I recently suggested that business development companies merit further investigation for income-oriented investors. Given the complexity of some of the management structures, as well as the risky nature of the underlying investments made, investors interested in this niche should pay careful attention to the alignment of interests between management and shareholders.
I had indicated that I would follow up with a review of this dynamic if readers were interested, and that was overwhelmingly the case. Therefore, I am reviewing each of the 14 dividend-paying BDCs I had highlighted in order to assess the amount of "skin in the game."
After recently reviewing Ares Capital (ARCC), the largest of the group, Apollo Investment (AINV), Prospect Capital (PSEC), Fifthe Street Finance (NYSE:FSC) and Solar Capital (SLRC) - which has been the one with the best alignment with outside shareholders - I am following with BlackRock Kelso Capital (NASDAQ:BKCC), which has a market cap of about $625 million. BKCC has traded publicly since 2007:
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The company filed its annual proxy statement on March 16. Like its five larger peers, where management is provided by an affiliated company, BKCC is managed by its investment adviser, BlackRock Capital Corp Advisers LLC. CEO James Maher co-founded the company with COO MIchael Lazar in 2004.
Total ownership of directors and officers is listed at 1.88%, but it is spread a bit more widely than typical for BDCs. Maher's stake of 541K at the time of the proxy is presently valued at about $4.6mm. The second largest holder is independent director Francois de Saint Phalle, while COO Lazar holds 288K. Unlike the other BDCs, there was no insider buying in August, but it appears that the adviser bought 200K shares at 10 a day after the proxy cut-off on 3/16. The Virginia Retirement System owned 22% of the company at the time of the proxy and continues to hold over 16mm shares.
Due to the structure of outside management, investors are unable to clearly weigh the alignment of interests, as there is no disclosure regarding salary and incentive pay levels (or metrics) for the individuals involved in running the company. As the 10-K describes in detail, there are many potential conflicts of interest. Maher, unlike some of his peers who serve on many boards of directors, seems to be focused on BKCC. With that said, the proxy details several transactions in which Maher and other employees had economic interests (related party transactions), mostly from several years ago.
While there are several other BDCs to evaluate regarding management's alignment with shareholder's, BKCC compares favorably to the previously reviewed ARCC, PSEC and, especially, AINV, while less so to SLRC and FSC. With the exception of FSC, all of the BDCs I have reviewed are permitted to sell stock below the NAV. While many factors ultimately influence the level of future dividends, it is likely that the broadly spread ownership at BKCC incentivizes its management team to steer the it in a direction that sustains or even grows the payment without taking excessive risk.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.