October 25, 2011: We’re going to briefly cover what’s been happening to the third quarter 2011 net asset value valuations of Private Equity owned portfolio companies, and then make a big jump and suggest what this mean for our bread and butter subject: the Business Development Company industry. Here’s the background: It’s earnings season and the handful of private equity groups which are publicly traded (ignore the oxymoron) have been reporting the values of their portfolios to shareholders. We tweeted earlier in the week that the biggest player on the street-Blackstone Group-had written down its holdings by 11% (while at the same time mentioning that metrics such as revenues and EBITDA were strong and improving over the last 6 months).
According to advisory firm Triago, quoted in a Forbes online article today, said that as more companies report that results are better than expected. Net Asset Values are being written down only 3-5% on average, which suggests that either the reporting firms are fooling themselves and their shareholders ( a possibility which Forbes is open to), or that conditions in the so-called “real economy” which these companies operate in are more benign than a glance at what has happened to the stock market would leave one to believe. The latter conclusion would be more in line with what we learned about Blackstone ‘s portfolio company metrics.
WHAT THIS MIGHT MEAN FOR THE BDC INDUSTRY
On paper, this might not seem to mean much to the BDC industry, which mostly does not get involved in the financing of the larger transactions which the big PE groups are reporting about. However, we’d guess that the relatively mild write-valuation write-downs that we’ve heard about suggests that the private equity industry in general, which includes groups which invest in the middle market and lower middle market and are truly “private”, may be closer to “business as usual” than crisis mode. When the PE sponsors are doing alright, their financiers (which includes Business Development Companies) should be OK too.
OTHER SCRAPS OF INFORMATION
This smidgeon of information, plus early results from a handful of BDC (including Saratoga Investment, Kayne Anderson Energy, Gladstone Capital and Main Street Capital) suggests that the third quarter may not have resulted in any dramatic shift in portfolio company fortunes, or any great upsurge in non-performing loans. Virtually all BDC stock prices have been down sharply in recent months in anticipation thereof and this quarter’s earnings season is the first opportunity to determine if the beginning of a deterioration in the performance of PE-owned private companies.
As usual, the data is not completely clear. Main Street and Kayne Anderson had no new troubled loans to report. Saratoga did have 1 loan get suddenly written-down to zero and Gladstone Capital had two loans go on non-accrual in the quarter. However these were portfolio companies which have been on the books for a while. Moreover, Gladstone Capital (ticker: GLAD) appears to be poised to raise medium term Preferred stock capital, which suggests there is no great fear amongst investors about the overall quality of their loan portfolio. Overall, we have not yet heard of any loan booked in the last couple of years under-performing.
BDC SECTOR DIRECTION ?
If the BDC market believes worse is yet to come, it’s not showing up in stock prices yet. Most companies have come off their 52 week lows, and there is the beginning of a mini-rally underway, but the European worries continually intrude and have made price movements very choppy. The combination of what happens in Europe and the flood of BDC earnings results in the next few weeks will determine what happens to stock prices next. You could have Europe go one way and the BDC sector another, or both in the same direction. It makes for a very difficult investment environment, but that’s stating the obvious.
