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BDC Preview: Week Of March 11-March 15, 2019

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Better Late Than Never: The most interesting news of the week will occur on Friday when the shareholders of the three Medley Group related companies finally vote on whether to merge together or not. Of course, the vote has now been twice suspended, apparently due to governmental delays relating to the Federal shut-down. Last week, after the vote was delayed at the last minute, very little was said by the parties involved, except confirmation of the date and times of the votes. Even the BDC Reporter did not have anything new to say, nor do we now. We’ll have much more to say once the votes have occurred, the last of which is scheduled for 11:00 a.m. EST. Then there will be fireworks of one kind or another.

Our guess – and it’s just that – is that Medley Capital (MCC)  and/or Sierra Income shareholders say “No Thanks” to the idea of being joined at the hip for the rest of time, and plump for a still to be defined better deal elsewhere.  Whatever happens the biggest losers in this long running scenario are MCC”s shareholders who first had to contend with terrible results and stock price and now have to contend with uncertainty about the future – and all the costs involved. Not to mention having to read multiple articles for the last couple of years on the BDC Reporter about all the shenanigans at and around the BDC. As we’ve said before, there’s a lot of money at stake and the key players are all playing for keeps. Will the incumbents home field advantage win the day ? It’s a question whose answer will be important both to everyone with a stake in one of the entities involved – including the debt – as well as BDC investors generally.

Markets Moving: Last week, we led the Preview wondering what might happen to BDC common stock prices after the week before saw ever lower levels and many more individual stocks trading in the red than in the black. Not unexpectedly, the BDC sector did drop for a second week, alongside the broader markets, which were having their worst week of 2019 . Our eyes remain on BDC market pricing this week as well, especially as BDC publicly traded bonds are stocks appear to be moving in opposite directions. The former had a good week price-wise and have almost returned to the levels of last summer, when all was good with unsecured BDC debt investments. Is this a sort of “flight to safety” in its earliest stage ? Will BDC common stocks drop for a third week ? By itself that’s not a sign of the Apocalypse or even the end of the rally that began Christmas Eve 2018, but certainly something to stick in our pipes and consider.  On the other hand, a bounce back in BDC common stock prices might suggest – now that all the earnings have been reported (see below) – that investors still see pockets of value in a group that has moved upward in value very quickly, even as fundamentals have plodded along at a normal pace.

Season’s Over: With the planned announcement of Harvest Capital’s (HCAP) results on Friday, BDC Earnings Season will be over. There are just 3 BDCs publishing results. MVC Capital (MVC) has already published its earnings and 10-Q and we’ve already reviewed both documents and undertaken a review of the highlights for our Premium subscribers. (There was a good deal of new information lurking in the 10-Q especially; made all the more important by the Investment Advisor’s peculiar policy of not having regular Conference Calls to discuss performance). Of the other 3 names making their quarterly confessional all are credit-challenged and all should make for interesting updates.

Alcentra Capital (ABDC) is first out of the gate. This BDC is in the midst of a classic attempted turnaround and re-positioning with a new management team and strategy. Investors will be anxious to hear from management – and review the portfolio valuation – about what progress is being made. Is the dividend safe ? Many investors will be asking themselves that question, as the BDC tackles the difficulty of targeting lower yielding – lower risk while simultaneously having to contend with several borrowers that might default – all of which impacts earnings and the sustainability of the distribution. What’s more, ABDC has to contend with a disgruntled major shareholder who’s already announced its intention to seek to appoint two Directors to the Board. We’re a long way from a Medley Group situation – and we wonder if the managers will even address what’s going on behind the scenes during their Conference Call – but the possibility of an escalation of both offense and defense by the interested parties has to be taken into account. For our part, we’re not hopeful for a rapid resolution of ABDC’s credit woes nor of the campaign to develop a much lower credit risk profile.

Next up is quirky Great Elm Corporation (GECC), whose strategy to date has been investing in bonds bought in the secondary markets rather than running around – like most of its BDC peers – booking new loans. As always, we will be looking for an update on the status of biggest investment Avanti Communications. This satellite operator could yet bring much shareholder value destruction to GECC’s shareholders if its ambitious plans do not work out. Or, if everything goes swimmingly and the debt and equity is sold at fair market value, this could give GECC a fillip and bring in investors who’ve been sitting on the sidelines since the BDC was first formed out of the remnants of Full Circle Capital and some dubious portfolio assets contributed by Mast Capital. Speaking of the latter, this major shareholder continues to sell stock in good times and bad, making shareholders who remain uncomfortable with the anxiousness to Get Out.

This quarter’s Conference Call will also be an opportunity to learn more about GECC’s latest gambit, a controlling stake in Prestige Capital Corporation, a commercial finance company. This has shades of what Solar Capital (SLRC) is seeking to do. However, we have little understanding of how much capital GECC intends to commit to the investment – now and in the future – as well as the expected returns. What’s more, we’re wondering if this a one-off for the BDC or the beginning of a new strategy to partly remake itself as a finance company holding company. Finally, we’ll be seeking to find out how much third party leverage exists on Prestige Capital, and on what terms, in order to evaluate some of the risks involved should GECC – never shy to take big bets – invests heavily in this concept.

Finally, we end the week and what has mostly been a routine BDC earnings with the results of micro-BDC HCAP. We already know HCAP has cut its distribution blaming too many repayments and not enough deployments for lower earnings and an inability to “service” its dividend liability. We’ll be interested to see if there are more  credit problems at the BDC that might erode earnings permanently or whether a return to the prior payout level is possible. As most long term BDC investors know, once a dividend is cut it’s the rare BDC that shortly thereafter reinstates the prior level. Investors punished the share price when the dividend cut was announced but there has been a partial recovery since. However, if the earnings and credit news is grim – even after adjusting for potential earnings from full capital de[loyment HCAP is in danger of dropping below $10.0. Way below.

Opening The Gates: Despite the drop in BDC common stock prices in the last fortnight, both the equity and debt markets seem to be open for business. We’ll be curious to see if any BDC  raises any form of new monies while the going is good. These windows open and close very quickly. Miss one and you might have to wait months or even years. After successful taps by Saratoga Investment (SAR), New Mountain Finance (NMFC), Prospect Capital (PSEC) and Ares Capital (ARCC) there are plenty of would-be issuers waiting in line. The type of capital; amount and terms can make a big difference in BDC returns over the long term, so we’ll be keeping our eyes peeled.

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