Christian Oberbeck: 5 Questions To Determine Which BDC To Invest In
The BDC Reporter is inaugurating a new section called “Other Views”, in which we feature BDC-related writings by third party authors. The idea is to provide readers with as wide an array of perspectives about subjects related to the Business Development Company sector. The BDC Reporter may not agree with all or anything contributors have to say, but believes in the principle that readers should have access to as many “Other Views” as possible to help in making up their own minds about how, why and when to invest. We begin this series with a brief article by Christian Oberbeck who suggests to would-be investors in the BDC space what key questions they might ask themselves before hitting the “Trade” button. Mr Oberbeck is a frequent author about a variety of BDC issues, most often published on his website. Chris is the Chairman and Chief Executive Officer of Saratoga Investment (SAR), and one of the few executives in the industry who regularly puts pen to paper for the benefit of readers.
“Financial experts have lauded business development companies (BDCs) for being “a terrific way to generate large dividends for your portfolio.” But how do you choose the right option? As you weigh your options, ask yourself these five questions to help you make the best decision for your investment goals.
1. Do I Understand What BDCs Are?
This is an important question. If you’re rushing into the investment because you read a headline somewhere about the “big yields” associated with BDCs, make sure you take a little time to get to the know this area of the investment industry. Review my primer about how BDCs stack up against traditional investments. In November 2015, I wrote an ABCs of BDCs that explains the history of BDCs and their growth in the last several years. Both articles would be a good introduction for the all-around first-time investor or if you’re building an already growing portfolio and considering BDCs for the first time.
The big thing to remember with BDCs: They are closed-end investment companies that are similar to venture capital funds in that BDCs invest shareholders’ money to generate investment income and turn a profit. BDCs, however, are different in two ways: 1) Accessibility (they’re open to the public, not just the wealthy) and 2) Transparency (BDCs disclose more information and have more open-ended dialogues with their investors).
2. Do I Understand How This BDC, In Particular, Works?
Under the Investment Company Act of 1940, nearly 60 companies have elected to be regulated as a BDC. And, to cite Saratoga Investment Corp’s research, these “companies represent $65 billion in assets under management and $25 billion in market cap.” The types of companies that a BDC invests in will vary by each BDC and its particular focus. Saratoga, for example, invests in later-stage, small- and middle-market companies ($10 million to $150 million in revenue, $2+ million in EBITDA) with strong margins and free cash flow. Other successful BDCs will have different characteristics and strategies, but will maintain discipline.
3. Am I Impressed with the Management?
The not only means the management team of the BDC itself but also the management of the company in which it’s investing. What you want, experts say, is “experienced management with skin in the game.” Though the company’s product or service might seem flashy or irresistible, keep in mind that BDCs invest in people. The BDC should have a good sense of the management personalities and business acumen of a company in which they plan to invest. Plus, that information about the management team should also be available to you (typically via earnings transcripts).
4. Am I Evaluating the Right Metrics?
First, don’t solely choose a BDC based on yield. “Yield is an inaccurate metric and doesn’t tell you anything about the underlying business. Yield should be based on return on equity as opposed to the percentage of yield of the stock,” explains Saratoga’s analysis on choosing BDCs as an investment.
But here are metrics that we at Saratoga recommend:
“A company’s record of building Net Asset Value (NAV) with high quality assets is important to consider. Saratoga’s NAV, for example, is up 76% since 2010, which is a CAGR of 8%. Assets under management are up 202% since 2010, a CAGR of 21%, and more than 98% of our loan investments have the highest credit rating. This indicates that management is concerned with the health of the BDC and is not pushing heedlessly for growth. And then ROE and total return are also very important.”
5. Is There a Clear Competitive Advantage?
The ideal BDC investments are “products that many people use every day that have the potential to take over market share, or products that lead a niche market,” explained financial expert Lawrence Meyers in a recent blog.
However, always go back to BDC earnings. The biggest things that you should look at are, again, the net asset value but also the non-accrual rates, what the portfolio looks like, and the diversification of the portfolio. At Saratoga, we look to diversify by industry and geography, so if one region of the country goes into recession, it will not harm the overall portfolio. But when you’re choosing a BDC, the type of industry and its location are not necessarily as important as disciplined investing and diversification.”
Chris Oberbeck is the Chairman and Chief Executive Officer at Saratoga Investment Corp., a publicly traded business development company. Mr. Oberbeck brings over 25 years of experience in leveraged finance, from distressed debt to private equity, to his position.
Mr. Oberbeck’s wealth of experience stems from originating, structuring, negotiating, consummating, managing and monitoring investments in a wide variety of middle-market businesses. In addition to his aforementioned roles, Mr. Oberbeck is the Managing Partner of Saratoga Partners, a middle market private equity investment firm, and has served on its investment committee since 1995. In 2008, he assumed management responsibility of Saratoga Partners.
Prior to joining Saratoga, Chris Oberbeck served as an integral figure in the early development of the corporate buyout firm Castle Harlan, Inc. Serving as Managing Director, he served as a key figure in successful investments in manufacturing and financial services companies, until departing in 1995 to join Saratoga. In addition to his work at Castle Harlan, Inc., Mr. Oberbeck established himself as a Financial Analyst and Associate at Blyth Eastman Paine Webber (’82-’84) and The Corporate Development Group of Arthur Young (’86-’87).
His financial acumen is a credit to a lifelong emphasis on education that took him overseas for schooling in France, as well as receiving an elite education from New Hampshire’s Phillips Exeter Academy. Upon entering university, he a diverse education–earning his ScB. in Physics and B.A. in Mathematics from Brown University (’82) and M.B.A. with a concentration in finance from Columbia University (’84).
When not at work, Chris Oberbeck endeavors to give back as much as possible through his non-profit efforts. Since 2010, he has remained active in the Chief Executive Organization as well as the World Presidents Organization’s Big Apple and Fairchester chapters. Furthermore, in 2011 he began with the PEN American Center, Literary and Human Rights Organization and Harvard Kennedy School’s Dean’s Council.