EC 2020 BDC List And The Top 4 BDCs For High Income

Source: Investor Presentation

Prospect reported first fiscal-quarter earnings on 11/6/19 and results met consensus, but were weak on a year-over-year basis. Net investment income came to $71.1 million, down sharply from the $85.2 million in the year-ago period. Net Asset Value (NAV) declined year-over-year from $9.39 to $8.87 as a result of the fair value of the company’s investments declining year-over-year and quarter-over-quarter to $5.45 billion.

Prospect’s annualized current yield on its portfolio of investments also declined from 10.6% to 10.2%. Prospect originated $95 million in new loans in Q1, but received $245 million in repayments. This led to a shrinking of the company’s portfolio as it was reduced in size by $150 million in Q1.

Growth has been tough to come by for Prospect for the past decade. Since 2012, net investment income has struggled to grow. Part of this is due to Prospect’s prodigious share count, which is about six times higher today than it was a decade ago. While it is typical for a BDC to issue shares to fund acquisitions, Prospect’s dilution has been excessive.

Given this history of dilution and weak net investment income performance, we don’t expect NII growth on a per share basis. This will weigh on future returns. Fortunately for investors, the stock has a very high yield of 11%. However, we expect the valuation multiple to decline and reduce annual returns by 3%-4% annually through 2025. Total returns are therefore expected in the 7%-8% range each year, over the next five years.

BDC #2: Main Street Capital (MAIN)

Main Street provides long-term debt and equity capital to lower middle market companies and debt capital to middle market companies. Main Street defines lower middle market companies as generally having annual revenues between $10 million and $150 million. The company’s investments typically support management buyouts, recapitalizations, growth financings, refinancing and acquisitions.

As of the end of third quarter 2019, Main Street had an interest in 68 lower middle market companies, 52 middle market companies and 62 private loan investments. The company has a market capitalization of $2.8 billion and generated $157 million in net investment income last year.

Main Street has generated impressive growth in NII, NAV, and dividends over the past decade.

Source: Investor Presentation

On November 7th, Main Street Capital released third quarter results and reported net investment income of $39.0 million, a 2% increase compared to $38.1 million a year ago. The corporation generated net investment income per share of $0.62 per share, down 1.6% from last year’s income of $0.63. Distributable net investment income totaled $0.66 per share, identical to the third quarter of 2018.

Main Street’s net asset value increased $0.11 to $24.20 since the start of 2019, an increase of 0.5%. Adjusting for the semi-annual supplemental cash dividend, net asset value would have increased by $0.36 per share, or 1.5%.

The company completed $25.5 million in total lower middle market portfolio investments, $8.8 million of which was issued to a new company in the lower middle market portfolio. The lower middle market portfolio had a net decrease of $9.8 million, while the middle market and private loan portfolios were both higher by $26 million, and $32 million.

We estimate total returns near 8% per year moving forward, consisting of the 5.5% yield, 4.0% expected NII per share growth and a ~2% negative reduction from multiple valuation compression.

BDC #1: Ares Capital Corporation (ARCC)

Ares Capital Corporation is a specialty finance BDC. It focuses on generating both current income and capital appreciation through debt and equity investments. The company invests primarily in U.S. middle-market companies, as well as larger companies.

Its portfolio is comprised of first and second lien senior secured loans as well as mezzanine debt, diversified by industry and sector. The company was founded in 2004 and has a market capitalization of ~$8 billion.

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