Prospect Capital Earnings Call Insights: Risk Reward Sweet Spot, First Tower Acquisition
On Friday, Prospect Capital Corporation (NASDAQ:PSEC) reported its third quarter earnings and discussed the following topics in its earnings conference call. Here’s what the C-suite shared.
Risk Reward Sweet Spot
Mickey Schleien – Ladenburg Thalmann & Co.: Let me start by saying, I don’t think you’re wooden and slow. But I really would appreciate it if you didn’t read the press release, because I am perfectly capable of reading it. What we do enjoy is the color that you can add in terms of the dynamics and the portfolio during the quarter given that we don’t have a lot of time to necessarily go through the Q in detail since multiple companies are reporting. That being said, what I would like to know is where you see the sweet spot in terms of risk-adjusted return in the investments that you’re making at the moment.
John Francis Barry III – Chairman and CEO: Okay, just before we go to that, I think what we might do is shorten the presentation that we read going forward. In terms of the sweet spot, what I would say to you – was that your whole question, Mickey?
Mickey Schleien – Ladenburg Thalmann & Co.: I’m sorry?
John Francis Barry III – Chairman and CEO: You didn’t get a chance to finish the question.
M. Grier Eliasek – President and COO: The risk reward sweet spot…
Mickey Schleien – Ladenburg Thalmann & Co.: No, no, my question was where is the sweet spot in terms of risk reward in the leverage loan market at the moment for you?
John Francis Barry III – Chairman and CEO: Okay, why don’t we give you two wildly varying answers, one from me and one I can’t quite predict from Grier? In my case, it’s always moving around. And on any given day, it might be different from where it was in the prior day. The first thing that we want to look to is preservation of capital. We want leveragability; we want higher-rated assets. So, we’re looking most carefully at senior assets where we see there is adequate collateral, good rating, good investment by the sponsor, a good track record by the management, audited historical financials going back five years, and we’d like to get into the low double-digits on those loans. I’d say that those types of opportunities get our attention quite quickly. Another set of opportunities that do are opportunities to invest in the equity of CLOs. We believe that there has been a wholesale abandonment of that asset class. And so, occasionally, we take equity participations; usually its junior notes in CLOs where we feel we’re richly rewarded for taking risk that has not eventuated with respect to the managers that we worked with. The managers we work with have not had any loss of capital with respect to the equity in their CLO. So those are two good areas; one is viewed by all people as being very safe; lower returning. The other area, if you’re wondering where can you get higher returns, we find that the CLO is an area where occasionally we can dip our toe and then get some nice returns. Grier?
M. Grier Eliasek – President and COO: Mickey, it’s an interesting question to ask us. As (dour) credit-oriented lenders about sweet spots because most probably we look at we deem to be sour since, we only invest in 1% or 2% approximately in what we see. So we usually don’t like what we see out there in any markets, bull market or bear, I guess you can say that’s discipline. We don’t really think about kind of tops-down sweet spot either, this is a credit shop where things have to do go through a rigorous and almost vicious ringer or something like 18 or 20 blue ink signatures are required before something funds and find something that everybody likes is almost a miracle, feels like sometime. So it’s all an incredibly bottoms-up process. It ends up resulting in a naturally diversified portfolio and we’re quite differentiated from our peers because we have a more diversified business. We have a sponsor finance business, we have a non-sponsor, we call direct lending business. Within sponsor finance, we are both agent deals, solely deals, club deals and anchor deals on upper middle-market type transactions. Then we have a one-stop business, which almost none of our peers were in, just like the direct lending business. Within the one-stop, we also look for other types of one-stop financings and buyouts where especially finance models are intriguing to us. So, our mission in life is to drive yield, to dive dividend, to drive earnings growth for our Company and a diversified risk adjusted fashion and also a tax efficient fashion. I think the Tower deal that we announced in March is an excellent example of that. It is extremely tax efficient, no taxes at the downstairs level, no takes at the upstairs level, as a non-tax paying Rick with all those cash flows being swept into prospective shareholders hands in the form of dividend distribution. I wish I gave you a better answer, but sweet spot really depends on whatever credit memo I am reading at that particular moment and time.
Mickey Schleien – Ladenburg Thalmann & Co.: I appreciate that, thanks very much.
John Francis Barry III – Chairman and CEO: There you go; two very different answers then. Let me point out that we believe one of the very strongest things in our Company is the fact that people are expected to do their own work, their own analysis, read their own conclusions, and defend them in a room with other people that will be opposing them. For example, we have a loyal opposition who is required to shoot down whatever position is being presented by someone concerning a credit, and the result is that in fact whether it is the lower end of the return scale where we ought to be getting a lot more collateral and a lot more security and safety or whether it’s an area where we’re seeking higher returns, there is a rigorous process, and that process tends to weed out surprises, which is the main thing we want to avoid here.
