We come to the end of the BDC Review Redux although last year I learned of some new BDCs after running what I thought was the last article so, if any reader knows of any I have missed, please let me know. We will cover two which were covered last year and, as a new feature, i will respond to the inquiries I have gotten about which would be my "strongest conviction" investment in the entire group.
After the name of each company, I will provide the price when it was first covered on September 12, 2012, Friday's closing price, the most recently calculated net asset value (NAV) and the dividend yield based on the most recent dividend.
1. Fidus Investment (FDUS) - (13.35) (16.29) (15.27) (9.2%) - FDUS is more of a conventional BDC than the group we reviewed in the preceding article. It tends to invest in mezzanine debt of lower middle market companies. Only 10% of its assets are senior secured notes. With some $328 million in assets and debt of $141.5 million, it would appear to be relatively highly leveraged given its asset composition. However, it holds $68 million in cash and it completed a secondary public equity offering in September at a price of $16.10 a share. A number of readers have asked about the secondary equity offerings that BDCs frequently make. Secondary offerings can often be a sign of trouble and can threaten existing shareholders with dilution. In the case of BDCs, these problems with secondary offerings are generally not applicable. BDCs are generally required to pay 90% of their earnings as dividends and are limited in leverage. Thus, a BDC that sees attractive investment opportunities in its space usually has no option other than a secondary offering to raise funds so that it can invest. FDUS has one large position in a company named Worldwide Express Operations valued at some $30 million which is large in comparison with the total FDUS portfolio. This is not good or bad in and of itself but it probably bears watching.
2. Oxford Lane Capital (OXLC) - (15.25) (15.99) (14.60) (12.6%) - OXLC is a company with a strategy which sets it apart from other BDCs. In fact, it is a closed end fund and is apparently not a BDC at all but since I covered it last year, I will update my coverage. On its website, it has a section on peer comparison and it apparently considers almost all of its peers to be BDCs. At any rate, OXLC invests in junior debt or equity tranches of CLO vehicles. This strategy is explained in more detail in an investor presentation on the company's website as well as in a registration statement recently filed with the SEC. Essentially, OXLC buys - at a big discount - the very junior tranches to bundles of corporate loans. The junior tranches get paid only after the senior tranches are paid and so there is some risk but there is also a very high return if the CLO vehicle performs well. OXLC appears to have no debt and is relatively small with roughly $68 million in assets. It is run by the same group which runs TICC Capital (TICC). If the economy recovers reasonably well, this strategy could work out very, very well. With no leverage, there appears to be no danger of actual failure or of forced liquidation to resolve "ratio" problems. OXLC periodically has "rights" offerings and raises money by selling more stock to existing shareholders. Its recent filing of a registration statement at the SEC may suggest that it is anticipating a secondary offering. No problem with any of this - especially since the stock is now trading at a premium to NAV but a shareholder should be aware so that he can decide whether he wants to participate in a rights offering if another one is arranged.
Readers have asked me what my top choice in the group is and that is difficult because these companies pursue varied strategies and have varied pluses and minuses on their balance sheets. Still, I come back to American Capital (ACAS) trading at $11.80, which is 68% of NAV ($17.39). ACAS now has very low leverage, a shareholder-friendly management which is buying back shares (a sound strategy when you are this far south of NAV), and a great asset mix. It has one subsidiary which manages American Capital Agency (AGNC), a large and growing agency mortgage REIT. Management appears to have a hot hand recently, and NAV has increased explosively since things bottomed out in 2009. I may be sentimental because I bought this down near the bottom for $1.75, but I still think it is a powerhouse of an investment that will pay off well for investors. It would be nice, however, if they started paying a dividend sometime soon.
Anyhow, readers interested in this group should bear in mind that these are relatively small companies and investors should DIVERSIFY for at least two reasons. One reason is that different strategies will perform in divergent ways through various economic conditions (higher interest rates, recession, lower dollar, etc.) and overweighting with one company can result in being on the wrong side of one of these macro trends. The second reason is that unique circumstances can clobber one of these companies; MCG Capital (MCGC) took huge writeoffs over several years due to one equity investment; a number of BDCs had covenants in their loans or notes which required them to stop paying dividends or to sell assets at the very bottom of the market. No matter how smart you are or how much time you spend on research, you cannot anticipate all of these quirky things which can spring up. Diversification is really the only effective defense.
I hope to do more in depth pieces on some of the companies over the next few months. It is great to see that BDC Land has recovered from the near death experience of 2008-09 and is, in fact, experiencing a period of healthy, solid growth.