In a dizzying turn of events, Prospect Capital (PSEC +0.00%) announced that it would slash its monthly dividend from an annual rate of roughly $1.33 per share to $1.00 per share.
The 25% reduction would put the company's dividend roughly in line with steady-state earnings power. The company revealed that it could cover the new dividend rate with net investment income provided it could earn just a single penny per share in fee and dividend income from its investment portfolio -- a probable reality.
Here are some of my thoughts following the announcement.
1. Really?
I find it peculiar that a month after the company's conference call, in which it was suggested that Prospect Capital could continue to pay its dividend from taxable income, the dividend gets slashed from $1.33 per year to $1.00.
In the long run, the company's net investment income and taxable income should converge. A dividend policy based on net investment income is much more reasonable than one based on taxable income.
Prospect Capital probably knows it. I bet insiders knew it when talking about it on the conference call a month ago. And the dividend cut confirms it.
2. A terribly timed cut
Notably, this dividend cut comes just days after the company's annual meeting, at which it asked shareholders for approval to issue shares under net asset value. If shareholders were made aware of a 25% dividend cut prior to a vote, I find it likely that its proposals would have come under much greater scrutiny.
The timing is all too suspect, but it is what it is.
3. "Smart money" doesn't matter
I've long believed that insider buying means absolutely nothing when it comes to externally managed companies like BDCs. Anyone who had any doubt about that should reconsider.
Consider the following:
- On Dec. 2, 2014, Prospect Capital's CFO Brian Oswald purchased 162,500 shares at price of $9.12 per share. The total purchase was valued at just under $1.5 million.
- On Dec. 5, 2014, Prospect Capital held its annual meeting.
- On Dec. 8, 2014, Prospect Capital slashed its dividend from an annual rate of $1.33 per share to $1.00 per share. Shares register their last trade of the day at $8.27 each.
Oswald wasn't a lone wolf. John Barry and Grier Eliasek, the company's CEO and COO, respectively, also purchased shares during the Dec. 1-2 period. Surely they knew a dividend cut was in the cards, especially the CFO. But they were still buying. It looks rather like showmanship, pure and simple.
In recent history, insider buying is happening only before terrible news (the SEC restatement, below-NAV stock sales, and now a dividend cut). I'm not kidding about this: When I see Prospect Capital insiders buying, I immediately wonder what terrible event I missed in its other filings. Yes, it has become that obvious.
4. Suspension of ATM sales isn't everything
Prospect Capital suspended sales of stock through its at-the-market program, citing the company's current discount to net asset value.
Frankly, it should be assumed that the company wouldn't be selling stock into the market at a time its shares are trading at a beefy 22% discount to book value. It shouldn't be news. Either way, a suspension is just that: a suspension. It's not forever.
5. Recent capital losses
I have the luxury (inconvenience?) of getting every SEC filing direct to my inbox. And if there's anything I've learned, it's that no BDC files as much paperwork with the SEC as Prospect Capital. That's not such a bad thing, though, in that it provides for frequent updates on its investment portfolio. In a recent SEC filing for the sale of InterNotes (debt financing), Prospect Capital detailed its investment activity.
In focus are the recent sales of four different CLO investments, all of which were sold at a loss. Only one of those CLOs was held at a discount to its original cost at the end of the Sept. 30, 2014, quarter.
Of the three CLOs that were marked at a premium as of Sept. 30, 2014, fair values ranged from 103%-109.7% of cost. Valuations would have necessarily fluctuated considerably within a short period of time for Prospect Capital to incur a loss on any of these CLOs.
If its CLO book were marked today, it's possible that the entirety of its CLO investments would be valued at significantly lower marks than at the end of the last quarter. That doesn't bode well for net asset value, given that CLO equity made up roughly 18% of net assets last quarter.
For the record, I'm not cherry picking. No gains were realized since Sept. 30, just losses.
Prospect Capital's dividend cut was a long time coming. It was necessary. But it was also ill-timed (shortly after a key shareholder's vote) and just a month after management implied the current rate was sustainable. I think that's ample reason to avoid this company, even at a substantial discount to book value.
