NGP: A Well Run BDC That's Still Cheap

Aug.10.10 | About: OHA Investment (OHAI)

NGP Capital Resources (NGPC) is a business development company (NYSE:BDC) that is run by NGP Energy Capital Management, a well regarded private equity firm in Houston with about $9.5BN invested in the energy sector. BDCs are similar to closed end funds in that they are registered investment companies and generally don’t pay corporate income tax as long as they meet certain criteria related to sources of income, distributions of cashflow, and portfolio diversification. Unlike closed end funds they invest in unregistered securities, typically by providing secured financing to middle market companies. Making such financing available to smaller companies was what motivated Congress to create their special tax status.

NGPC released their second quarter earnings this morning. The Credit Crisis of 2007-8 was enormously challenging for NGPC and the rest of the BDC sector. Their assets peaked in 2007 at $478MM, since when they’ve shrunk to $310MM through realizations and write-downs (including $64MM in realized losses). However, they managed their portfolio better than most and were able to reduce debt without engaging in a fire sale liquidation of their assets. As a result, they’ve reduced their leverage, increased cash and greatly reduced their capital structure.

Of their $11.18 per share NAV, $2.10 is net cash (i.e. cash after paying off LT debt). After adjusting for this you are effectively buying their portfolio at a discount of 36% to its carrying value. These are almost all Level 3 assets, meaning there is no public market from which to obtain quotes, and so the valuation may be wrong. But given their strong balance sheet, the portfolio would need a pretty severe write-down to justify today’s low stock price.

Another way to look at it is this year they increased NAV from $11.10 to $11.18, and also pay a $0.17 quarterly dividend. So ignoring for a moment that the stock price fell from $8.13 to $7.17 during 1H10, they actually increased book value by $0.08 as well as paying $0.34 in dividends; $0.42 on average equity of $11.14 is 3.8% over six months, or $7.7% p.a.

Finally, NGPC did have to restate their financials earlier this year due to errors in calculating certain tax liabilities (BDCs are not totally free of tax obligations). This drew a lot of criticism, was no doubt very embarrassing and is indefensible. However, fears of further accounting issues related to valuation appear unfounded and while the company continues to report a “material weakness” in its “determination…for income taxes”, the CFO Steve Gardner said on the conference call this morning that he expects this issue to be fully resolved by the end of 3Q10.

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Disclosure: Long NGPC