Prospect Capital Corporation (NASDAQ:PSEC)
2014 Wells Fargo Securities Specialty Finance Conference Call
May 20, 2014, 03:30 PM ET
M. Grier Eliasek - President and COO
Jonathan G. Bock - Wells Fargo Securities, LLC
Jonathan G. Bock - Wells Fargo Securities, LLC
To introduce one of the largest BDCs by market cap and certainly one with one of the most diversified business strategies amongst the BDC group, Prospect Capital Corporation. Here we’re with the President, Grier Eliasek of Prospect as well as Nishil Mehta also in the back that will be willing to take questions and talk to you afterwards. However in the meantime we’re going to have Grier come up and take it away. So thank you very much.
M. Grier Eliasek
Thank you Jon and it’s a pleasure to speak with all of you today. In interest of times we are going to dive right in and talk more about our company. So Prospect Capital as a friend of ours in the room has indicated is the only business development company, it’s a true multi-line BDC. And what I mean by that is 95% of the companies, fine companies presenting today and tomorrow are focused on one line of business which is lending money to private equity companies and that’s a good business. But we’ve got a more diversified business.
We lend money to private equity-owned companies, we lend money to non-private equity owned companies and we also buy controlling interest outright in companies in a much more diversified way that allows us to compete in markets with barriers to entry to protect on return and control our risk.
We’ve been a public company now for ten years, asset base in excess of $6 billion, equity base of about 3.7 billion currently, with capital under management in excess of $7 billion; so one of the two largest companies in our industry.
Well diversified; we have a 140 portfolio of companies currently. We’re well diversified by strategy as well, with a secured lending orientation. We run at about 80% secured lending as part of our asset mix. Assets are almost entirely floating rates, which will be interesting if the fed ever increases interest rates, question of probably when not if and our liability base is entirely today 100% fixed rate liability. So we expect to benefit when interest rates go up.
We’ve experienced growth over the years. We do expect that growth to a moderate overtime as our capital base has grown and the percentage rate of increase should lessen significantly going forward. And you see the growth in our equity base as well as our net investment income which has delivered record profitability in the past year.
Few highlights about our business; we pay an attractive dividend yield. We more than covered our dividends by taxable earnings to the tune of $60 million since inception. We’ve increased our net asset value, our non-accruals on a cumulative basis are about 0.3% of total which is a direct reflection of disciplined in our business. We only close one out of 50 or 100 deals we look at.
Secured learning orientation and I’ll talk about our strategies as we go. We've more than 100 people which allows us to work in a lot of things simultaneously. We originate more than 3,000 deals per annum so we can be in a lot of places. I think we closed 50, 60 deals in the last twelve months. We also focus on proprietary deal sourcing which is a phrase that gets utilized often times without real meaning attached to it. We try to have meaning attached to it.
We are, I think the only BDC that has a call center. We have eight full time resources that call small intermediaries across America originating opportunities. Well diversified on the right hand side of balance sheet as well. We have 27 banks who lend us money more than any other company in the industry and thousands of bond holders as well.
We capitalize ourselves on the right hand side of the balance sheet quite differently from others. Most of our peers encumber all of their assets in a blanket lien to benefit a bank facility. We do not. We only encumber about 20% of our assets in a non-recourse SPV structure that gives enhanced structured rating to banks that they like as they get better capital treatment, they get less collateral and are most interested money us money which is a good thing for us.
The other 80% of our assets are unencumbered. They significantly derisked things for fixed income investors whether they're convert holders or straight bond holders and equity investors alike. That’s not appreciated in a boom market right now. It will be appreciated when the next recession hits.
We as a management are some of the biggest -- I think we are the largest combined shareholder in the company about 50 million bucks of cash equity invested. And we do invest up and down the middle market, even though we do significant scale. We don’t just invest in larger situations we also do smaller ones as well; $5 million of EBITDA up to a $100 million plus.
