February 20, 2013: Yesterday, mid-sized Business Development Company ("BDC") MVC Capital ("MVC") announced the public offering of $70 million in "senior unsecured notes", with a yield of 7.25% and a maturity date ten years out in 2023. The Notes will trade under the ticker MCVB. The BDC Reporter has been tracking the surge in public issues of unsecured debt by BDCs, which has been underway for over a year. By our count there are now 19 public BDC issues, including MVC's.
We reviewed the Prospectus to determine if MVC's debt is worth owning. Here are the highlights of what we found:
1. The 10 year term is about average for a BDC issue. A few larger cap BDCs have managed to launch thirty year (!) issues, but there have also been 5 year and ten year issues. However, the 7.25% yield is above average.
2. MVC did not seek a rating for the issue, which differs from most of the prior issues in the market and makes it even more imperative for prospective investors to do their own homework.
3. MVC is different from most BDCs in that the Company-since 2004-has focused on making control equity investments in lower middle market companies rather than loans. As a result income is more episodic as companies are bought and sold, and more volatile. One year portfolio values are being marked up, the next year down.
4. MVC, the above notwithstanding, is in the process of making a strategic shift in it's business, and intends to build an investment portfolio with a preponderance of debt investments. Of course, that's music to the ears of prospective MVC Note Holders as this should result in a more consistent income stream with which to pay expenses and interest on the Notes. How well MVC implements this strategic shift will be critical to the performance of the Notes.
5. Like virtually all the other BDC debt offerings, the Notes are unsecured, have very few covenant protections and are structurally and specifically subordinated to obligations of the Company's subsidiaries and existing secured debt. The good news,though, is that the Notes will initially repay the $50mn in outstandings under MVC's financing with Guggenheim Corporate Funding, and the facility will be terminated. In other words, the Notes will be the most senior of the Company's obligations.
6. There has been some drama between Guggenheim and MVC due to the latter's inability to meet a covenant requirement of the lender's. This has resulted in default interest being charged and no renewal of the facility (which expires in April) being offered. As a result, the Company is paying almost as much for the secured Guggenheim debt as for the new Note. Page S-3 of the Prospectus says MVC is paying a LIBOR floor of 1.25%, plus a margin of LIBOR plus 5.25%, which suggests an all-in rate of around 7.0%.
Note Holders are now taking the risk that Guggenheim appears to have been unwilling to shoulder, but with fewer protections.
7. On the other hand, the Company should be cash rich in the short run. At October 2012 (the last reported data) the Company had $42mn in cash. Moreover, the Company has just announced the sale of a portfolio company which will result in $63mn of proceeds. $22mn of that will go right back into a loan (good for income), and the rest will be available for investment. Plus, there's the $20mn of surplus cash to be generated from the Notes issue (plus $10mn of over-allotment to the Manager). Very roughly, MVC might initially have $100mn in cash on it's balance sheet after paying off Guggenheim.
8. In the short run, income from portfolio companies should be higher than in the past, but concentrated in a few names. So Note holders will be looking to the Company's cash hoard, existing portfolio income and commitment to a more debt oriented investment portfolio, to service the debt load over time.
9. To put all this into proportion, MVC's has a portfolio of investments with a FMV just over $404mn (and a cost basis of $332mn, including the soon to be divested entity). After the portfolio sale and Note issuance, MVC's assets will be worth (as best we can tell) about $340mn, there will be cash of $100mn as discussed above, and $80mn in Notes outstanding (including the $10mn over-allotment). This suggests "asset coverage" of the Notes of over 550%. Even if MVC eventually arranges another bank line, and we are assuming (just to be conservative) $100mn, total assets will go to $540mn, and all debt outstanding to $180mn , which still results in asset coverage of all debt (including the Notes) of 300%.
Of course, MVC's investments are illiquid, relatively concentrated and prone to massive write-ups and downs. On the other hand, management does have a long track record in BDC terms, plenty of time to implement their refocusing their strategy, and the general environment favorable (not to be under-estimated). Is that appropriate for a 7.25% return for 10 year risk (in which period much can happen) with very few explicit lender provisions ? We think so, but risk and return are in the eye of the beholder.
Disclosure: I am long MVC.
Additional disclosure: May purchase the MCVB Notes in next 48 hours.