BDC Review: Part 5 - 5 More BDCs With Upside Potential

by: Philip Mause

As I have gone through my (hopefully) complete list of Business Development Companies (BDCs), I have discovered a mistake for which I hope my readers will forgive me. I neglected to include Medley Capital (NYSE:MCC) in the newbies group even though it is a very recently created BDC. It is interesting that late 2010 and early 2011 saw a large number of BDC security offerings - in some cases, initial public offerings for new BDCs and, in other cases, secondary offerings of additional shares by existing BDCs. These capital raises created the opportunity for BDCs to lend more money to small and middle sized businesses. The BDC capital raises provide a strong refutation of assertions that QE2 did not have any positive effect on the economy. These security offerings were successful because investors hungry for yield were "chased" out of safer investments by low interest rates and were open to taking some risk in order to get a better yield. I think we may see a repeat of this pattern over the Winter and, of course, it will be a positive factor for existing BDC stocks.

Another thing I have noted working on this series is that BDC stocks are generally down and this has pushed yields up considerably. I think that BDC stocks tend to move with the "financial stocks" group and that group has taken a beating this year. BDCs should be differentiated from some of the other financial stocks because of their low leverage which has become extraordinarily low in the wake of the Panic of 2008. I am more and more convinced that the present level of prices offer investors many attractive opportunities to buy into the BDC sector.

After each company's name I will provide the stock symbol, Wednesday's closing price, the yield and the price/NAV ratio.

Medley Capital (MCC): (10.50), (8.2), (.84). This is the stock which I should have put in the newbies group. It is a very recently initiated BDC; as of the end of the last reporting period, it still had a substantial amount of net cash. As it deploys this cash into interest producing investments, earnings and the dividend should go up. There was considerable insider buying in August.

Gladstone Capital (NASDAQ:GLAD): (7.79), (11.1), (.72). This is part of the Gladstone group of companies (another one is GAIN). It tends to invest in senior debt instruments and appears to have resolved some nasty lender issues which were nettlesome during the 2008-09 Panic. Given the relatively stable nature of its asset base, it is surprising to see it trading at a large discount to NAV. I think it is very attractive at this price level.

BlackRock Kelso Capital (NASDAQ:BKCC): (8.67), (12.6), (.85). This stock took a hit in March but seems to have stabilized. Its earnings recovered in the quarter just ended June 30. It has an asset base consisting of more than 65% of senior secured loans and notes and low leverage so it is unlikely that there will be a big leg down from here.

Apollo Investment (NASDAQ:AINV): (8.95), (13.1), (.88). This is a very large BDC with over $3 billion in gross assets. It has a fairly high level of debt; total assets equal $3.26 billion and debt equals $1.35 billion. Its asset mix is skewed toward subordinated debt instruments. It has announced a $200 million share repurchase which is a bit surprising given the level of debt and the 50% rule that requires BDCs to have debt at a level no higher than 50% of gross assets. This will probably not turn out to be a problem but, given what happened to many BDCs in 2008-09, I am a bit surprised to see a share buy back in this situation. On the positive side it probably means that management is fairly confident that no big asset write downs are on the horizon.

PennantPark Investment (NASDAQ:PNNT): (10.22), (11.2), (.89). This company has had a very strong management track record and I am frankly a bit surprised to see it trading under NAV. They has had a very low level of non-performing loans. This may partly be due to timing - PNNT was born in 2007 and many of the loans on its books were made in a time period in which lenders had the upper hand and could pick and choose and demand favorable terms. On the other hand some of its loans were made back in 2007 when lenders were giving away the store. PNNT weathered the 2008-09 storm well both in share price and company performance. It has now been approved to use SBIC financing which can be attractive. It pulled things together in an investor presentation in June 2011 which is available on the PNNT website.

We are getting near the final round up on BDCs although I do have a few more as well as other investments which allow investors to participate indirectly in the BDC sector.

Disclosure: I am long GLAD, AINV, PNNT, BKCC.