We are well diversified with funding on the right hand side of our balance sheet as the first company in our industry to ever issue a convert or an institutional bond. We have six of the former two of the later. We're the first and only company that has weekly program notes that are distributed to 800 different retail systems and then we have a baby bond, our bank facility and of course equity.
You see the scale of our business on this page and we put that scale to work. Increasingly what we are seeing is more competition, an increase of leverage and spread compression that is occurring with smaller ticket sponsor deals. There are just too many BDCs and non-bank financials bidding into the same deals. If you are a lower middle market private equity sponsor you are the favorite person and there is many, many lenders to go around to go to. You got a $7 million, $8 million EBITDA company and you are trying to get $30 million of financing, even if I get 50 people interested in that deal all of them can write the same undifferentiated commoditized checks for that deal. That business is completely uninteresting to us.
We like being a business where you have barriers to entry and differentiation. One differentiation is capital base. In the March quarter we closed four deals that were in excess of a $150 million in size. Once you get to that transaction size there are very few players that can compete on a single hold one-stop capability.
You see our growth in asset base in excess of $6 billion as of 3/31 and an increase in our diversity. We have grown the asset base while also growing our staffing. This is a heavy lifting business, the return on effort business also related to the asset mix that we have. We do buyouts, buyouts require 10 times as much work as making a straight loan and you have to have the requisite staffing for that. We do and we show how our ratio of number of portfolio companies per employee has actually declined.
We've invested in people, systems, processes and infrastructure to make sure we can handle that growth and that includes not just front office originators and credit people but also back office people. We have 12 in-house lawyers. We have 12 in-house CPAs; we have six in-house full time tax people, all that's required to give ourselves a competitive advantage of what we do.
Our income has grown substantially to record level on annualized basis. We have increased our dividends over time but they've been reasonably flat for the last 15 months. The last substantial increase was at the tailwind of 2012 and we've declared forward our dividends through the end of 2014 to give visibility paid on a monthly basis. We have paid at that point in time since inception over $1.3 billion in distributions and over $13 a share. This is a page that shows from a value standpoint. It's actually a bit dated as of May 9th, it becomes even more acute now.
We look at our business and see where we trade on a multiple of forward earnings basis, and we see that's actually sub 8x right now, comp to the peer group. We're determined to close that gap. And by doing so an investor enjoys a very healthy and attractive pay to a double-digit dividend yield plus the [hoped] for snap back. So we're determined through more education to close that gap.
Even with that we've outperformed relevant indices in the past two years and companies have been public over the same time period. Now let's spend a little bit more time on this page which talks about the differentiation on the left hand side of the balance sheet and emphasizes that multi line focus I was talking about.
The top left box is private equity sponsored deals, what every BDC basically does, is its sole focus except us. It's less than half of our business and we differentiate ourselves through scale. Then we shift into other strategies that require proprietary sourcing. We are in the direct lending business. These are family owned companies, less of a repeat business, a lot of originations come in through our call center sourcing.
That same sourcing also drives our buyout strategy. We buy controlling interest in companies which we seek to buy companies for lending multiples and get the equity ups for free. We like having equity ups. If you have just a straight credit book your [inaudible] go down through defaults. We like to have some ups to more than compensate for that especially we don't have to pay anything for the equity, especially we can buy companies for a lending multiple.
We have done so many times in our history, that's about 12% of our asset base today for operating buyouts. We are generating a double-digit yield from that. And we've had realizations like gas solutions and the midstream energy sector with a six times cash and cash return, energy manufacturing, 8x cash and cash return.
Then we shift to financial buyouts which we breakout separately because we generate enormous tax benefits in that strategy. We are the first players in the industry to figure out that we can buy finance co., hold it as a partnership avoid taxation at the portfolio company level and pay no taxes upstairs at the BDC level. We're reaping yields in excess of 20% from our finance co., book about 7% of our assets. Then we have structured credit, aka CLO equity a business Nishil Mehta who spearheads capital markets for us as well co-runs.
