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I seek to liberate investors from the chains of borrowed opinions by teaching metric awareness that leads to the formation of your own opinions. I am a retail investor that gathers, processes and analyzes significantly more data than average. I share that data in my articles. I let the data do... More
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  • A Good Day To Buy ARCC 11 comments
    Jul 16, 2014 9:24 AM

    After the market's close, Ares Capital Corporation (ARCC) announced that it plans to make a public offering of 11,850,000 shares of its common stock. Ares Capital also plans to grant the underwriters an option to purchase up to an additional 1,777,500 shares of common stock.

    The price dropped to $16.93 from $17.40 in after hours trading. At $17.00, and with a $0.38/quarter dividend (1.52 per year), the yield is 8.94%. ARCC has a history of providing special dividends on top of the regular dividends. With a $1.57 NII projection, the dividend is "covered". LTM NAV growth has been 2.75%, and that is with special dividends already hurting the NAV growth.

    There should be a very slim dividend CAGR projection. I am using 0.9%. So the yield + CAGR for ARCC is below market average. ARCC is not going to make you rich. It is a tool to pry loose income from a portfolio that is invested in growth else where. Because I own some BDCs, I can own lower yielding MLPs that offer growth. Because I own some BDCs, I can own a high growth Health Care/Pharma stocks - and not the low growth big Pharma stocks.

    Today will be a chance to buy ARCC at a discount. ARCC is a safer than average BDC. I would suggest buying some ARCC at a discount if you are also "buying growth for your portfolio" in other sectors.

    Disclosure: The author is long ARCC.

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Comments (11)
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  • tom007
    , contributor
    Comments (95) | Send Message
     
    Thanks FAC, I agree with your sentiment.
    16 Jul, 09:40 AM Reply Like
  • Scooter-Pop
    , contributor
    Comments (2111) | Send Message
     
    Jumped all over ARCC. Thanks!
    16 Jul, 09:41 AM Reply Like
  • MTURNV
    , contributor
    Comments (5) | Send Message
     
    Thank you for all your detailed work compiling data on BDCs, REITs etc. Much appreciated. Used this opportunity to dip a toe into the BDC realm by buying ARCC following a trim and sale of some of my overvalued utilities.
    Thanks
    16 Jul, 12:45 PM Reply Like
  • Robin Heiderscheit
    , contributor
    Comments (1955) | Send Message
     
    "ARCC is a safer than average BDC," sure, but don't kid yourself that buying at $17 today is as attractive as buying at $17 was two years ago. The leverage is up, both at the investment level and the fund level, and the quality of those investments is down.
    16 Jul, 12:50 PM Reply Like
  • Factoids
    , contributor
    Comments (472) | Send Message
     
    Author’s reply » Robin Heiderscheit wrote: "The leverage is up, both at the investment level and the fund level, and the quality of those investments is down."

     

    At the end of Q4-11, ARCC had Long-term debt ['debt'] of $2.073602 billion and Shares outstanding at the end of the quarter of 205.130 million, the Debt/share was $10.1087 and the Debt/NAV ratio was 65.90%.

     

    At the end of Q1-12, ARCC had Long-term debt ['debt'] of $2.018.866 billion and Shares outstanding at the end of the quarter of 221.875 million, the Debt/share was $9.0991 and the Debt/NAV ratio was 58.82%.

     

    At the end of Q1-14, ARCC had Long-term debt ['debt'] of $3,058.639 million and Shares outstanding at the end of the quarter of 298.270 million, the Debt/share was $10.25 and the Debt/NAV ratio was 62.45%.

     

    So the debt ratio was less than the end of Q4-11, but more than Q1-12. But it is in the same general neighborhood.

     

    At the end of Q1-12, the Debt/EBITDA ratio for ARCC's portfolio companies (that were not a part of the GE co-owned portfolio of senior secured debt) was 4.3x -- and the interest coverage ratio was 2.5x.
    At the end of Q1-14, the Debt/EBITDA ratio for ARCC's portfolio companies (that were not a part of the GE co-owned portfolio of senior secured debt) was 4.6x -- and the interest coverage ratio was 2.8x.

     

    So the change is that ARCC is loaning to companies with a weaker debt ratio - but a stronger amount of interest coverage. That is roughly a wash.

     

    Robin Heiderscheit - the stats that I have (which are from the ARCC earnings release and the earnings supplement) would indicate that your perception is not accurate. I would urge you to post the stats that you have that support your perception.
    16 Jul, 04:49 PM Reply Like
  • Robin Heiderscheit
    , contributor
    Comments (1955) | Send Message
     
    Hi Factoids.

     

    First, I think you are missing the impact of the SSLP program, which barely existed two years ago, but now constitutes something like 20% of total ARCC assets. This is off balance sheet quasi debt that, if consolidated, would greatly change the current debt/NAV ratio at the company level.

