How Main Street Capital Corporation Will Mimic Its High-Yield Peers

Main Street Capital is becoming a full-blown asset manager, following in the footsteps of larger rivals American Capital Ltd. and Ares Capital.

Mar 5, 2014 at 7:00AM

Main Street Capital (NYSE:MAIN) is the darling of the BDC industry, posting the highest total returns since it went public in 2007.

On the company's conference call, managers pointed to a new future for Main Street Capital, one that would have it following in the footsteps of larger BDC rivals.

A new way to make money
Main Street Capital runs a number of investment funds, rolling up several of its previously nonpublic funds into one company. A diagram in its annual report helps explain the complexity of Main Street Capital -- and most BDCs, for that matter.

Main

Source: Page 2 of Main Street Capital's 2013 annual report

But there's something brewing behind the scenes at Main Street. Whereas it has previously invested its own money in middle-market companies, it's working hard to build out an asset management business.

Main Street Capital wouldn't be the first BDC to manage other people's money for its own profits. American Capital Ltd. (NASDAQ:ACAS) owns a sizable asset manager that manages public mREITs, American Capital Agency (NASDAQ:AGNC), and American Capital Mortgage (NASDAQ:MTGE). Ares Capital (NASDAQ:ARCC), the largest BDC, owns Ivy Hill Asset Management, a company that manages its own and clients' capital.

Main Street's deal
Main Street Capital signed a deal in May 2012 to manage the HMS Income Fund as a subadvisor, collecting 1% of assets, plus 10% of returns when the fund clears a hurdle of 7.5% per year. Thus, Main Street Capital is rewarded handsomely for managing the fund, which invests in substantially similar assets as Main Street Capital.

In effect, the company earns money on other people's money, which is arguably one of the best businesses in the world.

So, what's the HMS Income Fund? Some Google-fu reveals it's a nontraded BDC sold by financial advisors to their clients. The HMS Income Fund isn't something you'd want to own. The fund has all the attributes of a nontraded BDC, including illiquidity, exorbitant transaction fees totaling 11.5% of the purchase price, and an on-going, 2-and-20-style management fee. This is the fund you've read warnings about.

But for Main Street Capital, the fund couldn't be better. The high transaction fees encourage financial advisors to sell the product. Thus far, assets under management have totaled $80 million in equity capital, according to the conference call. Main Street management implied that is levered to about $120 million in total assets, which will generate roughly $0.02-0.03 in annual income per share for Main Street Capital investors.

It gets better
The assumptions of $0.02-$0.03 in per-share earnings from its agreement with the HMS Income Fund is based on today's asset level. Main Street Capital's CEO, Vince Foster, noted that the HMS Income Fund is in a "big fund raising mood right now."

This shouldn't be surprising. Incentives are aligned to grow the fund. Financial advisors can make a killing selling it, so assets should only rise over time. Besides, Hines Securities has its own economic interest in promoting the fund, as it will generate larger management and administrative fees as HMS Income Fund grows.

On the second-quarter 2013 call, HMS was said to be raising about $5 to $6 million a month in equity capital.

The Foolish bottom line
This fund could be spectacular for Main Street Capital, providing a new source of revenue without any investment requirements. Additionally, it could serve as a way for Main Street Capital to grow without diluting equity holders of the BDC. Previously, I noted that future growth in Main Street Capital's balance sheet may increase its cost of funds, as its low-cost, government-backed debt would be diluted with additional equity and debt.

It'll be interesting to see how Main Street Capital grows its asset management arm. CEO Vince Foster alluded that this isn't the last asset management product we'll see, saying, "It wouldn't surprise me by this time next year there wasn't another entity out there like some of our competitors are doing."

Is Main Street the best dividend stock you can buy?
One of the dirty secrets that few finance professionals will openly admit is the fact that dividend stocks as a group handily outperform their non-dividend paying brethren. The reasons for this are too numerous to list here, but you can rest assured that it's true. However, knowing this is only half the battle. The other half is identifying which dividend stocks in particular are the best. With this in mind, our top analysts put together a free list of nine high-yielding stocks that should be in every income investor's portfolio. To learn the identity of these stocks instantly and for free, all you have to do is click here now.

Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

1 Key Step to Get Rich

Our mission at The Motley Fool is to help the world invest better. Whether that’s helping people overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we can help.

Feb 1, 2016 at 4:54PM

To be perfectly clear, this is not a get-rich action that my Foolish colleagues and I came up with. But we wouldn't argue with the approach.

A 2015 Business Insider article titled, "11 websites to bookmark if you want to get rich" rated The Motley Fool as the #1 place online to get smarter about investing.

"The Motley Fool aims to build a strong investment community, which it does by providing a variety of resources: the website, books, a newspaper column, a radio [show], and [newsletters]," wrote (the clearly insightful and talented) money reporter Kathleen Elkins. "This site has something for every type of investor, from basic lessons for beginners to investing commentary on mutual funds, stock sectors, and value for the more advanced."

Our mission at The Motley Fool is to help the world invest better, so it's nice to receive that kind of recognition. It lets us know we're doing our job.

Whether that's helping the entirely uninitiated overcome their fear of stocks all the way to offering clear and successful guidance on complicated-sounding options trades, we want to provide our readers with a boost to the next step on their journey to financial independence.

Articles and beyond

As Business Insider wrote, there are a number of resources available from the Fool for investors of all levels and styles.

In addition to the dozens of free articles we publish every day on our website, I want to highlight two must-see spots in your tour of fool.com.

For the beginning investor

Investing can seem like a Big Deal to those who have yet to buy their first stock. Many investment professionals try to infuse the conversation with jargon in order to deter individual investors from tackling it on their own (and to justify their often sky-high fees).

But the individual investor can beat the market. The real secret to investing is that it doesn't take tons of money, endless hours, or super-secret formulas that only experts possess.

That's why we created a best-selling guide that walks investors-to-be through everything they need to know to get started. And because we're so dedicated to our mission, we've made that available for free.

If you're just starting out (or want to help out someone who is), go to www.fool.com/beginners, drop in your email address, and you'll be able to instantly access the quick-read guide ... for free.

For the listener

Whether it's on the stationary exercise bike or during my daily commute, I spend a lot of time going nowhere. But I've found a way to make that time benefit me.

The Motley Fool offers five podcasts that I refer to as "binge-worthy financial information."

Motley Fool Money features a team of our analysts discussing the week's top business and investing stories, interviews, and an inside look at the stocks on our radar. It's also featured on several dozen radio stations across the country.

The hosts of Motley Fool Answers challenge the conventional wisdom on life's biggest financial issues to reveal what you really need to know to make smart money moves.

David Gardner, co-founder of The Motley Fool, is among the most respected and trusted sources on investing. And he's the host of Rule Breaker Investing, in which he shares his insights into today's most innovative and disruptive companies ... and how to profit from them.

Market Foolery is our daily look at stocks in the news, as well as the top business and investing stories.

And Industry Focus offers a deeper dive into a specific industry and the stories making headlines. Healthcare, technology, energy, consumer goods, and other industries take turns in the spotlight.

They're all informative, entertaining, and eminently listenable ... and I don't say that simply because the hosts all sit within a Nerf-gun shot of my desk. Rule Breaker Investing and Answers contain timeless advice, so you might want to go back to the beginning with those. The other three take their cues from the market, so you'll want to listen to the most recent first. All are available at www.fool.com/podcasts.

But wait, there's more

The book and the podcasts – both free ... both awesome – also come with an ongoing benefit. If you download the book, or if you enter your email address in the magical box at the podcasts page, you'll get ongoing market coverage sent straight to your inbox.

Investor Insights is valuable and enjoyable coverage of everything from macroeconomic events to investing strategies to our analyst's travels around the world to find the next big thing. Also free.

Get the book. Listen to a podcast. Sign up for Investor Insights. I'm not saying that any of those things will make you rich ... but Business Insider seems to think so.


Compare Brokers