Last quarter, Prospect Capital Corporation (PSEC 3.09%) announced plans to create shareholder value by spinning off certain assets. In particular, the company noted that its CLO equity and real estate investments may get a higher valuation as stand-alone companies.
That is, after all, the reason why spinoffs happen. Sometimes, the sum of the parts are worth more than the whole.
But why go through all the complexity when there are easier answers to create shareholder value? On the conference call, Robert Dodd of Raymond James asked plainly:
If this via the REIT, etc., you are generating north of 20% returns and potential to expand that further with securitization, why frankly bother will all these spins for the CLO and everything else?
It seems to me that shareholders will be better off if we just frankly dump the CLO business for a gain and invest it at higher returns in this new initiative. Why go through the extra complication?
Dodd wanted to know why Prospect Capital would bother with the complicated spin-offs if it could simply redeploy assets tagged for a spin-off into higher-yielding opportunities. It's a question worth asking.
That, of course, was Nov. 7, 2014, more than one month ago. Since then, shares have declined considerably, and now trade at $8.66 at the time of writing, significantly below the company's last-reported net asset value of $10.47 per share.
The share price decline only creates a more obvious solution to the company's low market price: Start buying back stock.
Would it be easy? Well, it wouldn't be a walk in the park. Grier Eliasek noted in a presentation to shareholders on Dec. 18 that the company isn't buying back stock because it would increase the company's financial leverage. That is, buying back stock without paying down debt would increase the company's debt-to-equity ratio.
But that's really only one half of the story. BDCs renegotiate credit facilities and call debt through the normal course of business. In fact, a substantial amount of its debt is callable, according to a quick FINRA search.
Many of its InterNotes have a call date coming up in the first calendar quarter of 2015. In an answer to another question, Eliasek pointed out that Prospect is calling its high interest debt and reissuing at lower rates, when possible. Calling debt is clearly not a roadblock to a repurchase plan, and neither is renegotiating a credit facility.
Really simple shareholder value creation
If shares represent ownership of assets worth $10.47 each, a repurchase at $8.66 is the best possible investment the company could make, bar none. Each dollar dedicated to repurchases would earn an instant return of nearly 21% given the discount to NAV. Its hundreds of millions of dollars in low-yielding assets would be a great place to start asset sales to fund repurchases.
The current discount to reported book value is so steep that it could afford to sell assets at discounts to their marks as of last quarter and still generate an accretive result for shareholders.
For once, in quite some time, net asset value would start trending up, not down. And insiders, who parrot insider buying as evidence of their conviction in the company, would only stand to benefit from a repurchase, right?
There is no excuse. The external manager gets paid a pretty penny to manage the portfolio, and it's time for it to start doing its job. Manage the portfolio -- sell assets, repay debt, and repurchase shares at today's significant discount to NAV.
