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Gladstone Capital : Prices New Term Preferred

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On September 20, 2017 Gladstone Capital (GLAD) announced in a press release the pricing of its new Term Preferred offering, and filed an updated Prospectus. Both documents are attached. The BDC Reporter – which has reviewed the initial news of the Term Offering on September 19 – provides an update, analysis and seeks to ascertain how GLAD’s debt liabilities might be constructed going forward.


NEWS

GLAD is selling 1.8mn shares of its Term Preferred at $25.00 a share for a total proceeds of $45,000,000. An additional 270,000 shares could be issued to the underwriters under the over-allotment arrangements.

The BDC expects to receive from the initial Term Preferred issuance $43.3mn, net of expenses.

The coupon on the Term Preferred has been fixed at 6.00%.

Dividends will be paid monthly.

The new Term Preferred with trade under the ticker GLADN.

The Term Preferred expires in 2024 but will be redeemable at an earlier date by the issuer , but no date is yet set in the Prospectus.

GLAD’s press release has made clear that all the proceeds will be used to repay the existing Term Preferred with the ticker GLADO as soon as practical.

The Prospectus shows that dividends have been set for GLADO to September 20, payable nine days later.

The shares for the new Preferred are targeted to be delivered by September 27.

However, given that the prior Term Preferred totals $61mn, up to $18mn will be drawn under the existing Revolver to pay-off GLADO.

The Prospectus also discloses that on August 24, 2017 the BDC negotiated a Third Amendment to its Credit Agreement.

At the time, the borrowings under the Revolver were $76.5mn.

The Prospectus also discloses that “in August” GLAD invested $12.5mn in a new portfolio investment: El Academies.

Not clear is whether the $12.5mn to fund the new investment was drawn and included in the $76.5mn balance of the Revolver on August 23, 2017.

In July – as previously reported – GLAD had received repayment of its loan in Source HOV for $4.8mn.


ANALYSIS

The interest/dividend savings on the new Term Preferred will be $0.325mn annually on the portion funded by GLADN, and approximately $0.266mn for the amount funded by the Revolver.

[The Prospectus indicated the current cost of the Revolver is 5.3%].

That’s a pro-forma annual savings of just under $0.6mn.

Swings And Roundabouts

However, the BDC will have to book a $1.7mn cost for the issuance of the new Term Preferred, and incur the acceleration of amortizing costs from the issuance of GLADO.

Moreover – as the Risk Disclosures in the Prospectus mentions – there may be a time gap between when the new Term Preferred is issued, and accruing interest, and the repayment of GLADO.

It’s unlikely to be more than a few days/weeks, but will result in a one-time doubling of interest/dividend expense.

Revolver Reliance

Initially, the use of the Revolver to pay off GLADO will increase the facility balance to approximately $95mn. That will be an even higher number if the El Academies funding happened subsequent to August 23, 2017.

The Revolver has a $170mn facility limit but not all the amount is available to be borrowed, due to borrowing base limitations.


VIEWS

Aimed Too High

We were too optimistic about both the new Term Preferred’s interest rate and amount raised.

In our prior post we had assumed the new Term Preferred might be raised at a 5.5% rate.

Moreover, we speculated that GLAD might even choose/ be able to raise an amount greater than the $61mn due to redeem GLADO.

From Management’s Perspective

However,  6.0% yield is still an achievement for GLAD for 7 year, unsecured money.

Sticking To Our Guns/Prediction

Moreover, we would not be surprised – as mentioned in our earlier post – if the BDC did not add to GLADN in the future or issue a pari passu Term Preferred offering with a shorter maturity and lower rate in the future.

From A Shareholder Perspective

From a shareholder standpoint, and notwithstanding the interest savings, we don’t expect much – if any – of the lower costs to have any material impact on reported earnings or the distribution.

In fact, we now expect even greater one-time debt facility arrangement costs and doubling up of interest charges in the IIIQ 2017 earnings.

However, this transaction is still in progress and we’ll revisit the changes to GLAD’s income statement and liability structure in a third article to be published once all the smoke clears.


INVESTMENT STRATEGY

Common Stock

As we indicated yesterday, we have no position in GLAD’s common stock under either of our investment strategies. Nothing that has transpired with the new Term Preferred and the repayment of GLADO that causes us to change our view.

Furthermore – as we’ve noted on more than one occasion – we continue to question -even at a 6.0% interest rate – if this Term Preferred or Baby Bonds issued by most other BDCs – results in any accretive earnings.

Once you’ve paid 6.0% on the Term Preferred , plus the cost of arranging the facility (0.1%-0.25% per annum) plus the 1.75% Management Fee, plus any incremental operating expenses for new investments booked, plus any Incentive Fee and taken into account the bad debts that might occur over a 7 year period, and remembering that not all the capital will go into yielding investments, we wonder how much shareholders see of the extra income generated by the portfolio assets acquired with this capital ?

With likely lower yields coming in the years ahead on new loans being made because of hyper competition our rhetorical question seems ever the more valid, but with no checks and balances from BDC Boards it’s a question with no answer.

You’ll notice that no Prospectus ever seeks to make the argument – with the sort of numbers we mention above – that shareholders can expect higher earnings per share over time from these debt raising expeditions.

Term Preferred

With greater clarity available, we expect to be repaid out of our GLADO position in our BDC-debt focused investment fund by the end of September or early October at $25.00, plus a small amount of accrued interest.

Given the 6.0% interest rate on GLADN and the strong protections afforded by the Term Preferred (superior to unsecured notes- but a subject unto itself) we expect to re-invest our proceeds from GLADO in the new issue at the lower rate and receive an (11%) lower yield.

[As we’ve said before, “spread compression” does not only affect the BDCs themselves when lending to borrowers but to their liability holders as well ].

We expect GLADN will include a three year redemption term.

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