Fidus Investment: Outlook For Common Stock And Baby Bond
The BDC Reporter is undertaking a combo: reviewing the prospects for both the common stock and new Baby Bond of Fidus Investment (FDUS). Two days ago the BDC released a substantial amount of new information about its activities since the September 30 2017 quarter end, contained in its Prospectus for the new debt issue. That has allowed us to sharpen our pencils and take an in-depth look in advance of the IVQ 2017 results, whose release date has not yet been announced. We took a first look minutes after the Prospectus was filed and are circling back now the Baby Bonds have been issued and priced and the key details known. Moreover, with FDUS joining two-thirds of the BDC universe on a downward price trend, we’ve been asking ourselves if investing in either the common stock or Unsecured Notes makes any sense before we get the Full Monty in the coming 10-K. Read on :
As we’ve been reporting, Fidus Investment (FDUS) has issued and priced its first Unsecured Notes, with the ticker FDUSL. The Baby Bonds have a maturity of 2023 but can be redeemed in 2010 at the BDC’s option and yields 5.875%. If the underwriter exercises its option, the total amount of the capital raised will be $48mn. FDUSL is already trading in the “grey market” and becomes the 36th publicly traded BDC issue on the BDC Reporter’s Fixed Income Table. Proceeds will be used to repay $50mn drawn under the BDC’s Revolver, which is fully utilized.
At September 30, 2017 FDUS had no drawings under its Revolver, no Unsecured Notes and $48mn in cash on the balance sheet. The only debt was $214mn of various SBIC debentures, which mature in fits and starts over the next several years. However, in the months since the end of the third quarter – and despite a high level of repayments – the BDC has been booking new investments at a very fast clip.
In our prior article we reviewed and discussed each investment repaid and made over this period. Leaving out the restructured FDS Avionics transaction and filling in a reasonable cash usage number for distributions paid out over the period, we cannot reconcile the numbers, and are left to speculate. Which we shall do.
Cash laid out for new investments is only slightly greater (around $6mn) than repayments. Even when the outlay for the IVQ distribution is counted, it’s not obvious why the BDC’s Revolver was fully drawn at $50mn just a few days ago.
We’re guessing that in the interim, FDUS has repaid a portion of its SBIC debentures. This was a process that was already underway in prior periods. This BDC – whose only source of capital initially were long term debentures arranged by the SBA – has begun to reach close to the maturity date of certain of its borrowings and is paying back the SBIC.
In the first 9 months of the year FDUS repaid $42mn in SBIC debentures and warned in its IIIQ 2017 10-Q that there were more debentures with 2019 maturities which they intended to repay. A chart on page 29 of the filing shows there still remained $25mn of debentures hitting their maturity dates in each of 2019 and 2020. The BDC may have – wisely – chosen to get ahead of the game and repay some of those debt liabilities.
We don’t know the status of the $47mn in cash sitting on the balance sheet at the end of September or whether FDUS used any of the $42mn of potential new SBIC debentures to finance any of its investment activity.
Our surmise is that the investment portfolio will grow slightly – based on what has already been booked through late January 2018 – towards $570mn, while SBIC debentures will drop below $200mn (from $211mn) and the new Unsecured Notes add another $50mn to the debt liabilities. We’re projecting debt to equity – if a snapshot could be taken as of now – would be about 0.60 to 1.00.
That’s a modest amount of leverage for many BDCs in absolute terms and especially for ones with SBIC licenses who get – thanks to exemptions from the SEC- not to count the SBA debentures as debt in debt coverage calculations.
While we’re guessing let’s have a look at credit quality:
We discussed in our prior article that FDUS has 8 Watch List names by the BDC Reporter’s count, out of a portfolio that consists of 58 “active investments” in portfolio companies and “residual investments in 5 portfolio companies that have sold their underlying operations. Of the 8 Watch List names one is the existing non-performing loan (Restaurant Finance Co.) , already not contributing to income and another is the recently restructured FDS Avionics, whose income producing Preferred and its non-income generating equity have been written off. The company’s debt remains outstanding but must be a question mark going forward, especially as FDUS seems to be funding the business. A third is United Biologics, whose debt has just been repaid.
Of the remaining 5 names only one – Simplexx Manufacturing – is on our Worry List. (There’s a $4mn loan (which we erroneously said was “nearly $5mn” in our prior article) at a 14% yield. Should that implode, FDUS could lose $0.56mn a year of Investment Income. That’s about 2 cents a year net of any lower management fee that would result from a write-down.
Overall, we are not overly concerned about FIDUS from a credit standpoint BASED ON WHAT WE KNOW. In fact, the BDC itself was signalling the credit picture was in pretty good shape, based on its own Portfolio Asset Quality report in the last 10-Q, which showed 4.8% of the portfolio at FMV was in the two riskiest credit categories, or $24.6mn in absolute terms.
The wild card is what might happen to credits which were performing okay as of IIIQ 2017, but which are in our -and their – Category 3. Or credits which were performing as planned but have taken a sudden dive that we are not aware of.
Notwithstanding our own optimism, potential and existing FDUS shareholders have reason to keep an eye on credit quality when the BDC reports IVQ 2017 results.
With so many disasters happening at other subordinated debt focused BDCs an unexpected tilt dowards from a credit standpoint is not inconceivable.
However, longer term the BDC Reporter looks to potential offsetting equity gains to reduce net credit losses should they occur; liquidity in cash and unused SBIC debentures; the progress made on repaying older debentures and the track record of the BDC over the past 7 years to provide comfort.
On the other hand, potential Note Holders in the new Baby Bonds appear to have a strong investment from a credit point of view.
First, FDUS has a relatively large and diversified portfolio.
Second, credit performance has been above average over a long period.
Third, once SBIC debt is deducted, investment assets and cash “cover” Notes outstanding by nearly 900%.
We bought FDUS for our Long Term Income strategy when the price was close to its then 52 Week low back on January 25, 2018 and again when the price dropped following the IVQ 2017 earnings estimate. We are currently marginally in the red.
According to our 5 year projections, we should achieve a 61% over the chosen period or 12.2% per annum.
Our model assumes only a marginal drop in the distribution in the five year period (10% in the last year) and a terminal price of $16.15, slightly above the current NAV Per Share.
We are seeking to acquire an initial position in the new Baby Bond in the “grey market”. However, the final decision will be guided by the price.
The 5 year maturity is not too exposed to interest rate risk and the two years of no redemption ensures a decent return can be achieved.
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