Learn more about Prospect Capital Corporation (PSEC), a BDC that trades on the NASDAQ exchange.
- Historical NAV per share
- Historical NII per share
- Historical share repurchases (buybacks)
- Historical underwriting performance
- Stock issued below NAV
- Meet Prospect Capital Management
- Prospect Capital History
1. Prospect Capital’s Net Asset Value (NAV)
- Dilutive stock issuance has hurt PSEC’s net asset value per share. The company issued millions of shares of stock in several fiscal years. The most dilution occurred coming out of the financial crisis, when PSEC issued stock to acquire Patriot Capital. Issuance reduced NAV by $2.11 and $0.85 per share in fiscal 2010 and 2011.
- Prospect Capital’s underwriting has been in the bottom tier. PSEC’s historical realized losses have exceeded gains by a wide margin.
- Accretive buybacks have been minimal contributors to its net asset value. Shareholders should know that PSEC bought back stock below NAV in only one fiscal year — 2014.
- Prospect Capital used questionable tactics to boost net investment income. Although its reported NII increased, these transactions stood to decrease net asset value per share.
- Prospect Capital’s net asset value has been called into question by credible publications including the Wall Street Journal and New York Times. In any event, PSEC’s net asset value is perhaps more controversial than the net asset value of other BDCs.
2. Prospect Capital’s Net Investment Income (NII)
- Prospect Capital’s net investment income has generally declined as net asset value declined per share. Ultimately, net investment income is a function of book value, and declines in net asset value will lead to declines in net investment income.
- PSEC’s NII in calendar 2012 was inflated by the sale of a portfolio company, Gas Solutions. The proceeds from the sale were paid back to PSEC as a dividend, rather than recognized as a realized gain. Thus, Prospect Capital was able to report significantly increased net investment income per share as a result of some gamesmanship of its books. Eventually, though, the benefits of the sale ran out as PSEC ran out of Gas Solutions proceeds to dividend back to PSEC. This explains the big 2012 jump in PSEC’s NII per share.
- In 2014, the Securities and Exchange Commission (SEC) took a look at PSEC’s accounting and ultimately required that it consolidate its wholly-owned holding companies. Prior to this decision, Prospect Capital was inflating NII per share by investing money into its holding companies and immediately paying the proceeds back to PSEC. The result is that Prospect Capital was turning book value into NII. In other words, PSEC’s net asset value went down by an amount roughly equal to the increase in net investment income.
- Prospect Capital’s net investment income per share would undoubtedly be higher if not for pedestrian use of share repurchase programs and its historical issuance of stock below net asset value.
3. PSEC’s Stock Buybacks
- Prospect Capital’s board of directors approved a share repurchase on August 2011. An earlier 2009 buyback was announced and approved, but never used. It helped drive a pop in the share price, which is documented on the company’s IR website.
- It did not use its authorization until calendar 3Q 2015.
- To date, Prospect Capital has issued far more shares below NAV than it has repurchased.
- Why doesn’t PSEC buy back stock like other BDCs? Some argue that it is because its external management team makes more money when it manages more money, and stock buybacks would reduce its manager’s fees. But other BDCs have similar fee agreements and have bought back stock. One good example is Apollo Investment. We believe that Prospect Capital does not buy back stock because of its fee agreement, and also because PSEC represents virtually all of its external managers’ AUM. That is to say that unlike Apollo, which has other important funds that generate fees, Prospect Capital Management just has PSEC. Therefore, it is very unlikely that PSEC will buy back stock, and in fact, it has issued substantially more stock below NAV than it has ever bought back. PSEC investors shouldn’t bank on stock buybacks any time soon, regardless of how cheap its shares might be compared to its net asset value.
4. Prospect Capital’s Underwriting Performance
- Prospect Capital’s large net realized losses in fiscal 2015 were the result of writing off several control portfolio investments, in addition to the realization of losses on four CLO equity positions. Among some of its most controversial investments, CLO equity has been a big question mark for PSEC. The Wall Street Journal and New York Times have written negatively about PSEC and its CLO valuations. However, because only a minority of PSEC’s CLOs have been sold, they have not played a big role in its realized gains/losses.
- The sizable losses realized in 2015 require greater scrutiny. Prospect Capital began consolidating its wholly-owned holding companies in fiscal 2015, and some believe that it took losses on money-losing portfolio companies rather than consolidate them into PSEC’s financial results.
- Prospect Capital’s unrealized losses are perhaps as important as its realized losses. Because PSEC invests in controlled companies, it can defer the realization of losses and thus show better underwriting results because it controls its portfolio companies. Substantial investments in Oil & Gas companies, currently unrealized, are likely to become realized losses in due time. Similarly, many of the company’s legacy equity investments are held at a discount to cost, and history has shown that its unrealized losses are rarely reversed.
