June 18,2013: Lower mid-market Business Development Company Gladstone Investment (NASDAQ:GAIN) announced the addition of 2 new lenders to it's loan group with $35mn of new firepower.That brings total commitments up to $105mn in aggregate.
WHY THIS IS BIG NEWS: What for most BDCs would be a routine story is big news for GAIN. The Company has never fully recovered from being ditched by it's lender in the Great Recession, selling it's syndicated loan portfolio in a fire sale and from several of it's debt and equity investments heading south. At one time we questioned the very viability of the Gladstone Investment model, which is to devote about 75% of investment assets to loans and the other 25% to equity investments in a relatively small number of proprietary investments in which they own a sizable stake. The idea is that the debt is supposed to support a steady dividend and the equity to provide irregular but significant capital gains as portfolio companies are sold. However, when a higher number of portfolio companies went on non-accrual both premises of the business model were in doubt. The dividend was cut. Net Investment Income Per Share was $0.79 in FY 2008, but only $0.48 in FY 2010. Management regularly discussed their commitment to raising new debt and equity capital, but were unable to do so. The stock price dropped way below the Net Asset Value, even though the latter was itself sharply off par. Not a pretty picture.
TURNING AROUND: The turn came when GAIN was able to sell a couple of portfolio investments (A Stucki and Chase Doors) for big gains. GAIN also managed to raise $40mn in Preferred (really subordinated debt), to provide long term capital which was desperately needed. More recently the Company raised new equity after years of investor indifference (albeit at a sharp discount to NAV). In recent weeks there has been some progress on a couple of the Company's under-performing portfolio loan/investments which has boosted both interest income and confidence.
POTENTIAL IMPACT ON PORTFOLIO SIZE: So the news that the Company's Revolver capacity is to increase by 50% is the cherry on the sundae of GAIN's turnaround. Just counting the $35mn gives the Company the ability to increase the total investment portfolio by 12% at Fair Market Value, 10% at par. Add to that the cash on the balance sheet from the recent equity raise, and you have about $60mn to spend (some of which has already gone into new deals), which would bring total investment assets up to a respectable $350mn, and the key asset coverage ratio of investment assets to debt (which includes the Preferred as per BDC rules) still a healthy 310% (versus a minimum requirement of 200%).
NOT IN THE BAG: We don't want to imply the healing in the GAIN portfolio is a given. Note that the investments at March 31st 2013 were still valued at a 12% discount to par, and the stock price at a further 20% discount. At a time when most BDCs are trading handily above Net Asset Value that's a sign that all is not yet well enough in GAIN-land. Accumulated Realized Losses are still ($40mn), equal to 17% the Company's invested capital before the recent equity raise. Several portfolio companies continue to be very troubled: ASH Holdings, with a cost of $16mn, has been written down to $0. Country Club Enterprises, which was on the brink, is recovering but is still valued at a discount. Long term investment Danco Acquisition , in which GAIN has $17.9mn invested, is valued at under $4mn. Then there's Tread Corp., which was a performing $8.5mn portfolio company a year ago, but is a $15mn non-performing company today. (We should balance this out by pointing out that there are several promising investments in other portfolio companies. We're particularly encouraged by the $6mn investment at cost in Venyu Solutions, which is carried at $25mn).
AN OPTIMISTIC CONCLUSION: Rightly or wrongly, we take some comfort that the new lenders must have taken a close look at the GAIN portfolio and still decided to proceed. Admittedly, lenders are secured, sitting way up on the Gladstone capital structure while shareholders sit you-know-where. Nonetheless, this additional liquidity gives Gladstone the opportunity to increase the balance sheet, and earnings while continuing to be a turnaround shop for several portfolio companies. If everything goes well on both new and existing investments , we may even see an increase in the dividend down the road. Too optimistic ? Maybe, as the stock price has not moved much in months, ranging from $7.10 to $7.6.
Disclosure: I am long GAIN.