On October 18th, 2011 former BDC Kayne Anderson Energy Development (KED) reported earnings for the quarter ended August 2011. (KED gave up its BDC status for technical reasons related to portfolio diversification and investment eligibility, but the Company continues to pay a regular dividend and is operated as before, so the BDC Reporter continues to track its progress).
“Real” Results On The Upswing
Because much of KED’s income consists of return of capital, you can’t take the nominal income and earnings numbers too seriously. The results have to be recast, which KED is happy to do for you in the press release. Adding to the complexity, KED has substantial amounts of Payment In Kind (“PIK”) income, and some of that is booked through the P&L and some directly by adjustment to the balance sheet. Here’s a quote from the press release to give you an idea of what we’re talking about:
Investment income totaled $2.9 million and consisted primarily of net dividends and distributions and interest income on the Company’s debt investments. The Company received $4.5 million of cash dividends and distributions, of which $2.9 million was treated as a return of capital during the period. During the quarter, the Company received $1.3 million of interest income, of which $0.4 million was paid-in-kind interest from ProPetro Services, Inc. (“ProPetro”). The Company also received $0.8 million of paid-in-kind dividends, of which $0.6 million was from VantaCore Partners LP (“VantaCore”). These paid-in-kind dividends are not included in investment income, but are reflected as an unrealized gain.
So what are “real” recurring earnings of KED? We’ll just skip over the quarter ending results, which you can read for yourself in the press release, and point you to the Company’s guidance, also in the press release. If you accept the Company’s way of counting income and expenses, the bottom line is $1.66 of recurring income per share annualized, well above the $1.52 of annualized dividend. The earnings, though, assume that some of the income will be in the form of non-cash additional shares in its VantaCore subsdiary, and will not be booked through the P&L. Backing out the VantaCore income the BDC Reporter “adjusted” projected recurring earnings are closer to $1.36 a share.
A Step Back: KED’S Stragety
KED’s unique business strategy is to invest a goodly portion of its capital in a handful of “private Master Limited Partnerships” in the energy industry, with a view to harvesting cash flow while owning them, and eventually selling them off for a capital gain. The rest of the Company’s capital is allocated to debt instruments to energy companies and investments in the common stock of public MLPs, which are very liquid, and pay out regular and stable dividends. As a result, though, much of the value of KED depends on what happens to its disproportionate bets on its private MLP investments, which include VantaCore, Direct Fuel Partners and ProPetro. These investments account for a fifth of total investment assets, and that’s down from prior periods thanks to the sale of a private MLP portfolio company earlier in the year.
The Company’s performance and stock price has been improving thanks to the improving fortunes of these private MLPs. This quarter’s results continued trends, for good and bad, which began in earlier periods. Let’s review all 3 companies:
ProPetro Services, in which KED has debt and equity investments, was under-performing through 2010. In recent quarters the ProPetro has turned around and now Kayne Anderson expects to receive back the $11.6mn loan to the company, and all the accrued interest that has been paid in kind. Moreover, KED’s equity investment in ProPetro was valued at $5.6mn as of May 2011, up 30%. This quarter there was a slight increase in ProPetro’s value. These numbers represent quite a turnaround in a brief period, but this will not be over till the fat lady sings, which is February 2012, when the loan matures. Management seems very bullish on the company, pointing out that EBITDA has doubled YTD in 2011 versus 2010 and August 2011 results were stellar.
Direct Fuels, which also had a checkered past, is on the upswing. Starting last quarter the subsidiary was able to resume paying cash dividends after a hiatus of more than a year. That continued in the latest quarter, and is projected to continue in the guidance. KED did not change the valuation in August from May’s levels due to lower public company comparables, but the subsidiary’s own performance has continued to ameliorate, helped by adding a new large customer, and by the managerial decision to get out of the cash sucking wholesale business.
That leaves VantaCore, KED’s second largest investment and in which they own a one-third equity interest. Performance at this aggregate producer has been less than stellar. The latest earnings announcement didn’t specifically address recent activities. We looked for the latest 10-Q filing on the Company’s website, but no luck. The Conference Call, though, confirmed that this subsidiary has continued to under-perform, and there has been a reduction in its valuation on KED’s books. Moreover, there was a management shake-up as recently as September, which is rarely a sign that all is well. At the same time, VantaCore did acquire a new quarry recently and KED contributed its share of the capital needed, which suggests this could still turn around, probably in line with the economy and the housing market in the area.
Despite the good news at two of the three private MLPs, management is cautious about the future, judging from the press release and the tone of the Conference Call. Here is what management said in the latest earnings announcement about why the dividend (unchanged from the prior quarter at $0.38, but substantially over the $0.31 being paid before it sold one its private MLP subsidiary for a large profit) is not being increased right now:
We believe the $0.38 dividend is sustainable under a variety of different events that could occur at our three largest private investments. As we get more clarity on these investments over the next few quarters, we will reassess our dividend guidance at that time.
Down The Road: More Concentration Risk
Another important variable is how the Company will use the proceeds from the successful portfolio company disposition. Management is committed to adding a new private MLP investment, and has been searching for a candidate. When a deal is finally done, KED will probably liquidate some of its public MLP investments to fund the purchase. In the interim the Company’s investment portfolio is filled to the brim with high yielding, super liquid public MLP investments, many of them acquired in recent weeks at good prices thanks to the lower prices ,which has accompanied the recent market turmoil. Ironically, today KED is more diversified than at any time in its history. In the long run, though, the Company’s success or otherwise will depend on how a handful of major investments (including a deal or two yet to be done) work out.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in KED over the next 72 hours.