What a month. Prospect Capital Corporation (NASDAQ:PSEC) shares fell 13% in the last month, erasing roughly one full year of dividends from the share price. Shares trade at a significant discount to book value -- 15% at last look.
Yet even at this price, buying may prove to be a bad move.
Lingering dilution concerns
Just a few weeks ago, Prospect Capital Corporation revealed it was selling shares below net asset value. Prospect Capital is eroding away at its net asset value per share with each share sold.
This week, we learned it wasn't just a one-time event. In all, some 6.9 million shares have been sold below net asset value. A recent N-2 filing notes that the impact hasn't been dramatic -- NAV fell only about $0.01 per share because of dilutive share sales -- but the implications are obvious.
It may be unsafe to buy Prospect Capital Corporation at any price.
As long as management is willing and able to issue new shares under net asset value, net asset value can decline month after month, even if the underlying investments perform well. What good is buying at a 15% discount to book value if book value may decline 15% from dilutive stock sales?
Dilution isn't in shareholders' best interests
Issuing new equity at the current share price is truly indefensible. Even some of the riskiest high-yield investments -- collateralized loan obligation equity -- yield roughly the same as Prospect Capital's stock.
At current prices, Prospect Capital should be doing the opposite of what it is doing currently. It should be buying back shares, growing net asset value per share, and reducing the amount it has to pay out in dividends. That would also help support the share price, calming investors.
Alas, Prospect Capital hasn't been much for buybacks. Its existing and open authorization to buy back $100 million of stock was approved in August 2011. To date, Prospect Capital hasn't repurchased a single share.
I think you can sum up the Prospect Capital situation pretty succinctly. Management is destroying trust by destroying its book value with dilutive offerings. And the market won't trust a management team that, when its shares trade below NAV, chooses not to repurchase shares, but issue new ones.