A Strategy For Enhancing Returns With Prospect Capital

| About: Prospect Capital (PSEC)

Prospect Capital (NASDAQ:PSEC) is a business development company (BDC) that lends to and invests in middle market privately-held companies. The company is a closed-end investment company. The company invests primarily in senior and subordinated debt and equity of companies in need of capital for acquisitions, divestitures, growth, development, project financing and recapitalization. A large majority of its holdings are in industries related to the Energy Sector.

Since Prospect Capital is a BDC, it must, by definition, pay out 90% of its net investment income in the form of dividends to shareholders. As such, since PSEC cannot retain earnings to fuel organic growth, the company taps the debt and/or equity markets on a regular basis to raise capital. In the last 2 years, PSEC has performed 5 secondary offerings as seen in the table below.

Date Closing Price Next Day Closing Price Difference ($)
11/1/2012 11.92 10.86 -1.06
7/10/2012 11.9 10.94 -0.96
2/22/2012 11.39 10.97 -0.42
6/20/2011 10.68 10.14 -0.54
4/4/2011 12.15 11.72 -0.43
average -0.68

In response to the public news of a secondary stock offering, PSEC opens at a significant discount relative to the closing price the day before. On average, the share price drops 68 cents following a secondary.

Using this historical stock price performance, one can calculate the enhanced return gained by buying PSEC the day after the secondary is announced versus the day of (prior to the announcement). The table breaks down the PSEC total return as a combination of dividends and stock price change using both the closing price the day of the secondary and the next day post-secondary. The total return is calculated using the 2/15/2013 closing price of $11.39. The average difference in total return between the initial purchase dates is 6.8%.

Prior to Secondary Following Secondary
date Price Return Dividend Return Total Return Price Return Dividend Return Total Return
11/1/2012 -4.4% 3.6% -0.8% 4.9% 4.0% 8.9%
7/10/2012 -4.3% 7.1% 2.8% 4.1% 7.7% 11.8%
2/22/2012 0.0% 11.8% 11.8% 3.8% 12.3% 16.1%
6/20/2011 6.6% 20.2% 26.8% 12.3% 21.3% 33.6%
4/4/2011 -6.3% 19.4% 13.2% -2.8% 20.1% 17.3%

In a similar fashion, the total return for SPY can be computed for a benchmark against PSEC. The table below shows the SPY total return as well as the total return difference between PSEC and SPY both before and after the secondary. Buying PSEC the day after a secondary offering resulted in a total return greater than the total return of SPY four out of the five times. The average outperformance across the 5 secondaries was +2.6%. Conversely, the PSEC total return lagged that of SPY by over 4% when PSEC was bought the day before a secondary offering.

Total Return Comparison
11/1/2012 7.2% 1.6% -8.0%
7/10/2012 14.7% -2.9% -12.0%
2/22/2012 14.1% 2.0% -2.3%
6/20/2011 21.8% 11.8% 5.0%
4/4/2011 16.6% 0.7% -3.5%
average 2.6% -4.1%

The takeaway here is that PSEC is a solid company (as discussed here) with strong underlying portfolio companies with a solid track record of outperformance. Based on an analysis of the historical data, purchasing PSEC the day after a secondary offering not only enhances PSEC total returns but has been shown to outperform the broader market as well.

Disclosure: I am long PSEC, SPY. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

About this article:

Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500. Become a contributor »
Problem with this article? Please tell us. Disagree with this article? .