Is Pennantpark the Best Business Development Company Around?

While I don't have a lot of time to diversify my portfolio as much as I would like, I know I need to do more than just buy gold and oil. Sometimes that is scary. Why? Because no one knows when this market is going to start acting "normal" again. (And yes, I do believe trillions of U.S. dollars will put people to work and that will mean people will buy things, and that means that we will re-stimulate the economy: I don’t have time to debate politics here, but whether you like Obama, Franklin D. Roosevelt, or “Spending” or not, if passed, and given time, these plans have a very high likelihood of success.

As one economics professor noted, it is a common misperception that it “took WWII to get America out of the Great Depression.” WRONG. In fact, if you had hired and paid millions of Americans to build airplanes, warships, fatigues, etc. and then simply dumped them into the ocean (instead of engage in war) this TOO would have stimulated the economy…thus Japan, during its own recent recession implemented similar tools to ensure people were working (without a war)...and now their yen is one of the stronger world currencies).

Yet I also agree with France and Germany: spending is not a substitute for fixing the rules so this does not recur (at least not soon!); but spending – especially on infrastructure projects is a tool which must be applied ASAP…if you realize that banks, similar to freeways, are part of the American infrastructure, then you will understand that even the Bush administration applied this tool.

Assuming you want to make money (not talk politics), the more focused issue is WHEN small caps and business investment stocks will start to feel the stimulus, and have their prices and profits rise. These stocks will probably not see their full "real" value confirmed by the market for another 2-3 years. The irony is that to have a balanced portfolio, one must have investments that will not only “pop” this year, but also in 3-5 years, and even 5-10 years, etc. Part of diversification is diversification by TIME.

Currently prices are so low that, I have been doing some research on BDCs (business development corporations). Fortunately, if you look in the message area of Ares Capital Corporation (ARCC) on the Yahoo website, you will see great write ups of several BDC. It was made by Jan814_1999. Jan’s articles are dated March 23, 2009, and titled, “BDCs Part 1” and “BDCs Part 2”. In the latter, Jan states:

One more thing. We should not forget the enormous capital gain potential present in these BDCs. A year and a half ago (before the chaos) BDCs were yielding on average, about 10%. If ARCC were to return to a 10% yield, with its current dividend, its’ stock price would go to $16.80 or 341% above its current stock price. That may take a bit of time but will make a nice addition to its 44% dividend yield of today. Turning to PNNT, its stock price would move 202% above the current price. The current PNNT yield is 30% and PNNT is covering its dividend with NOI with no current worries about any credit facility covenant violations.

I have not vetted the facts in these articles; the arguments made enough sense though, for me to take a position. I direct people to these articles in the hope that someone or other does attempt to verify some of the statements and perhaps might share what they find or know (was my purchase on a “hunch” or sense that Jan is correct, stupid, lucky, or smart?). The article deserves to be read in whole; and I applaud the author for the breadth of his analysis even if I do not know if the facts are correct.

In addition, due to the attention (and likely modifications) to the issue of mark to market accounting, I would believe BDCs are likely to have a significant rise (and then a fall, albeit not as big as the rise) as the FASB releases guidance that may allow ACAS (another BDC which I now own), Pennantpark Invt (PNNT), and other similar BDCs to see a rise in value.

Another question, which I have not been able to answer, and would appreciate comments upon, is whether ACAS (I believe the LARGEST BDC by market cap) or any other BDC, is a better pick than PNNT. It seems to me that ACAS will take longer to recover, but when / if it does, the company has the ability to generate higher returns than PNNT, simply due to the market cap that ACAS holds. Thus, maybe the best thing is to do what I’ve done: buy some of both. I welcome all thoughts as to how to make money in these turbulent times.

Disclosure: Private Trader holds positions in all stocks mentioned, and more, and may change positions at any time.

Comments

[BDC:]

Other than the headline making it seem that PNNHT is the "best" BDC around, wht did you pick PNNT? Nothing in the article suggests PNNT to be the "best." At least you describe ACAS as being the "largest" when you make comparisons between the two. How about some real analysis? Maybe focusing on BDCs that still pay a dividend? Or have net income (to pay a dividend) not based on PIK or capital gains (gains being fairly non-existent these days)? Or BDCs that do not have or can manage their liquidity issues? Without some analysis and background, it seems the headlines, not fundementals, may drive the stock of ACAS and PNNT.

