BDC News Of The Day: April 14, 2017
Here are the main news items and SEC filings from all the publicly traded BDCs that the BDC Reporter tracks for Friday April 14, 2017 at 11:00 a.m EST. External links to articles or filings are in blue, internal links to BDC Reporter’s prior posts on the subject are in red. Where appropriate, we add brief comments, and have taken to highliting one major topic every day. Today, we’ve covered a host of different BDCs press releases and a Company Presentation issued yesterday, but the main focus has been to review a press release by Gladstone Investment (GAIN) regarding its portfolio company Mitchell Rubber Products. The BDC Reporter does not just bring you the news, but also seeks to untangle and challenge what is being published out there to give existing and would-be shareholders another perspective besides that of the BDC itself. We try to be fair while still communicating our unalloyed view. If you think we’re being successful or not, please drop us a quick line at firstname.lastname@example.org. Always happy to get feed-back, even the negative kind.
Gladstone Investment (GAIN): Announced Sale Of Portfolio Company.
GAIN announced the sale of Mitchell Rubber Products and that it had “realized a capital gain on its equity investment and generated [a] success fee income from its debt investment”. The press release went on to remind readers that the BDC’s strategy is to invest both in the debt and equity of portfolio companies, and that the Mitchell transaction validated the strategy. Here’s the quote from David Dullum, President of GAIN:
“Since its inception, Gladstone Investment has exited eleven of its management supported buyouts and realized significant capital gains on the equity portion of these investments. The realization of these capital gains continue to validate Gladstone Investment’s strategy and capability as a buyout fund through our investment approach of realizing gains on equity, while generating strong current income for monthly distributions to shareholders over the investment period”.
The BDC Reporter has been following GAIN for more than a decade, and we have a more nuanced take on both the relative success of the BDC’s strategy and the Mitchell transaction. In regards to the latter, GAIN has recorded both very large losses and very large gains over the course of its history. Investing in lower middle market companies is not a one way street. Yes, Acme Cryogenics was sold in April of 2016 for a Realized Gain of $18.8mn. On the other hand, the investment in D.P.M.S./Danco was restructured in October of the same year in a perfect example of what we discussed yesterday about BDCs retaining under-performing portfolio companies in a post regarding Medley Capital Corporation. The Danco restructuring resulted in a Realized Loss of ($10.6mn). See page 25 of the 10-Q. Yes, if we look at the balance sheet and the aggregate of Realized Gains and Realized Losses, GAIN is showing a net positive at December 31, 2016. However, back at the end of its prior fiscal year, the balance was negative.
Management’s position is that GAIN’s strategy is an unqualified success from the standpoint of achieving net gains from its investments over the long haul, and that most of the losses incurred related to an unfortunate period in the Great Recession (which we remember well) when its senior lender withdrew on short notice and GAIN had to sell a portion of its loan portfolio at a discount. Here’s the language from page 43 of the 10-Q which sums up GAIN’s view:
“Since inception, we have completed nine buyout liquidity events, which, in the aggregate, have generated $95.5 million in net realized gains and $19.8 million in other income upon exit, for a total increase to our net assets of $115.3 million. We believe each of these transactions was an equity-oriented investment success and exemplifies our investment strategy of striving to achieve returns through current income on the debt portion of our investments and capital gains from the equity portion. The nine liquidity events have offset our cumulative realized losses since inception, which were primarily incurred during the recession in connection with the sale of performing syndicated loans at a realized loss to pay off a former lender. These successful exits, in part, enabled us to increase the monthly distribution by 56.3% since March 2011, and allowed us to declare and pay a $0.03 per common share special distribution in fiscal year 2012, a $0.05 per common share special distribution in November 2013, and a $0.05 per common share special distribution in December 2014”.
With all due respect for a BDC that has been through the thick and thin of the business cycle, the BDC Reporter believes that’s an over-simplification. Just look down the 10-Q a little to page 50, and you’ll see GAIN recorded two major Realized Losses in 2015, 6 years after the events of the Great Recession: Tread Corporation (still on the books) was restructured and a ($8.6mn) Realized Loss booked. Galaxy Tool Holding Corporation-a long standing difficult credit-also resulted in a ($10.5mn) Realized Loss and was restructured. Thrown in the 2016 Danco loss mentioned above that’s nearly ($30mn) in Realized Losses and we haven’t yet gotten out of the last couple of years.
Moreover, there are still many moving parts in the existing 44 company portfolio. The BDC Credit Reporter’s counts 20 companies on our un-patented Watch List, which is a high proportion even by BDC standards. To be fair only one company is in the Non Performing category (Tread Corporation, notwithstanding the prior restructuring), 4 are in our Corporate Credit Rating 4, where a loss is more likely than full repayment, and 15 are in Corporate Credit Rating 3, our first Watch List level. The BDC itself admits that in aggregate the cost of all investments remains above the fair market value several years into the expansion: “At December 31, 2016, the fair value of our investment portfolio was less than our cost basis by $27.5 million”.
