BDC Review Redux III: 6 Solid Citizens

by: Philip Mause

The third article in the series, written on September 7, 2011, featured six companies that had weathered the Panic of 2008 reasonably well without inordinate write-offs or near death experiences; in addition, the stocks of these companies held up "relatively" well during that period of time many of us would like to forget. These companies present different pros and cons in comparison with the companies in Part II. The solid citizens rarely trade at a substantial discount to Net Asset Value (NAV) and often trade at a substantial premium. They frequently have a somewhat lower dividend yield but a tendency to increase NAV and dividends over time. An investor is probably paying somewhat of a premium for a management team which has achieved a track record for avoiding bad loans and managing credits to avoid defaults. To the extent that the premium over NAV is large, there is some exposure to a "mood swing" on the part of investors.

One notable thing about this group of companies is that many of them have recently completed successful public offering of notes or bonds. The bond market has improved so that it appears that many companies are in a "get it while you can" mode and are raising money even if they do not have an immediate and desperate need for the cash. After the name and symbol for each company, I will provide the price on September 7,2011, Thursday's closing price and the current yield.

1. Hercules Technology Growth Capital (NASDAQ:HTGC) (8.85) (10.96) (8.8%) - HTGC invests primarily in the technology sector and often takes an equity kicker as part of a financing transaction. It recently completed an offer of 7 year senior notes at 7%. It has moved up nicely but is still not trading at a big premium to NAV.

2. Triangle Capital (NYSE:TCAP) (17.04) (25.26) (8.0%) - TCAP has a management team which appears to have been very adept at side stepping the credit mess and avoiding defaults. It trades at a substantial premium to NAV (which is $15.21 a share). Roughly 12% of its portfolio consists of common equity or warrants and there is substantial potential for appreciation in the value of the NAV. As an investor, I have always considered it to be on the expensive side in comparison with other BDCs and so have held off and have unfortunately missed quite a nice opportunity for appreciation.

3. Prospect Capital (NASDAQ:PSEC) (8.25) (11.56) (10.5%) - PSEC at one time focused on the energy industry. It then acquired Patriot Capital on attractive terms and broadened its focus to many other industry groups. At this time, its portfolio still contains some energy industry positions but the weighting is in line with the norm for a diversified BDC portfolio. It recently completely a successful offering of 7 year notes at 5.85%. There have also recently been some insider purchases.

4. TICC Capital (NASDAQ:TICC) (8.93) (10.23) (11.2%) - TICC specializes in loans to the technology sector. It has little leverage now but is in the process of selling notes. It focuses on companies with revenues below $200 million and market cap below $300 million. In recent quarters, it has generally had a strong record of beating earnings estimates. It appears to be in the process of employing more leverage which should push up earnings as long as credit quality is maintained.

5. Fifth Street Capital (NYSE:FSC) (9.32) (10.81) (10.4%) - Again, FSC has generally had a good track record of avoiding problematic credit situations. FSC completed a $91 million secondary offering of its stock recently at $10.79, so at this price you are in line with the offering price.

6. Main Street Capital (NYSE:MAIN) (17.97) (29.58) (6.0%) - MAIN trades at a generous premium to NAV (which is $16.89 a share). I have always considered this stock to be "too expensive" and I have obviously missed a great opportunity. MAIN has a somewhat unique strategy of focusing on the lower middle market; the companies it finances are probably, on average, smaller than the companies that many other BDCs finance. This market is underserved and therefore MAIN is able to obtain attractive terms - getting double digit interest rates on senior secured loans to good solid businesses. Each transaction is relatively small so that the exposure to the failure of any one of these businesses is not tremendous. MAIN also acquires equity in many transactions. It has had a solid track record of increasing NAV and dividends but its stock price always stays well ahead of NAV. At this price, the premium to NAV seems pretty steep but the management team has done such a great job that it just may be worth it.

Ares Capital (NASDAQ:ARCC) should really also be in this group because it has been a solid citizen through the credit crisis - it is in group II only because of the Allied acquisition but, with that transition completed, it should really be here.

A review of the BDC stocks thus far suggests that an investor did not have to be a pinball wizard at stock selection in order to make some serious money; the sector has done well as could have been predicted in a low interest rate environment. Are we getting "toppy"? These stocks present a real dilemma in this kind of interest rate environment. Dividend yields would suggest that further appreciation is possible to bring yields down to levels comparable to junk bonds. On the other hand, that would push stock prices much higher than NAV and would presumably lead to secondary offerings and new market entrants (as it has), ultimately saturating both the market for loans to businesses leading to less advantageous terms and the investment market for BDC stock leading to price declines. I think we really have a long way to go before that happens. We could have a fair volume of secondary equity offerings and debt offerings coming out of this sector as long as interest rates are this low. This would, of course, not be the worst thing in the world for American business.

Disclosure: I am long HTGC, PSEC, TICC, FSC, ARCC. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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