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Breaking News: Fidus Investment Results Preview

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INTRODUCTION

Fidus Investment (FDUS) is preparing to issue its first series of Unsecured Notes, which we’ll be discussing in a later article when more details (like the pricing !) are known. (We have already warned readers who check our constantly updated Fixed Income Table that a new Baby Bond is coming their way). However, the BDC also disclosed in its accompanying Prospectus a long list of developments in its portfolio since September 30, 2017 as well as a preliminary estimate of Net Investment Income Per Share, Adjusted Net Investment Income Per Share and NAV Per Share. The BDC Reporter seeks to analyze this new data on the fly as the stock – which has been dropping in recent weeks – falls on the news. We’re asking ourselves if FDUS is a Good Buy at this point. 


NEWS

Here is the full “Recent Developments “ disclosure from the Prospectus and the BDC Reporter’s notes and comments on each item involved:

“On October 17, 2017, we exited our debt and equity investments in Brook & Whittle Limited. We received payment in full on our subordinated notes. We sold our equity investments for a realized gain of approximately $1.0 million.

[BDC Reporter: This is a commercial printer. The equity value was carried at cost or below till just before this pay-off announced.  $11.1mn at Cost and $12.2mn at FMV at 9/30/2017. The above suggests investment sold at FMV. No Unrealized Gain or Loss. Realized Gain : $1.0mn. Seems like a positive result but loses $10.7mn in Subordinated Notes at 12.0%. However, FDUS has over $12mn to re-invest. If all earmarked to debt investment income could be same or grow when re-deployed.]

On October 30, 2017, our board of directors declared a regular quarterly dividend of $0.39 per share which was paid on December 27, 2017 to stockholders of record as of December 20, 2017. In addition, on October 30, 2017, our board of directors declared a special dividend of $0.04 per share which was paid on December 27, 2017 to stockholders of record as of December 20, 2017.

[FDUS still had substantial spill over taxable income as September 30, 2017: “At September 30, estimated spillover income or taxable income in excess of distributions was $11.9 million or $0.49 per share. Even after the Special Distribution, there should be Spillover income available. Given tax/book differences we won’t speculate more]

On November 10, 2017, we restructured our equity investments in FDS Avionics Corp. (dba Flight Display Systems). As part of the restructuring, we cancelled our common and preferred equity investments, and as a result we recognized a loss of approximately $2.4 million. Concurrently, we made a $0.7 million investment in new common equity interests of FDS Avionics Corp. (dba Flight Display Systems).

[FDS has been a Watch List credit since IVQ 2015. FDUS had been lender for years with $5.2mn of Subordinated and $2mn of equity. Recently added slightly to equity and a Preferred tranche for total of $7.8mn with both subordinated and Preferred income producing. The Subordinated yields 12.25%, which would will a definite loss to recurring earnings of $0.635mn a year should that go on non-accrual. All in, with Preferred income, the  loss could be $0.65mn. That’s just under 1% of the BDC’s Investment Income. The avionics saga is not over as FDUS has anted up more monies and may make the company a Control investment. It’s already an Affiliate. Leaves path to potential long term recovery but an immediate (modest) hit to earnings from the cancelled Preferred investment.]

On November 30, 2017, we invested $2.5 million in subordinated term loans and common equity of Consolidated Infrastructure Group Holdings, LP, a premier provider of infrastructure services and solutions.

[The Company is new to FDUS and the BDC sector. Minor exposure. We assume $2.0mn of debt and $0.5mn of equity for calculation purposes and a “normal” rate].

On November 30, 2017, we invested $9.6 million in subordinated term loans and common equity and made a commitment for up to $4.0 million of additional subordinated term loans of Mesa Line Services, LLC, a leading provider of outsourced electric utility infrastructure services in the Southwest region of the United States.

[The Company is a full service electrical infrastructure company with a unionized workforce. See website. This is an average size commitment. We do not have details but there is no other BDC exposure to this name at 9/30/2017. However the company was acquired by a PE group in December 2017, so there may be other lenders. The sponsors include the Rockefeller, Mellon and Harriman families, with $10bn invested in mid-market buyouts like this one. A good sign.]

On December 1, 2017, we exited our debt and equity investments in Malabar International. We received payment in full on our subordinated notes. We sold our preferred equity investment for a realized gain of approximately $6.8 million.

[This aircraft maintenance company was carried at a premium at 9/30/2017 by both FDUS and OFS Capital -OFS. The company has performed well since FDUS first got involved in 2012. The long term nature of the loan seems to suggest little – if any – prepayment or other fees on the $7.7mn of Subordinated Debt outstanding. The $2mn of income generating Preferred was valued last quarter at $7.6mn. However FDUS claims a “realized gain” of $6.8mn, suggesting the proceeds were $8.8mn for the Preferred, or $1.2mn higher than at September. Again a good news/bad news: FDUS loses debt paying 13% and Preferred generating 6%. On the other hand, redeployed into an 11% loan the $16.4mn of capital could result in higher earnings in the future]

On December 8, 2017, we invested $15.3 million in subordinated term loans and common equity of The Kyjen Company, LLC (dba Outward Hound), a manufacturer and distributor of innovative dog and cat toys, games, gear, collars, and feeders.