Mar 26 09:57 AM

[not_my_busi...:]

I am a frequent contributor to ACAS's Yahoo message board as well as a sizable investor with over 200k shares.

Before the downturn, ACAS was paying ~ $4/shr dividend. Currently, they have roll-over NOI's from 2008 of ~$300M that must be distributed by Sept 30, 2009. The IRS is allowing REIT's and BDC's to use stock-dividends to satisfy their NOI distribution requirements this year, so it is likely that this $300M will be distributed as 90% stock and 10% cash, but my guess is that it will be 75% stock and 25% cash to assist stockholders with tax liabilities.

So far, ACAS has accumulated ~$0.90/shr in NOI's so far in FY2009 that must be distributed to shareholders by Sept 2010 .. along with 90% of whatever they make in the 1st 3 calendar quarters of 2009, which will likely be a total of about $1.50/shr.

Looking at NAV, ACAS last reported ~$15/shr. Most believe that Q1-09's NAV will be somewhere between $11-$13/shr and that these writedowns will be leveling off this year, with a low-end NAV of approx ~$8 - $10.

ACAS has is currently trading in the $2's. It is likely that a $2 investment will pay at least $1.50 in 2010 and given that ACAS returns to ~0.50/qtr-shr NOI's in 2010, ACAS should be distributing ~0.40/qtr-shr after 2010 and thus support at least a $15 stock price in 18 months.

I hope that helps.

NMB

Mar 26 10:20 AM

[andydee:]

My goodness, where to start?

Jan has a habit of designing criteria for evaluating BDCs that justifies his own investments. That's not the first time I have written that...Last year we had a sparring match on the ARCC Yahoo Board.

I'm not suggesting that PNNT is a "Bad Choice", merely that there are other BDCs that may have more to offer. One for example is ARCC, the site of Jan's post.

ARCC will pay share owners 42 cents in a few days - that's the quarterly dividend for Q4 '08. This for a comp[any with a share price hovering around $4.75 as I write this. Michael Arougetti (sp?), the CEO of ARCC, although loathe to pre-announce dividends, has indicated that he believes they will be able to sustain the dividend for at least one more quarter (check the Q4 transcript Q&As). Even if that is not true and ARCC has to drop back to a dividend that is based on NOI alone, share owners might reasonably expect dividends in the order of 30 cents a quarter going forward.

Now here is an interesting notion. ARCC has been able to navigate it way through the recent morass that has been our capital markets without resorting to any acts of prestidigitation.

PNNT on the other hand adopted SFAS 159 on October 1, 2008, giving them the right to "mark down the value of their outstanding loans "to market". Entirely legal and permissible, but it did add almost $2 to NAV, and perhaps avoided an issue with the banks that hold their credit facility - (haven't checked to determine is that is so, so pls don't take that as a fact). But here's a quote from their earnings release..."On December 31, 2008, the Company had $157.4 million in borrowings outstanding with a fair market value under GAAP of $109.9 million." So they owe $157M but can put it on their books at about $110M.

There are other points I could make, as well as other BDC choices. I own three at the moment, because I believe they have the greatest potential upside. ACAS, ARCC, and AINV.

I believe all of the BDCs will get relief from the rewrite of FASB 157, and so all will prosper...

I do want to make one comment on the preamble to your discussion of the BDCs. I believe you are incorrect about your assessment of whether WWII pulled us out of the Depression. Spending was important, but so was employment. Men were taken out of the factories and put into the services, women then took their place in the factories. It wasn't enough to build the planes and dump them into the oceans -

BTW BDCs are a product of the recession that occurred in the late 30's...check out the background to the Investment Act of 1940, the act which created the possibility for the BDCs...

