CAPITAL SOUTHWEST CORP CSWC
January 01, 2016 - 1:15am EST by
david101
2016 2017
Price: 13.88 EPS 0 0
Shares Out. (in M): 16 P/E 0 0
Market Cap (in $M): 216 P/FCF 0 0
Net Debt (in $M): -184 EBIT 0 0
TEV ($): 32 TEV/EBIT 0 0

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  • BDC
  • Discount to NAV
  • Spin-Off
  • Special Purpose Entity
  • Micro Cap
  • Special Situation
  • Potential Dividend Initiation
  • Institutional Ownership
 

Description

 

CSWC is an internally-managed BDC that trades at 78% of NAV and 0% dividend yield. It is also the ugly twin that was separated from its bigger and more glamorous sibling, CSWI, presenting a special situation.

 

 

 

Background: CSWC has been written up before on VIC, most recently in January 2015. More details are also available at its 9/23/2015 presentation. The company began in 1961 with a SBIC license. Over the years, it transformed itself, made some hugely successful equity investments and converted to a BDC in 1988. I never understood why it became a BDC because it made more equity investments and paid very little in dividends over the years.

 

 

 

Spin-Off on 9/30/2015: Since 2013, the company made significant changes, resulting in the tax-free spin-off of the industrial products companies as CSW Industrials (CSWI). The split was one share of CSWI for each share of CSWC. CSWC retained no interest in CSWI. However, CSWC is smaller, currently with a $217 million market cap compared to CSWI's $573 million.

 

 

 

Portfolio: With the spin-off, CSWC ended up looking like a just launched BDC, with $184 million in cash and $93 million in investments. The current portfolio consists of 16 investments, split as $49 million equity and $44 million debt. 70% of the equity portfolio is in one company, Media Recovery, where the company has over $25 million of gains.

 

 

 

$68 million of the cash is being committed to a JV with MAIN called I-45 SLF. MAIN will contribute $17 million. This special purpose entity (SPE) does several things. It allows CSWC to generate investment income so it can support a dividend but is classified as non-qualified. The significance of non-qualified investments for BDC's is that normal BDC regulations do not apply, so it plans to use 2:1 leverage in I-45. BDC's have to pass the 200% asset coverage ratio test, which essentially means no more than 1:1 debt-to-equity. Since 2009, most BDC's have tended to max out between 0.7X and 0.8X debt. Although CSWC has had the SBIC license for over 50 years, it is now seeking approval for $150 million in SBA debentures. It will also look at add $50-$100 million of balance sheet leverage. Combining all the pieces, CSWC anticipates growing assets under management (AUM) to $600 - $650 million. The company plans to pursue a variety of debt in senior loans, middle market and lower market, but not equity.

 

 

 

Earnings/Dividends:  Since CSWC is going to be ramping up, we have to do some guess work as to what the earnings, and hence dividends, will be. In the presentation, the company provides all the inputs to do the calculation. Here is the income side:

 

 

 

 

AUM

Yield

Income

Senior Loans

$204.00

6.0%

 $ 12.24

2nd Lien

$130.00

9.6%

 $ 12.48

Lower market

$225.00

12.0%

 $ 27.00

Equity

$  41.00

0.0%

 $        -  

Total

$600.00

8.6%

 $ 51.72

 

 

 

On the expense side, management expects to reach an expense level of 2.5% of AUM or about $15.0 million. This is in-line with other internally managed BDC's. Assuming 90% distribution over 15.6 million shares, potential dividends are $2.12/sh. If AUM reached $650, it could be $2.33/sh.

 

 

 

I think CSWC will eventually trade to around 11% yield and 110-120% of NAV. That translates into a share price of $19.30 to $21.15. Add in some dividends and the potential returns are  45-60% over the next two years.

 

 

 

Management: Top management has been brought in over the past two years. Looking at the three top executives, CSWC could be called American Capital South. The CEO is Bowen Diehl who joined CSWC in 2014 after spending 13 years at ACAS. CFO Michael Sarner came in 2015 after serving 15 years at ACAS. Finally, Managing Director Douglas Kelley joined the company in 2015 after being at ACAS for 10 years. The chairman of the board is Joe Armes, who was hired in 2013 as the CEO of CSWC but became the CEO of CSWI at the spin-off.

