Main Street Capital: What Its Affiliate Acquisition Means for the Long Run

| About: Main Street (MAIN)

Main Street Capital Completes Exchange Offer for Main Street Capital II Partnership Interests – Yahoo! Finance.

We’d been hearing about Main Street Capital’s (NYSE:MAIN) acquisition of its affilated SBIC company for months, and now it’s done. The Company is already a “growth company” in the SBIC space because of its considerable cash and borrowing capacity before this happened.

As of September 30, 2009 MAIN had nearly $50 million in cash, an unused Revolver of $30 million and $65 million in SBIC money to lay out. That’s $145 million for a Company with only $135 million in investment assets at cost. Now MAIN has another $105 million in borrowing capacity with the SBIC, for a grand total (this is like a game show) of $250 million in theoretical spending power. On the flip side, MAIN had to issue 1,239,695 shares to the owners of its affiliate, which represents 11% of the current shares outstanding.

We don’t have any doubts that MAIN’s earnings will increase on a per share basis as the SBIC affiliate already has $70 million outstanding. By 2010, Net Investment Income may even cover the dividend. Down the road, a fully invested MAIN could have nearly $350 million in assets outstanding (assuming either the $30 million Revolver or the bulk of the cash are retained as reserves) and earnings per share could grow 50% from their current level :$0.28 to $0.42. That would be significantly above the current $0.375 in dividends paid out quarterly. Our assumptions assume a reasonable amount of bad debts. At times earnings could be even higher.

Still, MAIN is no undiscovered gem. The stock price is at $16.08, nearly ten times our pro-forma sustainable earnings projection, and over 14x the latest earnings. Even the dividend yield, plumped up by management paying out more than what the Company is earning, is down to 9.3%. Fully invested the yield only goes to 10.4%.

What’s more, by the time the Company becomes fully invested we’ll be worried about leverage. By our quick calculations debt will be 1.6X equity, and assets will cover debt by 155% versus the minimum 200% required for most BDCs. (Many companies have received a waiver of the 200% asset coverage required for BDCs for SBIC funded assets). Maybe MAIN will raise more equity to improve its balance sheet, but that would reduce our pro-forma earnings per share.

Disclosure: Long MAIN