Mar 26 10:29 AM

[drtrader:]

The BDCs are all lotto tickets on a short recession. Of the bunch, PNNT is probably the best choice. Their NOI for most recent quarter was .27 cents, they paid out .24 of that. I believe it was the only BDC to cover their existing dividend. I haven't seen any bdc's with a better balance sheet, pnnt is one of the "youngest" bdcs and was significantly less levered going into the crisis. They still have significant room on their credit facility and will likely be entering the very very lucractive DIP financing world. The management is basically all former ainv staff. The biggest relative downside is their relatively high management fees and the fact its relatively thinly traded. If you want to play the BDC lotto game, I agree PNNT is the best of a messy bunch.

I'm not sure if the BDCs are the best play on the short recession thesis. The hospitality reits(and their preferreds) work in the same scenario that the bdcs do and offer much more upside without much more risk. A couple of them still have relatively solid balance sheets(AHT, HT).

Mar 26 11:54 AM

[bsharvy:]

Why was this "article" published? The portion that has anything to do with BDC's is just a quote of a Yahoo message board followed by the disclaimer that the author hasn't "vetted" the facts. Gee thanks.

Mar 26 10:53 PM

[Private Trader:]

Thanks to everyone who commented; by doing so, you've helped me improve my analysis.

Specifically, BDC, many of your questions seem to match the conclusions I, too, arrived at after reading Jan's articles. As to your conclusion that the headline was driving things more than fundamentals, please note: my original headline was slightly modified by Seeking Alpha (SA), and I have no objections to that. Last but not least, my article is brief and in it I admit a lack of depth, but I submitted it for posting because on SA I could find nothing else on Pennant. Now, thanks to your and other comments, I can.

NMB, I appreciate your analysis because it helps me stay disciplined in continuing to hold or accumulate ACAS (I started buying it around $28 and it's been hard to keep buying as it goes down; however, as stated, I agree that it seems like it is even more likely to rise when the markets improve - assuming it overcomes creditors / lawsuits (issues PNNT does not have).

Andyyee; prestidigitation (ie - sleight of hand) is my word of the day; I also appreciate the history on BDCs: thanks! The decision of the management of PNNT to adopt FASB 159 (and thus avoid some of the credit / lawsuit issues of ACAS makes a compelling argument that it exercised better judgment than that of ACAS. IMO, your arguments for ARCC make it sound better than PNNT -- IF one can accept the idea that it's okay to payout more of a dividend than NOI (which I think is questionable, and even more so in the current market). Nonetheless, thanks to your arguments, I would consider diversifying my BDC holdings with ARCC, but having missed the ex-dividend date of March 12 (and simultaneous 52 week low), it is now overpriced ($5.14) considering that it's dividend may be cut, changed, or reduced. Congratulations if you bought it earlier, and thanks for putting it on my watchlist. Last but not least, I totally agree that spending is only one part of an economic cycle: employment is a crucial part of it as well. Hopefully, we both agree that America needs either private (not happening) or public (possibly happening) spending to employ people and we don't need that to be dependent on wars in Iraq or Afghanistan, or elsewhere, to "get us out" of our market problems.

Drtrader, I appreciate the recos for hospital reits. I will look into this sector.

Bsharvy, I published this brief article so I could share recent discoveries on BDCs, and PNNT which had no coverage on SA. Fortunately, your critique of my article has lead myself (and perhaps others - though I have not vetted the latter as a fact) to discover more about PNNT on your website. - You're welcome!

Mar 27 04:01 AM

[drtrader:]

One more comment on the FASB 159 change. A lot, if not most, of their mez loans are variable. Libor + x. When they mark these to market, the reduction in the Libor component is reflected in their NAV. Marking their credit facility down to reflect the decrease in libor isn't terribly dishonest because quarter over quarter, it keeps their credit spread the same.

Clearly it has that one-off effect of showing a big gain to NAV, but quarter over quarter its a better reflection of true NAV.

Mar 27 10:52 AM

[sticktoitiv...:]

You should also look at Compass Diversified Holdings (CODI). It is not technically a BDC but it operates like one.

