Business Development Companies Opportunity

Industry Overview

BDCs are lightly leveraged Closed End Funds that trade on US exchanges (NYSE and NASDAQ). They originate and invest in loans to companies that are generally too small to access public markets. Several BDCs are of institutional investor quality. Since September 2014 the S&P BDC Index has fallen 20%, and many BDCs are trading at that same level of discount to their book value per share. They have fallen in price due to expectations of interest rates rising and following the sell-off in high yield bonds and loans due to default worries in energy. A majority of the BDC industry now suffer from depressed share prices, with only a handful of companies trading above book value.

To characterize BDCs further:

  • Loans tend to be senior and secured in the BDC’s we are interested in. Other BDC’s do invest in mezzanine and subordinated debt.
  • Loans tend to be floating rate so there is no fixed rate risk and returns rise as rates rise.
  • Leverage in BDCs can be up to 100% of capital (2x invested). The 1940’s Investment Company Act limits BDC’s borrowings to the amount of its equity capital.
  • BDC’s are largely owned by retail investors. Institutional investors tend to invest in a few large ones such as the three recommended below.
  • BDCs have tended to avoid loans to energy companies, but retail investors were exposed to energy and have tended to reduce exposures to yield investments into a market with limited buyers. This is a potential driver of the opportunity.
  • BDCs typically return attractive dividend yields between 7-15% p.a., paid monthly.
  • BDCs are ‘permanent capital vehicles’, meaning that their equity capital is locked up and there is no need to sell assets in difficult financial circumstances. So they are insulated from market pressures to sell.
  • BDCs are a pass-through tax instrument that must pay out at least 90% of their earnings as dividends.

The tables below show some of the key metrics of the 10 BDC’s which make up the S&P BDC Index (SPBDCUP) with the inclusion of Solar Capital Ltd (SLRC).

Company Name

S&P BDC Index

Ticker ID

Ares Capital Corp

Yes

ARCC

American Capital Ltd

Yes

ACAS

Prospect Capital Corp

Yes

PSEC

FS Investment Corp

Yes

FSIC

Main Street Capital Corp

Yes

MAIN

Apollo Inv Corp

Yes

AINV

Fifth Street Finance Corp

Yes

FSC

Golub Capital BDC Inc

Yes

GBDC

New Mountain Finance Corp

Yes

NMFC

Hercules Technology Growth Capital Inc

Yes

HTGC

Solar Capital Ltd

No

SLRC

Figure 1: Table of BDC’s, whether or not they are included in the S&P BDC Index as well as their tickers- which are used in the following tables and graphs.

A Brief Comparison of 11 BDCs

To identify where the opportunity does and does not exist in this industry 3 BDC’s have been selected for further consideration according to the following major criteria:

  • Reasonable dividend yield (for the risk of small-middle sized companies)
  • Trading near book value or discount to book value
  • Levered <100%
  • Senior debt
  • Floating rate

The BDC’s which have been selected are:

  • Ares Capital Corp (ARCC)
  • Golub Capital BDC Inc (GBDC)
  • Solar Capital Ltd (SLRC)

The histograms below provide an industry wide comparison of BDC’s according to the desired criteria above.

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Profile of major players

Ares Capital Corp. (ARCC)

245 Park Avenue, 44th Floor

New York, NY 10167

Phone: +1-212-710-2100

Website: http://www.arescapitalcorp.com, http://finance.yahoo.com/q/pr?s=ARCC+Profile , http://www.nasdaq.com/symbol/arcc

