Main Street Capital Corporation and Its Massive Competitive Advantage

It's almost impossible for financiers to have a competitive advantage. The truth is, borrowing low and lending high is an extraordinarily commoditized business since borrowers just want the lowest possible rates, all else equal.

I think there's a case to be made that one company breaks from the mold. Main Street Capital  (NYSE: MAIN  ) has a huge cost advantage over its peers that pays off in more ways than one.

The low-cost advantage
Main Street Capital is a business development company that invests in smaller, middle-market companies. It primarily focuses on the lower middle market -- companies that post earnings before interest, taxes, depreciation, and amortization (EBITDA) of $3-$15 million per year.

By the very nature of the business, companies that make smaller loans have to be more efficient. Underwriting costs do not scale with the size of an investment. That is to say, there are fixed costs that you incur whether you're loaning out $10 million at a time or $100 million at a time. It doesn't cost 10 times more to make a loan that's 10 times larger.

So, for a company like Main Street Capital, costs are everything. And over the past few years, it has done an excellent job of holding down its operational expenses.

The company makes this point very clear in its presentations to shareholders. Here's a chart of Main Street Capital's total costs as a percentage of assets compared to other BDCs:

It's important to reflect on this chart because corporate presentations are often created to make the presenting company look much better than it is. But in this case, the chart is 100% truthful as it includes all real operating costs including stock compensation (which companies all too often ignore), as well as metrics from much larger competitors, which have a substantial scale advantage over this tiny middle-market financier.

Most middle-market BDCs charge fees based on a 2-and-20 schedule, taking 2% of assets under management plus 20% of all returns. Main Street Capital doesn't do that. Rather, it simply pays employees a salary, with some added stock-based compensation based on performance. The structure allows it to have some of the lowest operating costs in the business, and pass on more of its earnings to shareholders.

Why I'm bullish on Main Street's future
To be fair, Main Street Capital does have a relative scale disadvantage to its peers. For example, Ares Capital Corporation (NASDAQ: ARCC  ) , the largest BDC on the public markets, is so big and well known that it has managed to raise capital going out as far as 30 years. Likewise, larger rival Prospect Capital (NASDAQ: PSEC  ) is known to push its weight around to structure its own collateralized loan obligations and earn extra underwriting fees that smaller BDCs cannot negotiate.

But these are not inherent advantages -- those are just advantages that come along with being really, really big. Once a BDC crosses $2 billion or so in market cap, it tends to enjoy preferential treatment from investors and its customers.

There isn't anything that's really holding Main Street Capital back from growing into a size where it could have the advantages of scale. Its shares trade above book value and it has consistently raised more and more money with new stock issuance. At this point, it's just a waiting game.

The Foolish bottom line
Main Street Capital is a BDC to watch closely. After growing more than 5 times over since 2009, Main Street Capital is just a handful of new equity raises away from joining the big boys. When it does, it'll be a BDC with all the benefits of being a large-cap player with all the advantages of being a low-cost leader. That's when we'll see Main Street Capital really shine.

More high-yield champions
BDCs and other dividend stocks can make you rich. It's as simple as that. While they don't garner the notoriety of high-flying growth stocks, they're also less likely to crash and burn. And over the long term, the compounding effect of the quarterly payouts, as well as their growth, adds up faster than most investors imagine. With this in mind, our analysts sat down to identify the absolute best of the best when it comes to rock-solid dividend stocks, drawing up a list in this free report of nine that fit the bill. To discover the identities of these companies before the rest of the market catches on, you can download this valuable free report by simply clicking here now.


Read/Post Comments (0) | Recommend This Article (4)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Be the first one to comment on this article.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2658103, ~/Articles/ArticleHandler.aspx, 10/23/2014 10:45:35 AM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement