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Prospect Capital: Major Borrower To Repay Debt

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As we listed in the BDC Daily News Table, a portfolio company of Prospect Capital (PSEC) – Instant Web – has been acquired for $476mn. We discuss the publicly available highlights of the transaction and the potential impact on PSEC’s future earnings and balance sheet. We discuss our Dividend Outlook and investment approach for both the common stock and Baby Bond.


NEWS

On December 15, 2017 Instant Web was sold to ModusLink for $476mn. As part of the transaction, the buyer arranged $393mn in Term debt and a $25mn Revolver which -along with common equity and Preferred capital- which will fund the purchase and the refinancing of existing debt that had been on the books since 2014.

According to Advantage Data records, a good portion of the existing debt to Instant Web is held by PSEC, and to a much lesser degree by another BDC: American Capital Senior Floating (ACSF) for an aggregate amount of $365mn at cost, $353mn of which is held by the former.

The existing debt held by PSEC consists of different tranches of Senior Secured, with different pricing.

There is a $121mn tranche priced at LIBOR + 450 basis points, or roughly 6.0% all-in.

There are other tranches with an aggregate cost of $231mn which bear interest rates of anywhere between LIBOR + 1150 to 1250.

From available information, PSEC does not appear to be involved in providing the financing for the acquisition.


ANALYSIS

The Instant Web debt was a major financing for PSEC, accounting for 10.8% of the BDC’s net assets. See page 14 of the latest 10-Q.

Outstandings equal 9% of PSEC’s total debt portfolio at cost, net of CLO and equity investments.

Moreover, the Instant Web loans (except for the $121mn LIBOR + 450 bps tranche) are a major earner for the BDC.

PSEC’s average yield on performing debt investments is 11.8%.

Many of the Instant Web tranches are priced at rates higher than the average debt yield.

We calculate that income from these loans accounted for just shy of 6% of PSEC’s Total Investment Income, using the IIIQ 2017 results.


VIEWS

On one hand, PSEC is getting repaid from a multi-year financing at par, and may receive pre-payment or other fees.

On the other hand, the second largest BDC – whose average portfolio yield is already under pressure from spread compression, lower CLO income and non performing loans- is likely to drop even lower once the repaid capital is re-deployed.

This single transaction is likely to result in a further step down in the recurring earnings of the BDC in 2018.


DIVIDEND OUTLOOK

The BDC Reporter’s Dividend Outlook for 2018 rates PSEC AT RISK, notwithstanding the 2017 reduction in the payout.

Many of the factors which caused this year’s reduction in earnings and dividend cut continue to affect the BDC’s performance.

(The BDC Reporter projects Net Investment Income Per Share, which were $1.04 and $8.05 in the last two fiscal years, will drop to $0.64 in the coming calendar year.

At some point in the next 12 months that might cause PSEC to reduce its distribution. Again). 

The Instant Web repayment causes us to affirm our AT RISK assessment for the year ahead

The beleaguered BDC in the IIIQ 2017 already had no room for maneuver, as Net Investment Income Per Share at $0.18 was already equal to the new, reduced dividend level. 

The market – notwithstanding a recent boost in the stock price aided by MASSIVE insider buying which the BDC Reporter has been covering – yields 10.4% at the current price.

That suggests to us that the market remains doubtful of the sustainability of the $0.72 distribution as well. 


INVESTMENT APPROACH

Common Stock

We have no position in PSEC and no intention of investing either for our Special Situation or Long Term Income approach.

Fixed Income

We are Long PSEC’s Baby Bond with the ticker PBB and hold two Inter Notes which the BDC has issued.

With no senior debt currently outstanding, the asset coverage of PSEC’s near $6bn in cash and assets – even after discounting some of the BDC’s “dodgier” investments- is more than sufficient to ensure the ultimate repayment of $2.6bn in unsecured and Convertible debt outstanding.

PBB yields just over 6% per annum, but is vulnerable to being redeemed by PSEC at the end of next year.

Purchased today – and very roughly speaking and assuming redemption at the first date possible- PBB’s Total Return is likely to be just over 3.5%.

PBB is rated BBB-.

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