     

    Second, your own numbers bear out that portfolio companies -- two years mind you further into the business cycle -- are more levered today than they were at the beginning of 2012. (Although I was surprised that interest coverage was a tad better, that partly reflects the rate compression that is going on and, in any event, is not a surprise given that we are two years further into the business cycle.)

     

    Thanks for replying.
    16 Jul, 06:09 PM Reply Like
  • Factoids
    , contributor
    Comments (472) | Send Message
     
    Author’s reply » Robin Heiderscheit wrote "I think you are missing the impact of the SSLP program, which barely existed two years ago, but now constitutes something like 20% of total ARCC assets. This is off balance sheet quasi debt that, if consolidated, would greatly change the current debt/NAV ratio at the company level."

     

    I am not an accountant - so I can get in dangerous grounds when talking accounting. But I am a pretty good numbers guy. I am seeing the SSLP in the 10-Q as being included in the investments. It looks "on the balance sheet" to me. The balance sheet in the earnings release shows $7.799 billion in Total investments at fair value - and $1.185 billion of those investments are from the SSLP.

     

    And if it is listed as an asset, then by law the debt that roughly corresponds to that assets would also have to be on the balance sheet (but there is no way to say that debt item 'x' is associated with asset 'y').

     

    In summation - I do not see the basis of calling the SSLP investment an "off the balance sheet" item. But . . . . I know that accounting stuff can get weird.

     

    Let me provide an example. If Joe owns $1000 of ARCC on his "balance sheet" - then he has $1000 of equity. The debt level of ARCC does not matter to his own personal debt level. ARCC's debt is not on Joe's balance sheet.

     

    To some degree - ARCC is like Joe , and ARCC owns $1.185 billion of SSLP. SSLP can have debt - but any of the debt caused by SSLP is not on ARCC's balance sheet. Only the debt that assisted ARCC to have $1.185 worth of SSLP is on the balance sheet of ARCC.

     

    In summation - I am not buying that ARCC is more leveraged due to SSLP. On the other hand, I am willing to listen to the argument that this perception is wrong -- if you have the stats to make such an arguement.
    16 Jul, 07:57 PM Reply Like
  • Robin Heiderscheit
    , contributor
    Comments (1955) | Send Message
     
    A typical SSLP investment will be $1, with GE taking the senior 80 cents and ARCC taking the junior 20 cents. Let's say ARCC uses 10 cents of equity and 10 cents of debt to purchase the 20 cent subordinated investment. This investment is booked on the balance sheet as debit assets 20 cents, credit debt 10 cents, and credit shareholder equty 10 cents.

     

    Now suppose GAAP accounting changes so that the SSLP is treated the way some CLOs are. Under the slightly revised accounting treatment ARCC now gets to debit assets for the full dollar of the loan, but now the credit is shareholder equity 10 cents and debt 90 cents.

     

    Post consolidation you have a full dollar of assets from this transaction but 90 cents of debt. Obviously that is a nine to one debt to equity ratio. And it is leverage on leverage on (usually) leverage.

     

    Listen, ARCC is not alone in doing this. KCAP, PSEC, SAR, TICC, and several others are going heavily into off balance recourse financing arrangements. Levering up has allowed them to maintain decent earnings during a period of terrible spread compression, the tightest compression in history by several measures.

     

    I would refer you to Wells Fargo's research for all the details but anyway, my point was that all the players are more levered now than a couple of years ago. It isn't a particularly trenchant or controversional observation, I admit!
    17 Jul, 09:20 AM Reply Like
  • Factoids
    , contributor
    Comments (472) | Send Message
     
    Author’s reply » I am right now looking at the ARCC 10-Q from 3-31-14. On page 76, the details for the SSLP portfolio is provided. The amount of funding from ARCC and GE equals the SSLP portfolio. I do not see that the SSLP as a separate entity is using leverage at all.

     

    I do know that ARCC has a subordinated interest in the SSLP - and the act of "subordination" is a kind of leverage. But their is no "financial" leverage.

     

    My lack of knowledge of accounting appears to be hampering our communication. I failed to follow your argument that resulted in the line "but now the credit is shareholder equity 10 cents and debt 90 cents". You could easily be right - and I could easily be too dumb to see it.

     

    I have access to the Wells Fargo research, and on a day that happens outside of earnings season, I will take the time to read it.

     

    Thanks (a BIG "thanks") for taking the extra effort to make several replies.
    17 Jul, 10:33 AM Reply Like
  • aretailguy
    , contributor
    Comments (1196) | Send Message
     
    It was indeed a good day to back up the truck and buy $ARCC.
    16 Jul, 05:09 PM Reply Like
  • themeyergroup@gmail.com
    , contributor
    Comments (24) | Send Message
     
    Hi there,

     

    Actually I'd like to see a resolution of the erudite discussion above regarding the SSLP accounting. If Robin is right, ARCC could be vulnerable to a weaker balance sheet If Senor Factoid is right, as certainly seems plausible, then ARCC is highlighting an opportunity.

     

    Robin, what say you? Inquiring minds want to know.
    18 Jul, 04:21 PM Reply Like
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