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This BDC Is Rising in a Down Market

Since the Russell and S&P announced they would remove BDCs from some of their indexes, BDCs have been selling off.

But not all BDCs are in the dumps. FS Investment Corp. (NYSE: FSIC  ) stands as one of the few BDCs that has been gaining in value, not declining, in recent weeks.

FSIC Chart

The new kid on the block
FS Investment Corp. is a relatively new BDC, founded in the depths of the recession as a non-traded BDC. But where most non-traded BDCs get a bad rap, it is doing well by its new public owners.

Since going public, FS Investment Corp. has:

  1. Lowered its management fee to 1.75% of assets, from 2.00%, while modifying the incentive fee to be more favorable for long-term investors.
  2. Announced a tender offer to repurchase up to $250 million of its shares at $10.75, a premium to its last-reported NAV of $10.28 per share.
  3. Suggested its management team, external advisor, and sponsor (Franklin Square), would purchase a combined $175 million of stock.

A quality company?
FS Investment Corp. hasn't yet been tested by a downturn, but it's safe to say its managers certainly benefit from a better-than-average reputation. FS Investment Corp. has an exclusive arrangement with GSO Blackstone (NYSE: BX  ) , the credit arm of the giant private equity firm of the same name.

The external management arrangement is a boon to FS Investment Corp. The company recently reported that 57% of its portfolio was originated directly -- investments it completed with its own proprietary deal flow. BDCs that originate their own deals can usually obtain favorable terms -- higher rates, stronger covenants, and origination fees.

And FS Investment Corp. is actually putting the business development company name to work. Its portfolio companies have access to Blackstone's Group Purchasing Organization. This is an interesting value-add for borrowers, which can use the buying power of Blackstone's many portfolio companies to drive down operational expenses.

Since inception, FS Investment Corp. has managed to generate realized gains in excess  of losses, although this is what you'd expect given its 2009 launch date.

The risks
Excluding the company's brief history, some other risks remain. First, unlike most BDCs, FS Investment Corp. is financing the majority of its balance sheet with credit facilities.

Although this leads to low-cost funding, relying on credit facilities turned out to be a poor strategy in the last downturn, as the credit crunch left many banks to cut credit to marginal borrowers. A mix of long- and short-term debt is more favorable from a liquidity perspective.

Additionally, FS Investment Corp.'s average borrower is significantly larger than other public BDCs. Its average portfolio company had an average annual EBITDA of $174 million.

In the first quarter, its direct originations were to companies with average annual EBITDA of $38 million, roughly in line with the companies Ares Capital (NASDAQ: ARCC  ) and Prospect Capital (NASDAQ: PSEC  ) finance. This is part of a shift to grow the portion of smaller, higher-yielding direct origination loans on its balance sheet.

The last word
It pays to be patient. While the company performed well as a private fund, it now faces quarter-to-quarter scrutiny of its investment strategies. The transition to a public company may be difficult. As a private BDC, FS Investment Corp shareholders didn't get to see the volatility that is inherent in leveraged debt investments.

I remain somewhat concerned the company may have an embedded interest in "managing" its share price for investors who aren't used to seeing their investment move up and down daily on a public exchange. 

The company is likely better suited for your watch-list than your portfolio until we see what a "mature" FS Investment Corp. will look like. But keep it close -- betting on Blackstone-managed funds has historically been a pretty good wager. 

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Jordan Wathen

"The liabilities are always 100 percent good. It’s the assets you have to worry about." - Charlie Munger

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