5. Prospect Capital Management
Prospect Capital (PSEC) is an externally-managed BDC managed by Prospect Capital Management (“PCM”). PCM’s primary client is the BDC, Prospect Capital, which makes up the overwhelming majority of its assets under management.
Meet the external manager
Investment advisory employees: 39
Clients: Only investment companies (BDCs)
Assets under management: $6.33 billion (virtually all PSEC)
AUM per investment employee: $162.3 million
Source: FORM ADV filing.
Prospect Capital Board of Directors
|John F. Barry III||Chairman and CEO||2004||2016|
|Eugene S. Stark||Independent Director||2008||2016|
|William J. Gremp||Independent Director||2006||2017|
|Andrew C. Cooper||Lead Independent Director||2009||2018|
|M. Grier Eliasek||President and Chief Operating Officer||2004||2018|
Source: 2016 proxy filing.
- PCM’s Chief Compliance Officer, Daria Becker, is the wife of the CEO, John Barry.
- PCM does not manage money for any institutional clients. All of its AUM comes from retail vehicles.
- PSEC’s staggered Board of Directors elections make outside influence difficult, if impossible.
- PSEC’s 5-member board includes 2 PCM/PSEC insiders, and only 3 “independent” directors.
- Eugene S. Stark is listed as an “independent director,” but he was previously employed as PSEC’s Chief Financial Officer.
- The board of directors has repeatedly approved dilutive stock issuance that has the effect of benefiting management at the cost of shareholders.
C-Level Management summary
Chief Executive Officer: John Barry
Chief Operating Officer: Grier Eliasek
Chief Financial Officer: Brian Oswald
PCM Chief Compliance Officer: Daria Becker
6. Prospect Capital stock issued below NAV
- Prospect Capital is the poster-child of below NAV stock issuance by BDCs. The company has issued stock below net asset value in five fiscal years as a public company.
- PSEC started dilutive issuance in 2009, when the company purchased Patriot Capital, a failing business development company. The acquisition was funded by issuing shares below NAV. In all, Prospect Capital’s dilution reduced net asset value by $2.11 and $0.85 per share in fiscal 2010 and 2011, respectively.
- Dilutive issuance after the Patriot Capital years is highly questionable. PSEC was not distressed, it was not in poor shape, and other BDCs traded at a premium, so it is difficult to argue that Prospect Capital could win deals from its competitors on economic terms given its high cost of capital. We believe the dilutive issuance was purely for the benefit of its external management company. The BDC, PSEC, contains the majority of Prospect Capital Management’s assets under management.
- When Prospect Capital’s stock trades below NAV, it is far more likely for PSEC to issue stock rather than repurchase stock. While PSEC issued stock at prices below NAV in 5 fiscal years in its history, the company has repurchased minimal amounts of stock in only one fiscal year. Therefore, we believe investors are at risk of serious dilution in periods where PSEC stock trades below NAV.
- Prospect Capital views its ability to issue stock below NAV as very important to its business model. The company spends heavily to collect proxy votes, and previously adjourned annual meetings (2008 and 2015) to get shareholders to vote or change their vote on below-NAV stock issuance.
7. History of Prospect Capital
- 1998 — John Francis Barry III acquires a venture capital asset manager by the name of Prospect Street. At the time, the company managed a taxpayer-funded VC fund by the name of NYC Discovery Fund, which was designed to invest in hot internet startups located in New York. It quickly swayed from its mission, and the New York Times raised important questions about the fund’s mission. After riding the bubble up, the NYC Discovery Fund ended in disaster.
- 2004 — Prospect Street launches Prospect Energy Corporation. This is start of PSEC as we know it today. The fund launched with an IPO at $15.00 per share, with 7% of the proceeds going to the underwriters, leaving the fund with about $13.95 of cash per share sold. At the time, PSEC had a mandate to invest 80% of its net assets in energy companies. The N-2 filing named only 12 companies with which PSEC had a “non-binding memorandum of understanding” to make an investment, all of them energy companies, from coal to oil and gas. PSEC did not have any investments at the time of its IPO. It was, as some would call it, a “blank check IPO.” The external management company, owned by John Barry, would earn a management fee equal to 2% of assets, plus 20% of returns in excess of 7% on equity. The company continues to operate under the same fee structure today. (A promise to reduce fees to 1.5% on assets in excess of $750 million never came to fruition.)
- 2007 — Prospect Energy Corporation becomes Prospect Capital Corporation and diversifies. In May 2007, the company renamed itself “Prospect Capital Corporation” and ended its policy of investing at least 80% of its net assets in energy-related businesses. This marked the start of a number of changes at Prospect. In 2007, roughly halfway to $750 million in assets — the point at which it previously said it would cut management fees to 1.5% on all amounts in excess of $750 million — the management company terminated this fee waiver.
