Money is a commodity. You can find it from a multitude of sources, and at widely ranging prices.
Thus, for finance companies, there is nothing more important than the management team -- the jockeys. This is particularly true for business development companies, which are, in essence, actively managed funds of private company investments.
I'm a firm believer that incentives are everything, especially as it relates to management's actions.
Prospect Capital is managed by an external manager, and thus collects operating expenses in the form of fees charged to assets and hurdle-beating returns. Some, including me, have argued that this structure is subject to concern, since it incentivizes management for growth, not necessarily performance.
Main Street Capital, on the other hand, is an internally managed company. Thus, all of its expenses are plainly disclosed, and simply paid for out of ordinary profits and losses.
Main Street Capital easily takes the advantage here. Its operating expenses have come out to roughly 1.6% of average total assets. Prospect Capital's expenses start at 2% of gross assets, plus 20% of returns over the hurdle rate of 7% per year.
Could Main Street Capital pay its people more money? Sure. But they don't, as evidenced by the fact that its operating expenses have been among the lowest in the industry.
Insiders own a substantial stake in both BDCs. As of the latest proxy filing, directors and executives of Main Street Capital owned 6% of the company. The CEO, Vincent Foster, owned 3.6% of the company by himself.
Prospect Capital's management owned roughly 3.9 million shares of the company as of the last proxy filing, with the bulk (roughly 3.7 million shares) owned by its CEO, John Barry. Because of the company's size, insiders owned only about 1.5% of Prospect Capital when it last filed a proxy statement. (Since that filing, John Barry added another 100,000 shares for about $1.1 million.)
I point out the differences in ownership as a percentage of the total company because it's important for understanding the numbers that matter to the manager. Last year, Main Street CEO Vince Foster earned more from Main Street Capital dividends than he did from total compensation in his role as CEO. And, depending on the day, his stake in the company is worth as much as 20 times his annual salary.
No compensation data is available for Prospect Capital, but given that it will take in roughly $2 million in fees per employee, it's likely safe to say that its managers work for the external manager, not the public BDC.
It's also worth pointing out that both companies run other funds. But who gets a slice of the pie is very different. Main Street Capital gives external management fee revenue to its shareholders. Prospect Capital's other funds pay management fees to the external advisor. Main Street Capital's employees are always generating revenue for its public shareholders in some way; that isn't true of Prospect Capital.
It's here that Prospect Capital and Main Street Capital diverge substantially. Main Street Capital's portfolio has performed very well; Prospect Capital's leaves something to be desired, although it was historically invested in a single industry (oil and gas), which proved to be problematic during the financial crisis. Prospect Capital has since diversified.
Of course, Main Street Capital has the advantage of its start date. The company went public at a good time, and most of its early investments as a public company were underwritten during a recovery, not right before a terrible recession.
But that discounts some of the realities of Main Street Capital's performance before it went public. Remember, when Main Street Capital went public, it did so by buying out its previous investors at a 54.4% premium to their capital contributions. The SBA acknowledged its performance, naming Main Street Capital the SBIC of the Year in 2011.
Prospect Capital's performance before going public is difficult to track. Although, there is a noteworthy story about one of its funds, which suffered a crushing blow during the dot com boom. The NYC Discovery Fund ended up in the SBA's hands after massive losses. It's likely the reason Prospect Capital doesn't have an SBIC license, and probably never will. But, to be fair, nearly everyone lost their shirts, and their rational thinking, during the dot com boom.
The last word
Ultimately, I think the market reflects the differences between these two companies in the price. Prospect Capital generally trades at or around reported net asset value. Main Street Capital has been trading at a 70% premium to net asset value.
Is it unwarranted? I'd say no. Over time, the differences in expenses add up significantly. So, too, do the hidden costs of management incentives.
If I had to pick a BDC based solely on the management team -- ignoring anything related to valuation -- Main Street Capital is the obvious winner. Given the differences in expenses, I'm not entirely convinced that the premium for Main Street Capital shares is necessarily unwarranted, either.
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