[The Company was acquired in a major middle market buyout in December 2017 by JW Childs, a long established PE company. We don’t know any details but the pedigree (we had to say that) of the canine company’s new buyer is a plus. We assume $12mn in debt and $3.3mn in junior obligations from FDUS at “market rates”. That should add about $1.5mn in annual Investment Income]

On December 19, 2017, we invested $21.5 million in subordinated term loans and common equity of Gurobi Optimization, LLC, a leading commercial provider of optimization software for use in prescriptive analytics applications.

[We’ve looked at their website but we still don’t understand what Gurobi really DOES, but this seems like a standard deal. Thompson Street Capital recapitalized the Company this month, but amounts and terms are not known or the use of proceeds. Again, though FDUS is working with a respected PE group and a well established business. Total income therefrom should be above $2mn a year, given the subordinated nature of the debt]. 

On December 29, 2017, we entered into an amendment to our Credit Facility, which, among other things, extended the maturity date from June 16, 2018 to June 16, 2019.

[The BDC Reporter was wondering when FDUS would extend the loan. A 1 year extension is relatively normal. In any case – as we’ll see the Revolver serves more as a backup line than permanent financing]

On January 3, 2018, we invested $19.5 million in subordinated term loans and common equity of AVC Investors, LLC (dba Auveco), a provider of fasteners and autobody hardware to the automotive aftermarket and general industrial markets.

[Once again FDUS is part of an acquisition financing launched in January. This time the PE group involved in buying this fastener distributor, that has been around since 1916,  is well regarded Tenex Capital Management. The current CEO stays on board, which is always reassuring. Assuming about $16mn in debt, the investment should generate income of around $2.0mn annually].

On January 5, 2018, we exited our debt investment in United Biologics, LLC. We received payment in full of $8.9 million on our subordinated loan.

[FDUS is being a little coy in this disclosure. The debt was carried at par at 9/30/2017. Left unsaid – and unknown – is what has happened to $1.7mn in Preferred and common owned at 9/30/2017 but valued at deep discount in FMV. However, the FMV is only (!) half a million dollars and should not materially impact FDUS if written off down the road. Lost, though, will be the income from a 12% coupon on the debt. Also affected by the repayment -we would expect- are OFS and TCAP, both of whom have exposure to the Company. The debt seems to be safe but TCAP’s $2mn in equity in the company may be a Realized Loss but was already written off. In fact, TCAP might benefit in NAV form given its debt was carried at a discount and seems to have been repaid at par. Not a disaster for any of the BDCs involved but some losses likely, even if income should be unaffected].

On January 8, 2018, we invested $11.0 million in subordinated term loans and common equity of Spendmend LLC, a leading provider of spend visibility & audit recovery services to the healthcare industry.

On January 25, 2018, we exited our debt investment in Comprehensive Logistics Co., Inc. We received payment in full of $16.4 million on our subordinated note, which includes a prepayment penalty.

[Good news/bad news: This was a subordinated loan booked recently – in the IVQ of 2016. As a result FDUS will be receiving some prepayment fees. Bad news is the loss of a big loan at 11.5% or $1.9mn in Investment Income. FDUS was refinanced out by another lender.  An example of a competitive market at work ? ]

Since September 30, 2017, we have borrowed a total of $50.0 million under our Credit Facility, which is the total amount of indebtedness outstanding under our Credit Facility as of January 29, 2018. We intend to use the net proceeds from this offering to repay a portion of such indebtedness, and after giving effect to this offering and such repayment, we will have $         of indebtedness outstanding under our Credit Facility.”

[We cannot reconcile how FDUS went from $0 drawn on the Revolver to drawing $50mn currently. Moreover FDUS has $46mn in cash on the balance sheet but that may be committed to the SBIC subsidiary. However, the numbers do suggest that after all the comings and goings the BDC’s investment assets are headed upwards. That should translate into higher income even when the loss engendered from the FDS Avionics set-back. Sensibly enough the BDC is raising Unsecured Notes to finance this growth. However Baby Bonds don’t come with the attractive pricing of SBIC debt so interest expense will rise in the IQ 2018 after the debt is booked. However, the difference may not be too acute. FDUS borrows relatively expensively on its Revolver: LIBOR + 3.5%. Figuring in higher rates and unused fees, the cost of the secured debt is likely to be above 5.0%. That may prove to be within 1% of the cost of 5 year Unsecured Notes, minus those pesky covenants and annual renewals, etc. ]

Earnings Preview

FDUS offered this snapshot of its IVQ 2017 results:

Set forth below are certain preliminary estimates of our financial condition and results of operations for the three months ended December 31, 2017. These estimates are subject to the completion of financial closing procedures and are not a comprehensive statement of our financial results for the three months ended December 31, 2017. We advise you that this information is inherently uncertain. Our actual results may differ materially from these estimates, which are given only as of the date of this prospectus supplement, as a result of the completion of our financial closing procedures, final adjustments and other developments that arise between now and the time that our financial results for the three months ended December 31, 2017 are finalized.

