Golub Capital BDC (NASDAQ: GBDC ) makes money by providing loans to companies. In this installment, we'll take a look at the company's lending business, how it works, and how it's going.
Who are the borrowers?
Golub lends money to middle-market companies that are backed by private equity firms, meaning that they've already received private equity financing or are partially/completely owned by a private equity firm.
In Golub's case, "middle-market" means companies with earnings between $5 million and $50 per year (earnings are measured by EBITDA).
Golub likes companies with the following basic qualities:
- A leadership position in their market, with distinctive competitive advantages and a defensible strategy.
- A scalable business model with growth opportunities.
- An experienced management team and strong customer relationships.
- Predictable cash flows and a strong equity base.
In other words, Golub likes companies that are strong and stable.
Once Golub decides it wants to finance a company, it can make one of several types of loans:
- Senior secured loans are backed by assets in the company.
- One-stop loans are structured as senior secured loans and usually allow the borrower to make a single lump-sum payment at the end of the loan term.
- Second-lien loans are also backed by assets, but they come second in line -- meaning that the loan is the second one to be paid off if the assets have to be liquidated.
- Subordinated loans aren't backed by assets, pay a higher interest rate, and come with ore risk -- especially if the loan uses a payment-in-kind structure;
- Warrants and minority equity stakes are sometimes part of a loan deal, allowing Golub to take part in equity appreciation or even sell back its shares in certain situations.
How does Golub get paid? Income chiefly comes from interest on loans, but it could also come from capital gains or dividend income. Golub might also charge fees for activities like loan structuring, due diligence, or loan origination.
How's the lending business?
Golub's history as a BDC is relatively short, as the fund was only listed in 2010, but the history of the company's parent, Golub Capital, spans 20 years. That Golub Capital weathered the financial crisis very well, expanding its market share while its competitors struggled.
The reason? Golub's risk-averse approach. By being very careful to focus on companies with strong balance sheets and prospects, Golub didn't face the same problems that hit many other lenders in that period.
That being said, the lending business is pretty good right now. Low interest rates and high liquidity mean that not only is there more money to go around, but it has boosted demand for financing. It's likely a combination of this market environment and Golub's credentials as a lender that account for its revenue and earnings growth over the past few years:
Of course, the difference between a lender that gets through a crisis and one that doesn't is the ability to lend wisely. Golub is deliberately moving its portfolio toward lower-risk loans that offer greater principal protection even while the high-yield market around it booms. Lower-risk means lower interest rates, which means lower dividends paid out to investors -- and that's exactly what's happening with Golub.
Just take a look at Golub's risk-averse trend in comparison to two other BDCs that are paying higher yields, Prospect Capital and Ares Capital.
Whether you agree with Golub's sentiment or not, the company is deliberately reducing its riskier income streams in favor of those that could survive a pull back in the future.
In future installments, we'll compare Golub to its competitors and analyze its prospects.
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