As BDCs bounce back from their lows during the Russell 2000 fiasco, Fifth Street Finance (NASDAQ:FSC) and Ares Capital Corporation (NASDAQ:ARCC) are back in the market to raise fresh cash from investors.
The terms, and timing, of these equity raises are interesting -- just how much do existing shareholders stand to benefit?
A dilutive offering
Fifth Street Finance's secondary offering came at an interesting time -- just days after it announced a new, higher dividend yield. I warned in a previous post that a secondary offering might follow the dividend announcement, knowing full well that Fifth Street Finance hasn't raised new money since 2013.
I also find it peculiar that at the same time its manager opts to raise cash for its biggest BDC, it's pulling similar tricks with its floating rate fund. That fund announced a bigger dividend, perhaps to drum up more support for its shares and offer up the opportunity to grow the balance sheet.
I can't wrap my head around how the offering was especially good for existing shareholders. In the SEC filing, Fifth Street Finance discloses that it sold new shares at a price of $9.81, equal to its last reported net asset value.
Including all costs, Fifth Street Finance should receive about $9.79 per share in cash -- a modestly dilutive move if net asset value held ground since the previous quarter. If new money isn't put to work quickly, the cost of its secondary offering only grows, since it now has more shares on which it must pay a monthly dividend.
A small premium
Ares Capital Corporation also filed to sell new shares to the public as its share price reached $17.40 per share on Tuesday.
The deal was subsequently upsized, and we later learned that it sold shares at a price of $16.99. That price represents only a 3% premium to the low-end of its estimated NAV range of $16.49-16.57 per share.
Previously, Ares Capital Corporation sold new shares in December, when its stock was trading at $18.29. At the time, Ares received $17.38 per share after expenses, a sufficient premium of 6.2% to its net asset value.
Ares has a long record of selling shares only above NAV, but I find it interesting to see it not only upsize its latest offering, but do so at a smaller premium than it ordinarily receives.
It's certainly possible that middle-market investment opportunities improved as BDCs were thrown out of market indexes. With most BDCs trading under net asset value for months, and no secondary offerings announced, a reduced supply of cash could have led to improving terms and rates for middle-market loans.
The more pessimistic perspective is that the related third-party managers are seeking to raise new money on which they can earn lucrative management and incentive fees. Fifth Street and Ares are both externally managed.
We won't know, though, if either case is true for some time. Ares Capital and Fifth Street Finance report earnings in about three weeks -- and it won't be until then that public shareholders get a chance for these BDC managers to explain, why, exactly, they're raising new money at such small premiums to net asset value after all the associated costs and expenses.