- 2008 — The beginning of rapid expansion. For the first time, Prospect Capital asked its shareholders for the right to issue unlimited amounts of stock at prices below its current net asset value at the 2008 annual meeting of shareholders. The annual shareholders meeting originally planned for December 2008 was adjourned several times, and ultimately held in February 2009. Prospect Capital shareholders gave the company approval for dilutive stock issuance at the February 2009 meeting.
- 2009 — Prospect buys Patriot Capital PSEC starts to grow at all costs. In August 2009, Prospect Capital acquired Patriot Capital for $197 million, of which $110.5 million was paid in cash to Patriot’s creditors. The remainder of the consideration was paid in Prospect Capital stock to Patriot Capital shareholders. The true resulting economics of the deal are questionable, at best. Prospect Capital’s external manager was rewarded handsomely, however. In a press release, Prospect Capital stated that “Prospect’s gross assets increase by more than 35%” with the acquisition. In 2009 and 2010, dilutive stock issuance wiped away $2.11 and $0.85 of net asset value per share, respectively.
- 2010 — Prospect makes a bid at Allied Capital, and gets rejected. Prospect Capital wanted to double down on its Patriot acquisition by hunting for an even bigger deal in 2010. Hungry for growth at all costs, the company proposed acquiring Allied Capital, a substantially larger BDC. In an embarrassing back and forth exchange of letters, Allied Capital demonstrated that it had absolutely no interest in merging with PSEC. Allied would later merge with Ares Capital Corporation. Prospect was only about one-third as large as Allied Capital at the time. Compare PSEC’s historical NAV per share to ARCC’s historical NAV per share. ARCC proved to be a much better acquirer.
- 2010 to 2012 — Why not grow more? Having been rewarded for dilutive issuance in 2009, the company would continue to issue stock aggressively until 2012, issuing millions of shares at a discount to net asset value. Its rationale for the issuance was spurious. It announced a $100 million buyback program in 2011. That program was not used, and PSEC issued more stock below NAV and bought back zero shares below NAV in 2011 and 2012. To date, it has yet to make full use of its $100 million authorization from 2011.
- 2014 — The SEC takes issue with PSEC. In May 2014, Prospect Capital quietly disclosed that it was in discussion with the SEC regarding its accounting of wholly-owned companies. Prospect Capital made a habit of investing money in its wholly-owned portfolio companies and having them return the money as a dividend, inflating its reported net investment income. The company stated that a restatement of prior-period financials would be good for shareholders. Despite the fact that a restatement would benefit shareholders, PSEC pushed to avoid a restatement.
- June 2014 — PSEC announces it won’t restate prior period financials. However, the company does have to consolidate its wholly-owned holding companies starting in its 2015 fiscal year, which began on July 1, 2014. Following the 2014 SEC fiasco, Prospect Capital’s share price fell below net asset value. Growth slowed, and origination volume declined, resulting in lower earnings from declining origination fees. Having grown tremendously from stock issuance at prices nominally above net asset value in 2012 and 2013, Prospect Capital’s growth came to a standstill. In late 2014, it engaged in more dilutive stock issuance, which was highly controversial. PSEC COO Grier Eliasek appeared in a promotional video to explain that the ability to issue stock on dilutive terms helped it keep its investment-grade rating, and therefore, maintain its dividend. Shareholders ultimately voted in favor of dilutive issuance at the 2014 meeting. At the same meeting, Prospect Capital’s board of directors approved a 25% reduction to its dividend, and the company announced that it would suspend dilutive stock issuance.
- November 2014 — PSEC announces a “spin-off” plan. Prospect Capital announced its intention to complete three “spin-offs” from its existing investment holdings. Designed as pure plays, it intended to spin off its holdings into new publicly-traded entities that would hold collateralized loan obligation (CLO) equity, real estate, and peer-to-peer loans. PSEC suggested that the spins would allow the market to value its assets individually. The plans seem to have been abandoned. The last filing for the spins occurred in October 2015.
- December 2015 — Prospect Capital has to adjourn its annual meeting once again. In 2015, Prospect Capital again asked its shareholders for the right to issue stock at dilutive prices. The company could not round up enough votes for the proposal, so it adjourned the meeting until January 2016, at which point it had collected enough votes to issue stock below net asset value. Shareholders were rightfully concerned that giving PSEC management the ability to issue stock below NAV would dilute their investment. At the time of writing, Prospect Capital has not directly sold stock below NAV since its December 2014 annual shareholders meeting. However, it continues to issue stock to investors who enroll in its dividend reinvestment program at prices below NAV.