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By Simon Lack

Business development companies (BDCs) are an interesting sector for investors seeking some incremental yield. BDCs finance middle market companies with anything from senior secured debt to common equity. They are not subject to corporate income tax as long as their investments are with companies under $500 million in revenue. The constant complaint that small businesses cannot get financing from banks should make today’s environment a good one.

We focus on companies with low levels of debt trading at a discount to tangible book value. We’ve been invested in MVC all year, adding whenever its discount to book value widens out. MVC was formerly MeVC, a child of the dot.com bubble which flamed out in the crash of 2001-02. Through shareholder agitation a new management team was installed, headed by Michael Tokarz (formerly of KKR). They have long moved away from the focus on internet businesses and now own an eclectic portfolio of investments both in the U.S. and in Europe based in part on the connections of the Tokarz Group. We recently received an update from management, and they report a promising pipeline of new investments while maintaining a cautiously optimistic outlook.

Blackrock Kelso (BKCC) is another BDC that we follow but have never owned. While MVC and BKCC have tracked each other quite closely for most of the past twelve months, over the past eight weeks or so BKCC has outperformed quite strongly.

A comparison of key metrics reveals slightly stronger growth in book value per share by BKCC even while they support a substantially higher dividend. MVC has lagged, in part because of recent writedowns on two of their investments. BKCC’s stronger performance has led to it trading at a sharply higher multiple of book value than MVC, which is why we haven’t owned it, though they’ve certainly managed their portfolio well. BKCC recently announced another secondary offering of common equity – given where their stock price trades they evidently believe they can invest the proceeds to earn a higher return than their cost of equity. MVC still has authorization to buy back a further 1.4 million of its shares.

The table below illustrates the difference between a good investment and a good business. BKCC’s return on its portfolio have been higher, which is how they support a higher dividend. In recent quarters they’ve run a better business. However, the stock now trades substantially above its book value and they are becoming serial issuers of their own equity. By contrast, MVC trades substantially below its book value, and has been buying back its equity. At the same valuation one might well choose BKCC over MVC. However, BKCC’s operating performance comes at a steep price, and we prefer the margin of safety provided by MVC’s current pricing.

BKCC

MVC

Market Cap (mm)

$768

$310

Assets (mm)

$812

$491

Book Value (mm)

$642

$417

LT Debt (mm)

$145

$50

Debt:Equity

0.23

0.12

P/B

1.20

0.74

TTM Change in BVPS

6.32%

5.41%

Dividend

$1.28

$0.48

Stock Price

$11.75

$12.88

Div Yield

10.89%

3.73%

click to enlarge


Disclosure: Author is long MVC

Source: Seeking Yield in BDCs: Why We Chose MVC Over BlackRock Kelso