FIFTH STREET FINANCE CORP FSC
July 09, 2015 - 10:15am EST by
MSG257
2015 2016
Price: 6.44 EPS 0 0
Shares Out. (in M): 153 P/E 0 0
Market Cap (in $M): 987 P/FCF 0 0
Net Debt (in $M): 1 EBIT 0 0
TEV ($): 2 TEV/EBIT 0 0

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  • BDC
  • Discount to NAV

Description

We are recommending a long position in the shares Fifth Street Finance Corp.  (“FSC”, “Fifth Street”, or the “Company”).  We believe the current share price ($6.44 based on 7/8/15 close) offers the potential for substantial upside, while providing a healthy margin of safety.  FSC trades at .70x tangible book (.95x average since inception) and an 11.2% dividend yield vs. a mean P/TBV of .91x and 9.5% dividend yield for the Business Development Company (“BDC”) peer group.  We value the shares at $8.35 (.91x TBV) for a 1 year forward return of 41% (29% price appreciation + 11% dividend).  We believe the Company’s focus on senior loans (80% of the portfolio at fair value) and the current discount to NAV provide a margin of safety.  Current tangible book value per share is only slightly above the .6x average during the market trough in March of 2009 (note FSC trough was .42x in 10/2008), despite a much a healthier credit profile for FSC’s portfolio and a significantly healthier macro-economic environment.  Below we provide an analysis of the impact on FSC NAV of a recession/deterioration in corporate credit. 

 

 

NAV Under Stress Scenario
                Cost                Default               Loss       Loss
Senior secured debt         2,075,723.0 10% 30%     62,271.69
Subordinated debt            253,952.0 15% 80%     30,474.24
CLO debt              29,500.0 100% 80%     23,600.00
Subordinated notes of SLF JV I              80,985.0 10% 0%                  -  
LLC equity interests of SLF JV I                8,998.0 10% 87%       7,856.55
Purchased equity            115,536.0 50% 100%     57,768.00
Equity grants                3,085.0 50% 100%       1,542.50
Limited partnership interests              19,652.0 50% 100%       9,826.00
Total         2,587,431.0       193,338.98
Incremental Loss/Share        $          1.26
         
Current NAV        $          9.18
Downside NAV        $          7.92
         
Share Price        $          6.44
Appreciation/Depreciation                   23.0%

 

Description

FSC is BDC that lends to and invests in small and mid- sized companies (revenues between $25 million and $250 million), primarily in connection with investments by private equity sponsors.  FSC’s portfolio totaled $2.5 billion at fair value at March 31, 2015 and was comprised of 137 investments and had a weighted average debt to EBITDA multiple of 4.75x. The Company’s investments generally range in size from $10 million to $100 million and are principally in the form of first lien, second lien (collectively, "senior secured") and subordinated debt investments, which may also include an equity component.  The weighted average yield on the Company’s debt investments has increased quarter-over-quarter from 10.4% to 10.7%, including the joint venture return with a cash component of the yield making up 10.0%. The average size of a portfolio debt investment was $21.4 million, and the average portfolio company EBITDA was $32 million at March 31, 2015. As of March 31, 2015, there were four investments on non-accrual representing 4.0% of the portfolio at cost and 2.1% at fair value. 

 

Exhbit 1:  Portfolio Composition

March 31, 2015 Investment Portfolio
    % Value   Composition %
    Cost  Fair Value   Cost  Fair Value
Senior secured debt                    2,075,723.0                  2,033,631.0   80.2% 80.1%
Subordinated debt                       253,952.0                     234,250.0   9.8% 9.2%
CLO debt                         29,500.0                       28,901.0   1.1% 1.1%
Subordinated notes of SLF JV I                         80,985.0                       80,934.0   3.1% 3.2%
LLC equity interests of SLF JV I                           8,998.0                         9,024.0   0.3% 0.4%
Purchased equity                       115,536.0                     124,595.0   4.5% 4.9%
Equity grants                           3,085.0                         7,736.0   0.1% 0.3%
Limited partnership interests                         19,652.0                       19,072.0   0.8% 0.8%
Total                    2,587,431.0                  2,538,143.0   100.0% 100.0%
             

 

 Exhbit 2:  CapitalIQ Comparables

 

BDC Comps (Source:  CapitalIQ)
             
