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BDC Preview: Week Of October 29 – November 2, 2018

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The BDC Reporter is kicking off a new series for all readers: BDC Preview. Our goal is to provide a heads up at the beginning of every week of what lie ahead for anyone interested in the Business Development Company sector. For our Premium Subscribers, we hope this weekly reminder will dovetail with our ongoing stream of  “news, views and analysis” about the most salient stories of the day. For our Free Subscribers – many of whom may not follow the BDC on a daily basis – we hope to provide advance warning of what to expect in the short term this ever expanding sector (45 public companies trading on all the main exchanges and 40 traded Fixed Income issues). 

UNSTABLE MARKET: At the end of every week, the BDC Reporter discusses BDC stock market conditions in excruciating detail and by reference to numerous data points, giving our Premium readers a short, medium and long term perspective in a recap. All we’ll say here is that battle scarred investors this week will be back in a BDC common stock sector that has dropped for 5 weeks in a row, and where average prices have dropped by 8% from their end of August high and are now at their lowest point in 2018.

For some that will represent a buying opportunity. For others, this might be a way station to even lower prices. What happens in the wider markets this week – and in the weeks to come – may be as important as BDC fundamentals if recent history is any guide.

For our part as investors we’ve been well served of late by being skeptical of the little price run-ups we’ve seen for short periods. So we’ve kept our hands in our pockets – except for buying a small position in Main Street Capital (MAIN).

Maybe the worst is over, but another 5%-10% drop is not out of character with what we’ve experienced before.

We are playing this by ear.

EARNINGS SEASON BEGINS:  The third quarter 2018 BDC earnings seasons officially begins on Tuesday October 30 – appropriately just before Halloween, and will last through the end of November. Through the week ended Friday November 2, 2018, eleven BDCs will be reporting results- or a quarter of the total. For the BDC Reporter’s BDC Earnings Calendar – a feature available to all readers –  just check out the Subscriber Tools section on the front page.

WATCH OUT BELOW !  Two BDCs reporting this week have big question marks hanging over them, including potential dividend decreases. Apollo Investment (AINV) saw its stock price drop to a new 18 month low of $4.97 last week. The BDC Reporter tackled the subject last week. Here’s an extract from what we wrote:

The drop in AINV may be related to investors positioning themselves in advance of the quarter’s earnings release.

While the new management at AINV has made substantial progress in “cleaning up” and re-positioning its portfolio several credits remain troubled.

Investors may be preparing themselves for write-downs or news of potential defaults in a handful of major portfolio companies.

We went on to list 5 questionable company investments, out of 95 in portfolio and concluded:

Just these 5 investments by themselves have a FMV equal to a fifth of AINV’s net asset value in a 96 company portfolio.

What we hear about progress on these – and the other names on the Watch List (total :9) – may sway AINV’s stock price come the October 30 release.

Shareholders in AINV will want to dig into AINV’s disclosures right after the close. We note, though, that the BDC will be issuing its results and holding its Conference Call in the span of just an hour. The 10-Q, where much of this portfolio data resides, may not even be available.

Then there’s BlackRock Capital Investment (BKCC), which used to be BlackRock Kelso. The BDC has kept its ticker but changed its name, management team and strategy. Unfortunately, performance under the illustrious BlackRock name has been poor. Last quarter NAV Per Share dropped by (2.3%) to $7.65 and Net Investment Income Per Share was $0.16, or less than the quarterly dividend paid. Dig just a little deeper and add-back the Incentive Fee waiver made by the Investment Advisor and “adjusted” recurring earnings falls short of the payout by 22%.

Moreover, BKCC has several troubled loans still on its books – despite a stalwart turnaround effort in recent quarters. Most of the focus will be on a loan that should probably never been made in the first place: Westmoreland Resource Partners, LP – also known as Oxford Mining Company. That’s coal mining… If you hadn’t heard, the company filed for Chapter 11 on October 9. As of last June 2018 the $26.4mn in senior debt to Westmoreland was already on non-accrual where PIK income was concerned and the value dropped to $12.0mn. We expect to hear the rest of the investment income – a material $2.8mn per annum – will also go on non accrual. The value of the investment – too – may take a hit. Nor is that all. We can’t name all the names here, but we count 7 names on our Watch List for BKCC, two of whom at least could cause further damage to earnings and book value. Sadly, having sold off a number of investments under the new regime, BKCC has only two equity stakes valued at a premium to cost than might offset losses elsewhere.

We continue to believe BKCC might eventually be folded by Blackrock into TCP Capital (TCPC) which the investment manager behemoth just acquired and renamed BlackRock TCP Capital (a fact that even its own website does not reflect). Or, Blackrock might turn over the investment advisory role to the TCP Capital team. After all, both Oaktree BDCs (OCSL and OCSI) and PennantPark BDCs (PNNT and PFLT) are run by the same teams, with different strategies. What BKCC’s results – and credit performance – looks like this quarter might have some bearing on what BlackRock does next.

Otherwise, we’re not expecting anything very surprising from the other nine BDCs reporting earnings. Of course, we’ll be curious to see how market leader Ares Capital (ARCC) fares a quarter after raising its dividend out of the blue. Also coming up to the plate are several other BDC aristocrats like MAIN, whose stock price has dropped by more than 10% since the end of August. MAIN – and its devoted shareholders – are not used to such price pull-backs. Maybe investors are worrying about the imminent retirement of the CEO from day-to-day management; and/or that the frothy conditions for lower middle market investing – which has brought MAIN multiple Realized Gains of late and offset the occasional credit misfire – might be playing out. We still have the faith but who knows what might lurk in that 200 or so company portfolio ?

We’ll learn a good deal more about how market conditions are in the technology sector with Triple Point Venture Growth (TPVG), Hercules Capital (HTGC) and Horizon Technology Finance (HRZN) all reporting results.  All 3 BDCs have adopted the higher leverage rules allowed under the Small Business Credit Availability Act (SBCAA) – with varying amendments- so we hope conditions are good.

BEST IDEA RIGHT NOW: The BDC Reporter undertakes – for just about every BDC out there – likely earnings, distributions and credit losses over a 5 year timeframe, which we update in real time as new information pops up. We throw our dividend projections and a terminal value for every stock in 2023 into a discounted dividend model to calculate potential risk-adjusted returns.

With all that said, the BDC stock looking the most promising for the long run- which will be reporting November 6 – is TPG Specialty (TSLX). Much even to our own surprise – and despite a couple of re-calculations in our model to make we haven’t slipped up – our projections are showing a POTENTIAL return of nearly 100% over a 5 year time frame, between distributions and price appreciation. That’s very high by BDC standards and all the more notable because TSLX has dropped only 5% in the recent turmoil. We’re already investors and may buy more this week and hope that our high expectations for TSLX are met. (Note: This does not assume a major recession in the period involved).

SUMMING UP: This should be a very busy – and potentially tumultuous week for BDC investors.

The sector may find a bottom for the year with only two months to go. In any case, with a quarter of the public BDCs reporting  we expect to get a pretty good idea what current market conditions are looking like across upper middle market (ARCC,AINV,BKCC); technology (HTGC,HRZN, TPVG); the lower middle market (FDUS,OFS) and even CLO investing (OXSQ).

Long days ahead for the BDC Reporter, but we expect some very interesting findings for our readers after several weeks of high drama and lower prices.

CORRECTION: A reader has pointed out that we referred to BlackRock as Blackstone not once but twice in this article. We’ve made the correction and apologize for the slip.

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