January 24, 2012: Here’s the window of opportunity that Business Development Companies (“BDCs”) dream of. After six months of turmoil for BDC stocks, we’ve been in rally mode for the past month. Prices are up and are now, just 10% down from June 2011 levels. This has given many BDCs the opportunity to dust off their offering documents and raise new equity. It’s quite a testament to an industry that back in October was 28% down (April 29 to October 3) that investors should be clamoring to put more money to work. In the past few days, 4 different BDCs have announced secondary equity offerings and more may be on the way.
One of the capital raisers is Fifth Street Finance (ticker: “FSC”), which announced its intention to offer 10mn shares (plus 1.5mn shares for over-allotments) on January 23rd. At time of writing, the final price for the new stock was not set but should be around $10.0, which suggests FSC will be raising around $115.0. That will grow the share count by over 15%. It’s quite an accomplishment for a company that was notable in 2011 for being one of the very few BDCs to cut it’s dividend. Moreover, stock price action has been dramatic. After peaking just below $14.0, FSC’s stock price dropped as low as $8.38 : a 40% decline in just 6 months. Even today, after recovering from its August low, FSC still trades 30% below the 52 week high.
GRAB WITH BOTH HANDS
FSC is raising a boatload of cash, but does not have any pressing need to put the money to work. As the company’s own newsletter reveals, financing activity has shrunk in recent months (as you’d expect) with new lending almost completely offset by repayments. However, FSC says it makes money by turning over its portfolio from front-end fees, back-end fees and syndications to other lenders. As we’ve noted in earlier posts, though, the wise BDC knows to grab the chance to raise new equity if the opportunity presents itself and this is such a time.
Presumably investors are drawn to the fact that the company is trading at the discounts mentioned above, and the fact that loan spreads are elevated after months of market turmoil, dire predictions about double dip recessions and less competition from banks concerned about capital ratios and maintaining solvency. The analysts were projecting higher earnings in fiscal 2012 (which ends in September) than in fiscal 2011, and another increase in FY 2013. Valuing FSC as a multiple of FY 2013 earnings per share of $1.19, the $10.0 stock price for new shares implies a forward multiple of just 8.4x. As of September 2011 the Net Asset Value was $10.07, and will probably be close to that when the December results are announced.
WORRIED ABOUT THE DIVIDEND
FSC has a chequered history when it comes to paying a steady dividend. Twice in recent years the dividend has been cut as the dividend liability increased faster than the company’s ability to pay. Recently FSC’s management has promised to keep its payouts in line with earnings. However, 11.5mn new shares to “feed” in an anemic new loan environment may put pressure on the company’s ability to keep paying the current monthly dividend $0.0958 ($1.15 annually) as recurring earnings per share will probably drop in the next couple of quarters until the new capital is deployed. In the longer run, assuming FSC steers clear of adding new non-performing loans, earnings per share and dividends should increase, if only modestly.
WE ARE LONG FSC