A lot has happened at Prospect Capital (NASDAQ:PSEC) since it last reported its third-quarter earnings in May. The company started up a buyback program, repurchased a handful of shares, and has sold some lower-yielding assets on its balance sheet, all of which are positive developments.
On the other hand, a troubled investment was restructured, and the company's plans to spin off assets through a rights offering remain up in the air. As it will soon cap off its 2015 fiscal year with an earnings report later in August, let's talk through a few of these developments, item by item.
1. Share repurchases
It's difficult to argue that there is a better use of the company's capital than buying back stock. With shares trading at a 29% discount to net asset value, buying back stock at the current price is the equivalent of buying dollar bills for $0.71.
Prospect Capital has purchased roughly 2.8 million shares at an average price of $7.13 each, for a total of roughly $20 million after the end of its fourth fiscal quarter.
It's not earth shattering by any means, given that $20 million equates to about 0.3% of its assets, and will improve NAV by roughly two cents per share. This is the first time ever that Prospect Capital has repurchased shares at prices below NAV.
Is it a behavior change? Possibly. But consider this: At a pace of $10 million a week, Prospect Capital's repurchase authorization will be exhausted in late September, just as shareholders receive proxy materials to vote on a slate of issues at the company's annual meeting. Last year, Prospect Capital led shareholders to believe its $1.32 annual dividend was "safe," only to slash payouts by 25% days after securing shareholder votes at the annual meeting. Behavior often temporarily changes ahead of controversial shareholder votes, but I'll happily eat my words if Prospect continues to buy $10 million of stock week after week after its current authorization expires.
2. Selling low-yield assets
Recently, I noted that Prospect Capital needs to earn roughly 11% on its assets to generate earnings that are sufficient to pay its current dividend. That's a high bar in a low-yield world, made even higher than the fact that a substantial percentage of its assets -- roughly 9% at fair value at the end of the last quarter -- were yielding less than 8% per year. Some are yielding as little as 5%-6%, making them dead weight on the portfolio.
Again, though, progress is being made. It sold roughly $208 million of loans with a weighted average yield of roughly 8.2% in the fourth quarter. Including sales after quarter end, it sold $242.3 million of loans, with a weighted average yield of roughly 7.9%.
Of course, some monetization events are outside of Prospect Capital's control. It realized some additional repayments, which brought its total amount of loans sold or repaid to $428.53 million from the end of the third quarter to today. Getting low-yielding assets off the balance should remain a priority, as it will improve its net investment income and generate upfront structuring fees.
3. The loser last quarter
Much has been made of Edmentum, a company in which several BDCs have invested. Edmentum was restructured in Prospect's fiscal fourth quarter. We can infer from Fifth Street Finance's quarterly report that Prospect took a pretty significant realized loss on the restructuring. Fifth Street Finance realized a 46% loss on its investment.
Notably, most of the new securities Prospect Capital and Fifth Street Finance received or purchased in the restructuring do not pay interest in cash. And given the value at which Fifth Street values its equity investment, it appears the company left restructuring very leveraged. Of a total value $12.818 million, Fifth Street ascribed only $126,000 to the equity. This company will stay on the watch list.
4. The spinoff plan
When it comes to Prospect Capital's plan to spin off asset via a rights offering, there's little we can possibly know for certain. But we can make an informed opinion based on what's knowable. We know that:
- Management opined in an interview that it hoped to complete the spinoff around September or October.
- Prospect Capital's fiscal year ends on August 31, an important date for dividends to meet the 90% payout requirement for registered investment companies like Prospect Capital.
- Prospect Capital hasn't filed any public documentation for the spinoffs with the SEC since May 19.
- Peer-to-peer loan company Lending Club and online lender OnDeck (from which Prospect Capital sources its online loans that make up one of three spinoffs) are trading at depressed prices relative to when the spinoffs were announced.
- The last filing for the spinoffs suggest Prospect Capital might entertain the idea of selling shares in its spinoffs at prices below net asset value.
Given the above, I personally find it unlikely that the spinoff can be done on favorable terms for shareholders, if it happens at all. We've heard very little about the spinoffs, comparable companies are trading at depressed multiples, and the market is telling Prospect that the best way to create shareholder value is to shrink by buying back stock.
Killing off the spins certainly isn't the worst of outcomes. In fact, I tend to think that killing it off would be unquestionably good for shareholders. But any word here will be important -- I expect it to be the highlight of the post-earnings conference call.