NEWS

On March 30, 2020 Bain Capital Specialty Finance (BCSF) filed a preliminary form N-2 – see attached.

The BDC appears to be preparing to undertake a Rights Offering to raise equity capital in order to pay down debt in order to “continue to maintain an appropriate debt to equity ratio in a challenging market environment” and for future investments.

Neither the amount nor the price of the offering have yet been set.

The draft Prospectus adds the following:

 because the subscription price per share will likely be less than the net asset value (“NAV”) per share, based on our current market price, the offer will likely result in an immediate dilution of NAV per share for all of our stockholders. This offering will also cause dilution in the distributions per share we are able to distribute subsequent to completion of the offering. Such dilution is not currently determinable because it is not known how many shares will be subscribed for or what the NAV or market price of our common stock will be on the expiration date for the offer. If the subscription price per share is substantially less than the current NAV per share, such dilution could be substantial. Any such dilution will disproportionately affect non-exercising stockholders. If the subscription price is less than our NAV per share, then all stockholders will experience a decrease in the NAV per share held by them, irrespective of whether they exercise all or any portion of their rights

ANALYSIS

Twenty Minutes

The BDC Reporter is writing this analysis on the run only minutes after hearing of the N-2 filing.

The BDC has not yet even filed the new Prospectus on its website but has done so with the SEC.

History Repeating Itself

With this Rights Offering, BCSF is returning to one of the most popular – and controversial – emergency capital raising methods used by several BDCS during the Great Recession.

As we understand how the offering will go, BCSF will offer to issue shares at a price substantially its book value at 12/31/2019, which was $19.72.

Furthermore, the new stock may be priced below the BDC’s latest stock price, which was $10.98.

However – as noted above – the new share price has not been set.

Shareholders who do not participate in the Rights Offering will be diluted.

Inevitable

However, in any case, the BDC’s book value and dividend are both expected to drop sharply due to the impact of the Covid-19 crisis on the BDC’s assets.

The BDC Reporter – in its off-the-cuff calculations a few days ago estimated book value per share could drop to $7.48.

That was based on assuming a 25% drop in asset values on a balance sheet that was one of the most levered in the BDC space at 1.48x.

Straw Grasping

Since we made that estimate the market value of leveraged loans – a rough proxy for BCSF’s portfolio – has increased modestly, so the pro-forma book value per share may be higher.

However, given that BCSF seems to be raising capital in an emergency appears to suggest debt to equity/asset/debt coverage has broken through regulatory limits.

That suggests – given the nominal gap between the regulatory limit of 2:1 compared with the 1.48x at year end 2019, the drop in asset value with which the BDC is contending is high.

VIEWS

Heavily Caveated

Again, the BDC Reporter would remind readers that we have reviewed the N-2, a subsequent press release from BCSF and written this article in a matter of minutes in an attempt to alert readers before the open.

Please treat all information – and these views – with appropriate caution.

Not Happy

However our first reaction on hearing the news – and before fully understanding how the Rights Offering will work was extreme concern.

Any time – based on our remembrance – any BDC undertook a Rights Offering during the Great Recession the result was highly dilutive and caused the stock price of the BDC involved to drop sharply.

BCSF’s stock price has dropped (45%) since February 20, 2020 – when the market meltdown – began, in line with the sector as a whole.

Double Whammy ?

This Rights Offering – if the past is any indication – may cause an even bigger drop in the price as shareholders seek to bail preemptively.

Silver Lining

From a longer term perspective, though, BCSF may be undertaking the right move if the BDC sector drops further in price and other BDCs adopt a similar capital raising technique.

There may be a first mover advantage where Rights Offerings are concerned.

Not Alone

The BDC Reporter’s calculations have suggested that 18 BDCs in all might at be at risk – thanks to a combination of having high REGULATORY leverage and lower asset values – of being in the same boat as BCSF.

However, there are a host of other evasive measures that a BDC can take instead of, or to supplement, a Rights Offering and we may see all of them deployed in the months ahead.

Unpopular

We worry – and again take this as our pre-market gut reaction and no sort of gospel – that BDC investors generally will react poorly to the prospect of BCSF’s Rights Offering.

This will involve wondering who might be next in the public BDC universe and selling those BDCs shares in response.

One Last Hedge

We’ve been tarred as being unduly pessimistic and we hope we are, but are alerting any reader interested of our view.

The BDC Reporter will return to this subject once more details are known and the market reaction has been assessed.

That may be as later today.

Written at 6:05 a.m. PST/9:05 a.m. EST Monday March 30, 2020.