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."
So far, I have reviewed Ares Capital (ARCC), the largest of the group, Apollo Investment (AINV), the worst in terms of alignment, Prospect Capital (PSEC), Fifth Street Finance (FSC), BlackRock Kelso (BKCC), PennantPark (PNNT), Solar Capital (SLRC), Hercules Technology Growth Capital (HTGC), Main Street Capital (MAIN) and Triangle Capital (TCAP). MCG Capital (MCGP), which has a market cap of about $330 million, has traded publicly since 2001, which is the longest by far of any of the BDCs previously reviewed:
(Click chart to expand)
The company filed its annual proxy statement on May 2nd. Western Investment, a long-term shareholder, had filed its intention to nominate an alternative slate of directors at the June annual meeting, but it appears that they didn't do so. The filing from March 4th is worth a read, as it cited poor relative performance, which appears to be rather obvious. In October, its CEO, Steve Tunney, was fired (with a $2.2mm severance). Outside director Richard Neu (55) was named CEO, with long-time exec Hagen Saville named COO.
Unlike most of its peers, where management is provided by an affiliated company, MCGC is self-managed, like TCAP and HTGC. Former CEO Steve Tunney Sr. (50) had served as CEO since 2006 and was COO from 1998. Hagen Saville has served as a director and had served as EVP of Business Development since 1998 before his promotion. New CEO Neu had served on the board from 2007 and was formerly CFO of Charter One Financial from 1985-2004. The CFO and the Chief Compliance Officer both joined the firm in 2008, while several other executive officers have been on the team for longer.
Total ownership of directors and officers is listed at 9.9%, which puts it above average for the BDCs. A large part of this ownership, though, is held by Springbok Capital and is included because it has a representative serving as a director. Absent those shares, ownership was still reasonably high at 4.1%. At the time of the proxy, Tunney owned almost 850K shares (1.1%). The balance was widely distributed to other executive officers and the independent directors, including 84K for Neu. Netting out Tunney's shares, 3% is reasonable. There was some small insider buying in August (74K shares), including 30K for Neu. More recently, SpringBok appears to be a seller based on filings from Mid-November.
Due to the common structure of outside management, BDC investors are often 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. Because it is internally managed, this information is available for MCGC. Tunney's salary in 2010 was $522K, and he received a cash bonus of $607K. The bulk of the cash was due to former incentives for getting the stock to touch 5 and 6, which is a poorly designed plan in my view. This team is much more expensive than TCAP or even MAIN in terms of cash and total compensation. One aspect that I view positively is that the short-term bonus plan is linked very clearly to several metrics like originations, monetizations, asset coverage, NOI and EPS.
While there are a few more BDCs to evaluate regarding management's alignment with shareholders, MCG Capital appears about average given insider ownership levels, with the positive of internal management offset what appears to be expensive compensation. Main Street looks superior to all of the previously reviewed BDCs, especially Apollo Investment. With the exception of MCG Capital and Fifth Street Finance, all of the BDCs I have reviewed are permitted to sell stock below the NAV, which I find to be a negative. The best alignment so far beyond MAIN has been Hercules Technology Growth Capital. I think that Solar Capital, Triangle Capital and Fifth Street Finance stand out from the crowd as well.
While many factors ultimately influence the level of future dividends, it is very likely that the ownership of MCGC's management team and outside directors creates an incentive for its executives to steer it in a direction that sustains or even grows the payment without taking excessive risk. Still, with turmoil at the top and clearly bad historical performance, this is one to investigate more closely.