OK, strictly speaking Compass Diversified (CODI) is not a Business Development Company. CODI is not really a lender but a buyer of middle market businesses, what used to be called a mini conglomerate. Unlike other business buyers,though, CODI finances all its acquisitions internally, rather than having each portfolio company borrow from third party lenders. Nonetheless, we track the company because it is i) involved in the middle market which is the bread and butter business of the BDC industry, ii) pays a regular quarterly dividend.
Speaking of dividends, Compass has been a very dependable dividend payer ever since its IPO in May 2006, and journeyed through the recession without any dividend reduction or suspension. In fact, CODI has been paying the same 34 cents a share quarterly dividend since the third quarter of 2008, and reiterated the same pay-out for the IVQ of 2010 today. The company was fortunate to have made a very successful sale of a portfolio company just before the Great Recession, which paid down debt and generated cash. Rather than pay out all the proceeds of such a sale, Compass retains the profits and pays them out over time in the form of distributions, along with ordinary income generated by its portfolio companies. During the last two years, cash generated by the business was often lower than the dividend liability, but Compass has always maintained a conservative balance sheet and access to enough liquidity to keep paying its shareholders in the amount to which they have become accustomed.
In recent quarters, buoyed by several acquisitions, cash available for distribution or CAD (which is the company’s term for surplus funds generated) has begun to outpace the dividend. For example in the third quarter of 2010, so called CAD was $23.8mn, but dividends totaled only $14.2mn. By contrast, a year before CAD was only $11.7mn.
We note that Compass has not chosen to increase its dividend despite its recent success. Management is aware that CAD can change quickly. Even last quarter, Compass had to write-off (as a non-cash item) much of its investment in its furniture manufacturing subsidiary, a sober reminder that not every deal will work out. From a capital structure viewpoint, the non-changing of the dividend is a conservative step as it retains cash in the company for further acquisitions (add-ons or new platform companies) and maintains the company’s reputation for being a steady distribution payer.
The balance sheet looks strong at this point, with a moderate $175mn in debt and $25mn in cash, and plenty of availability under its $340mn Revolver (not all of which could be drawn due to collateral limitations). If you care for such metrics net debt (that’s debt net of cash) is below 0.3:1.0, which compares favorably with most BDCs. There is no debt due for refinancing till 2012, which is a plus.
All this to say that the Compass dividend seems safe for 2011, barring a major catastrophe (the risk of which is decreased by its current diversification into 8 platform companies). At today’s stock price of $17.7, the $1.36 annual dividend yields 7.7%. Will there be a dividend increase in the future? We have no idea, but we’ll be listening on future Conference Calls to get a sense of management’s thinking.