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Prospect Capital: Dividends, Not Capital Gains

http://www.fool.com/investing/general/2014/04/16/prospect-capital-dividends-not-capital-gains.aspx

Jordan Wathen
April 16, 2014

Photo: LendingMemo.com.

Business development companies are a mixed bag of investment potential. Some BDCs seek to provide income in the form of dividends, and capital gains from a rising share price.

Others, however, focus primarily on yields. A company like Prospect Capital (NASDAQ: PSEC) fits in the yield category, and thus investors should expect only limited capital gains.

Here's why Prospect investors should bank on yields, not capital gains.

1. Convertible debt
Prospect Capital has a history of funding its balance sheet with longer-term debt, not short-term bank financing. This debt is largely raised with the issuance of institutional convertible notes, which can be swapped for stock at the conversion rate.

A recent filing shows that a block of 2015 notes is convertible at $11.23 per share. If shares trade above the conversion price, the debt can be swapped for stock.

These share sales aren't dilutive, as they're well above the last-reported NAV of $10.73 per share, but they do constrain the share price, as new shares will be issued when share prices are above the conversion rate.

2. At-the-market sales
Prospect Capital monetizes its shares when they trade over net asset value, even by modest amounts. This quarter, even though Prospect Capital trades very close to its last net asset value, it filed a new shelf registration t