To DRIP or Not to DRIP (Seeking Alpha Article)

I just posted a Seeking Alpha article over here that outlines BDCs and whether or not reinvesting your dividends is worthwhile.

The companies to be examined for this article will be American Capital (ACAS), Apollo Investments (AINV), Ares Capital Corp (ARCC), Blackrock Kelso Capital Corp (BKCC), Kohlberg Capital (KCAP), Main Street Capital Corporation (MAIN), PennantPark (PNNT), Prospect Capital (PSEC), Solar Capital (SLRC) and Triangle Capital Corp (TCAP).

BDC Weekly Roundup 4/22/2011

The BDCR Index had a slight loss this past week by an amount of -0.13% from a level of 321.00 on 4/15/2011 to 321.00 for the week ending 4/22/2011. The major winners were ARCC (+3.12%) and EQS (+3.03%) and the major losers were TINY (-2.90%) and TCAP (-2.79%).

Chart:

News:
CODI - Some insider transactions - http://www.sec.gov/cgi-bin/own-disp?action=getissuer&CIK=0001345126
FSC - Releases annual letter - http://finance.yahoo.com/news/Fifth-Street-Finance-Corp-pz-3301990663.html?x=0&.v=1
HTGC - Closes $75m convertible offering
MCGC - Sells stake in Avenue, realizing $51.4m in proceeds (not return) - http://www.bizjournals.com/washington/news/2011/04/18/mcg-capital-sells-stake-in-avenue.html
PSEC - Adds two new lenders, increases Revolver - http://finance.yahoo.com/news/Prospect-Capital-Announces-iw-3521834156.html?x=0&.v=1

Prospect Capital (PSEC) - What a Difference a Year Makes

(Author's note: I originally started this post with the goal of highlighting some of the changes PSEC has made to their company over the past year. In light of their recent equity raise - a private offering of 9 million shares at a market price destroying $11.40 a share maybe the management of PSEC still is learning. To be fair, the offering does add to Book Value. Although their continued practice of announcing "good news" and trying to sneak in some "bad news" does not sit well. The only way you can find the current pricing of the offering is to go into the SEC filing that I linked above.)

It has been just over a year since Prospect Capital's attempted acquisition of Allied was denied by Allied's management in one of the most eviscerating letters you will see written by a public company . Let us review some of the highlights:

• As a result of this review, Allied’s Board of Directors has unanimously concluded that this revised offer does not constitute, and is not reasonably likely to result in, a “Superior Proposal” as defined under our merger agreement with Ares Capital Corporation (“Ares” or “ARCC”). Allied’s Board of Directors has unanimously reaffirmed its recommendation that Allied shareholders vote for the transaction with Ares announced on October 26, 2009.

Allied added the bold for emphasis.

• During our discussions, Prospect made claims to have access to a significant amount of third party capital. While we were intrigued by these references, Prospect was unwilling to disclose any details, including the identity of the mysterious capital source, nor was Prospect willing to provide any information regarding the financial outline of a potential transaction.

Allied called Prospect out for their lack of transparency in the transaction and refuted the idea that Prospect had been an actual suitor. It is interesting to note that ARCC never increased their takeover offer in response to PSEC.

• We believe Prospect’s unsolicited offer does NOT provide Allied shareholders “Superior Value” as compared to the Ares transaction.

PSEC had made an offer that on its surface was at a premium to ARCC's offer. At the time of PSEC's revised offer to acquire ARCC, the transaction would have resulted in a 20% premium over ARCC's offer. Allied noted that after this offer was made, PSEC's stock dropped more than 5% and eroded the premium. In front, most of the market knew that taking over Allied would have been too much for PSEC to handle. After the offer was withdrawn, PSEC's stock price rebounded.

