Main Street Capital Corporation (NYSE:MAIN) has been a highflyer in its industry, delivering the best total returns of any BDC since the financial crisis. As its first quarter has now come to a close, here's what I'll be watching carefully when it reports on May 7, 2014.
1. Houston, do we have a problem?
The gems in Main Street Capital's portfolio are its lower middle-market investments -- stakes in the smallest of private companies. In all, the company holds investments in 66 lower middle-market companies, many of which are located in and around its headquarters in Houston, Texas. Several predate its IPO in 2007.
As a whole, Texas was booming until recently. But lower oil prices have resulted in mass layoffs by many Houston-based majors. Meanwhile, anecdotes of a slowing residential real estate market and a potentially overbuilt commercial market suggest that the boom years may be over, at least for a time.
Measuring Main Street's exposure to Houston and oil prices is difficult, to say the least. Its investment in Bond-Coat, a small Houston-based casing and tubing company, has clear exposure to the oil industry. Meanwhile, its Houston-based lighting and design outfit, Lighting Unlimited, invariably draws oil-related shoppers, but at the moment drillers obviously aren't using its high-end lighting to drill through the night.
Granted, Texan oil fields aren't particularly high-cost to develop. Estimates peg the economic breakeven price of Eagle Ford Shale production at $53-$65 per barrel -- not far removed from current prices. In the Permian, breakeven estimates range from $57-$75 per barrel. That said, the corporate office workers who fill up Houston's high rises aren't all working on local drilling projects. Houston is an epicenter for the global oil trade, housing thousands of office workers and roughnecks alike.
Some BDCs provide a hint of how their investments have performed by revealing their intra-quarter NAV estimate in various SEC filings. Main Street has never done that, so its filings since year-end aren't useful for gauging performance between quarterly reports.
Making a simple adjustment for its secondary stock offering in February, I can estimate that NAV should be in the region of $21.56 per share, ignoring any fluctuations in its investment portfolio. NAV was last reported at $20.85 as of Dec. 31, 2014.
2. What's it going to do with all that cash?
Main Street ended the fourth quarter with about $60 million in cash. After deploying $55 million in at least two investments in January and raising $128 million by selling stock in March, the company should have ample growth capital to make new investments.
Main Street's standard practice is to immediately deploy cash into liquid loans to avoid the "cash drag" that comes from having underutilized cash on its balance sheet. Later, it can sell its liquid credits to raise cash for its higher-yielding, but illiquid, lower middle-market investments.
I'll be interested to see its plans for its excess capital. Will any of it go to support some of its smaller, Houston-based businesses? Will it flow directly into new lower middle-market investments? These are topics that should be discussed on its conference call.
3. What's next for its "extras"
Main Street Capital has an "extra" asset that most BDC's do not have: A lucrative asset-management business. On the last conference call, management suggested that growth in its asset manager will slow as the regulatory environment changes. Fair enough.
But what's next? Management pointed to a senior loan fund, which other BDCs have used successfully to earn beefy returns on equity of 13%-17%. It also suggested a potential venture with another unnamed public company that could effectively hire Main Street to manage an existing portfolio of assets.
It's all up in the air, but Vince Foster, Main Street's CEO, was optimistic that "one or more of these is going to materialize by the end of the year." Any progress on this front would be good to hear about.
One of the best parts of the Main Street model is that its income is not entirely dependent on taking risks with its own capital. It may be largely irrelevant in an upturn, but it'll set the company apart from the pack in any downturn.