Prospect Earnings Preview: What’s In Play in Q1?

Prospect Capital Corporation (NASDAQ: PSEC  ) will report earnings on May 6th, following an incredibly active first quarter for its portfolio. The company set a record in the first calendar quarter, closing on $1.3 billion in new investments.

Here's what I'll be looking for this quarter:

1. What's the deal with Harbortouch?
I expect Harbortouch to be a focal point of Prospect Capital's conference call. In the first calendar quarter, Prospect Capital closed another investment round with Harbortouch, which included an equity stake in the company for the first time. The co-investment with the founder was valued at $279 million.

At first glance, Harbortouch appears to be a simple point of sale transaction service. Underlying the business, however, is a lending platform that allows small businesses to borrow against their credit card sales.

Remember that Prospect Capital foreshadowed its interest in small business lending in the fourth calendar quarter, when management pointed to online, direct lending to small businesses via peer-to-peer networks. Though this isn't peer-to-peer lending, Harbortouch opens an avenue to make very high interest loans to business owners based on their credit card receivables.

We know now from an SEC filing that Prospect Capital's participation in Harbortouch was valued at $246.3 million in cash, plus $25.5 million of Prospect stock. The deal included $24.9 million in equity and $253.8 million in debt between the holding company and operating company. Harbortouch's size alone makes it very important to Prospect's balance sheet.

2. Consumer lending volumes
Prospect Capital is a consumer lender in disguise. It has investments in several consumer lending businesses which issue loans to subprime borrowers on an installment basis. The largest is First Tower, a company in which Prospect Capital owns an 80.1% equity stake.

First Tower is a seasonal business. The company is most active in the fourth-quarter, when loan demand ramps up ahead of the holiday season. As one would imagine, prepayments and repayments are also seasonal. Tax refunds provide a "chunk" of capital to borrowers to repay loans rather quickly. (Trivia: Motorcycles seem to be a common reason customers turn to First Tower for financing.) 

Prospect's consumer lending businesses make up a substantial portion of the company's balance sheet and income. Combined, three consumer loan companies in which Prospect Capital owns an equity stake -- First Tower, Credit Central, Nationwide Acceptance -- generate roughly $66.5 million in annual interest income and make up $401 million of fair value on the balance sheet.

To put the significance in perspective, consumer lending is 8% of the balance sheet and just over 11% of interest income. 

3. Eyes on future growth
Prospect Capital is no stranger to a growing balance sheet. The company has historically monetized any premium to book value with equity issuance, which is why I think it's a play on dividends alone, not capital gains.

Growth for growth sake isn't always in favor of the investor, however. In recent quarters, Prospect Capital has been raising new equity capital even as its portfolio yields have come down.

Again, we'll want to see what Prospect Capital can do in the financial engineering department. Making greater use of its credit facility is one of the easiest ways for the company to cover its dividend. I have doubts that the facility will have been put to work, but it would be nice to see -- a large, low-cost credit facility is a huge asset. Tapping it would provide immediate dividend coverage for the first time in two quarters. 

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