Conference calls can can be a bit of a corporate boondoggle. Many are just home run derbies, where analysts lob softball questions at management teams. On occasion, the back-and-forth discussion leads to some interesting insights into a company's business model.
I waded throughMain Street Capital's fourth-quarter conference call to find the most relevant tidbits for investors. Here are three things shareholders should know now.
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1. The asset manager's growth may slowI've long believed Main Street Capital's best portfolio company is its asset management company. It currently manages a private, non-listed BDC, from which it earns a steadily growing stream of fee income. That BDC has now swelled in size to manage some $506 million in assets, generating quarterly profits equal to $0.02-0.03 per Main Street share.
It seems insignificant, sure, but its profits are roughly equal to the amount of cash needed to support interest payments on $100 million of debt at the parent company -- something that will prove to be valuable in a downturn.
On the recent conference call, Main Street Capital's CEO, Vince Foster, indicated that the days of robust growth in assets for unlisted BDCs may be coming to an end:
In general, unlisted BDCs are not good investments. They're loaded with up-front fees often nearing 10% of the investment, which are largely kicked back to the advisor who sells them. As regulatory winds shift, and the view toward unlisted yield investments like REITs and BDCs change, the opportunity to raise billions of dollars through broker channels is quickly becoming yesterday's news.
Main Street believes it may supplant its asset manager's growth with other opportunities. Management suggested that it may borrow out of the playbook of other BDCs and create a senior loan fund. Or it may strike a deal with another public company to generate more fee-earning assets under management.
There is no better income than asset management income, as it adds to earnings without credit risk. Making money from risks you take with other people's money is a much better business than risking your own capital. And shareholders will want to see that Main Street Capital can continue to grow this highly valuable income stream.
2. A secondary offering is probably in the cardsBecause BDCs must distribute at least 90% of their taxable earnings to shareholders, for all intents and purposes, they cannot retain earnings. The central limit to their growth is their ability to sell stock to the public. Main Street Capital will probably grow by issuing new equity in the coming quarters.
Foster described the logic behind raising new equity:
It's hard not to like selling new stock at the current price, as it is immediately accretive to net asset value. Existing shareholders benefit tremendously from selling new stock with a book value of $20.85 per share for the current market price of just over $31.00 per share. Book value per share goes up, and earnings per share rise as capital is invested in new yielding assets.
3. On the worst case for oil exposureIf you had one glimpse into a crystal ball of investment information, you'd probably ask about oil. There is serious money to be made in the oil patch if you can know exactly where oil prices are headed. When asked about Main Street Capital's worst-case scenario for its oil investments, Foster said the following:
Nicholas Meserve, the company's middle market managing director, added to the conversation with the following:
These are important points that are rarely discussed. In the here and now, most energy borrowers have hedged their exposure so that they can continue to service their debts. As time passes, however, they'll start selling more and more of their production at current market rates -- prices lower than their current hedges. Prices for oil in 2016 are probably more relevant for credit risk than prices in 2015.
Secondly, having a first-lien position protects lenders in the event of default. Obviously, it's no sure thing -- if a loan is secured by acres of oil-producing land that is profitable only when oil is ... say, $100 a barrel, it doesn't provide as much security as land which is profitable at $60 a barrel.
The higher-cost oil collateral is only valuable as an option -- its value hinges on the uncertain potential for oil prices to rise to a level at which the collateral can be employed profitably.
But being a first-lien lender does give you a lot more protection than second-lien or unsecured lenders. Main Street implies that its loans are first-lien, so if the borrower defaults, its assets become property of Main Street Capital, and other debt would be discharged in bankruptcy. That should help offset some of the losses that would result from years and years of low oil prices.
The article 3 Things Main Street Capital Corp.s Management Wants You to Know originally appeared on Fool.com.
Jordan Wathen has no position in any stocks mentioned. The Motley Fool recommends Apple and Bank of America. The Motley Fool owns shares of Apple and Bank of America. 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.
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