Blyth Fund Financials Group Tommy Fan Bill Kwai Nick LaGrandeur David Lopez Nick Burakoff Jacobo Ochoa Vedant Ahluwalia Habib Olapade Sophia Huard Andrea Wang ID: 431114
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Slide1
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
MackSlide2
Business Overview
Prospect Capital is a business development corporation (BDC)Similar to a private equity firm, but welcomes public investors through common stockInvests 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 BDCsClassified 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
corporationsSlide3
PSEC Investment Thesis
Significant growth in performance metrics over the past 5 yearsRegulatory benefits such as high dividend yieldsDiversified ExposuresRelatively UndervaluedSlide4
Portfolio Growth
Total AssetsSlide5
Growth in Net Investment IncomeSlide6
Increasing Revenue distributionSlide7
Superior cumulative returnsSlide8
Increasing Origination
Increased origination → improved IRRQ3 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.Slide9
Diversified debt investmentsSlide10
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%)Slide11
Lender DiversificationSlide12
Regulatory Benefits
High dividend yields.Heavily invested in US Middle Market, which accounts for 40 percent of US GDP. Slide13
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 goalsDespite that, dividend yield still at 11.59%. It is currently trading at a 21% discount relative to the Net Asset ValueSlide14
Undervalued compared to peers
Company NameFiscal PeriodRevenueEBITDA MarginP/E Ratio
Market Cap to Book Value
Dividend Yield
Prospect Capital
12/31/2014
615.8
52.5%
9.18x
0.83x
11.59%
Average
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%Slide15
DCF ValuationSlide16
Applicable Risks
CLO exposureInterest rate riskLBO debt fundingSlide17
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 2014Not 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.Slide18
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 capitalSafe 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 Slide19
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: 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. PSEC taking steps to lower overall risk exposure: increased its portfolio allocation to first-lien loans (i.e. secured debt)Slide20
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.