Conference calls can can be a bit of a corporate boondoggle. Many are just home run derbies, where analysts lob softball questions at management teams. On occasion, the back-and-forth discussion leads to some interesting insights into a company's business model.
I waded through Main Street Capital's (NYSE:MAIN) fourth-quarter conference call to find the most relevant tidbits for investors. Here are three things shareholders should know now.
1. The asset manager's growth may slow
I've long believed Main Street Capital's best portfolio company is its asset management company. It currently manages a private, non-listed BDC, from which it earns a steadily growing stream of fee income. That BDC has now swelled in size to manage some $506 million in assets, generating quarterly profits equal to $0.02-0.03 per Main Street share.
It seems insignificant, sure, but its profits are roughly equal to the amount of cash needed to support interest payments on $100 million of debt at the parent company -- something that will prove to be valuable in a downturn.
On the recent conference call, Main Street Capital's CEO, Vince Foster, indicated that the days of robust growth in assets for unlisted BDCs may be coming to an end:
That -- the nonlisted BBC World is changing as a result. It is projected to change pretty materially as a result of some new regulations. So that's kind of an ongoing area of study, and a lot of that is dictated by the independent broker-dealers...
I think most of the scrutiny that you are talking about really is more focused on the nonlisted REITs. Whatever changes they decide to make there spill over on to the nonlisted BDCs. And the REITs weren't -- they didn't have a fair value NAV requirement that BDCs do. So those -- the REIT changes really don't really impact the BDC as much. But it doesn't really matter what we think, it matters, it really matters what the large independent broker-dealers think and what they want to do and what they want to sell. And indications are that things are going to change
In general, unlisted BDCs are not good investments. They're loaded with up-front fees often nearing 10% of the investment, which are largely kicked back to the advisor who sells them. As regulatory winds shift, and the view toward unlisted yield investments like REITs and BDCs change, the opportunity to raise billions of dollars through broker channels is quickly becoming yesterday's news.
Main Street believes it may supplant its asset manager's growth with other opportunities. Management suggested that it may borrow out of the playbook of other BDCs and create a senior loan fund. Or it may strike a deal with another public company to generate more fee-earning assets under management.
And the third category is asset management, and there's a specific opportunity out there for another public company that has a lease versus buy-type decision with respect to some assets that they need managed or do they want to bring on their own people. Or do they want to do something with us? And that's a particularly promising opportunity there that we're spending quite a bit of time on. I predict one or more of these is going to materialize by the end of the year.
There is no better income than asset management income, as it adds to earnings without credit risk. Making money from risks you take with other people's money is a much better business than risking your own capital. And shareholders will want to see that Main Street Capital can continue to grow this highly valuable income stream.
2. A secondary offering is probably in the cards
Because BDCs must distribute at least 90% of their taxable earnings to shareholders, for all intents and purposes, they cannot retain earnings. The central limit to their growth is their ability to sell stock to the public. Main Street Capital will probably grow by issuing new equity in the coming quarters.
Foster described the logic behind raising new equity:
We kind of formally announced a target in connection with our S&P rating, about 75% leverage target, if you will, including the SBIC debt. And we're at that level. You're absolutely right...
So I would -- I wouldn't be surprised if we decided to raise equity.
It's hard not to like selling new stock at the current price, as it is immediately accretive to net asset value. Existing shareholders benefit tremendously from selling new stock with a book value of $20.85 per share for the current market price of just over $31.00 per share. Book value per share goes up, and earnings per share rise as capital is invested in new yielding assets.
3. On the worst case for oil exposure
If you had one glimpse into a crystal ball of investment information, you'd probably ask about oil. There is serious money to be made in the oil patch if you can know exactly where oil prices are headed. When asked about Main Street Capital's worst-case scenario for its oil investments, Foster said the following:
And I think your worst case is your credit positions. If you enjoy being in the first lien position, which we are, you would equitize those positions and you'd own the companies on a debt-free basis. And they could survive on that basis or you could sell the assets. So we're not terribly concerned about where we are.
Nicholas Meserve, the company's middle market managing director, added to the conversation with the following:
I think the key is most of the E&P companies we'll see out there in the loan space will be hedged well north of 50%, probably closer to 75% through '15. '16 is really where the differential hits, some names are covered up to 50%, some names are lower than 10% and you really see it flow through at that point.
These are important points that are rarely discussed. In the here and now, most energy borrowers have hedged their exposure so that they can continue to service their debts. As time passes, however, they'll start selling more and more of their production at current market rates -- prices lower than their current hedges. Prices for oil in 2016 are probably more relevant for credit risk than prices in 2015.
Secondly, having a first-lien position protects lenders in the event of default. Obviously, it's no sure thing -- if a loan is secured by acres of oil-producing land that is profitable only when oil is ... say, $100 a barrel, it doesn't provide as much security as land which is profitable at $60 a barrel.
The higher-cost oil collateral is only valuable as an option -- its value hinges on the uncertain potential for oil prices to rise to a level at which the collateral can be employed profitably.
But being a first-lien lender does give you a lot more protection than second-lien or unsecured lenders. Main Street implies that its loans are first-lien, so if the borrower defaults, its assets become property of Main Street Capital, and other debt would be discharged in bankruptcy. That should help offset some of the losses that would result from years and years of low oil prices.