Business Development Companies Raising Capital in a Recession

Surprise! In the midst of a stock price meltdown amongst Business Development Companies (BDCs) which has lasted over six months, two BDCs yesterday managed to raise new equity. Before we get into the details of the capital raised, let's quantify how drastic has been the bear market in BDC stocks. Notwithstanding that none of the 19 BDCs we track has reduced its dividend, nor even registered more than a minimal drop in reported Investment Income, every single BDC has seen their stock price drop by double digits (calculated as the market price as of yesterday, January 30, 2008 versus the 52 week high). The lowest decline is BlackRock Kelso (BKCC), down only 14%, and the greatest decline TICC Capital (TICC), down a whopping 46%. On average, these 19 BDCs are down 29%. Moreover, most of the companies trade below their Net Asset Value (NAV). (For example, TICC is currently trading at 26% below its NAV). Dark times indeed for this little known corner of the Financial sector.

So we were delighted to see that Allied Capital (ALD) and Gladstone Capital (GLAD) were able to launch public offerings yesterday. Allied Capital issued 4 million shares at $22.0 a share, for an infusion of $88 million. Gladstone, a much smaller company with a market cap of only $212 million, raised an impressive $48 million. Allied and Gladstone's stock prices are trading 35% and 30% respectively off their 52-week highs. Nonetheless, both companies were able to convince investors to ante up $136 million to reinvest in middle market buy-outs. Gladstone was even able to raise the money at a "bargain" price. The $17 stock issue bears just a 9.8% dividend at the current dividend rate. Allied Capital had to pay up: the new stock yield is 13%.

We may be reading too much into yesterday's capital raisings, but we believe other BDCs will follow suit in the weeks ahead. On a macro basis this will increase the amount of capital available to the BDC industry for leveraged buy-outs at a time when many other players (including hedge funds, money center banks and regional banks) are leaving the building. Yesterday may also mark the famous "bottom" of the market for BDC stocks.

Disclosure: We are Long TICC and BKCC.

Comments

[johnheiderscheit]

The thing is that stock must be sold above NAV. Even with the nice rally of the past week or so the club of BDCs selling above NAV is extremely exclusive. So your point that "other BDCs will be following suit in the weeks ahead" is questionable.

[stink726]

I enjoy reading your opinions and analysis articles. Thank you for writing.

[Nicholas Marshi]

With the passage of nearly two months, our prediction that substantial new equity raising by BDCs was about to occur has been proven correct. Allied Capital (ALD) and Gladstone Capital (GLAD) led the way in January. Now several more BDCs have announced equity raisings. Most notably, American Capital Strategies (ACAS) and Prospect Capital (PSEC) have announced substantial stock issuance at prices above NAV, which seemed impossible only weeks ago.

More interesting is that several other BDCs have announced rights offerings to raise capital from existing investors. As the companies stock price trade below NAV, this is the only allowable way to raise equity in this environment. To date, Ares Capital (ARCC), MCG capital (MCGC) and Gladstone Investment (GAIN) have announced "transferable rights offerings" to shareholders.

One could see these moves, especially for MCG Capital, as more defensive than offensive-building up a balance sheet being eroded by questionable investments. Gladstone likewise did mention that the new capital would help with diversification by expanding total assets. Overall, though, most of these capital raisings reflect managements belief that lending and investment opportunities in the months ahead will be unprecedented and the more "dry powder" available the better the returns to shareholders. Barring a melt down in the economy-also of unprecedented proportions-we agree that this is a good time to generate liquidity. With most of the money center banks preoccupied, CLOs in deep freeze and hedge funds in panic mode the supply of capital will drop and those remaining providers will be able to command better terms. Even buying existing loans in the secondary marketplace may result in oversized returns thanks to the rush for the doors underway, even in the middle market.

The bad news is that even with new equity being raised in the BDC industry (about one third of the universe of BDC companies has raised new money or announced their intention to do so in 2008 to date), the bottom has not yet been found as we so optimistically predicted back in January.