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BlackRock Capital: Stock Jumps After Earnings Release.

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NEWS

On March 7, 2018 BlackRock Capital (BKCC) reported IVQ 2017 and full year results. Net Investment Income Per Share was $0.20, up from $0.17 the quarter before.

NAV Per Share dropped to $7.83 from $7.96 in September 2017 and $8.21 at year end 2016.

Debt To Equity was at 0.32: 1.00 as the BDC de-leverages the balance sheet, with total debt decreasing from $336mn to $227mn in the course of 2017.

BKCC’s stock price jumped by as much as 10% on March 8 over the March 7 close, hitting just over $6 a share.


ANALYSIS

Net Investment Income Per Share was affected  by several non-permanent items.

First, with a flurry of repayments Fee Income jumped in the quarter to $2.9mn. As the press release points out in the prior quarter the fees were $0.2mn.

That alone accounts for the growth in Net Investment Income in the period: adding $0.028 per share.

Secondly, the Investment Advisor continued a policy of waiving Incentive Fees – promised till the end of this year – which amounted to $2.9mn.

That raised Net Investment Income Per Share by $0.03 in the period.

Those issues have been raised by other commentators.

Funny Money

Also worth noting, though, is the very high proportion of Pay-In-Kind income booked by BKCC in the period and in the past two years.

In absolute terms PIK interest and dividend income was $5.7mn.

That’s equal to 23% of Total Investment Income in the quarter and 39% of Net Investment Income.

Paper Chase

Some of that PIK income is derived from performing borrowers being charged high to absurdly high interest rates, usually only in non-cash form

On the 10-K, in the portfolio list check out Unsecured Notes with CB-HDT Holdings at 12.00% PIK.

Then there is Preferred Stock with Advantage Insurance at 8.00% PIK.

Most noteworthy is KAGY Holding at 20.00% PIK in Preferred.

High Rates

Then there are full or partially cash paying loans at unsustainably high rates much above the average yield of BKCC’s portfolio.

Recently restructured Advanced Lighting Technologies is being charged LIBOR + 700 basis points and a 10% PIK. Through 2023.

That yielded 18.34% in the quarter and might reach 20% or higher if LIBOR continues to rise.

There are 6 of these high interest loans on the books to performing borrowers (including Advanced Lighting), 5 of which are valued at or above par.

Non Accruals

BKCC has 2 loans on non accrual, one of which appears to have been resolved following year end.

MBS Group was recapitalized during the quarter “in connection with a change of control transaction”.

BKCC provided “new debt and a modest portion of the equity”. Proceeds  were in escrow at December 31, 2017.

In 2018 some of the proceeds were applied to “partially exit the legacy MBS Group Holdings debt”.

SVP worldwide is still being renegotiated.

Watch List

According to the BDC Reporter’s review there are a number of other Watch List names at different stages still on the books.

Advanced Lighting 

Advanced Lighting Technologies has been restructured in the IVQ 2017, but remains a concern.

The second lien debt has been discounted by a third by BKCC and 9% by KCAP, which also owns that tranche.

In total – between First Lien and Second Lien debt – BKCC has advanced $7.2mn to the new Advanced Technologies, after taking a Realized Loss.

As we saw above, the second lien debt is priced at a very high rate although the loan itself is only $2.2mn at cost.

Red Apple

Red Apple Stores – a Canadian retailer which has been under-performing for ages- was written up this quarter, but only marginally.

Still, with $23mn of exposure at cost and most in debt, Red Apple remains a worry.

U.S. Well Services

This restructured oil services company is benefiting from higher oil prices and a more optimistic outlook.

In very recent quarters the company has been benefiting from a more positive energy environment.

The $16.4mn invested in the equity has been valued at twice its cost.

The debt which BKCC holds is valued at par or better.

However, this remains a risky investment, with one tranche of debt yielding 12.35%.

Concentration

For reasons unknown, BKCC appears to be comfortable holding an increasingly concentrated portfolio.

At the end of 2017, the whole three quarters of a billion portfolio was invested in just 30 companies (28 when the JV and the Gordon Brothers investment are taken out).

The five largest investments account for a third of the portfolio in size, and the three top industries 50%.

Risk Rating

Judging by the BDC’s own year end risk ratings, shareholders should expect more write-downs of the portfolio in 2018.

At the end of 2017, $66mn of portfolio assets (9 % of the total) are rated in Category 4 – the lowest rating where “some loss of principal is expected”.

The two non-accruals only account for $22mn, begging the question as to what else is included on the BDC’s own Watch List.


VIEWS

On One Hand

If this is not the end of BKCC’s credit troubles, it is the beginning of the end – for the moment -with MBS Group being recapitalized, Advanced Lighting Restructured and Red Apple and U.S. Well currently improving.

That might explain the  jump in stock price following earnings as investors seek a bottom to credit troubles.

Only SVP Worldwide remains to be sorted.

Wait. There’s More.

That’s fine as a short term view, but the portfolio – as we’ve shown – continues to be highly concentrated and filled with numerous borrowers paying very high rates.

Moreover, much of what BKCC is receiving in income is in paper form. Until that PIK turns to cash, the BDC will be paying out distributions and fees, etc by drawing on its liquidity.

Recurring income is likely to drop if higher yielding loans do get repaid without a fuss, and an ever smaller portfolio results in consistently lower fee income.

Waved Away

The biggest question mark relating to earnings is what will happen when the Incentive Fee waiver goes away at the end of 2018.

On a pro-forma basis, without the unusually high fee income and the fee concession, BKCC would have earned $0.14 per share in the IV 2017 rather than $0.20.

If we left out non-cash income the recurring EPS would probably be under $0.10.

On The Plus Side

BKCC may be able to squeeze out a penny or two of earnings by reducing borrowing costs, investing more in their JV and Gordon Brothers (which are highly leveraged structures) and growing their balance sheet.

Time To Face Facts

However “spread compression” and the re-positioning of the portfolio towards less risky assets will also take their toll over the next few quarters.

BKCC is towards the end of accomplishing its credit turnaround” but the BDC, its Investment Advisor and shareholders may still have to adjust – after temporary factors go away – to much lower recurring earnings than suggested by the IVQ 2017 results.

Down the road -once BKCC goes back to paying Incentive Fees and sorts out its remaining credit troubles – we expect Net Investment Income Per Share to drop substantially below $0.60 a share from $0.80 currently.

At worst, we could see future recurring earnings dropping to $0.50 by early 2019 even if no new credit hot spots pop up.

 

 

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