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  • Prospect Capital (PSEC) - 85% Finance Company, 15% Ponzi Scheme

    EXECUTIVE SUMMARY

    Prospect Capital's book value appears misstated. We estimate their current "true" book value at approximately 85% of the reported book value.

    As long as Prospect is able to raise ever-increasing amounts of equity and debt capital and "grow" their balance sheet, they will be able to make dividend payments to shareholders, which we believe are higher than the economic net income of the Company.

    OVERVIEW

    Prospect Capital is a commercial lender that provides loans to private companies that do not have access to capital from the traditional banking channels.

    SIGNS OF PROSPECT CAPITAL OVERSTATING BOOK VALUE

    1) Ever-increasing amounts of capital being raised

    2) Regular issuance of common stock at or below "stated book value"

    3) Limited transparency surrounding At-the-Market stock offerings

    4) Mis-stating investment type. Equity investments are often mis-classified as debt investments (e.g. investment in First Tower Holdings, a financial services company, earns Libor plus 18.5% and has a 1.5% Libor floor. This is clearly an equity investment). This also mis-states Prospect's real business which should be to be a lender to small businesses. Instead, Prospect is a concentrated equity position in questionable businesses in the U.S. For example, Prospect's position in First Tower make it one of the largest non-bank subprime lenders in the U.S.

    5) Fair value marks on investments that earn high coupons are not consistent

    6) Recent investment sectors highlight the urgency to increase earnings dramatically (swinging for the fences) by undertaking risks that are not commensurate with the priced return, amplifying the risk for shareholders

    7) Frequent small equity and debt issuances muddy the waters for even the most diligent investors in keeping up with the capital structure

    8) Almost all of the peers of Prospect Capital pay dividends on a quarterly basis to match the cash flows from their portfolios to cash outflows to shareholders. The monthly dividends implies using capital raise cash flows to service shareholder dividends. The monthly dividends also allow for a more difficult analysis of cash for investors, allowing Prospect to operate in an non-transparent manner

    GAMEPLAY

    Prospect is likely to continue to operate given that capital raising will not cease for them. Banks hungry to lend to them or sell their securities to retail investors will keep feeding this company. The day of judgment arrives when credit markets freeze again and Prospect is unable to raise capital, conceal their then-increasing credit (and equity position) losses. Till then, make merry while the sun shines.

    Sep 29 12:22 PM | Link | Comment!
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