Ticker Company Name Share Price MVE          Dividend Yield                  P/TBV          Debt/Equity
ACAS American Capital, Ltd.  $                                   13.37  $                              3,676.58 0.0%   0.66x 36.9%
AINV Apollo Investment Corporation  $                                     7.11  $                              1,683.23 11.1%   0.87x 77.4%
ARCC Ares Capital Corporation  $                                   16.31  $                              5,128.99 9.5%   0.98x 65.3%
BKCC BlackRock Capital Investment Corporation  $                                     9.15  $                                 684.20 9.2%   0.86x 59.8%
GLAD Gladstone Capital Corporation  $                                     8.01  $                                 169.27 10.4%   0.84x 87.4%
GAIN Gladstone Investment Corporation  $                                     8.01  $                                 242.47 9.3%   0.87x 75.1%
GBDC Golub Capital BDC, Inc.  $                                   16.10  $                                 824.77 7.9%   1.03x 102.4%
HTGC Hercules Technology Growth Capital, Inc.  $                                   11.29  $                                 819.48 10.8%   1.08x 80.5%
HRZN Horizon Technology Finance Corporation  $                                   12.18  $                                 141.67 11.0%   0.86x 45.1%
KED Kayne Anderson Energy Development Company  $                                   24.12  $                                 254.27 8.4%   0.81x 27.8%
MAIN Main Street Capital Corporation  $                                   31.59  $                              1,574.60 6.6%   1.44x 60.3%
MCGC MCG Capital Corporation  $                                     4.51  $                                 167.20 0.0%   0.95x 0.0%
TAXI Medallion Financial Corp.  $                                     8.76  $                                 215.99 11.4%   0.79x 128.0%
MCC Medley Capital Corporation  $                                     8.98  $                                 520.01 13.3%   0.77x 85.6%
MVC MVC Capital, Inc.  $                                   10.19  $                                 231.34 5.3%   0.64x 59.5%
NMFC New Mountain Finance Corporation  $                                   14.46  $                                 839.77 9.4%   1.04x 82.3%
PNNT PennantPark Investment Corporation  $                                     8.48  $                                 636.79 13.0%   0.83x 74.0%
PSEC Prospect Capital Corporation  $                                     7.32  $                              2,625.40 13.6%   0.71x 80.8%
SLRC Solar Capital Ltd.  $                                   18.07  $                                 767.34 8.8%   0.82x 24.2%
SUNS Solar Senior Capital Ltd.  $                                   15.72  $                                 181.30 9.0%   0.89x 69.2%
TCRD THL Credit, Inc.  $                                   11.38  $                                 385.84 12.0%   0.86x 69.8%
TICC TICC Capital Corp.  $                                     6.65  $                                 398.92 17.5%   0.76x 95.8%
TCAP Triangle Capital Corporation  $                                   23.01  $                                 764.53 10.3%   1.47x 90.4%
             
MIN       0.0%   0.64x 0.0%
Max       17.5%   1.47x 128.0%
Mean       9.5%   0.91x 68.6%
Median       9.5%   0.86x 74.0%
             
FSC Fifth Street Finance Corp.  $                                     6.44  $                                 987.51 13.4%   0.70x 91.3%

 

 

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

  • Company begins building credibility by executing on $100M share buyback program
  • Company continues to pay dividend and rebuilds credibility around dividend policy
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    Description

    We are recommending a long position in the shares Fifth Street Finance Corp.  (“FSC”, “Fifth Street”, or the “Company”).  We believe the current share price ($6.44 based on 7/8/15 close) offers the potential for substantial upside, while providing a healthy margin of safety.  FSC trades at .70x tangible book (.95x average since inception) and an 11.2% dividend yield vs. a mean P/TBV of .91x and 9.5% dividend yield for the Business Development Company (“BDC”) peer group.  We value the shares at $8.35 (.91x TBV) for a 1 year forward return of 41% (29% price appreciation + 11% dividend).  We believe the Company’s focus on senior loans (80% of the portfolio at fair value) and the current discount to NAV provide a margin of safety.  Current tangible book value per share is only slightly above the .6x average during the market trough in March of 2009 (note FSC trough was .42x in 10/2008), despite a much a healthier credit profile for FSC’s portfolio and a significantly healthier macro-economic environment.  Below we provide an analysis of the impact on FSC NAV of a recession/deterioration in corporate credit. 

     

     

    NAV Under Stress Scenario
                    Cost                Default               Loss       Loss
    Senior secured debt         2,075,723.0 10% 30%     62,271.69
    Subordinated debt            253,952.0 15% 80%     30,474.24
    CLO debt              29,500.0 100% 80%     23,600.00
    Subordinated notes of SLF JV I              80,985.0 10% 0%                  -  
    LLC equity interests of SLF JV I                8,998.0 10% 87%       7,856.55
    Purchased equity            115,536.0 50% 100%     57,768.00
    Equity grants                3,085.0 50% 100%       1,542.50
    Limited partnership interests              19,652.0 50% 100%       9,826.00
    Total         2,587,431.0       193,338.98
    Incremental Loss/Share        $          1.26
             
    Current NAV        $          9.18
    Downside NAV        $          7.92
             
    Share Price        $          6.44
    Appreciation/Depreciation                   23.0%

     

    Description

    FSC is BDC that lends to and invests in small and mid- sized companies (revenues between $25 million and $250 million), primarily in connection with investments by private equity sponsors.  FSC’s portfolio totaled $2.5 billion at fair value at March 31, 2015 and was comprised of 137 investments and had a weighted average debt to EBITDA multiple of 4.75x. The Company’s investments generally range in size from $10 million to $100 million and are principally in the form of first lien, second lien (collectively, "senior secured") and subordinated debt investments, which may also include an equity component.  The weighted average yield on the Company’s debt investments has increased quarter-over-quarter from 10.4% to 10.7%, including the joint venture return with a cash component of the yield making up 10.0%. The average size of a portfolio debt investment was $21.4 million, and the average portfolio company EBITDA was $32 million at March 31, 2015. As of March 31, 2015, there were four investments on non-accrual representing 4.0% of the portfolio at cost and 2.1% at fair value. 