 

 

 

Institutional Ownership: It will be interesting to see how the ownership changes. The spin was completed 9/30/2015, so I expect to see some changes. There appears to have been a lot of year-end selling in the name. Anyway, here are the top 15 holders as of 9/30/2015:

 

 

 

Firm

 Shares

Pct

Moab Capital Partners LLC

       1,468,662

9.4%

Zuckerman Investment Group, LLC

       1,384,830

8.9%

First Manhattan Co.

           943,059

6.1%

Clover Partners, L.P.

           661,058

4.2%

Advisory Research Inc

           423,252

2.7%

River Road Asset Management LP

           513,689

3.3%

ISZO Capital Management LP

           509,137

3.3%

Greywolf Capital Management LP

           445,710

2.9%

Newtyn Management LLC

           282,477

1.8%

UBS Group AG

           265,473

1.7%

Artisan Partners Limited Partnership

           241,078

1.5%

Comerica Bank

           184,193

1.2%

Lazard Asset Management LLC

           169,240

1.1%

Third Avenue Asset Management LLC

           150,348

1.0%

Morgan Stanley

           141,154

0.9%

 

 

 

Good news, bad news, it looks to be a bit of a hedge fund hotel.

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

- Start deploying capital and making loans

- Set SBA borrowing

- Pay dividends

    sort by    

    Description

     

    CSWC is an internally-managed BDC that trades at 78% of NAV and 0% dividend yield. It is also the ugly twin that was separated from its bigger and more glamorous sibling, CSWI, presenting a special situation.

     

     

     

    Background: CSWC has been written up before on VIC, most recently in January 2015. More details are also available at its 9/23/2015 presentation. The company began in 1961 with a SBIC license. Over the years, it transformed itself, made some hugely successful equity investments and converted to a BDC in 1988. I never understood why it became a BDC because it made more equity investments and paid very little in dividends over the years.

     

     

     

    Spin-Off on 9/30/2015: Since 2013, the company made significant changes, resulting in the tax-free spin-off of the industrial products companies as CSW Industrials (CSWI). The split was one share of CSWI for each share of CSWC. CSWC retained no interest in CSWI. However, CSWC is smaller, currently with a $217 million market cap compared to CSWI's $573 million.

     

     

     

    Portfolio: With the spin-off, CSWC ended up looking like a just launched BDC, with $184 million in cash and $93 million in investments. The current portfolio consists of 16 investments, split as $49 million equity and $44 million debt. 70% of the equity portfolio is in one company, Media Recovery, where the company has over $25 million of gains.

     

     

     

    $68 million of the cash is being committed to a JV with MAIN called I-45 SLF. MAIN will contribute $17 million. This special purpose entity (SPE) does several things. It allows CSWC to generate investment income so it can support a dividend but is classified as non-qualified. The significance of non-qualified investments for BDC's is that normal BDC regulations do not apply, so it plans to use 2:1 leverage in I-45. BDC's have to pass the 200% asset coverage ratio test, which essentially means no more than 1:1 debt-to-equity. Since 2009, most BDC's have tended to max out between 0.7X and 0.8X debt. Although CSWC has had the SBIC license for over 50 years, it is now seeking approval for $150 million in SBA debentures. It will also look at add $50-$100 million of balance sheet leverage. Combining all the pieces, CSWC anticipates growing assets under management (AUM) to $600 - $650 million. The company plans to pursue a variety of debt in senior loans, middle market and lower market, but not equity.

     

     

     

    Earnings/Dividends:  Since CSWC is going to be ramping up, we have to do some guess work as to what the earnings, and hence dividends, will be. In the presentation, the company provides all the inputs to do the calculation. Here is the income side:

     

     

     

     

    AUM

    Yield

    Income

    Senior Loans

    $204.00

    6.0%

     $ 12.24

    2nd Lien

    $130.00

    9.6%

     $ 12.48

    Lower market

    $225.00

    12.0%

     $ 27.00

    Equity

    $  41.00

    0.0%

     $        -  

    Total

    $600.00

    8.6%

     $ 51.72

     

     

     

    On the expense side, management expects to reach an expense level of 2.5% of AUM or about $15.0 million. This is in-line with other internally managed BDC's. Assuming 90% distribution over 15.6 million shares, potential dividends are $2.12/sh. If AUM reached $650, it could be $2.33/sh.

