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Ares Capital: Pricing of Convertible

NEW YORK–(BUSINESS WIRE)– Ares Capital Corporation (Nasdaq:ARCC) announced that it has agreed to sell to initial purchasers in a private offering $350 million aggregate principal amount of its 3.75% Convertible Notes due 2022 (the “Convertible Notes”). Ares Capital has also granted the initial purchasers an option to purchase up to an additional $52.5 million aggregate principal amount of the Convertible Notes. The Convertible Notes will be offered only to qualified institutional buyers (as defined in the Securities Act of 1933, as amended (the “Securities Act”)) pursuant to Rule 144A under the Securities Act. The closing of the transaction is subject to customary closing conditions and the Convertible Notes are expected to be delivered and paid for on January 27, 2017.

The Convertible Notes are unsecured and bear interest at a rate of 3.75% per year, payable semiannually. In certain circumstances, the Convertible Notes will be convertible into cash, shares of Ares Capital’s common stock or a combination of cash and shares of Ares Capital’s common stock, at Ares Capital’s election, at an initial conversion rate of 51.5756 shares of common stock per $1,000 principal amount of Convertible Notes, which is equivalent to an initial conversion price of approximately $19.39 per share of Ares Capital’s common stock, subject to customary anti-dilution adjustments. The conversion price is approximately 15% above the $16.86 per share closing price of Ares Capital’s common stock on January 23, 2017. Ares Capital will not have the right to redeem the Convertible Notes prior to maturity. The Convertible Notes will mature on February 1, 2022, unless repurchased or converted in accordance with their terms prior to such date.

Ares Capital expects to use the net proceeds of this offering to repay certain outstanding indebtedness under its debt facilities. Ares Capital may reborrow under its debt facilities for general corporate purposes, which include investing in portfolio companies in accordance with its investment objective.

Neither the Convertible Notes nor the common stock that may be issued upon conversion thereof will be registered under the Securities Act. Neither the Convertible Notes nor the common stock that may be issued upon conversion thereof may be offered or sold in the United States absent registration or an applicable exemption from the registration requirements of the Securities Act.

View source version on businesswire.com: http://www.businesswire.com/news/home/20170124005584/en/

 

The results are in for the Ares Capital (ARCC) pricing exercise for its new Convertible Notes offering, which we discussed in an earlier post.

At the time, we dared to wonder if the biggest BDC would be able to raise this new debt capital under 4.0%.

Yes is the answer, with ARCC pricing the Convertible at 3.75%

By our calculations, the interest cost on the Convertible is within a 0.25% annual rate from its secured, short term Revolving Funding facility.

We’re one rate hike away from (unsecured) medium term debt capital being priced the same as (secured) short term.

Now, that’s a flat yield curve.

For a few BDC players, at least.

GET GOING WHEN THE GOING IS GOOD

The amount of the Convertible-like with the Hercules Capital Convertible of last week-has also increased.

On Monday the amount to be raised was $287.5mn (including over-allotments). On Tuesday-with no explanation-the amount was up to $402.5mn.

CONVERSION PRICE

The Convertible Notes have to rise 15% to become “convertible” into shares, or a price of $19.39.

Admittedly, ARCC’s stock price has not reached that level since the Great Recession, peaking at $18.52 on February 1, 2013.

However, as the chart shows for ARCC’s full life as a public company, that rarefied price level was reached at its IPO and again in 2007.

The BDC’s September 30, 2016 Net Asset Value was $16.59, so the conversion price is a fair premium, and should be accretive to existing shareholders.

HOME RUN

ARCC has hit a solid home run with this debt capital raise, based on the low yield achieved, the equity strike price and the amount brought in.

Shareholders should benefit, both in lower interest expense (the Note being repaid was at 4.875%), and by the fixing of the liability for 5 years.

ARCC will continue to have plenty of latitude-given the very few covenants involved in the Convertible-to invest in what they want with the monies raised.

LOOKING AHEAD

As we said yesterday -in our schoolmaster tone-the principal risk is that this easy money will go to the External Manager’s head and ARCC will bend its own credit and leverage discipline.

Don’t expect  any schoolmaster warnings from the credit rating agencies.

On Monday, S&P (not even waiting for the issue to price) assigned a BBB rating to the Convertible Notes. (Hercules Capital had to be satisfied with a BBB-).

As the following quote suggests, S&P is not much worried about too much debt accumulating at ARCC, like heavy snow on the roof:

“ARCC intends to use the proceeds for general corporate purposes, including paying down outstanding borrowings on its revolver. Therefore, we expect the transaction to be leverage neutral. We believe the company will eventually draw upon the revolver again to fund growth. As of Sept. 30, 2016, ARCC’s debt to adjusted total equity (ATE) was 1.19x. Despite high leverage relative to peers, we maintain a favorable view of the company’s capital, leverage, and earnings due to good realized returns and non-deal-dependent income. “

From S&P’s lips to God’s ears, the BDC Reporter says, but we’ll still be watching what happens at the biggest BDC in the quarters ahead.