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Nicholas Marshi
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Nicholas Marshi is the Chief Investment Officer of Southland Capital Management (SCM). The Company is a Registered Investment Adviser in Santa Monica, California. SCM's principal expertise is in the area of publicly traded leveraged finance to U.S. private companies, including the Business... More
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  • Why OFS Capital Was Downgraded By Oppenheimer 7 comments
    May 9, 2013 4:01 PM | about stocks: OFS

    BDC Reporter: Today, Oppenheimer downgraded the stock of Business Development Company newbie OFS Capital. We thought it would be useful to provide some context around the story. The fly in the ointment is what is happening-or not-about the Company's intention to convert the investment in it's SBIC investment into a wholly-owned subsidiary.

    We read the IQ Conference Call (best as we can-transcriptions make some of the language goofy). Certainly, management had to admit on the call that there was considerable uncertainty about converting their separately owned SBIC into a subsidiary, and getting heir hands on that large amount of cheap capital. Otherwise, the Company's remaining cash and unused Revolver capacity won't be sufficient to cover their current dividend. Here's the basic language in the Earnings Report:

    "Simultaneously, we continue to work towards converting our Tamarix Capital Partners L.P. (Tamarix LP) investment into a drop-down small business investment company fund (SBIC) within OFS Capital. We are working to obtain the necessary investor and regulatory approvals. "

    Here is what the CEO Bob Pittson said early in the Conference Call about the process of getting the SBIC into the Company:

    "... I want to update everyone on our progress and converting the SBIC fund into a drop-down subsidiary. I personally had conversations with a large number of third-party investors in the fund. Based on these discussions, we will soon be sending out a proposal to acquire all their commitments on which $4.5 million is currently funded. We are also finalizing a drop-down documentation, which will be submitted to the SBA for their approval. While we are generally pleased with our progress, there are number of variables that could impact consummation of the drop-down and we cannot provide guidance as to the timing or ultimate outcome. The company [ph] required unanimous consent, there are by my count about 20 potential stakeholders including SBA, who's non-approval could materially alter the drop-down process or derail the process in its entirety".

    Later on, following an analyst's question the CEO made it clear that if SBIC and shareholder approvals from the 20 "stakeholders" are not received, the strategy of OFS will be to invest $25mn in the SBIC anyway (as a minority investor). If approvals are received, the goal is to invest $75mn to maximize the SBIC leverage.

    "We currently have a firm commitment to invest. I think we're roughly at $19 million to $20 million in commitment for the fund, but there is overarching commitment depending on the diversification of investors in the fund, that commitment can move up to $25 million, if we don't become a drop-down. In case of becoming a drop-down, our plan is to and our discussions with the SBA involves committing $75 million in capital to that to maximize the benefits and roll the fund to $225 million."

    The CEO spelled out later why the economics of the planned SBIC subsidiary are so critical to the Company's future:

    "(At the time of the roadshow in October 2012) we were looking at the SBIC fund generating a rate of return fully utilizing the leverage and looking at today's interest rates where they're above 20% rate of return on that investment and the senior loan fund itself, is kind of below teens maybe 12% depending on how much leverage, we can put into that.

    The strategy works, concert with one another getting that exemptive relief essentially creates the ability to create a little more leverage in the BDC with very low cost long-term capital. So really does drive our profitability. ...Our interest rates haven't moved much, maybe there's been a little competition and compression in maybe risk premium side. I'd still hold to mid teens kind of rate of return off of this business model, net of management, based management fees."

    The CEO went on to explain that the projected risk-adjusted return at the SBIC should be very good, especially as OFS intends to provide uni-tranche financing in the SBIC rather than pure mezzanine debt. That means a portion of the assets will be higher up in the capital structure and losses should be lower than in a pure mezzanine vehicle.

    All of that is in the future, and at a time when loan spreads are under pressure, so the uncertainty about getting the SBIC subsidiary approvals is weighing on the stock price. Not helping is that management admits the time being spent on getting the SBIC approved has kept OFS from booking much in new uni-tranche deals.

    The good news here is that the existing portfolio of 58 senior loans is performing well, with only one non-performing loans on nearly a quarter billion of assets. However, management did mention that pricing pressure in the market, has caused the syndicates in which OFS is invested to lower rates on 15% of the portfolio in recent weeks. There is no reason to believe that this won't continue, and only makes more important the ability to invest bi-laterally at higher rates through the SBIC.

