Both Prospect Capital (PSEC) and Gladstone Capital (GLAD) are business development companies (BDCs), that pay monthly dividends with substantial yields (PSEC 12% and GLAD 10%), and trade below book value. That’s pretty much where the similarities end. The two companies just reported their 3rd quarter earnings, and after listening to the calls and digesting the earnings reports, it is obvious that the companies are headed in different directions as discussed below.
Net Asset Value (NAV)
Over the last four quarters, GLAD has featured a decreasing NAV: 11.85 to 11.18 to 10.34 to 10.16. Conversely, PSEC’s NAV numbers have increased nicely: 10.25 to 10.30 to 10.36 to 10.41. PSEC’s most recent book value of 10.41 represents a -9.2% discount to NAV, whereas GLAD trades at a -23.6% discount.
From PSEC’s latest earnings, it was reported that for the quarter ending September 30, no new loans were placed on non-accrual. The following statement was also made:
The fair market value of our loan assets on non-accrual as a percentage of total assets stood at approximately 3.0% on September 30, 2011, down from 3.5% on June 30, 2011. Approximately 2.2% of that 3.0% related to one investment that we anticipate, but cannot guarantee, exiting in the current quarter to reduce our non-accruals even further.
An inspection GLAD’s latest earnings paints a much different picture. GLAD has about $290 million of self-originated assets. Of those, 14% are on non-accrual and almost 16% are marked less than $0.50 on the $1.That’s 30% of the portfolio that GLAD has underwritten - all of which are looking pretty bad.
GLAD placed two new loans on non-accrual (compared to PSEC’s zero) - Newhall Holdings and Access Television. These investments have a cost basis of $41.1 million or about 10.8% of the cost basis of all investments in their portfolio. The recent performance of GLAD management is downright ugly. Another example of poor performance is Sunshine Media, which is currently valued at about $0.30 on the $1.00, but has not yet been placed on non-accrual status. It is loans such as these which are currently generating cash flow, but could easily stop the next quarter or two given their current value. GLAD’s current portfolio is valued at $0.79 on the $1.00 – not pretty.
Yield on Assets
For the most recent quarter, PSEC reported an annualized yield on assets of 12.4%, with GLAD coming in at 11.2%. This is driving better top-line performance for PSEC.
PSEC continues to gradually increase their dividend month-over-month. The dividend has increased from 0.1010 as of January 2011 to 0.101425 as of December 2011. GLAD’s divided remained at 0.07 for the entire year. The one black eye for PSEC is that net investment income (0.26) came in slightly below dividends declared (0.303). It should be noted that GLAD has covered their dividend for the quarter (0.21) with net investment income (0.23). Regarding GLAD’s NAV, and its impact on future dividends, I took notice of the following quote from the earnings report:
The cumulative unrealized depreciation of our investments does not have an impact on our current ability to pay distributions to stockholders, but thus indicate that the value is lower and there may be future realized losses that could ultimately reduce our distribution.
Ability to Raise Capital
PSEC has consistently shown the ability to raise capital. For example, from the latest earnings report:
On December 21, 2010, we issued $150 million of five-year unsecured 6.25% senior convertible notes due December 2015 ("2015 Notes"). On February 18, 2011, we issued $172.5 million in aggregate principal amount of 5.5-year unsecured 5.50% senior convertible notes due August 2016 ("2016 Notes") for net proceeds of approximately $167.3 million.
On the other hand, GLAD is having a much tougher time. GLAD raised just 33 million at 7.125% via a preferred stock offering. Notice that the cost of funds is much greater than PSEC’s recent debt raises. Further, GLAD management had this to say:
I want to remind everybody that our biggest challenge today is the long-term debt marketplace for our company. We have a line of credit with very supportive lenders. Those institutions seem to be behind us. The line of credit is working fine and we believe it’s sufficient for our near-term needs, but it is a short-term line of credit...But at the end of the day, we have to find long-term funding solutions for our company. In order to make a lot of long-term investments, we need to raise long-term debt and long-term capital such as the issuance of our preferred stock that we issued just last month.. And this lack of long-term debt and long-term equity can stunt the growth or if we can find it, it will accelerate our growth. And that’s our challenge in the near time.
The above quote does not exactly make you feel warm and fuzzy.
PSEC has provided solid results quarter-over-quarter, and management spends its time on conference calls discussing their performance and how they hope to build on that going forward. GLAD’s quarterly conference call, as per usual, can be pretty painful to listen in on. CEO David Gladstone gets on his soapbox to blame everything under the sun for their sub-standard performance rather than owning their poor business decisions. An example of this from the most recent conference call is as follows:
We do have our worries and I mention them each time. I’ll just run through them now. And we worry about oil prices. Oil is on the way up. ..We are worried about inflation, decisions by congress and the president to expand the money supply will ultimately cause more inflation and more problems...The amount of money being spent on the war in Iraq and Afghanistan certainly hurts the economy…And of course, the government is talking about raising taxes again. I don’t know how much the economy can stand in more taxes. But we all know that we have a spending problem and not a tax problem today…In addition, the trade deficit with China, certainly, China’s just one of those nations that continues to subsidize their industries to the disadvantage of our businesses here that aren’t subsidized…And that means that our companies have a hard time competing with them and that means jobs leaving the United States and go to Asia…The downturn in housing has been a real drag on the economy. It’s been a disaster obviously for mortgage holders, as well as those who have mortgages that are now underwater...I’m just glad that we weren’t investors in anything in the housing industry.
What business does not worry about at least one of the items Gladstone mentions? GLAD comes off as making excuses for its performance, whereas its peers, such as PSEC, continue to put up solid numbers and improve their book value quarter-over-quarter.
Given GLAD’s issues, I recommend a paired trade of going long PSEC and shorting GLAD. The short should provide any downside protection if the US economy does falter. GLAD would be impacted more severely given its poorer portfolio quality.