Our company is the number one market leader in the planet for CLO equity. We have a $13 billion asset base of which we have a 1.1 billion of equity, all control stakes the way we do it. Control stakes, control the call, we work at only top 15% collateral managers on a repeat business. All primary issuance, all underwriting of credit in conjunction with our collateral manager partners and we are generating a 22% current cash yield out of that book.
Sure beats making a mez loan to a sponsor which doesn’t have diversification risk for 9% which is the alternative in today’s market. Real estate part of our diversified multi-line business also pursued generally in the controlled context. We own three private REITs, we’re a large player in multifamily real estate, the golden age for apartments out there as mortgage rates go up people stay in apartments, they’re not buying homes.
We own 30 properties across the Southeast, dial-in to a double-digit out of the box yield with rent growth and the opportunity for increases through CapEx programs. Online lending; aka peer-to-peer lending. You’re going to hear a lot more about that in the future. Folks in this room maybe familiar with Lending Club, with Prosper, with On Jack and the small business side; we’re an early mover there, purchasing loans from existing origination servicing platforms, primarily prime based consumer and small business.
We’re also in a process of launching and starting our own servicer and origination platform which will drive increased volumes our way and maybe a nice valuation path. I think lending club’s last private round was something like $3.8 billion and if we can capture some of that premium with our business we’ll be delighted.
Aircraft leasing we hired Marc Cho who is a senior person in the aviation space of BofA. He’s the CEO of Echelon Aviation. We’ve closed one acquisition to-date about a 12% yielder and expect to look at other deals in the future. So this is a diversified middle market credit yield play with a lot of synergies across it. If we go and call it a private equity firm we might bid out of sale lease back made possible because of our REITs. We might have a company that we have a loan to and we like the business so much we make an offer to the owner to purchase the company, so called try before you buy deal.
We did that for example last quarter, a company called Harbortouch, a payment processing business based in Pennsylvania run by the Founder, as the CEO of the company. We made a loan to that company last year, a direct loan proprietary origination out of the mainstream, away from sponsors, no competition; closed that loan to finance an add-on acquisition. The company made another add-on acquisition recently we put up the capital for that and took a controlling interest in the company. We own 53% of the company and we have a catch up point we think about five turns, senior to everybody else. That’s like getting your equity ups for free, great example of synergies across the portfolio.
Proprietary deal flow is a big emphasis in our company, not only calling on 800 private equity firms, 4,000 intermediaries through our call center. We have invested in hundreds of companies, management teams, they work for us, with us, sent us deals on a repeat basis, whenever we close the deal we let 75,000 our closest friends know about it and then we get inned on opportunities having been in business for 26 years.
It’s a disciplined credit strategy with a cumulative non-accrual rate of 0.3%. We think we’re very good at picking credits, it’s very hard to get a deal done with our company, one out of every 50 or 100 deals makes it through, hard to run the gauntlet and that’s hard for people to appreciate. They see a business like ours, it's grown, it's closed $3 billion of originations last 12 months, they think these guys have got to be throwing money out the door like drunken sailors. Anyone spent five seconds inside our company know it's very difficult to get deals done and to get everyone in agreement. We need 20 unanimous blue ink signatures for deals to go through.
And it takes a long time to get these deals through, the gestation period is sometimes measured in years or at a minimum several months. It’s a heavy lifting agency proprietary origination model that we promote. All independent valuations we’re the first company in the industry to bring best practice to the industry which means every company, every quarter since inception independently fair value before we shut up people were doing self-evaluations galore, now that’s no longer the case. We think it’s the best practice for us to take the test and somebody else grades us pretty simple stuff.
Because we’ve been putting attractive credits on the books, you’ve seen our non-accrual rate continue to drop honestly entire peak non-accrual rate from 2009 during the last cycle was in project finance, an area we discontinued in 2007 and we have a near zero non-accrual rate today. Portfolio continues to grow because of our asset mix. We have a weighted average asset yield of 12.5% which is a couple hundred basis points higher than the rest of the industry.
