Main Street Capital Corporation (NYSE:MAIN) announced that it earned $0.57 per share from net investment income, covering its regular dividends of $0.555 per share paid to its investors in the first quarter of 2017.
Here's what shareholders should know now.
1. Dividend coverage remains thin
Main Street Capital increased its monthly dividend to $0.185 per share, up from $0.18 per share, starting with the last payment in the third-quarter 2016 period. Main Street Capital's net investment income of $0.567 per share covered its regular $0.555 dividends by 102.2% during the first quarter of 2017.
Unlike other business development companies, Main Street Capital generates an impressive amount of dividend income from the companies in which it invests due to its outsize equity stakes. This quarter, dividend income made up approximately 15% of its net investment income. As I've said repeatedly, this deserves extra attention from investors, since dividend income from equity investments is inherently less stable and predictable than interest income earned on lower-risk debt investments.
The company earns dividend income from a variety of sources, but portfolio companies by the name of CBT Nuggets and MSC Adviser (its asset management arm) remain outsize contributors, paying about $1.7 million of dividends back to Main Street Capital this quarter, which equates to about 24% of its total dividend income. Learn more about Main Street Capital's most important dividend payers.
2. Stock issuance is driving growth in NAV
Net asset value, or book value, grew to $22.44 per share in the first quarter of 2017. Substantially all of the increase in NAV came from the company's ability to issue shares to new and existing shareholders (DRIP) at a price above net asset value. Net asset value grew approximately $0.34 during the first quarter.
Main Street Capital enjoys the highest valuation of any BDC, recently trading for a massive 79% premium to its net asset value as of March 31, 2017. When Main Street Capital issues new stock, the benefits accrete to current owners in the form of rising net asset value per share.
3. Comments on externalizing the manager
Main Street Capital's business model works well because it has married good underwriting with low-cost operations. The company's cost controls are very favorable for shareholders, as expenses tallied to approximately 1.6% of assets in the most recent quarter. Other BDCs have fees that start at 1.5% to 2% of assets, in addition to incentive fees that redirect 20% of a BDC's income to the management company.
Put simply, Main Street Capital's cost advantage means that average underwriting performance results in above-average investment returns for its shareholders.
Recently, one internally managed BDC, Hercules Capital (NYSE:HTGC), announced its intention to externalize its management structure in a proposal that can only be described as self-dealing. Shares dropped more than 10% on the day the externalization plan was announced, as Hercules Capital joined the growing group of "bad guys" in the BDC industry. (Whether or not this particular proposal passes, shareholders will forever question whether Hercules Capital has their best interests at heart.)
When an analyst asked if Main Street Capital had any interest in externalizing the management team, Main Street Capital's CEO, Vince Foster, fired a few shots at Hercules Capital:
Yeah. If I went to the Board and expressed an intent to externalize, I would -- I think I would become externalized. I expect to be terminated. And if the Board let me, I would hope that the shareholders would terminate them.
Foster knows what everyone else does: Externalizing an internal management team is a way to transfer wealth from shareholders to management.
Unfortunately, if Hercules Capital's campaign to become externally managed is successful, it will have paved the path for internally managed BDCs to accumulate billions of dollars in assets before flipping the script and paying off their management teams.
I don't think this is a risk with Main Street Capital, which routinely cheers the benefits of internally managed BDCs. But Hercules Capital was an internal management cheerleader, too... until it wasn't.