NGP Capital Resources (NGPC) is a financial services company investing dedicated to investing in the Energy sector. The Company is regulated as a Business Development Company (BDC). This means that it receives certain tax benefits and in exchange it must pay out a substantial portion of its earnings in the form of dividends to shareholders.
BDCs have received a bad rap recently, some of which is definitely deserved. David Einhorn’s descriptive commentary of his research on Allied Capital (NYSEARCA:ALD) in Fooling Some of the People All of the Time gives the reader great insights on some of the potential issues in these entities.
Unlike Allied, NGPC invests solely in Energy, generally in senior secured investments with hard assets as collateral. With oil and natural gas prices declining markedly over the past year, immense pressure has been put on the energy industry. While I am a long-term bull on energy (for reasons that warrant its own piece), I admit that in the short-run the industry faces headwinds due to weak demand caused by the economic downturn.
So given this short-term cautious, long-term bullish view on the industry, what do I think of NGPC? I am bullish on NGPC for the following reasons:
- The company is largely positioned at upper end of capital structure.
- The company is relatively unlevered with investments of just 94% of equity.
- The company has immense liquidity (134mm of cash on balance sheet).
- The company offers optionality on bullish scenario through warrants, convertibles and other non-linear pay-off structures.
In a bad environment such as the one we are in, you want to sit very high in the capital structure. This is somewhat akin to being first in line at a bank run. The senior bonds get paid first and being Senior Secured just increases both the likelihood and percent that you get paid.
Let's assume, for the sake of argument the following: currently defaulted Senior Secured pays back 30% of principal, all else goes to zero. Additionally, all performing Senior Secured only pays back 70% of principal and all other assets only pay back half (assume warrants go to zero). What underlying value do we get for the company? Under this scenario the portfolio would be written down by $129mm (from 12/31/08), resulting in book value per share of $6.35.
How about a bull case? I think we can safely assume that assets are marked accurately, if not conservative under a bull case (warrants, convertibles, and profits interests provide optionality) which results in a current book value of $12.29.
So in a bad case you get paid back and in a bull case you get roughly a double, and get paid 10+% current dividend yield to wait. That is a good investment.
Disclosure: I am long NGPC, no position in ALD.