    There's too much uncertainty here for Oppenheimer, which downgraded the stock. The price has been stumbling, down $2 off the IPO price and could go lower until the uncertainty about the Company's likely business model is resolved.

    Disclosure: I am long OFS.

    Themes: Dividend Income Stocks: OFS
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Comments (7)
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  • green tube
    , contributor
    Comments (386) | Send Message
    Nicholas, do you feel OFS is a buy down here at $12.37? (as of 5/17). is the floor in sight? on 3/31 the NAV was $14.76. i'm tempted to pull the trigger and buy.


    do you have any opinion on the likelihood of OFS getting the SBIC subsidiary? thanks.
    19 May 2013, 02:51 PM Reply Like
  • Nicholas Marshi
    , contributor
    Comments (376) | Send Message
    Author’s reply » Hard to determine if OFS price has bottomed out. We bought more on the way down so that means the stock will drop further ! The issues that need to be resolved, including the full capture of the SBIC license, will take weeks or months to fully resolve so the price could be in limbo for awhile.


    We read the 10-Q in some detail, and made a number of assumptions (the SBIC "drop-down" would be/would not be approved) and sought to calculate out the pro-forma earnings accordingly as all the capital available to OFS is deployed. The good news is that even if OFS is stymied, and can only invest $25mn as an investor in the SBIC, the Company will still be generating a decent profit (albeit at a lower level than anticipated by the level of the dividend) . Moreover, management will have the option to invest capital in higher yielding investments going forward, and/or raise "baby bonds" instead of SBIC debt. In such a fluid situation with so many alternatives available to OFS there's no point in trying to predict what management's exact steps might be. Still, with $142mn in GAAP equity, we'd be surprised if OFS could not earn an 8% NOI, or $11.4mn, or $1.18. That would suggest at today's price OFS could pay a dividend yielding 9.5%-10.0%. Of course, if everything goes as originally planned earnings could be substantially higher.


    We like special situations with limited downside and a greater degree of upside, and that seems to apply in this situation.
    20 May 2013, 05:25 PM Reply Like
  • green tube
    , contributor
    Comments (386) | Send Message
    excellent. thanks very much!
    22 May 2013, 12:49 AM Reply Like
  • green tube
    , contributor
    Comments (386) | Send Message
    Nicholas... any new insight since MAY? SBIC drop down still in limbo. the share price has been very stable. trading volume is super low, and institutional ownership is small. how much of a concern should that be (if any)? or is this perfectly reasonable, since the IPO was only 10 months ago?
    25 Aug 2013, 01:43 PM Reply Like
  • Nicholas Marshi
    , contributor
    Comments (376) | Send Message
    Author’s reply » We have been buying since May, but with very little new information. The Company issued a release about the SBIC application of it's proposed subsidiary Tamarix,and discussed the subject on it's Conference Call, but there was very little meat on the bones. This is what we know (quoting liberally):


    1. "Currently, OFS Capital owns approximately 67.5% of the limited partnership interests of the SBIC. The Fund and has reached an agreement to acquire all of the remaining limited partnership interests. Third-party commitments total approximately $11 million, with less than half of those commitments presently funded."


    On the Conference Call management explained that OFS has an option to buy out the outside owners of the SBIC by December 2013, at a price which will depend on capital deployed and earnings accrued to that date.


    "If we close the purchase on the day we made the announcement at the end of July, the purchase price for the $4.5 million of funded commitments would be roughly $6.3 million. The final price to acquire their interest however would be dictated by the following factors. First, the final timing of the drop-down, and second the amount of drawn capital. It should be emphasized that of this capital we’d be acquiring all of the earnings of the SBIC fund since it received its license in May 2012. The only distribution made by the SBIC fund since the IPO there’s been a tax distribution of approximately $50,000 at third party investors. Keep in mind, we do believe that the fund has been performing well and that there are embedded gains as noted in our second quarter filing the fair value of our equity stake approximates a 110% of cost."


    Translation: We may have to pay up somewhat to buy out the minority investors.


    2 "OFS Capital also intends to acquire all of the membership interests in Tamarix Capital G.P. LLC, the SBIC Fund’s general partner, as well as retain the services of the entire Tamarix investment team. "


    We don't think that's an issue, as there are related parties and OFS, the parent of Tamarix, is a public company, which is a very good thing for any ambitious SBIC management team who needs capital. Note,though, that the deal is not yet done.