Ares Capital Corporation specializes in acquisition, recapitalization, mezzanine debt, restructurings, rescue financing, and leveraged buyout transactions of middle market companies. It also makes growth capital and general refinancing loans. It prefers to make investments in companies engaged in the basic and growth manufacturing, business services, consumer products, health care products and services, and information technology service sectors. The fund also considers investments in restaurants, retail, oil and gas, and technology sectors. It focuses on investments in Northeast, Mid-Atlantic, Southeast and Southwest regions from its New York office, the Midwest region, from the Chicago office, and the Western region from the Los Angeles office. The fund typically invests between $20 million and $200 million and a maximum of $400 million in companies with an EBITDA between $10 million and $250 million. It makes debt investments between $10 million and $100 million The fund invests through revolvers, first lien loans, warrants, unitranche structures, second lien loans, mezzanine debt, private high yield, junior capital, subordinated debt, and non-control preferred and common equity. The fund also selectively considers third-party-led senior and subordinated debt financings and opportunistically considers the purchase of stressed and discounted debt positions. The fund prefers to be an agent and/or lead the transactions in which it invests. The fund also seeks board representation in its portfolio companies.

Comment

Ares have performed extraordinarily well since coming public in 2004. Ares have expanded their book value by 21%, while paying out 90% of earnings as dividends. Signet understands that 57% of loans are senior, 33% second-lien and senior-subordinated, 2% preferred and 8% other. 81% is floating rate. Ares is 168% invested and 1.3% is non-accruing. Ares is trading at a 10% discount to book value and yields 10%.

Golub (GBDC)

(Grants suggests that they are the industry’s gold standard).

DE, United States

Website: http://www.golubcapitalbdc.com, www.golubcapital.com, http://finance.yahoo.com/q?s=GBDC, http://www.nasdaq.com/symbol/gbdc

Golub Capital has over $15 billion of capital under management in its middle market lending business.  Golub has four business lines led by experienced teams of credit professionals: Middle Market Lending, Late Stage Lending, Broadly Syndicated Loans and Opportunistic Credit. Golub offices are located in Chicago, New York, San Francisco and Charlotte.

Comment

Golub invests in first-lien senior secured loans and what they call one-stops (senior and junior credits). Virtually all credits are floating rate and virtually all are current (0.2% non-accruals). Debt amounts to 1x capital. The share trades at about book value and yields 7.9%. Golub are the largest player in middle market lending in the US. The company’s management fee is 1.375% of assets annually.

Solar Capital Ltd. (SLRC)

500 Park Avenue, 3rd Floor

New York, NY 10022, Phone: +1-212-993-1670

Website: http://www.solarcapltd.com, http://finance.yahoo.com/q/pr?s=SLRC+Profile , http://www.nasdaq.com/symbol/slrc

Solar Capital Ltd. is a business development company specializing in investments in leveraged middle market companies. The fund invests in aerospace and defence; automotive; banking; beverage, food and tobacco; buildings and real estate; broadcasting and entertainment; cargo transport; chemicals, plastics and rubber; containers, packaging and glass; diversified/conglomerate manufacturing; diversified/conglomerate services; electronics; farming and agriculture; finance; grocery; healthcare, education and childcare; home and office furnishing, durable consumer products; hotels, motels, inns and gaming; insurance; leisure, amusement, and entertainment; machinery; mining, steel, iron, and non precious metals; oil and gas; personal, food and miscellaneous services; printing and publishing; retail stores; telecommunications; textiles and leather; and utilities. The fund primarily invests in United States. The fund’s investments generally range between $20 million and $100 million. It invests in the form of senior secured loans, mezzanine loans, and equity securities. The fund invests in United States. It may also seek investments in thinly traded public companies and also make secondary investments. The fund makes non-control equity investments.

Comment

Solar Capital trades at a 24% discount to its book value in November 2015 and offers a 9.6% dividend yield. The portfolio comprises 90.2% senior secured loans and 6.3% subordinated debt, with the remainder being equity and warrant investments. Solar is currently invested 1.23x, this level chosen to maximize quarterly earnings while limiting credit risk exposure. Solar would benefit from rising rates as 89% of its portfolio has a floating yield. Slow repayment loans amount to 0.5% so underwriting seems to be top quality. There is no exposure to energy related companies. They tend to lend to asset rich borrowers and loans are made at conservative LTVs (loan-to-value) where they assess they can recoup 100% of the loan value.

