A couple of days ago, Saratoga Investment Corp. (SAR) held a conference call for the quarter ended August 31, 2010. This was notable because the conference call represented the first time shareholders heard from the management of Saratoga since taking over the stewardship of the company from GSC Investments. Since the change of control we haven’t heard much from Saratoga, so we were anxious to hear what would be said.
Here’s our summary of the highlights, but don’t expect too much. Management remained very tight fisted with information. We won’t be summarizing the first part of the conference call, which was just a reiteration of the quarterly earnings report. It was in the Q&A session that we learned a little more:
REASON FOR BUYING GSC (THE FORMER NAME OF SARATOGA)
When asked why Saratoga “bought” GSC, CEO Overbeck gave two reasons:
- Saratoga is a 26 year experienced middle management investment firm. They bought GSC (as it was) because its financial distress was due largely to the structure of its liabilities and as it was essentially in liquidation mode. Saratoga saw the investment as an opportunity to fix a “broken capital structure”.
- Saratoga was also intrigued by the BDC format because they see it as a good way to lend into the middle market, and with many institutions withdrawing from the market the risk reward is favoring lenders, after the opposite being true for many years previously.
The initial goal was to stabilize the capital structure and that has been accomplished by injecting $15mn in equity, bringing in new lender Madison Financial and (most importantly) paying off the prior lenders. Now Saratoga want to liquefy the existing portfolio, and reinvest the monies AND increase total assets by drawing on availability under the Madison facility. Overbeck, though, used the opportunity to point to the recent Terphane transaction (more below) to point out that the restructuring took over a year. This suggests that the liquefaction of the portfolio will be a multiple quarter process. Overbeck is hopeful because SAR is seeing uptick in restructuring activity in marketplace, which creates confidence that the more troubled portions of the portfolio can be turned into cash.
Nonetheless, SAR looking to make new investments right now, and have a pipeline of new deals. Primarily looking for second lien and mezzanine characteristics, which have better risk-reward characteristics. This suggests that over time the Saratoga portfolio will substantially change.
PRICING AND STRUCTURE OF NEW DEALS
Overbeck was asked what were typical terms of the new type of deal that Saratoga might be booking. As the company did not add new deals, the new CEO provided details on the recent restructuring of portfolio company Terphane Holdings, which occurred after quarter end. Anyway, SAR received new notes in Terphane (as well as receiving a partial cash pay-off) with a 14% fixed rate, with a 5 year maturity. The company has a 3.5X EBITDA. We would have preferred to hear about some of the new deals under consideration rather than Terphane, which was a distressed loan.
AVAILABILITY UNDER REVOLVER
The earnings report showed availability under the Madison Revolver was only $3mn at quarter end. Very logically a questioner asked how could Saratoga be considering new deals with such little room for maneuver. Overbeck answered that current availability is higher than the $3mn available at August 30 (because of the Terphane repayments presumably) and because new deals provide collateral, so availability is a moving target. He reminded listeners that there is the possibility of increasing the Revolver limit further.
Again, Overbeck could have just given the latest loan balance but didn’t share that on the call. We’re guessing (and we hate to do that) that the loan must be around $14mn.
When CEO Overbeck was asked what the asked Taxable Income of Saratoga is, he declined to provide the info (maybe the number is still being calculated for the quarter), but said Taxable Income would affect dividend policy and an announcement would be made before year end on this subject.
If you’ve read the earnings report, you’ll see professional fees were huge for the quarter. Overbeck confirmed that these fees will be down in the future now the restructuring has occurred, but warned that some ongoing reporting costs would keep fees from going to zero.
When asked what Saratoga was doing/going to do about hedging interest rate risk, Overbeck said they plan to “watch interest rates very carefully” but current floating rate portfolio does not create much of a risk until investment book increases.
PLANS TO SELL NAV BELOW BOOK
When asked about possible plans to grow by raising equity below book value (which a number of BDCs have asked for shareholder approval), the CEO pointed out that new owners have a substantial stake and want to avoid dilution, but accept that growth will help spread costs over book. They will not rule out issuing stock below NAV, but want to find other things to do. Nothing is decided.
Last but not least: Dividends. SAR’s dividends have been suspended for ages. At the top of the prepared remarks, the company indicated that they would not be paying dividends for the period. Later on the call , Overbeck indicated Saratoga have to file tax return by November 15th for the prior year, and will discuss dividend policy by [calendar?] year end. So the bottom line is: No dividends yet.
As part of the recapitalization, Saratoga agreed to waive management incentive fees through year-end. The former managers waived $2.6mn in deferred management fees, which greatly boosted results in the period.
Saratoga’s Collateralized Loan Obligation (“CLO”) which represents a large portion (about 25%) of its asset base, received some discussion. The CLO is performing “very well”, marked up to $22mn.
The CLO is a major contributor to earnings as well: $800k of earnings for quarter and $1.5mn for six months plus the management fees.
Shareholders learned that Saratoga is seeking to turn over the current senior loan portfolio and replace the assets with mezzanine type investments, presumably with higher yields. Restructuring and repayments of the existing portfolio will happen in parallel with new business activity, but the latter has not yet hit the books. Total assets should ultimately increase. The company may or may not raise equity under NAV (very unlikely in the short run in our position with so many matters up in the air), and earnings will be helped in the future by lower professional fees but will be partly balanced by the manager’s incentive fee. There is no hedging strategy underway for interest rate risk. Taxable income is unknown, as is a dividend strategy.
By the way, the call is still available if you’d like to hear it. The details are below:
A replay of the call will be available from 1:30 p.m. ET on Monday, October 18, 2010 through 11:59 p.m. ET on Monday, October 25, 2010 by dialing (800) 642-1687 (U.S. and Canada) or (706) 645-9291 (outside U.S. and Canada), passcode for both replay numbers: 18661153.
Disclosure: Author is long SAR