    Why the hold-up on 1 and 2 ?


    "Acquiring the limited partnership interests in the SBIC Fund and the membership interests in the General Partner requires SBA approval. "


    On July 29th, OFS announced paperwork had been submitted to the SBA on July 26th , presumably for approval of 1 and 2. The goal is to have Tamarix be a "drop down subsidiary" of OFS, 100% owned and managed by the BDC.


    Now OFS, it's shareholders, the Tamarix team etc. are all waiting on a very busy SBA.


    What else do we know ?


    1. OFS has spent $250,000 in professional fees on this subject to date, so they are giving it the old college try.
    2. There are 23 outside investors in the SBIC.All have consented to the sale.
    3. The SBIC continues to seek out transactions and recently made a capital call to fund new business ($3.5mn, of which $2.5mn came from OFS and the rest from the third party investors).
    4. Nobody knows how long the SBA will take to adjudicate this matter. Here's a perfect quote from OFS' CEO about that subject:


    "Glenn Pittson - Chairman & Chief Executive Officer


    They [the SBA] have the information; they are working on it right now this much we know. And yes it's hard to estimate it is August, and but they have acknowledged that they are working on the process and it would be hard to estimate when it could be completed although I got to say the SBA has been pretty responsive with us over the last couple of years, and fairly drawn up process, they have not been the big hold up on lot of this so I think keeping my fingers crossed and hoping that well things will move along in a fairly good order."


    We'll know by mid-December most likely. If there is no answer from the SBA, then the option will lapse and anything could happen.


    We think the chances look very good. It makes sense for the SBA, the Tamarix team and even the outside SBIC investors to favor a well capitalized BDC as the parent of Tamarix to provide the equity capital necessary to access the SBIC debentures.


    If all goes as planned and OFS converts itself into a predominantly SBIC lender with a senior loan portfolio bolted on (funded by Wells Fargo), our back-of-the-envelope calculations suggest a $1.4 a share earnings is very reasonable from $225mn in SBIC assets and $160mn in Senior Loan assets, assuming the Company receives the traditional approval from the SBIC of not having to count SBIC debt against the BDC regulatory 200% asset coverage requirement.


    At a 11x multiple (which is average for most BDCs with SBIC strategies), that would value the stock at $15.4 versus $12.0 today.


    Of course, if the SBIC plan does not work out earnings are likely to be lower. But OFS will still own 65% of Tamarix (and will be at least partly benefiting from the 12% yields therefrom and the very low cost of SBA debt capital), and will have substantial capital coming from repayments on it's senior loan facility to redeploy into higher earning assets of some other kind to mitigate the blow. We've done some pro-forma numbers (another term for broad guessing as management is not willing to be drawn into what Plan B might look like) and concluded that -ultimately-OFS would be able to generate earnings per share close to the current dividend level even if their best laid plans for a wholly owned drop-down SBIC subsidiary come to naught.


    We're being patient (what else can we do ?), and betting that if everything works out there's a 25-30% upside here, which is unusually high in the BDC space years into the economic recovery. Still, even the SBA says yes, there's still the whole issue of whether the OFS team can build up the requisite loan portfolio, avoiding credit disasters and deploying capital in a timely manner. That's a parallel issue for which we also have no definitive answer yet.


    Isn't investing fun ?
    26 Aug 2013, 09:48 PM Reply Like
  • green tube
    , contributor
    Comments (386) | Send Message
    wow... the check is in the mail, brother! thank you. OFS seems like the most interesting company in the BDC space right now, based on the potential upside. it appears a "SBIC failure to launch" is already priced into the stock, and that makes it very compelling here and now. but the extremely low trading volume of OFS (2000 shares traded last friday), high retail ownership, and possible choppy september ahead in the broader market is making me hold my powder. very intriguing nevertheless.
    26 Aug 2013, 11:38 PM Reply Like
  • Nicholas Marshi
    , contributor
    Comments (376) | Send Message
    Author’s reply » Absolutely. In a BDC downdraft, or if this gets delayed beyond December (but gets resolved in 2014, for example), there could be another step down in the price, as investors don't know how to value the Company should the consensus become OFS has to turn to Plan B.
    27 Aug 2013, 12:10 PM Reply Like
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