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Prospect Capital Corporation's SEC Drama Is Creating a Buying Opportunity

Shares of Prospect Capital Corp (NASDAQ: PSEC  ) dropped by nearly 3% Tuesday morning on the news that several class action lawsuits have been filed against the company.

These though its possible these complaints could have a adverse short-term impact on the company, this is creating an opportunity to buy into Prospect's excellent business at an even better discount than it was already trading for. The past month or so has been a series of unfortunate events for the company which has produced the opportunity to get into Prospect very cheaply.

The allegations: Do they have any merit?
In at least three separate class action lawsuits, it is alleged that Prospect Capital violated U.S. securities law by making false or misleading statements about some of its investments. Specifically, one of the lawsuits claims Prospect "fraudulently announced inflated revenues, earnings, and earnings per share." Another lawsuit alleges the company's financial statements were false, and its internal and financial controls were inadequate.

This all stems from the May 6 earnings release by Prospect where it disclosed ongoing discussions with the SEC about possibly needing to consolidate certain holding companies. Shares fell about 5% after that announcement, but recovered in the subsequent weeks.

As far as the allegations or misrepresentation and inflation of earnings go, Prospect said in a press release about a week after the discussions with the SEC were made public that there would be no negative effects on the company's taxable income or leverage ratio resulting from the possible consolidation.

While the ongoing discussions do create uncertainty, unless the company's press release is completely false, it's going to be very tough to say the company inflated earnings, or deliberately misled investors. From what it sounds like, the SEC said some of Prospect's wholly owned companies may be miscategorized for accounting purposes, and the company is cooperating fully in order to rectify the situation.

Higher credit commitments spooked investors recently as well
In between the announcement of the SEC issues and the class action suits, Prospect announced two separate increases to their revolving credit facility commitments, which investors reacted negatively to. In the same press release where it emphasized the non-effects of the possible consolidation of assets, Prospect also announced it has increased its revolving credit commitments by about 5%, or $45 million.

Just recently on May 30, Prospect announced another $20 million increase, bringing the total to $857.5 million of the company's $1.0 billion revolving credit facility.

Now, it may frighten investors that Prospect's credit facility is getting closer to being maxed out, but I don't think this is a big deal. On the contrary, it means more money for Prospect to do what it does best: Lend to and invest in mid-market companies and collect more in interest than it pays. Since the recession, the quality of the company's credit portfolio has been pristine.

The benefits greatly outweigh the risks
Prospect's track record of delivering for its shareholders should help put investors' minds at ease. The company has never cut its dividend since it began making monthly payments in 2010, and actually raises the dividend a little each month.  In fact, the company has already declared its monthly payments all the way through December, which will be the 54th consecutive increase.

After the decline in the stock price, which I feel is overdone and will be temporary, Prospect pays a 13.8% annual dividend. What makes this even sweeter is the monthly payment schedule since your investment will compound more frequently, bringing the yield up to an effective annualized yield of about 14.7%.

So, while Prospect works out its issues with the SEC, you'll get paid extremely well for your patience. And don't forget that once all this drama blows over and we see in black and white the non-effects of the accounting changes, the added certainty could push the share price higher, giving you the potential for capital appreciation as well.

Is this a better investment than Prospect Capital?
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Read/Post Comments (7) | Recommend This Article (19)

Comments from our Foolish Readers

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  • Report this Comment On June 03, 2014, at 2:58 PM, Foolaloof wrote:

    Thanks for this, KWMatt82.

    I agree with the theme of overreaction and your take on the factual underpinnings.

    A digression about class actions (CAs):

    Properly created to advance essential social imperatives, the mischiefs CAs were to undo have largely fallen from view in favour of opportunism - and here I mean much more than the opportunity for judgment at trial.

    My instinct - and there is no way to measure whether I'm right or wrong in this view - is that very likely much more money is being made from a completely different sort of insiderism than the ever-vigilant SEC ever has in view, than from the direct proceeds of litigation.

    Consider last Fall's spate of class actions against Tesla for failing to warn of the unwarnable risk of driving the safest car ever made for public purchase. Now dried up on the vine, at the time they caused (with the help of poison pen journo-sensationalists) fluctuations of billions of dollars of value. Tesla's, but more importantly the hard earned dollars of the little investor.

    Where is the watchdog whose mandate it is to know the mind of the figurehead investor with a paper loss who becomes named as representative plaintiff in a class action, but who - the day or week before he gives instructions to sue - informs a short-sniffer of his intentions? Or the lawyers themselves: who better than anyone know with precision when the writ will fall? How many attorneys' second cousins have made millions thus?

    You and I can never know. But we can know statistics- which show the low success rate of

    of these suits.

    I'll take PSEC long, fellow fools.


  • Report this Comment On June 03, 2014, at 3:41 PM, eagledd wrote:

    to these law firms I say kardoolock and mindy moe. they've got their ambulances started and ready to roll. hopefully no one will fall for this abject minsehrmanism. they should recall the words of loribeen in the book of frapnod ch. 25 to 9: "let there be no chasing of gold in the fervor of the relevance. demeaning attempts will be met and smite with rotation and ennui." that

    'll show 'em.

  • Report this Comment On June 03, 2014, at 6:35 PM, randyrado wrote:

    I wholly agree with your article. I had started buying PSEC recently, then really dove all in this morning when it dropped to its lowest levels in two years. Foolaloof's comments about class actions are spot on too!

  • Report this Comment On June 03, 2014, at 7:04 PM, scm68gt wrote:

    These sleaze ball 'lawyers' do NOT represent me - a long time PSEC shareholder. In fact, the SEC should be investigating them for securities fraud. I would bet dollars to donuts that they alert their 'clients' before they announce their frivolous lawsuit so that those 'clients', and themselves, can short the stock.

    If I could find a lawyer just as rotten, I would file a class action lawsuit against these low lifes because I have truly suffered a loss because of their actions.

  • Report this Comment On June 03, 2014, at 10:33 PM, fish2026 wrote:

    Scum68 - although I believe Prospect will win their suit - you have made the dumbest and most dishonest statement I have ever seen on here.

    I'll bet --they alert their clients" Umm there has to be client before they file. Someone has to hire them. They can not recruit clients as that is a criminal offense. IF you have evidence that they did so then you actually have a duty to report it. I say you're full of sht, but actions speak louder than words so fgr it.

    for disclosure I am retired from prosecution and a buyer of Prospect. Its basically a good company that made a small mistake. if the overall market corrects - this will be even more of a bargain.

  • Report this Comment On June 05, 2014, at 9:39 AM, gyroscoope wrote:

    Here we go again, guess these lawyers need to make a payment on their expensive car, house and pay for their kids education. They will make a couple hundred million and offer the stock holders .o5 per share. Ever wonder why your insurance rates are so high. I am tired of being told to pick up the soap in the shower, someone needs to give them a right cross.

  • Report this Comment On June 05, 2014, at 5:01 PM, Babone wrote:

    Fish 2026....".you are absolutely wrong! Did you read any one of the articles about the class actions suits. They are LOOKING for someone to serve as lead plaintiff for the lawsuit so they can easily let their "insiders" know that the are going to file the paperwork for a suit and have them short the stock. Boy, you are one nieve individual!

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Matthew Frankel

Matt brought his love of teaching and investing to the Fool in order to help people invest better, after several years as a math teacher. Matt specializes in writing about the best opportunities in bank stocks, real estate, and personal finance, but loves any investment at the right price. Follow me on Twitter to keep up with all of the best financial coverage!

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9/1/2015 3:59 PM
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Prospect Capital C… CAPS Rating: ****