The preliminary financial estimates provided in this prospectus supplement have been prepared by, and are the responsibility of, management. Neither RSM US LLP, our independent registered public accounting firm, nor any other independent accountants has audited, reviewed, compiled, or performed any procedures with respect to the accompanying preliminary financial data. Accordingly, RSM US LLP does not express an opinion or any form of assurance with respect thereto and assumes no responsibility for, and disclaims any association with, this information.

As of the date of this prospectus supplement, we estimate that the range of our net investment income per share was between $0.30 and $0.32 for the three months ended December 31, 2017.

As of the date of this prospectus supplement, we estimate that the range of our net asset value per share was between $16.02 to $16.07 as of December 31, 2017.

        [Adjusted Net Investment Income is projected to be $0.34-$0.36, which is below the prior quarter when FDUS reported $0.40. The second quarter was at $0.39. NAV last quarter was $15.97 and at year end 2016 was $15.76]

Further Analysis

Of course, the information provided is far less comprehensive than a quarterly report. Still unknown is the credit status of the rest of the FIDUS portfolio which may impact earnings and book value in the short or medium term. The BDC Reporter identified 8 Watch List names of material importance which could affect FDUS as of September 30, 2017. We will focus principally on the one non-performing investment and 3 Worry List companies (where the risk of an eventual loss seems higher than the prospect of full recovery.

The only non-performing loan is Restaurant Finance Company, with a cost of $9.3mn and a FMV of $4.2mn. This loan has been non-performing since the IQ of 2017 and keeps getting written down every quarter. For our purposes we are not counting on any resumption of income or any value.

Worrying

Of the three Worry List Companies one was United Biologics – discussed above – whose loan has seen been repaid at par. We’re keeping expectations low for the $0.550mn of Preferred and warrant investments at FMV.

Then there is FDS Avionics – also tackled above – which has been “restructured” – a euphemism for being rescued from the abyss. What happens to the $5.4mn Subordinated Note now the equity and Preferred have been cancelled will a critical factor.

Finally, there is Inflexxion Inc.  This name, to which FDUS has advanced $6.6mn in debt and Preferred continues to struggle along. A new CEO was just announced, but we’ll be interested to see if the nearly $5mn in debt to the Company is performing and what value FDUS has ascribed.

Otherwise, we have on our Watch List SES Investors (dba SES Foam); Caldwell & Gregory, LLC (laundry services) ; Oaktree Medical Centre P.C. and Ohio Medical Corporation. These account for $30mn in loans and credit problems with one or more could impact FDUS’s earnings down the road.

On the other hand – like MAIN – FDUS seeks to offset credit and investment losses with capital gains. This quarter is an example of how the BDC can both lose and win at the same time and still come out ahead. We count about a dozen equity stakes with an aggregate value of $50mn that might serve to mitigate the blow of potential credit losses. FDUS has a good track record – like MAIN- of cashing in repeatedly on these lower middle market equity stakes.


VIEWS

There’s  plenty that we don’t know but the FDUS Prospectus provides a half opened window into the Company’s most recent performance. We’re setting aside obvious concerns that even estimated IVQ 2017 Adjusted Net Investment Income is coming in lower than the distribution. Much of that may have more to do with how Incentive Fees for Realized Gains are booked than a true permanent drop in Investment Income. Looking at the data on a granular level, FDUS appears to be performing as well as ever.With the growth in the balance sheet, we expect recurring earnings to bounce back up in the IQ of 2018 (even though there are still months to go). Moreover, armed with both “spillover income” and new Realized Gains, the BDC has the firepower to maintain or – by making a Special Distribution as in prior years – even boosting its payout. Even if costs rise slightly due to the new Baby Bonds, the FDUS capital structure will be strengthened by raising medium term debt, alongside the 10 year debentures in its SBIC subsidiary.

There is always the possibility that there are negative developments which FDUS has not included in the Prospectus which will come to light when the earnings are released. Moreover, the current atmosphere for BDC investing – especially for funds with a focus on subordinated debt – has become increasingly toxic for the last several months, helped by the blow-ups at TCAP, ABDC, CPTA and TCRD. Nonetheless, the BDC Reporter is encouraged rather than discouraged by this granular review of FDUS on short notice.


Investment Disclosure: See our holdings here.

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