Prospect Capital: The Nicholas Financial Deal Is A No-Go

| About: Prospect Capital (PSEC)


Nicholas Financial has terminated the agreement to sell itself to Prospect Capital.

The June 12, 2014 deadline has passed, with the conditions required not met.

Due to its now resolved SEC issues, Prospect Capital noted that it did not expect to close the transaction before the deadline.

Prospect Capital (NASDAQ:PSEC) has most certainly had an interesting year. Its stock price has seen unusual volatility, mostly stemming from an SEC request to consolidate its subsidiaries. This issue has been recently resolved, sending shares of the company up 4% as a result. However, Prospect Capital now has another problem on its plate, namely that its proposal to buy out Nicholas Financial (NASDAQ:NICK) has been terminated.

Nicholas Financial nixes deal with Prospect Capital

On June 12, NICK provided an update regarding its proposed sale to Prospect Capital. In the release, NICK made it clear that it was terminating the agreement. Below is the key section from the press release:

The termination deadline for completion of the Arrangement pursuant to the Arrangement Agreement is June 12, 2014. At its June 11, 2014 meeting, the Company's Board of Directors determined to terminate the Arrangement Agreement on the basis that certain conditions requisite to consummation of the Arrangement could not be satisfied by the termination deadline.

While the announcement was somewhat a surprise, the writing was on the wall. The companies had already noted that the proposed transaction would not occur on or before the deadline of June 12, 2014. Furthermore, since the SEC issues at Prospect Capital arose, NICK's share price had been trading well below the buyout price of $16 per share.

Prospect Capital had been trying to amend the agreement to extend the deadline. However, NICK's board was waiting to see how Prospect Capital's appeal to the SEC played out.

Given that the appeal and restatement issue was only resolved on June 10, the companies only had two days, clearly not enough time to make an informed decision.

What does the future hold for Nicholas Financial?

One must wonder, now that the sale to Prospect Capital is terminated, what will happen to NICK? The answer to this may be hinted at from the following section in the press release:

The Board of Directors further determined to continue to retain Janney Montgomery Scott LLC as its independent financial advisor to assist the Board in evaluating strategic alternatives for the Company, including, but not limited to, the possible sale of the Company to Prospect or another third party, potential acquisition and expansion opportunities, and/or a possible debt or equity financing.

It appears that NICK is still trying to sell itself, with Prospect Capital clearly mentioned as a potential candidate. The company was also exploring other unnamed "strategic alternatives", along with a debt and or equity offering.

Glancing at NICK's metrics, the company is clearly being undervalued by the market, with its TTM EV/EBITDA around 9.5 and TTM PE below 11.0x. Furthermore, the company is trading at under 8.0x TTM FCF.

With that in mind, NICK appears to be a good buyout target for BDCs. When the initial sale was announced, I had estimated that NICK could add up to $0.10 per year in NII to Prospect Capital.

I would not be surprised if the companies agreed to another agreement similar (around $16 per share) to the terminated one, now that the SEC issue has been settled.

Even without Nicholas Financial, Prospect Capital is still a strong buy

Without a doubt, the main reason most investors own Prospect Capital is for its massive monthly dividend. At about 11 cents per month, Prospect Capital yields over 1% monthly, or nearly 13% annually.

This level of income can lead to some serious total returns, if reinvested. As shown below, Prospect Capital has mostly kept pace with the S&P 500's bull rally over the past 5-year period.

PSEC Total Return Price Chart

PSEC Total Return Price data by YCharts


With the SEC turmoil now mostly behind it, Prospect Capital is worth owning. As noted above, the stock offers a compelling yield, "locked in" through the end of 2014.

Prospect Capital is a value play, with its March 2014 NAV of $10.68 2% below current prices. In addition, I would argue that the stock should start commanding a small premium to NAV soon. The Russell June reconstitution, a major factor in the sell-off in BDCs, should occur at the end of the month.

Disclaimer: The opinions in this article are for informational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned. Please do your own due diligence before making any investment decision.

Disclosure: The author is long PSEC. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.