BDC Review: Part 2 - 6 Companies In Recovery

by: Philip Mause

This series will provide readers with a review of the Business Development Company (BDC) sector and will attempt to cover all companies in the sector. Readers should be aware that virtually all of these companies are registered investment companies (RICs); they avoid corporate income taxes but are generally required to pay out 90% of earnings as dividends and that dividends are generally treated as ordinary income to the shareholders. You can find part 1 here.

This part will deal with BDCs which ran into series difficulties during the 2008-09 Panic and have been in the process of recovery. BDCs ran into problems because the value of their debt and equity holdings declined and this, in turn, lead to leverage issues and nasty disputes with lenders. Most of these companies have succeeded in reducing leverage and gradually improving the quality of their assets. The general trend has been to migrate capital from equity, preferred equity and subordinated debt investments to senior secured debt and senior debt instrument investments. This change in asset quality, as well as the reduction in leverage has put these companies in a better position to weather the storm of another downturn than the position they were in in 2008

After each company's name, I provide the stock symbol, Thursday's closing price, the current yield, the price/book ratio, and the highest price in the last 52 weeks.

  1. American Capital (NASDAQ:ACAS): (8.36), (0), (.66), (10.65)
  2. MCG Capital (NASDAQ:MCGC): (4.53), (14.4%), (.68), (7.62)
  3. Saratoga Investment (NYSE:SAR): (16.98), (0), (.60), (22.92)
  4. Gladstone Investment (NASDAQ:GAIN): (6.60), (8.6%), (.75), (8.55)
  5. Ares Capital (NASDAQ:ARCC): (14.73), (9.3%), (.99), (17.97)
  6. Kohlberg Capital (NASDAQ:KCAP): (6.29), (10.4%), (.76), (8.71)

Some of these are well off recent highs. I tend to put a fair amount of emphasis on book value because assets can generally be redeployed at fairly short time intervals in this industry. Assuming assets are valued reasonably, sooner or later they will generate income even if they are currently underperforming. I find all of these companies reasonably attractive at these valuations. Reduced leverage means that even if there are some nasty write downs ahead, it is not likely that any of these companies will have the near death experiences we saw in this industry in 2009.

ACAS is trading at a big discount to book and seems to have its leverage problems behind it. There is the potential for quite a bit of upside from the current price level but there is still no dividend. MCGC made big investments in competitive local exchange carriers (CLECs), and they have not worked out well. It has experienced large write-downs in recent quarters (especially with respect to its investment in a company named Broadview). It is getting to the point at which some of these bad investments have been written down so much that there may not be much more bad news ahead. Meanwhile MCGC has been investing the bulk of available funds in senior secured debt and other senior debt and has been gradually producing a much more conservative and current income oriented asset base. At the current discount-to-book value, MCGC investors are paying virtually nothing for the remaining troubled and risky assets.

GAIN is another BDC that had lender issues but has resolved them. Its portfolio is dominantly made up of debt instruments that are yielding at good levels. Its book value per share has been increasing in recent quarters. SAR is the successor to a BDC which had a near death experience. Its size is probably below the optimal size for a BDC and it still faces challenges. The current discount-to-book value more than compensates investors for these problems.

ARCC made the list only because it took over the troubled Allied Capital (formerly ALD) - ARCC itself weathered the storm pretty well in 08-09 but ALD was on the ropes. It should be a reliable dividend payer with some potential for appreciation from here. KCAP got in a nasty dispute with a lender during the last Panic. But it is now resolved and things should continue to improve from here. Book value per share has increased 31 cents in the last 6 months even though sizeable dividends have been paid.

I wouldn't put all of my eggs in any one of these baskets but these stocks can be an interesting though somewhat risky part of a yield oriented portfolio.

Disclosure: I am long ARCC, ACAS, SAR, MCGC, KCAP, GAIN.