NEWS

On June 17, 2020 FS KKR Capital II – ticker FSKR – began trading on the New York Stock Exchange (NYSE).

The stock opened at $13.75 and closed at $14.30.

See the press release attached.

ANALYSIS

Mark Your Calendar

The arrival on the scene of any new public BDC is always notable.

That’s only the more so when the new public entity has $8.2bn in total assets, including $7.5bn in portfolio assets.

FSKR also has a net book value of $4.2bn.

Joining The Club

With its accession to the public arena there are now 46 different BDCs that we track involved in leveraged lending and 33 non-traded, now that FSKR has made the trip across the aisle.

At March 31, 2020 – according to Advantage Data – total BDC portfolio assets at FMV were $112bn.

By portfolio value, FSKR is the third largest BDC in size, representing 6.7% of the total.

The only two BDCs larger in AUM are Ares Capital (ARCC) at $14.4bn and Owl Rock Capital (ORCC) at $8.9bn.

In The Family

FSKR is even larger than its sister BDC with a similar name and ticker : FS KKR Capital (FSK), which has portfolio assets of $6.9bn.

Should FSK and FSKR ever combine – as was officially the plan at one time – the combined BDC would have assets of $14.4bn, which would cause a dead heat for first place.

Major Player

For the moment – and using the BDC Reporter’s own data from IQ 2020 – total public BDC portfolio assets have a value of $85.2bn.

FSKR’s AUM represents 8.7% of the total.

Or, put another way, by its addition to the public BDC pool, FSKR has grown the size of this segment of the industry by 9.6%.

In terms of market capitalization (stock prices and shares outstanding) FSKR has a value of $2.471bn, or 7.0% of the total public market cap, which is $35.5bn as of June 17, 2020.

History

The BDC was officially formed on July 13, 2011 but became active June 18, 2012

The BDC was sponsored by Franklin Square Holdings (which does business as FS Investments) and its “sub-advisor” was GSO Blackstone.

The mandate of the firm was described in this way at the outset:

” FSIC II focuses primarily on investing in the debt securities of private companies throughout the United States, with the investment objectives of generating current income and, to a lesser extent, long-term capital appreciation for its investors”.

On December 11, 2017 GSO/Blackstone resigned as sub-advisor and was replaced by KKR Credit Advisors (US) LLC, or KKR Credit, beginning in April 2018, after a transition period.

This new relationship between FS Holdings was structured as a co-advisory.

At March 31, 2018 FS Investment II had portfolio assets at cost of $4.5bn and of $4.4bn at FMV; debt of $2.2bn and net assets of $2.7bn.

Total losses on just over $3bn of equity capital raised was ($0.259bn).

Recent Growth

In the subsequent two years, total portfolio assets at cost have increased to $8.519bn, a 89% increase.

Assets at FMV have increased by 69%.

Net assets have increased by 55%.

Aggregate losses – both Realized and Unrealized and net of any undistributed Net Investment Income – were ($1.609bn), or 6.2x higher.

Into The Pot

Much of the increase in assets and losses can be attributed to the December 18, 2019  merger of the BDC with several other  non-traded BDCs co-managed by KKR and FS Investments.

These are FS Investment III, FS Investment IV and CCT II.

All three BDCs had similar business strategies to FSIC II/FSKR.

Reversal

At 12/31/2019, FSIC II had 678,379,301 shares and a net asset value per share of $7.36.

In anticipation of the public listing, the BDC undertook a 4:1 reverse stock split.

According to an 8-K on June 10 that reduced shares outstanding from approximately 691.2 million to approximately 172.8 million.

That last number is what we have used in our database.

Current Portfolio

We have not had time – given the size of FSKR’s portfolio – to yet undertake a granular review of the 113 company portfolio, including a joint venture.

The JV had portfolio assets of $1.086bn.

Nonetheless, we have undertaken a first pass.

We estimate that 47 of the 113 companies were underperforming at March 31, 2020, or 42% of the total.

In terms of asset value at least $1.225bn were in the BDC Reporter’s underperforming category, or 16.4% of the total portfolio.

Non Performing

Included in the number of underperforming companies are 15 that were on non accrual.

