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Troubled BDCs + Denied Dilution = Catnip for Activist Investors

By Motley Fool Staff – Nov 30, 2016 at 8:21AM

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It's no secret that activist investors love troubled companies, but activist investors especially love BDCs that are NOT allowed to dilute shareholder value.

Have you ever noticed that activist investors love business development companies (BDCs) that have not received permission to issue shares below net asset value? Maybe, or maybe you're thinking to yourself, "BORING." Industry Focus hosts Kristine Harjes and Gaby Lapera will change your mind about this esoteric topic during this clip from Industry Focus.

A full transcript follows the video.

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This podcast was recorded on Nov. 16, 2016.

Kristine Harjes: I know BDCs have a pretty heavy presence of activist investors, and I have to assume that's because of all these things they were just saying, where there's this opportunity for mismanagement.

Gaby Lapera: Yeah, absolutely. But interestingly, activist investors are actually more attracted to BDCs that cannot issue more shares, because it's a lot easier for them to take control of them --

Harjes: You mean, people voted no?

Lapera: Yeah, people voted no. Typically, if people vote no, that means there's something wrong with the BDC, because it takes a lot for shareholders to vote no, for whatever reason. So if they're voting no, it's because there's already something bad going on.

Harjes: So that's an indication of a lack of trust?

Lapera: Yeah, on the shareholders' part. And there's plenty of companies that never actually use this -- that the shareholders vote yes and the company's never do it, they just ask every year just because, because they're fine raising capital in other ways. But if you think about it, if a BDC has been told, "No, you can't issue any more shares," it suddenly becomes a lot more easy -- and they're already in trouble, so no one really wants to buy more shares of them, so they can't finance themselves, they can't issue themselves more shares below net asset value -- it becomes a lot easier for an activist investor to start buying up shares and be able to take a stake in that company that allows them to force that company to do what they want.

Harjes: So what is it that they want them to do at that point? How do you take this and turn it around?

Lapera: It totally depends on the activist investor. I think some have better intentions than others.

Harjes: Do you think the primary goal there is to get that yes vote the next time it comes around?

Lapera: No. For most activist investors, they want to retain control of the company.

Harjes: And that's why they go for the ones that already voted no, that makes sense.

Lapera: Most frequently, activist investors want to change management structures or fee structures, in order, generally, to make it more profitable for shareholders. But every once in a while, they want to devalue the company to make it easier for someone else to buy.

Harjes: Interesting. Have they been successful, on the whole?

Lapera: Yeah. BDCs are prime targets for activist investors. Especially because they're so complicated, and not a lot of people really 100% understand what's going on with them. But they are really high-yielding investment vehicles because they, much like real estate investment trusts, are required to pay out 90% of their taxable income as dividends. Because they're investing in high-risk, tiny businesses, the margin on their loans, or the debt they have, is a lot higher. So, they have the potential to yield super high returns.

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