Prospect Capital provides a large $210 million loan to a leading food services company in the H.I.G. Capital portfolio.
This is one of Prospect’s largest deals in months, ending a recent drought and marks a return to form.
Prospect’s stock is well known as a high income vehicle, offering a dividend yield north of 12% while trading near its NAV.
Prospect Capital (NASDAQ:PSEC) has most certainly had its highs and lows during 2014. The stock was hammered earlier in the year due to various issues, most notably concerns regarding a possible SEC restatement. However, with this particular matter now resolved, Prospect has recovered nicely. Indeed, the stock is now trading at a small premium to its NAV per share of $10.68, compared to the small discount I noted in my earlier article, and offers a solid yield of over 12%, well above average for the BDC sector.
Prospect makes a major investment into H.I.G. Capital
Terms and other details were not released. However, I expect new information regarding this investment to be provided soon after Q2 2014 (Fiscal Q4) results come out.
A return to form?
Over the past few months, Prospect has been in somewhat of a rut, not closing nearly as many deals compared to prior periods. However, this $210 million investment may mark a return to form for the company.
Earlier in the year, Prospect was originating deals at a record pace, with well over $1.3 billion completed during the March 2014 quarter.
Indeed, the highlight of that period were two massive investments much in the same vein as the current transaction:
A $277.5 million of first-lien floating-rate debt to support the refinancing of IWCO Direct, a leading provider of direct marketing solutions
A $279 million of first-lien senior secured debt and equity to recapitalize Harbortouch Payments, a leading provider of transaction processing services and point-of-sale ("POS") equipment
Is Prospect facing increased competition for loans?
In the past, it has been argued that Prospect may be taking on elevated risk in order to generate returns to fund its outsized 12% dividend.
The company has repeatedly noted that its loans go through quite the rigorous due diligence process. Indeed, under 2% of loans reviewed survive to closing.
Furthermore, Prospect has a tiny 0.3% of its portfolio on non-accrual status. Do note that this does not include New Century Transportation, which filed for Chapter 7 bankruptcy in June.
However, where Prospect may be facing pressure is via increased competition in the middle market area. Some have noted that BDCs are jumping into the areas outside their core competencies, essentially taking on "big fish" deals to boost profits.
I tend to largely agree with this viewpoint. Prospect has been taking on more concentration risk via its larger deals. Also, some of its moves, such as into rental properties, do not seem to fit the classic BDC model.
Indeed, the size of this transaction with H.I.G. represents a rather large commitment for Prospect at around 5.8% of its $3.6 billion market cap and 3.5% of its $6.0 billion portfolio (as of March 2014).
Prospect is a stock that does merit constant monitoring. NII has been coming in lower over the past few quarters, resulting in a dividend coverage ratio below 1.00x in 2014, a worrying trend. I believe the company may need to increase its leverage to alleviate this concern.
That being said, Prospect is rewarding its shareholders for the risk, offering a 12% yield, much higher compared to its BDC peers. Besides income, Prospect is hardly an expensive stock, trading right inline with its NAV.
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.