Mar 27 11:00 AM

[not_my_busi...:]

NMB wrote:

"So far, ACAS has accumulated ~$0.90/shr in NOI's so far in FY2009 that must be distributed to shareholders by Sept 2010 .. along with 90% of whatever they make in the 1st 3 calendar quarters of 2009, which will likely be a total of about $1.50/shr."

I made a mistake here .. sorry.

The NOI's for the first FY quarter of 2009 (Q4-08), NOI was only ~$0.20 after one time charges. I would think the average NOI before OTC's will be $0.45/shr .. and maybe figure more OTC's thru the 1st 3 quarters of '09. So, the FY2009 NOI's will probably be in area of $1.30-$1.40 .. and thus maybe $1.20-$1.30 payable as div's by Sept 2010.

NMB

Mar 27 12:14 PM

[andydee:]

drtrader,

I'd like the penultimate word on FASB 159 to be that of Malon Wilkus, in response to a question from someone I believe is also a regular poster, (in addition to NMB), on the ACAS Yahoo Board .
***********
"Angelo Guarino – PRI

"Can you talk a little bit about the 159 election and the arguments that the regulators are giving you in the feedback of why the bifurcated balance sheet valuation approach makes sense? and, if you get a window to re-elect, would your lenders be obligated to accept that accounting change?

"Malon Wilkus

"Under 159 the requirement is that you had a one-time election to revalue existing liabilities and that for us was on January 1, 2008 and unfortunately, we, but – not only American Capital, but I think many BDCs were struggling - trying to understand the implications of FAS 157 in valuing the asset side of the balance sheet. And up through January and February of 2008, through January and through parts of February, it was entirely uncertain from our auditors as how the FAS 157 would be implemented with respect to our third tier assets. And as a result, neither American Capital, nor any (of the) other (large) BDCs that had the end of the year financials, elected to implement FAS 159. Now (we) can’t apply FAS 159 – and therefore by the time we did understand the impact of FAS 157, it was too late and you couldn't go back and implement it.

(As far as the second part of your question is concerned), "You could, under 159, apply at any time you enter into a new loan agreement, but that really doesn’t help the situation in (our) case.

"So, now the ... SFAS 159 was implemented by FASB and it is questionable to what extent a regulator could have an impact on that.

"But it does seem pretty odd for us, because if we were able to retroactively implement 159, we would have $1.2 billion of additional book value."
**************

The last word will be mine. With $1.2B of additional book value ACAS share price would not be wallowing in the single digits...it would mean access to additional credit and phenomenal buying opportunities - the kind of opportunities, for example buying back their own debt -- sort of like what Michael Arougheti described ARCC did earlier this year...(from the last CC)

" As disclosed in the release this morning, we recently executed and are closing on multiple opportunistic debt repurchases of our on balance sheet CLO notes totaling $27 million at a total cost of $6.6 million. These 2009 transactions reduced our debt by a net $20.4 million and also created a distributed realized gain of $20.4 million or $0.21 per share.

"Importantly, these transactions increase the cushion under our asset coverage ratio by $40.8 million bringing the total cushion on a pro forma basis to $276 million for an adjusted net debt to equity ratio of .75 times using our 12/31/08 balance sheet. This calculation nets out to $48.6 million in cash not restricted for our dividend paid on January 2nd. "

So I guess I gave Mike A. the last word...


______________________...
On Mar 27 10:52 AM drtrader wrote:

> One more comment on the FASB 159 change. A lot, if not most, of
> their mez loans are variable. Libor + x. When they mark these to
> market, the reduction in the Libor component is reflected in their
> NAV. Marking their credit facility down to reflect the decrease
> in libor isn't terribly dishonest because quarter over quarter, it
> keeps their credit spread the same.
>
> Clearly it has that one-off effect of showing a big gain to NAV,
> but quarter over quarter its a better reflection of true NAV.

Mar 27 12:18 PM

[andydee:]

NMB

You wrote...

"> The NOI's for the first FY quarter of 2009 (Q4-08), NOI was only
~$0.20 after one time charges. I would think the average NOI before OTC's will be $0.45/shr .. and maybe figure more OTC's thru the 1st 3 quarters of '09. So, the FY2009 NOI's will probably be in area of $1.30-$1.40 .. and thus maybe $1.20-$1.30 payable as div's by Sept 2010."

