Buying Dollar Bills for $0.70

What if you could buy a dollar for $0.70? Would you do it?

What if you rotate your capital every day, turning $0.70 into a dollar, $1 into $1.43 and so on? By the end of the month, your pocket change would have turned into nearly $22,000.

I don't have a magic machine that can turn $0.70 into dollar bills. But there are businesses that do, and unfortunately they aren't making use of it.

The best investment ever turned down
Business-development companies are turning down the best investment opportunity ever seen. Many report that their portfolios are worth ... say, $10 per share, only to refuse share repurchases when their shares trade for as little as $7 or $8 on the open market.

In other words, many BDCs are turning down the opportunity to buy dollar bills for $0.70 or $0.80. Most egregiously, many continue to make new investments at full price to preserve the size of their portfolio. Unfortunately, most management teams are paid based on the size of their assets, not returns on their assets.

That might change. Activists are starting to compel the bad actors and the deeply discounted companies in the industry to start buying back stock. But the industry's individual investors need to get on board, too.

Cheers and jeers (or just jeers ...)
I'm going to start a quarterly "cheers and jeers" table to compile buyback activity across the industry. With the average BDC now trading at a rough 20% discount to book value, most should be buying back stock with every excess dollar on their balance sheets.

Buybacks at discounts to book value increase earnings, book value, and ultimately dividends, on a per-share basis, creating value for their owners.

Without further ado, here's this quarter's table for the largest companies in the industry that trade at discounts of 20% or more to net asset value.

Note: All data from SEC filings from the third calendar quarter of 2015, except for Fifth Street Finance, which was based on calendar Q2 numbers.
*Fifth Street Finance has yet to report full results for the third quarter, though it pre-announced $5 million of stock buybacks and guided that it could repurchase perhaps $15 million more in September, before the end of the quarter. I gave them credit for the full $20 million, which may prove too optimistic.
**American Capital is an internally managed BDC. Unlike the others on the list, it pays insiders with stock options. Thus, a good portion of its repurchases merely paper over stock grants given to insiders.

Get to buying
Buying back stock isn't as difficult as many companies say it is. In any given year, one-fifth to one-third of a BDC's portfolio will typically turn over as clients refinance or repay their loans. That should give BDCs ample firepower to retire a substantial portion of their shares each quarter.

Of the above companies, Fifth Street Finance and American Capital are probably the most likely to expand their repurchase activity, if only due to outside pressure. Fifth Street Finance is under fire from RiverNorth, which reported owns 6% of the company. RiverNorth also announced its intention to seek board seats and fire the management company if it doesn't improve its capital allocation.

Likewise, American Capital is under the gun of Elliot Management, which announced it effectively owns 8.4% of the company. Elliot Management is pushing hard for buybacks, suggesting that American Capital should kill its spin off plans to deploy cash to repurchase shares.

Neither Apollo Investment nor PennantPark Investment have attracted any activist attention to date. However, given steep discounts to book value and meager repurchases to date, it can't be ruled out. That PennantPark and Apollo have significant exposure to oil and gas may deter activists for now.

It's high time for shareholders to hold management's feet to the fire. Shareholders deserve meaningful action to create value, not token quarterly buybacks that amount to a fractional percentage of assets. If a BDC won't buy it stock at a 20% discount, why should anyone else?