Mickey Schleien – Ladenburg Thalmann & Co.: Fair enough. I appreciate your time this morning.
M. Grier Eliasek – President and COO: Thank you, Mickey.
First Tower Acquisition
Arren Cyganovich – Evercore Partners: Could you talk a little bit more about the First Tower acquisition about the company itself. It’s going to be, I guess, a relatively large company; looks like about 14% pro forma for the total investment portfolio, and then maybe some of the – your expectations in terms of dividend returns from that investment?
M. Grier Eliasek – President and COO: Sure. We’re very excited about the Tower deal. I talked about the tax efficiency a few minutes ago. We think this is a world-class management team lead by Mr. Frank Lee. The Company is based in Mississippi. It’s diversified in several states with future growth anticipated in new markets as well. The Company has performed well for many years with consistent earnings growth across multiple cycles. We think it’s an attractive part of the consumer finance industry. This is not a payday lender. This is not a 4% APR type business. This is much lower on the APR level, focusing on ‘larger loan segments’ of installment lenders. There’s a couple of comps publicly traded, one that went public more recently that you can look at as well to get a sense of the industry. We announced that inverting our purchase multiple on a cash flow basis results in about 20-ish percent return on a trailing 12-month basis. Obviously we are not predicting the future, but our intention is to distribute the vast bulk of such cash flows upstairs to Prospect Capital Corporation. We’re also pleased that the management team has made a significant co-investment alongside our capital to line incentives. We’re already looking at potential tuck-in acquisition opportunities, even though we haven’t closed the deal yet. We’re hoping to sometime next month and we think it’s an excellent specialty finance model. It’s a model that is run with a reasonably low leverage downstairs as we referenced, less than (30%) debt to total cap. So this is not a highly leveraged specialty finance model. We have support of lender bank group supporting the transaction. We’re looking for future optimization from that standpoint as well.
Arren Cyganovich – Evercore Partners: Can you tell if you are leaning towards closing in cash or if you’re still anticipating paying for the transaction partially in shares?
M. Grier Eliasek – President and COO: We have not decided that yet, but we are seeing a pretty big uptick in our investment pipeline anticipated cash needs, tower would be about $270-ish million and so give or take depending on our stock price should we choose shares this quarter and then we referenced more than $500 million pipeline is probably more than $600 million at this point versus our liquidity of about that amount of capital. So we’ll decide and we don’t have to decide today (indiscernible) time. We can decide in the next few weeks and it really will depend upon other competing capital needs and a number of factors.
Arren Cyganovich – Evercore Partners: And then lastly the new guidance for the upcoming quarter to $0.38 to $0.42 is a bit above what you’re recurring income would be. What’s included in that that would be I guess from maybe the NRG or Gas Solutions that would be elevating that to a higher level?
M. Grier Eliasek – President and COO: Well, there’s nothing from NRG included in that figure. We’ve sold that company and had a very strong record quarter in this most recent completed March 2012 quarter. It does include some expected distributions and continued servicing of interest from Energy Solutions Holding, which is not just Gas Solutions. It has multiple energy companies within it.
Arren Cyganovich – Evercore Partners: You can’t detail any specifics about – I think my run rate for recurring income is somewhere around $0.25 for your portfolio, so it’s pretty elevated.
M. Grier Eliasek – President and COO: At this point in time where we are in the quarter, I think we’re comfortable with the level of prediction, which is what guidance is embedded in the June outlook, and I don’t think we want to break that out at this point in time. But I will say one of the thing about this recurring income aspect. As I said before, we have a very a highly diversified business that we think gives us the opportunity to participate in markets and to look at a far wider range of attractive opportunities and peers who are just kind of long and strong sponsor financed at any and all moments in time. That’s a good business for us mind you, but it just want multiple businesses that a company like ours can participate in. So, recurring is an interesting concept. When you make double-digit coupon loans in the marketplace, arguably all capital is bridge capital, but people want to repay as quickly as possible. So, what’s recurring when you are charging points upfront, when your capital is outstanding for a year or two or you’re repaid and maybe you are getting a back-end prepayment and/or some type of equity-like participation kicker that you purchased or got as part of additional consideration? We’ve had several attractive deals; buying Patriot Capital for about $0.60ish on the $1 and reaping 40% plus IRRs on a realized basis of loans from that; monetizing Energy, monetizing Gas Solutions. We think when you look at a team you look at the track record and performance and you have multiple ‘non-recurring’ items. You have to ask yourself at what point do they become recurring. So, I’ll leave you with that thought.