We are not doing that by taking more risk. We are doing so by having a different origination profile in a higher barrier to entry markets. They require more work to source and monitor these deals. We have a significant diversified portfolio today across all of the industries with no meaningful industry concentration risk. In the first quarter of calendar 2014 we deployed about a $1.4 about $3.3 billion trailing twelve months. In that quarter we closed four deals in excess of a $150 million of a total hold position.
From an industry standpoint our largest chunk shows up 70% which is our structured credit CLO business that itself is all industries. So really the largest industry concentration is 9% with no industry no more than about 5% we are well diversified and sleep well at night from an industry diversification standpoint.
Our portfolio focus is predominantly secured debt, 7% to 8% secured and even our structured credit business that shows up as CLO residual interest that’s our first lien business levered appropriately. So we are very focused in being as high up in the capital structure as possible in these deals, lot of repeat business and banks who lend us money 27 as I mentioned.
Diversified funding with our converts, our baby bonds, our program notes that are unique, our institutional term debt offerings and our bank facility with 27 lenders. We have lots of different diversified access to capital and we have about a $1 billion of liquidity currently between our cash on hand and our undrawn revolver that we can use for the future.
A large team both in the front office, folks have worked together for a long time, I have worked with John Barry, our CEO for the last 15 years now with the company and then we have our accounting finance legal and business development folks. That’s a real competitive advantage is our people, not patents, not technology but people.
So that’s really some highlights about our business and this repeats what I said before. I see I’ve got four minutes on this rigid clock to answer any questions if folks might have. Yes.
M. Grier Eliasek
He's referring to taxable earnings, huge difference. A company makes a $100 of operating profit, its taxable earnings might only be 50 bucks and if you shift the basis for income recognition from the same cash flow the business is generating and with servicing paying debt to an equity distribution investment company accounting so as you look at taxable earnings for dividend recognition. So that doesn’t mean we didn’t make a 100 bucks we still made a 100 bucks for that business, just 50 will shows up about the net investment income line and 50 will show up below the net investment income line.
Yes, our net income therefore goes up through restatement and that’s what we want people to understand. Net income will go up, net asset value will go up, leverage will be unchanged because we are using no third party debt the holding company. There is no attempt to lever up off the balance sheet. Yes?
M. Grier Eliasek
Through a restatement our net income would go up, shareholders will make more money, net income will go up, and as the value go up taxable earnings will go up where we under distribute have banks $60 million of excess that will go up and we haven’t quantified exactly by how much but it's only positive for shareholders. So why has the stock dropped 8% in two weeks, SEC restatement, sell first, ask questions later.
The reality is shareholders got money in their pocket. And our equity issuance has stopped and we won't be issuing equity for a while. So folks are worried about equity issuance essentially a team overhang, that’s done for a while.
M. Grier Eliasek
We have tons liquidity in this business as usual. We have $1 billion of liquidity on hand. We also get about $1 billion of repayments roughly on annualized basis. Thirdly we announced which sadly was missed in our earnings call with a lot of good things to say that we're over shadowed.
We've announced a strategic initiative to basically take our lower yielding assets and sell them into a vehicle, not like others have done in the cross collateralized fashion that consumes a 30% basket. But in a way where we sell assets and retain management and basically manage account where we receive a creative fee income from some of those assets into pool.
We think that's the best way to utilize our regulatory baskets, it's a hold one-stop paper and to optimize the yield and we can take the same. We had about $0.5 billion of those assets on our balance sheet. So we can sell those and then portfolio rotate into more attractive yielding assets without reducing our risk and without increasing leverage one bit on any type of system-wide basis.
Any other questions that are remaining? No, I think I am out of time now, clocks counting up. Terrific, well thank you all for your questions. If you have any addition ones feel free to contact myself, Brian Oswald, our Chief Financial Officer, Nishil Mehta who spearheads Capital Markets. Thank you.
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