• We believe a merger with Allied would put Prospect’s dividend at risk, resulting in a near term dividend cut, which would reduce Prospect’s stock price and imply a lower value for Allied’s shareholders

For PSEC to complete this transaction, they would have to more than double the current share count. Given PSEC's eroding Net Interest Income, the only way to maintain the dividend would be to pay out of Capital Gains realized upon completion of the merger and asset write-ups. At the time of the offer, PSEC was already underfunding their dividend by 50%. In retrospect, the management team at Allied was correct and PSEC cut the dividend in May from 41 cents a quarter to 10 cents per month (25% reduction per quarter + they "skipped" the Q2 dividend by only paying 10 cents, although the change to monthly does provide a salve). Further underscoring the lack of transparency, the management team at PSEC hid this dividend cut in another news release discussing Q4 results. The market did not take this news well and the stock dropped another 10% in the aftermath.

• We believe Prospect lacks the managerial expertise to run the combined company.

This one is calling a spade a spade. Allied acknowledged PSEC was still in the "Junior Varsity" of the BDC league and would have a difficult time handling the merger. While this may or may not be true, PSEC did have a much smaller investment/support staff and they would have tripled their investment portfolio.

• There is no assurance that any agreement with Prospect could be reached or closed

Allied knows PSEC has not done its research and any delays would only hurt shareholder value. Also, Allied had already agreed to pay ARCC a $30mm "break-up" fee if the merger did not come to pass (it dropped to $15mm if the ALD shareholders had voted against ARCC).

• We believe Prospect has limited liquidity to operate the combined business

Ares (ARCC) had more relationships and available credit lines to draw than PSEC. Since that time PSEC and ARCC have both reorganized their debt structure. For example, PSEC's revolver is now is one-month LIBOR plus 325 basis points, subject to a minimum LIBOR floor of 100 basis points as opposed to 400 basis points with a floor of 200 basis points.

• We believe the Prospect management platform is inferior to the Ares management platform, providing weaker long term growth opportunities for Allied’s shareholders. Allied’s Board has no confidence in Prospect’s ability to manage the assets in Allied’s portfolio.

Again, this is basically saying PSEC was not ready for the big-time yet.

• We believe the acquisition of Patriot Capital further weakens Prospect’s platform, making Prospect a less attractive merger partner.  

There is always the risk of taking on too much at once. Allied and Ares were already down the line with regards to integrating their firms with ARCC purchasing the unitranche fund in November 2009. While these steps may call into question if Allied would have considered another offer from any BDC, PSEC was still working on integrating the PCAP assets at this time.

• Prospect has a track record of highly dilutive equity capital raises which we do not believe provides responsible growth to shareholders.

Most BDCs at the time were issuing shares below NAV that were dilutive to shareholders. This was the nature of the beast in 2009-2010 before capital markets reopened. The below chart (care of PSEC's Prospectus) shows the dilutive issues.

• We believe, by combining with Prospect, Allied shareholders would be inheriting a much riskier portfolio.

Prospect had recently acquired the PCAP portfolio, which if you had the chance to review before the acquisition was head scratching at best (one investment made prior to PCAP going under was in a hot-tub maker even though the recession had already taken hold). Prospect's management has turned the portfolio around and as of December 31, 2010, about 2.3% of the net assets were on non-accrual (as opposed to 6.8% as of the Allied letter).

Allied management closed the letter with a unanimous "No" against PSEC and the ARCC merger went through as of April 1st 2010.

BDC Weekly Roundup 4/8/2011

The BDCR Index had a small loss this past week by an amount of -0.27% from a level of 325.61 on 4/1/2011 to 324.75 for the week ending 4/8/2011. The major winners were TTO (+2.48%) and NGPC(+2.33%) and the major losers were PSEC (-4.68%) and KCAP (-3.87%).

Chart:

News from the past week:

BKCC - Earnings release AND call on May 9th. I suppose they would prefer investors not have time to really dissect the 10-Q this time...