     

     

     

    I think CSWC will eventually trade to around 11% yield and 110-120% of NAV. That translates into a share price of $19.30 to $21.15. Add in some dividends and the potential returns are  45-60% over the next two years.

     

     

     

    Management: Top management has been brought in over the past two years. Looking at the three top executives, CSWC could be called American Capital South. The CEO is Bowen Diehl who joined CSWC in 2014 after spending 13 years at ACAS. CFO Michael Sarner came in 2015 after serving 15 years at ACAS. Finally, Managing Director Douglas Kelley joined the company in 2015 after being at ACAS for 10 years. The chairman of the board is Joe Armes, who was hired in 2013 as the CEO of CSWC but became the CEO of CSWI at the spin-off.

     

     

     

    Institutional Ownership: It will be interesting to see how the ownership changes. The spin was completed 9/30/2015, so I expect to see some changes. There appears to have been a lot of year-end selling in the name. Anyway, here are the top 15 holders as of 9/30/2015:

     

     

     

    Firm

     Shares

    Pct

    Moab Capital Partners LLC

           1,468,662

    9.4%

    Zuckerman Investment Group, LLC

           1,384,830

    8.9%

    First Manhattan Co.

               943,059

    6.1%

    Clover Partners, L.P.

               661,058

    4.2%

    Advisory Research Inc

               423,252

    2.7%

    River Road Asset Management LP

               513,689

    3.3%

    ISZO Capital Management LP

               509,137

    3.3%

    Greywolf Capital Management LP

               445,710

    2.9%

    Newtyn Management LLC

               282,477

    1.8%

    UBS Group AG

               265,473

    1.7%

    Artisan Partners Limited Partnership

               241,078

    1.5%

    Comerica Bank

               184,193

    1.2%

    Lazard Asset Management LLC

               169,240

    1.1%

    Third Avenue Asset Management LLC

               150,348

    1.0%

    Morgan Stanley

               141,154

    0.9%

     

     

     

    Good news, bad news, it looks to be a bit of a hedge fund hotel.

     

    I do not hold a position with the issuer such as employment, directorship, or consultancy.
    I and/or others I advise hold a material investment in the issuer's securities.

    Catalyst

    - Start deploying capital and making loans

    - Set SBA borrowing

    - Pay dividends

    Messages


    SubjectBook value - cash burn
    Entry01/01/2016 05:17 PM
    Membermadler934

    Do you have any sense for how much cash burn there might be over the next several quarters until there is enough income in the entity to offset the SG&A expenses?  Between now and then, the burn rate will eat into book value.  Any thoughts would be appreciated.


    SubjectQuestions
    Entry01/05/2016 09:04 PM
    Memberblaueskobalt

    Thanks for the writeup.  An internally-managed BDC can create a lot of value if managed prudently.  We like the setup here, and I would appreciate hearing your thoughts on the following questions/concerns:

    1) What is your sense of Bowen Diehl?  Obviously, the quality of the team is everything here, and ACAS's reputation--from both a governance and an underwriting perspective--is not sterling.  Do you know anything of Diehl's reputation from within ACAS?

    2) Does management expect to hit the 2.5% of AUM expense target at current scale (i.e., without raising additional equity)?  

    3) Have you diligenced the portfolio much--and Media Recovery in particular?

    4) Is there any reason to think that CSWC will wind down the I-45 SLF as it ramps up its lower middle market portfolio?  This vehicle makes a lot of sense in terms of deploying capital quckly to ramp NII while it builds its core strategy, but it's harder to see them adding much value in the more liquid/broadly syndicated space in the long term.

    Thanks.


    SubjectRe: Questions
    Entry01/05/2016 11:42 PM
    Memberblaueskobalt

    5) Why CSWC over various other BDCs?  (e.g., ACAS has similar management pedigree and comparable discount, but with Elliott steering the ship)

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