Prospect Capital (PSEC)
Blyth Fund Financials Group
Tommy Fan
Bill Kwai
Nick LaGrandeur
David Lopez
Nick Burakoff
Jacobo Ochoa
Vedant Ahluwalia
Habib Olapade
Sophia Huard
Andrea Wang
Alex Mack
Business Overview
• Prospect Capital is a business development corporation (BDC)
–Similar to a private equity firm, but welcomes public investors through common stock
- Invests in senior and subordinate secured loans, mezzanine loans and equity of small-sized businesses
($50M to $2B in annual revenues).
–Highly fragmented Industry, with no major dominating players (the top 50 companies of the sector
contribute less than 25% to the overall revenue of this sector).
–Asset managers don’t quite know how to value BDCs
• Classified as a business development corporation under the Investment Company
Act of 1940
–Must pay out at least 90% taxable income in dividends. In return, no corporate tax
–At least 70% of its assets must be in private or thinly-traded, public US corporations
PSEC Investment Thesis
• Significant growth in performance metrics over the past 5 years
• Regulatory benefits such as high dividend yields
• Diversified Exposures
• Relatively Undervalued
Portfolio Growth
Total Assets
Growth in Net Investment Income
Increasing Revenue distribution
Superior cumulative returns
Increasing Origination
• Increased origination → improved IRR
–Q3 2014: sharp slowdown in its originations - company posted $887M in new investments. But:
repayments also spiked higher to $862.9M. So: investments net of repayments were only $24M.
–However: in Q4 2014, new investments totaled $522.7M, while repayments were $223.7M.
Result: improved $299M in investments net of repayments.
–Q4: PSEC was able to score many smaller sub-$100M sized deals, which should result in improved
IRR.
Diversified debt investments
Diversified sector investments
•
Highly sector diversified holdings
with the highest percentage holding
in CLO’s (18% based on fair value).
•
Portfolio consists of long term
investments.
•
At December 31, 2014,
approximately $6,523,723, or
176.0%, of net assets are invested in
134 long-term portfolio investments
and CLOs.
•
Many of these are PE-firm
sponsored (46%)
Lender Diversification
Regulatory Benefits
• High dividend yields.
• Heavily invested in US Middle Market, which accounts for 40 percent of US GDP.
Undervalued according to overreaction
• When management cut dividends from 11.1 cents to 8.333 in December 2014 to reflect the
shift towards more secured debt, investors panicked, causing its stock price to drop by ~20%
• Cut resulted from a shift in management’s risk goals
• Despite that, dividend yield still at 11.59%.
• It is currently trading at a 21% discount relative to the Net Asset Value
Undervalued compared to peers
Company Name
Prospect Capital
Fiscal Period
12/31/2014
Average
Revenue
EBITDA Margin P/E Ratio
Market Cap to
Dividend Yield
Book Value
615.8
52.5%
9.18x
0.83x
11.59%
284.5
44.7%
13.04x
1.05x
9.44%
Apollo Investment
12/31/2014
427.9
31.5%
11.80x
0.92x
10.27%
Ares Capital
09/30/2014
1,024.5
57.3%
9.01x
1.04x
8.79%
BlackRock Kelso Capital
09/30/2014
206.4
55.6%
6.14x
0.88x
9.57%
Fifth Street Finance
12/31/2014
280.3
16.9%
19.23x
0.77x
10.17%
Golub Capital BDC
12/31/2014
123.6
53.2%
12.51x
1.14x
7.21%
Hercules Tech Growth Cap
09/30/2014
156.5
48.9%
13.52x
1.52x
7.97%
Main Street Capital
09/30/2014
157.4
66.7%
13.17x
1.47x
6.79%
Medley Capital
12/31/2014
147.7
14.2%
22.00x
0.81x
12.68%
New Mountain Finance
09/30/2014
131.8
55.4%
10.34x
1.04x
9.13%
PennantPark Investment
12/31/2014
188.9
25.2%
12.68x
0.91x
11.78%
DCF Valuation
Applicable Risks
•CLO exposure
•Interest rate risk
•LBO debt funding
Risks: CLO’s
• What are they: A security backed by a pool of
debt, often low-rated corporate loans.
Collateralized loan obligations (CLOs) are
similar to collateralized mortgage obligations,
except for the different type of underlying loan.
• Exposure: Prospect Capital also has exposure
to oil/energy in its CLO investments that
account for 18.5% of the portfolio.
• Fast-growing market: $55B in 2012 to $124B
in 2014
• Not a threat for 2015:
–Such assets are being heavily monitored
by the government and market participants
after CDO’s, and thus have a very small
likelihood of being overvalued
significantly.
Risks: Interest Rates
• Problem: “net investment income is affected by the difference between the rate at
which we invest and the rate at which we borrow”
–According to the industry: increased interest rates should reduce the value of
its portfolio and raise the cost of its own capital
• Safe for 2015 as rise is in near future and exposure is positive
− Increase in interest rates of 5.00% would increase net investment income by
$0.14 per share per annum or $48.9 million for the 6 months remaining in FYE
2015 and $0.33 per share per annum or $116.6M for FYE 2016
− 95% of interest bearing assets(2) are floating rate and approximately 94% of
liabilities fixed rate as of 12/31/2014
Risks: LBO
• Problem: PSEC specializes in debt produced by LBOs, which can yield high
returns. This is accompanied by an increased risk of default (coupon payments for
firms with LBO debt correlated with market performance).
• Should not cause much problem in 2015:
1. This risk is highly systematic: depends generally on the overall US economic
condition. Since we have been out of the economic crisis for a while, and don’t
foresee one in the near future, we feel that taking a hefty premium (~11%
dividend yield) for holding this risk is valuable.
2. PSEC taking steps to lower overall risk exposure: increased its portfolio
allocation to first-lien loans (i.e. secured debt)
Conclusion
• DCF projection is $14.50, currently trading at $8.63 (as of Sunday)
• Stock is currently undervalued.
• Has a historically consistent dividend yield of over 10%.
• Provides a diversified exposure to US small cap and private companies which
are illiquid and highly risky to hold individually.
• Risks are not of concern until end of 2015 by when we will have re-evaluated
the portfolio 2 times!
Cases for Re-evaluation:
• If the stock price drops by $7.5, we will need to re-evaluate the thesis as PSEC as it
will have had a deviation of 7% from nearest trough signaling that the next support
will only come near 6.58 which is the all time low.
• If dividend yield drops below 8%, we will need to re-evaluate the companies
agendas.