FSC - Issued $150m in convertible notes with a conversion price of $14.76 and an interest rate of 5.375%

GAIN - Sale of $5.6m equity investment in Cavert and reinvestment into Subordinated Debt - http://www.gladstone.com/article.php?q=%3FModule%3DMediaViewer%26GUID%3D18077006%26Ticker%3DGAIN

PNNT - Sibling company PFLT has a poor IPO - http://www.reuters.com/article/2011/04/08/pennantpark-ipo-idUSN0829180920110408?feedType=RSS&feedName=rbssFinancialServicesAndRealEstateNews&rpc=43

PSEC - Publishes updated earnings guidance, new investment disclosures and sneaks in a secondary. They priced the offering at 11.40 which was highly below the current price, but accretive to Book Value - http://www.sec.gov/Archives/edgar/data/1287032/000104746911003314/a2203200z497.htm 

BDC Weekly Roundup 4/1/2011

The BDCR Index enjoyed a healthy gain this past week by an amount of 2.11% from a level of 318.75 on 3/25/2011 to 325.762 for the week ending 4/1/2011. Note, the index is still below the high set on February 22nd 2011 of 337.57. The major winners were ACAS (+8.12%) and TCAP (+5.54%) and the major losers were GAIN (-3.06%) and NGPC (-2.97%).

Chart:

News items from this past week. Looks like the first week of May will be a busy earnings season:

ARCC - Earnings release scheduled for 5/3.

FSC - Locks in a 4.03% borrowing rate for 10 years - http://finance.yahoo.com/news/Fifth-Street-Finance-Corp-pz-1409467551.html?x=0&.v=1

KCAP - Seeks to win shareholder approval to issue shares below NAV (common in 2009), but Nicholas Marshi disagrees - http://seekingalpha.com/article/261391-dubious-feelings-about-kohlberg-s-equity-raising-plan

KED - Increases dividend from 30 cents to 31 cents per share - http://finance.yahoo.com/news/Kayne-Anderson-Energy-bw-736572173.html?x=0&.v=1

KFN - Investopedia looking at yield vs. P/E - http://stocks.investopedia.com/stock-analysis/2011/Single-Digit-PE-Stocks-With-Juicy-Dividends-CH-KFN-HCII-KED0328.aspx

PNNT - Earnings release scheduled for 5/4.

PSEC - Popular with Wall Street insiders - http://www.fool.com/investing/general/2011/03/28/wall-streets-buy-list.aspx

SLRC - Earnings release scheduled for 5/2.

Prospect Capital (PSEC) to join SmallCap 600

I was intrigued by this headline as it is always exciting when a member of the BDC Index joins a major index. The S&P SmallCap 600 Index (as taken from their website):

The S&P SmallCap 600 covers approximately 3% of the domestic equities market. Measuring the small cap segment of the market that is typically renowned for poor trading liquidity and financial instability, the index is designed to be an efficient portfolio of companies that meet specific inclusion criteria to ensure that they are investable and financially viable.

The purpose of this index is to take a sample of the Small Cap (market capitalization of between $250mm and $1.2b) market and provide investors exposure to the universe of these stocks. Some of the qualifications (aside from market capitalization) include liquidity (at least 250,000 share volume), domicile (US), public float (at least 50%) and financial viability. The inclusion into this index should be fairly beneficial to current shareholders of PSEC (or if you were fortunate enough to buy a day before S&P published the announcement). Below is an extremely crude look at other stocks and some technical analysis on them. This is NOT A RECOMMENDATION TO BUY OR SELL.

Some sample recent additions to the S&P SmallCap 600 and their performance:

As you can see, not every addition produces a winner, but it is safe to say for the next few days PSEC's stock price should trend upward with the majority of the volume trades happening this week. If we ignore ATNI (which had a number of other issues at the time it was added to the index), the average performance boost from A-3 to A+2 (this upcoming Tuesday) is 2.42%, this means the expected close is 12.08 for PSEC.