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Blackrock Capital: Changes At The Top. Look Out Below.

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NEWS/VIEWS

We’ve been wondering how the decision by BlackRock,Inc. to acquire Tennenbaum Capital Partners, and acquire control of TCP Capital (TCPC)  would play at the asset managers “other” BDC, Blackrock Capital Investment Corporation (BKCC). Here’s an extract from what we wrote back on April 18, 2018 when the news of the acquisition first broke:

“..what is going to happen to BlackRock’s other public BDC: BlackRock Capital Investment (BKCC).

Curiously – and tellingly – no mention has been made even of the existence of the BDC in any of the announcements we’ve read.

Yet last time we checked BlackRock has a namesake fund – owned in all or in part for over a decade – and with three quarters of a billion dollars under management”.

Now – as of April 30, 2018 – we know a little more.  The CEO of BKCC Michael Zugay is not waiting around. According to a press release Mr Zugay – who is also a Board member of BKCC and head of the US Private Capital unit which is responsible for managing the BDC and other activities – is resigning for “personal reasons”.

This is resulting in a series of senior personnel changes which are detailed in the press release, but all of which are likely to be subject to further reshuffling once the Tennenbaum acquisition goes through.See the release above for full details.

Despite the immediate replacement of Mr Zugay in his various roles, this departure and the proposed acquisition of an external firm that might serve as the Investment Advisor to BKCC, leaves the BDC in limbo that could last through till the summer, or whenever the acquisition closes.

BKCC’s stock price has quickly climbed of late – up 10% –  presumably on expectations that SOMETHING positive might come out of this drastic change in the BDC’s leadership.

In The Interim

Unfortunately for BKCC shareholders time and markets do not wait.

There are likely to be two earnings releases before new management – if that is the BlackRock plan – and much can happen even to a BDC in a low gear.

(Last year investment assets dropped 19%).

Credit Is Always Job 1.

BKCC continues to dig itself out of multiple credit problems.

There are two loans – out of 30 in the entire three quarter billion dollar portfolio – on non accrual.

Those are SVP Worldwide and MBS Group Holdings.

MBS Group Holdings

Early in March 2018 – on BKCC’s Conference Call – investors received an update about the latter:

“During the [IVQ 2017] quarter, we recapitalized MBS Group Holdings in connection with a change of control transaction. As part of the recapitalization, we provided new debt and a modest portion of the equity to the new MBS entity.

At the end of the quarter, proceeds of these investments were held in escrow, pending completion of the transactions. Subsequent to the end of the quarter, a part of the proceeds were applied to partially exit the Legacy MBS Group Holdings debt, which was on non-accrual.

We are now partnered with a private equity sponsor that has industry expertise to improve the business and its operations, with the assistance from their operating partners”.

We won’t speculate on the specifics of how the MBS transaction has played out so far in terms of Realized and Unrealized Gains. However, we note that BKCC had invested $40.9mn in a first lien debt position and had marked down the loan to $15.1mn  at year end 2017.

SVP Worldwide

SVP Worldwide continues to be in negotiations with its creditors.

BKCC – which has historically chosen to take large positions in a relatively small portfolio – has advanced $57.7mn in debt to the borrower and written down the loan to $7.1mn.

However, there are several other credits that investors should be aware of and which might roil BKCC’s results in the months ahead.

Advanced Lighting Technologies, LLC

First, there is Advanced Lighting Technologies,Inc.  in which BKCC has $7.8mn invested.

The company was rolled into/merged with a successor entity in October 2017 called (confusingly) Advanced Lighting Technologies, LLC as part of a restructuring.

That involved second lien holders of Inc. converting their debt into second lien obligations and 95% of the equity of LLC.

Some debt holders advanced new funds after the recapitalization which greatly reduced total borrowings outstanding and gave the lighting company another shot at being successful.

BKCC owns both first lien and second lien debt in the new entity.

At 12/31/2017, the second lien debt had a cost of $2.2mn and a FMV of $1.5mn.

More importantly – and likely to be sustained – BKCC was charging an 18.5% interest rate, the majority of which was in PIK form.

This quarter we’ll be interested to see what has happened to this investment and the income therefrom.

Red Apple Stores

Another storied credit is a Canadian retail chain called Red Apple Stores.

BKCC advanced $0.5mn in equity to Red Apple in 2017, all of which had been written off at year end.

The BDC’s major exposure is a second lien loan of $23.1mn, which has been written down by (30%).

Should that income be interrupted by a default, BKCC could lose $2.3mn of annual Investment Income.

U.S. Well Services

Less worrisome right now following a massive restructuring and the increase in oil prices – but with major exposure – is U.S. Well Services, in which BKCC has invested $56.4mn in debt and equity.

Much of that is non income producing.

Should there be some sort of exit or further restructuring, BKCC’s numbers could be materially impacted to the good.

Earnings Quality Questionable

Besides credit, investors will also be looking at BKCC’s “earnings quality” this quarter and next.

As of the last reported numbers a massive 30% of Net Investment Income was earned in non-cash form.

That’s a very high percentage even in a sector where booking non-cash income is a prevalent practice.

Picked From The 10-K

By way of illustration, CB-HDT Holdings $5mn of Unsecured Debt is carried at par, but all interest income is in the form of a 12.00% PIK.

Ditto for KAGY Holding ($10.3mn and 20.00% PIK).

Plus Advantage Insurance ($10.3mn and 8% PIK).

No Charge

Then there’s the matter of the Incentive Fee waiver.

Since 2017 and through December 2018, BKCC has agreed to waive those fees.

Very generously that helped shareholders avoid $8mn of Incentive Fees in 2017.

(On the other hand BKCC did manage to lose $52.4mn in Realized Losses in that year and $85mn in 2016.

Plus BKCC shareholders were at the wrong end of the stick for a $17.5mn legal settlement in 2016).

Distorted

However, that fee waiver and a few very high yields on a few investments and that large amount of PIK obscures the real earnings power of the BDC.

As of the IVQ 2017, BKCC boasted a Net Investment Income Per Share of $0.20 versus a dividend of $0.18.

Strip out the fee subsidy and the over the top loans, etc. and the “real” EPS might be closer to two-thirds to half of the reported number.

If that’s right, BKCC investors who’ve been paying $6.30 to get into the stock of late might wake up one day to realize they’re paying as much as 16x “normalized” earnings.

We’ll be reviewing the next set of results for a better sense of what BKCC is really earning.

After all, 2019 is just round the corner.

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