How Main Street Capital Is Busting the BDC Trend

Main Street Capital (NYSE: MAIN  ) stands alone as a high-quality operator. Last week, the company announced that it expects to beat its November guidance for the fourth quarter.

This, of course, comes after larger rivals have found the competitive landscape more difficult. Last month, Fifth Street Finance (NASDAQ: FSC  ) cut its dividend. Prospect Capital (NASDAQ: PSEC  )  failed to earn its dividend in the last quarter. But Main Street Capital, being a much smaller BDC with an internally managed structure, is not only holding steady, but improving quarter after quarter.

The company reported it expects to beat earlier fourth-quarter guidance, and increase its dividend to more than $2.50 per share, per year, starting in 2014.

What makes Main Street better than other BDCs
Lending is a competitive business. There aren't many ways -- or any, really -- to have a strong competitive advantage. Money is money. Lenders are lenders.

But one advantage Main Street does have is that it's small. Therefore, it can focus on lower middle-market companies -- companies with annual earnings in the single million dollar range per year. It's here in the lower middle market where Main Street Capital gets the most advantageous terms.

Main Street Capital's lower middle market loan portfolio had an average weighted yield of 14.9% as of the last quarter. Yields have compressed recently in the true middle market, with lenders getting as little as 7%-8% on senior debt. For Main Street Capital to earn 14.9% on its lower middle-market loans shows that going smaller is paying off. Main Street Capital invests in much smaller companies than Fifth Street and Prospect Capital. 

Naturally, Main Street Capital's improved guidance comes with the announcement of new lower middle-market investments worth more than $60 million. Although, it's worth noting that two other lower middle-market debt investments were moved to "non-accrual," a move that indicates Main Street Capital may write down the debt as it fails to collect on its investment.

The company also announced new middle-market investments worth $75 million, as well as $43.2 million of new investments in its private loan portfolio.

Recent good news is great for Main Street Capital shareholders. The stock is up more than 5% on a bullish outlook for 2014, though with its growing appetite for new investments, I wouldn't be surprised if the company uses its premium to book value to raise new funds with a secondary offering. The company currently trades at 1.7 times tangible book value, one of the highest valuations in the business development company industry. 

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Comments from our Foolish Readers

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  • Report this Comment On January 09, 2014, at 12:15 PM, caapt727 wrote:

    Yes, Main is doing very well, but they pay a much lower dividend that most of the other BDC's which gives them a much lower cost of capital to invest. Even with their projected dividend increase for 2014, they will still be much less that many of their competitors. I would hope they would beat the other BDC's every quarter with that dividend. The reason I invest is to get dividends.

  • Report this Comment On January 09, 2014, at 12:24 PM, TMFValueMagnet wrote:

    Caapt727, the lower dividend is a result of a much higher valuation. Even though Main Street has a lower cost of capital (if you use it's yield as the cost of capital), it has a much higher yielding portfolio than many BDCs out there.

  • Report this Comment On January 09, 2014, at 4:06 PM, caapt727 wrote:

    TMFValueMagnet, thanks for the reply. I realize the lower dividend today will produce a higher valuation in the future which will hopefully equate to dividend in the future, but at my sage in life, I'm looking for income now. I think Main will be a great investment for the long haul.

  • Report this Comment On January 10, 2014, at 3:34 PM, TMFValueMagnet wrote:

    Caapt727, I understand. The point I wanted to make is that Main Street Capital isn't using its low cost of capital as a reason to make low-yielding investments.

    I also understand why someone searching for current income might turn away from the BDC with the lowest current yield. It makes complete sense. Fool on!

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