The private equity world thrives on exclusivity. Everyday investors, unfortunately, are generally not given the opportunity to invest in these types of funds.
A way to bypass this exclusivity is through business development companies, or BDCs, often run by some of the largest and best-regarded financial institutions. These BDCs enable regular investors to gain exposure to private companies just like private equity firms. BDCs make loans to and/or buy equity stakes in mostly private businesses of all shapes and sizes.
Here we highlight four promising BDCs, ranging in market valuation from $800 million to $8 billion.
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1. Ares Capital is sized for success
Ares Capital (ARCC 0.39%) tops this list of companies with the highest valuation, a cool $7.95 billion. Generating $742 million in net income from $954 million in revenue over the trailing 12 months, Ares Capital continues to deploy capital to new businesses.
In the third quarter, Ares Capital committed $2.4 billion in new capital to 18 new and 32 existing portfolio companies. First lien senior secured loans, which are loans that have priority to get repaid first, made up 90% of this quarter's commitments. Second lien senior secured loans, the next loans in line to be repaid, comprised 7% of Ares Capital's portfolio. Only 2% of its investments take the form of equity.
If you're trying to feel like a private equity fat cat, pay attention to the portfolio you will indirectly own if you buy Ares Capital's stock. The businesses receiving third-quarter commitments include a provider of central institutional review boards for clinical trials, a specialty insurance provider, a manufacturer of pet prescription medicines, a laundry service and equipment supplier, two electronic health records providers, an oil exploration and production company, and many others. Broad diversification in types of businesses and industries mitigates risk should any one industry hit headwinds.
Based on its lending, Ares Capital dividends currently yield around 8.6%. That's attractive enough for 40% of the shares to be owned by institutional shareholders, primarily funds seeking income.
2. Main Street funds smaller companies
The next BDC up for consideration is Main Street Capital (MAIN 1.10%). Sporting a $2.7 billion market cap, Main Street Capital's stock just edged out the gains made by the S&P 500 index this year, gaining 25% year to date. Investment income for the quarter and first nine months of the year were $60 million and $182 million, respectively.
Main Street's president and chief investment officer, David Magdol, highlighted on its recent earnings conference call that the investment portfolio contains 182 companies from more than 50 industries. Investors should peruse the latest 10-Q to see the portfolio companies, ranging from a commercial security and alarm company to a manufacturer of sportfishing boats to healthcare equipment dealers, a crane company, several specialized software companies, and oil and gas exploration outfits.
The investment strategy focuses on illiquid debt and equities for lower middle market private businesses with revenues ranging from $10 million to $150 million. Additionally, Main Street provides debt capital to middle-market companies that have revenues in the $150 million to $1.5 billion range.
Main Street generally invests in smaller companies than Ares Capital and holds more equity positions. Main Street usually monetizes its stakes through dividends paid or from a portfolio company sale. Based on the debt and investments Main Street maintains, investors can earn a 5.9% dividend yield.
3. Apollo leads on yield
Apollo Investment (AINV) is focused on providing capital to middle-market companies with annual revenues ranging from $50 million to $2 billion. For the quarter and 12 months ending Sept. 30, Apollo hauled in investment income of $70.3 million and $262.3 million, respectively. Net investment income was $35.7 million and $130.2 million, respectively, in those same periods.
Apollo's portfolio spans a variety of industries including healthcare, aircraft leasing, tech, oil and gas, transportation, retail, and automotive, among others. As of Sept. 30, Apollo had 139 companies in its portfolio.
Apollo committed $377 million to 22 investments in the third quarter. During the quarter, Apollo reduced its exposure to second-lien loans to 22% of the loan portfolio. First-lien loans now comprise 77% of the loans.
Apollo paid investors $1.80 per share in dividends over the past year, yielding a very attractive 11% return. Further, the board authorized a $250 million share buyback plan. In the last quarter, Apollo repurchased $14.2 million in stock. Fewer shares should lead to greater per-share value for investors.
4. Goldman Sachs BDC rebalances its portfolio
Goldman Sachs BDC (GSBD 0.07%) rounds out the list today. The name alone conjures up images of pinstriped bankers cutting deals left and right.
Oddly enough, this is the smallest BDC on this list. Does size matter? At $820 million in market cap and giving investors nearly a 9% return, Goldman Sachs BDC deserves more attention.
Goldman's portfolio touts 102 companies across 35 industries. New commitments in the last quarter totaled $172.5 million for 10 new portfolio companies and seven existing ones.
Investment income was $36.9 million and $111.8 million, respectively, for the three and nine months ending Sept. 30. After-tax income was $19 million and $60.3 million for the same periods, respectively.
Not unlike Apollo, Goldman Sachs BDC continues to reduce its exposure to subordinated loans. A year and a half ago, first-lien investments made up 33% of the portfolio. Today, 72% of the portfolio is higher-quality first lien debt. This may turn out to have been a savvy move in the event of an economic slowdown.
Some caveats for BDC investors
BDC investors should keep in mind that the timing and size of investments can fluctuate dramatically from quarter to quarter. Sales of portfolio companies can cause choppy earnings, too, because of timing and the varying sizes of the companies.
Further, these businesses primarily provide loans. If a recession hits and the economy slows, will the portfolio companies be able to repay? Ares, Apollo, and Goldman primarily focus on first-lien loans, which provide protection to get paid before other debtors and equity owners in the event the company receiving the loan gets into serious financial difficulties.
On the positive side, each BDC referenced in this article invests in more than 100 companies from diverse industries, which should mitigate risk due to a specific company or industry setback. The loan payments from portfolio companies generate substantial cash inflows, which should sustain or allow for growth of the current dividends.