We might disagree a bit on what ACAS NOI will be over the next 2 or 3 quarters, (it dropped from 75 cents in Q3 to 41 cents in Q4, before one-time charges - and I expect that Q1 and possibly Q2 won't show a flattening out of the NOI decline, especially given the hike in interest rates), However, I subscribe to your larger point:

ACAS will distribute as much or more in dividends over the next 18 months than the share price at today's market opening. And therefore it is a "BUY" at these levels.


On Mar 27 12:14 PM not_my_business wrote:

> NMB wrote:
>
> "So far, ACAS has accumulated ~$0.90/shr in NOI's so far in FY2009
> that must be distributed to shareholders by Sept 2010 .. along with
> 90% of whatever they make in the 1st 3 calendar quarters of 2009,
> which will likely be a total of about $1.50/shr."
>
> I made a mistake here .. sorry.
>
> The NOI's for the first FY quarter of 2009 (Q4-08), NOI was only
> ~$0.20 after one time charges. I would think the average NOI before
> OTC's will be $0.45/shr .. and maybe figure more OTC's thru the 1st
> 3 quarters of '09. So, the FY2009 NOI's will probably be in area
> of $1.30-$1.40 .. and thus maybe $1.20-$1.30 payable as div's by
> Sept 2010.
>
> NMB

Mar 27 12:31 PM

[berloe:]

living on interest and dividends has made me look for high dividends so I took a bath on BDC's. Realized my error and took the losses and can now buy them back with pennies. S0-now I will try to make a living on GAINS. I will probably buy more CODI and LUK (not much income)

Mar 28 03:35 PM

[Edit or perish:]

Well, thanks for sharing ... and wasting our time.


"While I don't have a lot of time to diversify my portfolio ...

"I don’t have time to debate politics here..."

"I applaud the ...even if I do not know if the facts are correct. "

"Another question, which I have not been able to answer ..."


"I hope that helps.

NMB"

Not really. You've been mindlessly pumping this stock and (allegedly) buying it all the way down.

Mar 31 06:19 AM

[Private Trader:]

What I am seeing is that while PNNT has a better balance sheet, ACAS is the stock with the volume necessary to provide some assurance of entry and exit points. I'm betting both will see a nice bump if the MTM rules change. Appears more like "WHEN" they change. NMB, I for one, appreciate your comments (bought MORE ACAS after reading them) - I believe it's likely ACAS will weather this storm, though will be close, and if so, will rise higher than PNNT.

Mar 31 05:11 PM

[not_my_busi...:]

The only thing I actually wrote was the politics statement .. you are correct .. I have written that I think investment boards are not a place to scream at each other about politics.

NMB

On Mar 31 06:19 AM Edit or perish wrote:

> Well, thanks for sharing ... and wasting our time.
>
>
> "While I don't have a lot of time to diversify my portfolio ...<br/>
>
> "I don’t have time to debate politics here..."
>
> "I applaud the ...even if I do not know if the facts are correct.
> "
>
> "Another question, which I have not been able to answer ..."
>
>
> "I hope that helps.
>
> NMB"
>
> Not really. You've been mindlessly pumping this stock and (allegedly)
> buying it all the way down.

Mar 31 05:16 PM

[Private Trader:]

According to Yahoo, the closing price of PNNT was 5.75 today. This is approximately $2 up from the closing price on 3/26/09 when this article was published. Basically it is moving towards twice it's previous price; however, the 52 week high is appx 8.64. While everyone has different goals (long and short term) this stock has had a good run and some may wish to sell now or soon; due to the dividends, I remain long at this time.

May 07 05:17 PM

[Private Trader:]

Depending on your situation (eg - if you are a short term trader) you may want to unload some or all of this position as PNNT is releasing appx 4.3M shares at $8/sh. LT this should grow the value of the company and the price, but ST I suspect the price of PNNT will go down. Here is a link I found to the press release made on 09/24/09:

www.easyir.com/easyir/...

Sep 25 03:22 PM