The companies below are on Signet’s watch list due to their large premium to book value:

Main Street Capital Corporation (MAIN)

Oak Boulevard, 8th floor

Houston, TX 77056

Phone: +1-713-350-6000

Website: http://www.mainstcapital.com, http://finance.yahoo.com/q?s=MAIN , http://www.nasdaq.com/symbol/main/interactive-chart

Main Street Capital Corporation specialises in long-term equity and debt investments in small and lower middle market companies. The firm focuses on investments in subordinated loans, private equity, venture debt, mezzanine investments, mature, mid venture, industry consolidation, later stage, late venture, emerging growth, management buyouts, change of control transactions, ownership transitions, recapitalizations, strategic acquisitions, refinancing, business expansion capital, growth financings, family estate planning, and other growth initiatives primarily for later stage businesses. It invests in consumer discretionary, consumer staples, energy, healthcare, industrials, information technology, materials, telecommunication services, and utilities sectors. It does not invest in start-up companies or companies with speculative business plans. It invests in traditional or basic businesses. The firm primarily invests in companies based in the Southern, South Central, and South-Western regions of the United States but also considers other domestic investment opportunities. It invests between $2 million and $75 million in companies with revenues between $5 million and $300 million, enterprise values between $3 million and $50 million, and EBITDA between $1 million and $20 million. The firm typically invests in the form of term debt with equity participation. It seeks to exit its debt investments through the repayment of the investment from internally generated cash flow and/or refinancing within a period of three to seven years. It participates in warrants, PIK (Payment in Kind) interest, convertible securities, junior secured or unsecured, senior secured debt, unitranche debt, equity related, common equity, and preferred equity. Main Street Capital Corporation was founded in 1997 and is based in Houston, Texas.

This is a rare BDC that is trading at a 30% premium to its book value. Their dividend yield is currently 8% while their net debt to equity ratio is 73%.

Goldman Sachs BDC (NYSE: GSBD)

(not recommended as new and untested, lower credit quality and not the prime focus of GS.

GSBD was initially a private fund but came public in mid-March 2015 and Trades at a 2% premium to book value. Back in the summer, GSBD had a portfolio of 45 investments in 34 different companies with a fair market value of $914mn. The borrowers are spread over 23 different industries. Exposure to oil and gas is only 3.3%. Virtually every loan is to a domestic U.S. corporation. The Company is essentially a leveraged lender, with 94% of assets in debt instruments. The average yield on the loan portfolio is 10.9% at cost.

Comment

Worth noting is that GSBD has booked three different types of loans: First lien secured; Second Lien Secured, and First Lien Last-Out Unitranche Loans. Two-thirds of the portfolio is in the latter two categories.

Triangle Capital (NYSE: TCAP)

3700 Glenwood Avenue, Suite 530

Raleigh, NC 27612

Phone: +1-919-719-4770

Website: http://www.tcap.com,

Triangle Capital Corporation (2002) specializes in private equity and mezzanine investments. It focuses on leveraged buyouts, management buyouts, ESOPs, change of control transactions, acquisition financings, growth financing, and recapitalizations in lower middle market, mature, and later stage companies. The firm prefers to make investments in many business sectors including manufacturing, distribution, transportation, energy, communications, health services, restaurants, media, and others. It primarily invests in companies located throughout the United States, with an emphasis on the Southeast and Mid-Atlantic. The firm makes equity investments between $1 million and $25 million and debt investments between $5 million and $30 million per transaction, in companies having annual revenues between $20 million and $200 million and EBITDA between $3 million and $35 million and can also co-invest. It typically makes investments between $5 million and $35 million.

Triangle primarily invests in senior subordinated debt securities secured by second lien security interests in portfolio company assets, coupled with equity interests. The firm also invests in senior debt securities secured by first lien security interests in portfolio companies.

Triangle Capital trades at a 14% premium to book value.

Comparison of some key metrics

The primary goal of this section is to establish whether or not these companies have performed consistently over a 3-5 year time frame.

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