Saratoga Investment Corp. (NYSE:SAR) is one of only two Business Development Companies (“BDC”s) not paying a regular cash dividend. The company paid its tax liability last time in the mix of 10% cash and 90% in additional stock that is being temporarily allowed under the BDC rules (ditto in the REIT space). We’d hoped that with the recapitalization of Saratoga (GSC Investment that was) in the summer, the new management would resume regular quarterly cash dividends. As far back as April (see our post of April 15, 2010) , we were proponents of the recapitalization of the company by the Saratoga group, and were hopeful that one of the benefits would be a resumption of cash dividends.
The first earnings call post-restructure made clear that was not going to happen in 2010. However, upon reviewing the 10-Q for the quarter ended August 31, 2010, we recognized that Saratoga was not yet out of the woods from a credit perspective. 54% of the company’s yield assets (not including its CLO investment) are still rated Red (which is defined in the 10-Q as “payment default risk, in payment default and/or significant restructuring activity” (page 31). By way of contrast, only 13% of the CLO portfolio which Saratoga manages and invests in were rated Red, with the remainder higher rated.
Moreover, the new financing arranged with Madison Capital has more conditions and provisos than we’ve ever seen in the BDC space and a very high effective interest rate (over 8% once the 2% floor and unused management fees are included, and at a time when LIBOR itself is at 0.25% or so). Moreover, Saratoga has not been making much progress in getting its investment portfolio paid off to bring down debt and redeploy into new assets.Here’s what the 10-Q said:
During the three months ended August 31, 2010, we made no investments in new or existing portfolio companies, had no exits and $0.1 million in repayments, resulting in net repayments of $0.1 million for the period.
(Yes, Terphane Holdings did restructure after quarter end, which resulted in some loan pay-down but debt outstanding is still around $14mn or so, and borrowing availability is limited).
All the above to make the case that it’s probably in the company’s best interests to use earnings that would otherwise go to shareholders in dividend form to pay down debt and continue the still unfinished righting of the Saratoga ship. (There was good news in the last 10-Q about the status of the company’s CLO which now represents a quarter of total assets and brings in the highest yield of all its investments; and the company benefited from a one time savings from the waiver of management fees due to the prior manager-see more below).
So it was no great surprise to be greeted last Friday after business close with an announcement by the company that it would pay its current tax obligation with additional stock- again. Here are some of the details, or go to the press release for the full monty:
The dividend has been set at $4.40 per share payable on December 23, 2010 to common shareholders of record on November 19, 2010. The dividend will be paid in cash or shares of the company’s common stock at the election of the shareholders . The total amount of cash to be distributed to all shareholders will be limited to approximately 10% of the total dividend to be paid to all shareholders. The remainder of the dividend (approximately 90%) will be paid in the form of shares of the company’s common stock. The press release indicates that the dividend includes a carry-over balance from the company’s fiscal year 2010 taxable income and a significant portion of the company’s fiscal year 2011 taxable income, including one-time transaction-related income such as the $2.6 million waiver of deferred incentive management fees by its former manager. Shareholders at the record date,thus, will face taxable income with only a fraction of cash dividend income to pay their tax obligations.
CEO Overbeck said the following:
We believe paying this dividend largely in stock is prudent and consistent with our focus on maintaining and enhancing our balance sheet liquidity and ability to diversify our portfolio,This dividend satisfies our regulated investment company taxable income distribution requirement. Importantly, it allows the company to resolve all known past tax liabilities and move forward with a clean slate.
The press release adds:
The liquidity from the use of the stock dividend is intended to provide the company with incremental capital to grow and diversify its portfolio, which should ultimately allow the company to increase its net asset value. There has been an increase in net assets of $9.3 million as a result of operations over the first six months of this fiscal year.
As for when the dividend might be paid in a normal manner, all the press release offered was the following:
“ The company intends to review its current dividend strategy in early 2011”.
As we’ve shown above, we sympathize with management’s decision not to resume cash dividend payments until the company is out of the woods from a credit perspective, even though it’s onerous to shareholders from a tax perspective. However, the vagueness about when or under what conditions Saratoga might resume dividend payments is distressing, and reinforces the first impression we received on the last Conference Call that the new managers of the company are unduly tight lipped about disclosure. See our post of October 20, 2010.
Maybe it’s nervousness about the rights and wrongs of public disclosure for a new management group. Maybe the company’s counsel is advising this say nothing approach. We’re not experts in securities law, and are not fully versed on what limitations management considers itself under. However, with the managers of Saratoga also owning one-third of the company’s stock the BDC Reporter is concerned about a two tier information system developing. Two thirds of shareholders are told nothing about the company’s dividend game plan or intentions , while one third have substantially greater knowledge and insight about a critical aspect of the company’s business which will probably have a material impact on i) the stock price; ii) phantom income if future tax liabilities continue to be paid in stock.
We’d like to see management spell out the main conditions that they would deem necessary to recommend to SAR’s Board a resumption of the dividend such as bringing debt under a certain threshold, or a minimum level of asset coverage. Even if that road map was hedged with all the standard caveats the non-insider shareholders (and any new would-be investors) would at least have a sense of where Saratoga is headed. Instead we are left in the dark.
Disclosure: Author is long SAR