e. not generating income for FULL) but are valued above zero and troubled companies with sub-standard valuations but remain income-producing.

Portfolio Companies on Non-Accrual

I filtered across FULL's portfolio to return loans on non-accrual and valued at less than 80 cents on the dollar but more than zero. All data were pulled from the most recent 10-Q. Were one of these companies to be written down to zero, it would result in a NAV hit (but no income hit). The valuation metric is computed by dividing the fair value by the cost. Two companies were returned from this query, as seen in the table below. If both Texas Westchester Financial and West World Media were written down to zero, this would result in a NAV decrease of $0.095 and $0.035 per share, respectively, or a total NAV decrease about 13 cents per share.

Company Description Cost (M) Fair Value (M) Valuation
Texas Westchester Financial Limited Liability Company Interests 0.905 0.592 0.65
West World Media Limited Liability Company Interests 0.431 0.217 0.50

Troubled Portfolio Companies Currently Generating Income

Rather than focusing on companies on non-accrual status (as was done in the previous section), the second piece of the portfolio analysis was limited to holdings valued at less than 80 cents on the dollar, which are currently generating income. This was done to identify companies currently generating cash for FULL, but that may not continue do so in the quarters ahead. Only two companies were returned from this filter, as seen in the table below.

Company Coupon (%) Cost Valuation annual cash flow cash flow per share per qtr
ProGrade Ammo 15.24 5.7 0.73 0.89 $0.04
TransAmerican Asset Servicing Group 14.25 1.959 0.77 0.29 $0.01

ProGrade Ammo is currently valued at 73 cents on the dollar. Based on the loan coupon of 15.24%, it is estimated that the loan generates $0.89M per year for FULL. To calculate the cash flow per share per quarter for this loan, the aforementioned value is divided by four and then divided by the number of shares outstanding. The calculations for TransAmerican Asset Servicing Group are performed in an identical manner.

Findings from this analysis are significant. On a combined basis, the quarterly cash flow could drop by 5 cents per share were both of these loans to be placed on non-accrual status. Furthermore, were both of these loans to be completely written off, the NAV per share would decrease by 91 cents.

Net Investment Income vs. Dividends Paid

Per the latest 10-Q, FULL earned $1.238M in net investment income and paid out $1.437M during the last quarter. The dividend payout ratio is below unity; that is, FULL pays out more in dividends than it earns in net investment income.

Share Issuance

Subsequent to the September 30, quarter end, FULL issued 1.35M shares at $7.90 per share, or $0.61 per share below NAV! This is a significant dilution for current shareholders. The total number of shares has increased by 18%. The adjusted NAV is computed by: 0.18 x $7.90 + (1-0.18) x $8.51 = $8.40. This share issuance resulted in a $0.11 per share decrease in NAV.

Putting It All Together

FULL cannot continue to pay out more in dividends than the income it earns. Based on the current payout ratio, the break-even payout is 0.86 times the current monthly dividend of $0.077, or about $0.066 per share. Further, were both TransAmerican Asset and ProAmmo to cease generating income (such a scenario is possible given their low valuation), the dividend would further decrease by $0.016 per share (sum of the right-most column in the previous table divided by 3). Thus, in a worst-case scenario, the dividend would drop from its current value of $0.077 to $0.05 per share.

FULL's closing share price of $7.72 represents a significant discount to quarter end NAV of $8.51 per share (discount of 79 cents). After accounting for the NAV decrease via share dilution, the discount drops to 68 cents per share. We have identified a number of troubled portfolio companies that suggest further NAV declines are possible. Were the four troubled companies of TransAmerican Asset, ProGrade Ammo, Texas Westchester Financial and West World Media to be written down to zero, the NAV would decrease by $7.0M, or $1.13 per share based on 6.22M shares outstanding as of September 30, 2012. While a complete write-down of these companies is unlikely, I believe the current share price is warranted and perhaps should be a bit lower as a result of the troubled portfolio holdings.

To summarize, this analysis of FULL suggests that a dividend cut is unavoidable, and that the current share price discount is warranted. For those investors interested in the high-dividend yields of BDCs, I recommend Prospect Capital as an alternative. PSEC has a healthier overall portfolio and a dividend that is supported by its net investment income.

Disclosure: I am long PSEC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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