Is it time for a stock buyback at Prospect Capital (NASDAQ:PSEC)?

When business development companies trade substantially below their last-reported net asset values, or NAV, repurchasing shares can be quite beneficial for shareholders. A repurchase allows a BDC to essentially acquire a portfolio of loans and investments at prices below their stated value.

Prospect Capital trades at roughly $10 per share, while its net asset value stands at $10.68 per share. Repurchasing shares is like buying $10.68 for $10.

A no-brainer?
Historically, Prospect Capital hasn't been that active repurchasing its shares. It last announced a stock buyback below net asset value in August 2011, when it decided to dedicate up to $100 million to the cause. That announcement followed a secondary offering in June 2011, in which shares were sold below net asset value.

Following the repurchase announcement nearly three years ago, not a single dollar was deployed to reduce share count. Here's the language from Prospect's most recent quarterly report: "We have not made any purchases of our common stock during the period from August 24, 2011 to March 31, 2014 pursuant to this plan."

It seems unlikely, given the company's history, that it will support the share price with repurchases, despite the fact it would be good for investors. Since yields on new investments have declined, repurchasing shares, which represent ownership of a higher-yielding loan book, simply makes sense.

Waiting for a signal
Prospect Capital is required to give advance notice to shareholders that it may repurchase shares -- that notice is only valid for six months. That window has since expired, and if Prospect Capital intends to start buying back stock, it would have to inform shareholders before starting.

There's two takeaways here for investors in BDCs. First, it may be prudent for shareholders to encourage BDCs to maintain an active repurchasing program to make use of market opportunities when their shares trade below NAV. Having an active repurchase program costs nothing, yet it provides a mechanism to create stockholder value by buying shares under their book value.

Second, I think it's important to see how BDCs behave when their shares trade under NAV. Buying back stock is beneficial for shareholders at the cost of management. Share repurchases reduce ongoing management fees paid to the external investment adviser.

When BDCs repurchase shares under NAV, I see a sign of goodwill that their managers are willing to make small sacrifices for those who have entrusted them with money to manage. 

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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.

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