     

    Exhbit 1:  Portfolio Composition

    March 31, 2015 Investment Portfolio
        % Value   Composition %
        Cost  Fair Value   Cost  Fair Value
    Senior secured debt                    2,075,723.0                  2,033,631.0   80.2% 80.1%
    Subordinated debt                       253,952.0                     234,250.0   9.8% 9.2%
    CLO debt                         29,500.0                       28,901.0   1.1% 1.1%
    Subordinated notes of SLF JV I                         80,985.0                       80,934.0   3.1% 3.2%
    LLC equity interests of SLF JV I                           8,998.0                         9,024.0   0.3% 0.4%
    Purchased equity                       115,536.0                     124,595.0   4.5% 4.9%
    Equity grants                           3,085.0                         7,736.0   0.1% 0.3%
    Limited partnership interests                         19,652.0                       19,072.0   0.8% 0.8%
    Total                    2,587,431.0                  2,538,143.0   100.0% 100.0%
                 

     

     Exhbit 2:  CapitalIQ Comparables

     

    BDC Comps (Source:  CapitalIQ)
                 
    Ticker Company Name Share Price MVE          Dividend Yield                  P/TBV          Debt/Equity
    ACAS American Capital, Ltd.  $                                   13.37  $                              3,676.58 0.0%   0.66x 36.9%
    AINV Apollo Investment Corporation  $                                     7.11  $                              1,683.23 11.1%   0.87x 77.4%
    ARCC Ares Capital Corporation  $                                   16.31  $                              5,128.99 9.5%   0.98x 65.3%
    BKCC BlackRock Capital Investment Corporation  $                                     9.15  $                                 684.20 9.2%   0.86x 59.8%
    GLAD Gladstone Capital Corporation  $                                     8.01  $                                 169.27 10.4%   0.84x 87.4%
    GAIN Gladstone Investment Corporation  $                                     8.01  $                                 242.47 9.3%   0.87x 75.1%
    GBDC Golub Capital BDC, Inc.  $                                   16.10  $                                 824.77 7.9%   1.03x 102.4%
    HTGC Hercules Technology Growth Capital, Inc.  $                                   11.29  $                                 819.48 10.8%   1.08x 80.5%
    HRZN Horizon Technology Finance Corporation  $                                   12.18  $                                 141.67 11.0%   0.86x 45.1%
    KED Kayne Anderson Energy Development Company  $                                   24.12  $                                 254.27 8.4%   0.81x 27.8%
    MAIN Main Street Capital Corporation  $                                   31.59  $                              1,574.60 6.6%   1.44x 60.3%
    MCGC MCG Capital Corporation  $                                     4.51  $                                 167.20 0.0%   0.95x 0.0%
    TAXI Medallion Financial Corp.  $                                     8.76  $                                 215.99 11.4%   0.79x 128.0%
    MCC Medley Capital Corporation  $                                     8.98  $                                 520.01 13.3%   0.77x 85.6%
    MVC MVC Capital, Inc.  $                                   10.19  $                                 231.34 5.3%   0.64x 59.5%
    NMFC New Mountain Finance Corporation  $                                   14.46  $                                 839.77 9.4%   1.04x 82.3%
    PNNT PennantPark Investment Corporation  $                                     8.48  $                                 636.79 13.0%   0.83x 74.0%
    PSEC Prospect Capital Corporation  $                                     7.32  $                              2,625.40 13.6%   0.71x 80.8%
    SLRC Solar Capital Ltd.  $                                   18.07  $                                 767.34 8.8%   0.82x 24.2%
    SUNS Solar Senior Capital Ltd.  $                                   15.72  $                                 181.30 9.0%   0.89x 69.2%
    TCRD THL Credit, Inc.  $                                   11.38  $                                 385.84 12.0%   0.86x 69.8%
    TICC TICC Capital Corp.  $                                     6.65  $                                 398.92 17.5%   0.76x 95.8%
    TCAP Triangle Capital Corporation  $                                   23.01  $                                 764.53 10.3%   1.47x 90.4%
                 
    MIN       0.0%   0.64x 0.0%
    Max       17.5%   1.47x 128.0%
    Mean       9.5%   0.91x 68.6%
    Median       9.5%   0.86x 74.0%
                 
    FSC Fifth Street Finance Corp.  $                                     6.44  $                                 987.51 13.4%   0.70x 91.3%

     

     

    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

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