That’s the second highest number of any public BDC that we’ve identified so far for the IQ 2020, after sister BDC FSK.

By contrast, ARCC has 13 non-performers.

Given that FSK and FS Investment II/FSKR frequently invest together there are several overlapping companies in this count.

Leverage

Debt to equity (leaving out cash, investments in process, etc) was 0.87x at March 31, 2020. 

By the BDC’s own calculation “net debt to equity” was 0.76x.

The “target leverage” – set out in the latest Investment Summary – is 1.00x-1.25x. 

Distributions

Prior to the reverse split the quarterly distribution for the IQ 2020 was $0.15, reduced recently from $0.18.

Barring any change in the payout, the future distribution should be $0.60 or $2.40 per annum.

That represents a 9.7% yield at book value and a 16.8% yield at the most recent stock price mentioned above.

[Note: We had previously posted an incorrect market yield, which we’ve now corrected, thanks to an eagl-eyed reader with a calculator] 

Earnings

According to the BDC, the Adjusted Net Investment Income for IQ 2020 was $93mn, or $0.56 per share, adjusting for the reverse stock split.

We’ve not been able to find any analyst projections for future earnings.

Based on the annualization of the IQ 2020 Adjusted Net Investment Income Per Share, the price to current earnings is 7.0x. 

Price To Book Value

FSKR is trading at 58% of book value.

By contrast, sister BDC FSK trades at 62% of book value.

Target Market

Based on the average and median EBITDA of portfolio companies – both first and second lien – FSKR’s investments are principally in the form of loans and the target borrowers in the upper middle and large cap borrower markets.

As a chart in the BDC’s Investor Presentation shows (see slide 25), this is almost identical to the focus of FSK.

We have not yet determined what percentage of the FSKR and FSK portfolios directly overlap in the manner that Golub Capital (GBDC) divulged when absorbing one of its non-traded funds into the public vehicle.

That may be available in the future.

Coming Up

The BDC Reporter proposes to undertake a more thorough review of the new BDC following the publication of the IIQ 2020 results and conference call.

In the interim, we’ll be adding all the underperforming companies into the BDC Credit Reporter’s database.

For readers interested in further color about some of thew BDC’s underperformers we recommend going to the BDC Credit Reporter and searching by the BDC’s name for a list of all companies and articles written.

VIEWS

Shocking

We are still familiarizing ourselves with the new public BDC and have no considered views to share as yet about the BDC’s strategy; performance; credit quality or outlook.

There’s a great deal of data that needs to be absorbed but we do have the example of FSKR’s almost identical twin – FSK – to aid in the process.

The Great March 

For the moment, we’ll limit ourselves to underlining again the importance – in terms of size – of the addition of FSKR to the public BDC segment represents.

This continues a process that has been underway since the Great Recession ended of large asset managers increasingly dominating the BDC landscape where investment assets are concerned.

By The Numbers

These statistics drawn from the BDC Reporter’s database speaks volumes:

86% of all public BDC portfolio assets are held by the 20 BDCs with $1.0bn or more in investments.

The remaining 26 BDCs are left with only 14% of the market.

Even more telling:

The largest 6 BDCs, managed by 5 different asset managers, account for 50% of all public BDC portfolio assets.

Dominators

In the years ahead despite all the articles we’ll write about Fidus Investment, Harvest Capital, Oxford Square Capital etc, the performance of investors in the “BDC space” will depend largely on how successful these 5 external managers prove to be.

The question has to be whether bigger will prove better in terms of long term return on equity.

We are keeping an open mind and will only say that to date the evidence is mixed. At best.

Pointed Same Way

The 5 huge managers involved – and several just one rung down – have made a big bet on becoming major players in the public BDC sector.

Can they deliver or will the top 5 list be much altered a few years out ?

We are entering a very interesting period given that Goldman Sachs BDC (GSBD) will be merging its non-traded sister fund shortly; GBDC may do so for a second time and Owl Rock (ORCC) has expressed interest in same.

There are several other asset managers besides with similar ambitions in this rush to size.

We wonder if there are enough “good” loans and borrowers in an increasingly commoditized leveraged lending business for everyone….