Are Buyouts the Next Step for These High-Yield Stocks?

By Markets Fool.com

Image source: Flickr/Eigenberg Fotografie.

Continue Reading Below

Business development company Ares Capital Corporation wasted no time bringing up the subject of acquisitions on its most recent conference call. The company's CEO, Kipp de Veer, used his prepared remarks to open the stage for a discussion on the potential for Ares Capital to acquire a smaller competitor.

It's somewhat odd. De Veer, who called acquisitions of BDCs a "mess" at the company's 2015 analyst day, may have had a change of heart. It could have to do with the emergence of an easy target.American Capital , the third largest BDC by assets, has seemingly accepted its fate as a discount store for other investment funds.

In a January press release, American Capital announced interest in shopping its assets to the highest bidder after years of planning for a spin-off of its asset-management business.Selling out wasn't exactly American Capital's ideal plan -- it took some prodding from activists -- but it appears that closure for its investors is near. With just under $5 billion of investment assets on its balance sheet, there's more than enough to go around.

The only problem for discounted sellers is that potential buyers are dealing with similar discounts. Save for the blessed few, most have little borrowing capacity and are light on cash. Furthermore, the median BDC trades at about an 18% discount to book value, which limits the attraction for would-be acquirers.

Ares Capital's acquisition discussion was interestingly timed, happening just before it mailed out proxy materials to its shareholders. Ares Capital is asking its shareholders for approval to issue stock at prices below its last-reported book value, a gift that would enable Ares to trade its discounted stock for slightly more discounted assets from other BDCs.

Continue Reading Below

FS Investment Corp. is also on the list as a potential acquirer, given that its shares trade at exactly book value. When asked about its interest in acquiring assets from another BDC, FS Investment's president, Jerry Stahlecker, noted the scale of its platform, the fact that it has private BDCs that are raising money, and that it doesn't really need to grow. He may have just been playing friendly, downplaying any interest as the combined $15.7 billion balance sheet of the FS entities makes it an easy acquirer. A trophy kill could be sliced and diced, shared between its spider web of BDCs.

I, for one, tend to think consolidation would be a good thing. Fewer, larger BDCs are better than many smaller, less efficient BDCs. The advantages of scale don't appear to kick in until a company reaches about $1.5 billion in assets -- the point at which a company starts getting a look for an investment-grade rating and fixed expenses are spread among a sufficiently large asset base. The hard part is convincing a rival's management team that they're better off jobless, and the assets are better off in your hands.

The article Are Buyouts the Next Step for These High-Yield Stocks? originally appeared on Fool.com.

Jordan Wathen has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.