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), Fifth Street Finance (FSC), BlackRock Kelso (BKCC) and Solar Capital (SLRC)) - which has been the one with the best alignment with outside shareholders - I am following with PennantPark Investment (PNNT), which has a market cap of about $470 million. PNNT has traded publicly since 2007:
The company, whose fiscal year ended in September (and reports 11/16/11) filed its annual proxy statement on December 7. Like its six larger peers, where management is provided by an affiliated company, PNNT is managed by its investment adviser, PennantPark Investment Advisers. Arthur Penn (48) founded the company in 2007 after having co-founded Apollo Investment (AINV) with Solar Capital's Michael Gross.
Total ownership of directors and officers is listed at 2.3%. Penn's stake of 479K at the time of the proxy was the largest position, but it included 296K shares held by the adviser. The other larger positions are held by independent directors. Unlike the other BDCs, there was only limited insider buying in August.
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.
While there are several other BDCs to evaluate regarding management's alignment with shareholder's, PNNT compares similarly with the previously reviewed ARCC, PSEC and BKCC, favorably to AINV, and worse than SLRC and FSC. With the exception of FSC, all of the BDCs I have reviewed are permitted to sell stock below the NAV. One interesting observation is that it appears PNNT has done a better job than its peers in terms of at least maintaining if not growing the dividend, even through the Great Recession. While many factors ultimately influence the level of future dividends, it is likely that the ownership of Penn and outside directors incentivizes its management team to steer 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.