As an outside observer, the BDC Reporter’s assessment is that there remains a question mark over whether GAIN’s strategy of investing principally in the debt of lower middle market companies, while also investing a good portion of its capital in minority equity stakes with a view to achieving Realized Gains which will offset credit losses and more, is working. Of course, we are currently in a very positive environment for corporate M&A- even in the lower middle market- which is enhancing equity realizations. Moreover, the liquidity in the markets is reducing credit losses as troubled companies can more readily find white knights and ways to remain operating when things go wrong. Moreover, GAIN itself is willing to take over non-performing companies when necessary and provide another shot at corporate success. In recent years that has resulted in a greater preponderance of success than failure, but we shouldn’t generalize too much about the weather from a few sunny days. Moreover, the BDC Reporter remains concerned about the continuing concentration of GAIN’s portfolio in a few big names. Our trusty 10-Q shows on page 47 that just 5 companies represent 27% of total investment assets and 22% of Investment Income at GAIN. Thankfully none of the Famous Five are also on our Watch List but should that change…
We wish GAIN well, and the External Manager must be anxious to raise additional equity capital after being stymied for years by the earlier credit losses and the discount of fair value to cost. Asset growth has come partly by issuing Preferred, which is treated as debt for regulatory reasons, which has the benefit of providing medium term capital, but which is expensive and hardly accretive from an income point of view after management fees, incentive fees, operating costs and the dividends are factored in, as well as the non-income producing equity investments purchased with the proceeds. No wonder the External Manager has had to subsidize GAIN’s very stable distributions by regularly waiving a portion of its compensation, much to its credit and reflecting David Gladstone’s long term perspective. Nonetheless, shareholders should take with a grain of salt the Mission Accomplished banner that is being flown over the BDC following the Mitchell transaction.
As a postscript, you’ll notice no numbers are mentioned when the press release speaks of a “realized capital gain” from Mitchell. At December 31, 2016 GAIN was carrying its Preferred stock investment in the Company at a discount to cost. The $27,000 invested in common stock was valued at zero. Yet, the note to the senior loan suggests GAIN already knew Mitchell was being prepped for a sale, given the success fee for loan pay-off was already booked in Fair Market Value. Shareholders should not be expecting -unless we are completely wrong- much in the way of increased value from the ultimate sale of Mitchell over how the investment was booked at the end of 2016. What is more pertinent, and not mentioned in the press release, is Mitchell’s remarkable recovery from a valuation standpoint. As late as September 2016, Mitchell had been on our Watch List and had arrived there back in IVQ 2014. It’s a clear validation of the BDC Reporter’s thesis that the GAIN business model is subject to wide fluctuations in value.
GAIN’s shareholders who-if we’re right about minimal Realized Gains coming – might have a sweet and sour feeling about the Mitchell transaction. Yes, the investment will get repaid and a $1.5mn in fees or more booked, but the BDC will be losing a $13.6mn Second Lien loan that’s been on the books since 2011 and which yields 13.0% fixed and represented by itself over 3% of total investment income in the last calendar quarter of 2016.
Fifth Street Finance (FSC): Announced IQ 2017 Earnings Release Date.
The troubled BDC, which just lost its CEO, will be announcing its first results since that departure and just three months after a series of major credit reversals. Shareholders and speculators will be very interested to see where the portfolio stands when the BDC announces the first quarter 2017 results.
Fifth Street Senior Floating Rate Corp: Announced IQ 2017 Earnings Release Date.
FSFR-sister BDC to FSC- and facing the same CEO departure- will be announcing its results on the same day. FSC comes out before the market open and FSFR after ! As the Yahoo Finance chart shows, FSC is trading very close to its all time lows since the shock announcement of Patrick Dalton’s departure shortly after arriving as CEO and Board member at both BDCs, but FSFR (whose credit problems may be smaller) has perked up from a price standpoint. As always the markets are trying to get ahead of the news. For what it’s worth the BDC Reporter has no firm idea about what Mr Tannenbaum and Fifth Street Asset Management (FSAM), the Investment Advisor to both BDCs, have in store for shareholders. Unless someone has some juicy inside information about what’s going to happen next (which is possible given that there must be a plethora of officers, investment bankers, lenders and insiders involved in hammering out a path forward for both BDCs) the upward trending price at FSFR may just reflect that better looking portfolio.
Hercules Capital (HTGC): Announced IQ 2017 Earnings Release Date.
The highly successful venture lender and investor will be releasing its results and holding its Conference Call on May 7th on the same day after the close. East coast investors and analysts will have to attend the Conference Call on their subway ride home. Those of us on the West Coast will not have to get up at the crack of dawn, as the Conference Call is scheduled for 2 p.m. PST. Nonetheless, the BDC Reporter does not approve when BDCs leave very little time between the release of new information and the only generally available time for shareholders to ask questions of the senior management. Presumably the analysts can get their questions answered most any time, but other shareholders will be communicating with Investor Relations.
MVC Capital (MVC): Announced A Quarterly Dividend Of $0.135 A Share For April 2017.
MVC has consistently paid a distribution to shareholders, even though it’s strategy for many years was to invest principally in non-income producing equity investments. As the press release points out, this is the 48th sequential quarterly distribution since July 2005. More recently MVC decided to become a more “normal” lender BDC and has been seeking to add more yielding investments to its portfolio. The jury is still very much out, from the BDC Reporter’s perspective, on how successful the transformation has been, but that’s a story for another time. However, MVC’s stock price has been on the ups in the last year, reversing a prior long term decline.
OFS Capital (OFS) : Publishes IVQ 2016 Investor Presentation.
Here is the slide show that accompanies the SBIC-focused BDC’s latest earnings release. There’s nothing there which is not already in the public record but does serve as a useful, succinct and timely summary of the case for OFS Capital. The BDC recently raised new equity capital in a successful secondary offering and is expected to increase its balance sheet size if and when a new SBIC license is approved. For anyone thinking about investing in this unusual BDC, with a focus on the lower middle market (which has dynamics quite different from the middle and upper middle market) this is a useful starting point.