Prospect Capital Wants Too Much From Shareholders

Prospect Capital recently filed its proxy materials for the upcoming annual meeting of shareholders. Consistent with its request in prior years, the company has asked shareholders to give it the right to sell shares below net asset value, or book value.

There may be no more controversial issue in the world of business development companies. A handful of BDCs request the right to issue shares below book value each year, but most never use the authorization. It's seen as a nuclear option -- a last resort should a BDC need to raise equity capital in a time of crisis.

The right to issue new shares under NAV is not something a BDC has to have. Main Street Capitaland Golub Capital BDC, for example, don't ask their shareholders to approve sales of stock below NAV.

BDCs also don't have to ask permission to issue shares below net asset value. As registered investment companies, they already have that right. RICs can issue shares below net asset value through a rights offering at any time.Getting shareholder approval just means that issuing shares at dilutive prices can be done a little easier, and a little more quietly.

Historical examples of companies that have abused this power are plenty. Since 2009, Prospect Capital has issued more than 75 million shares below NAV. That's more than one out of every five shares outstanding.

Similarly, Fifth Street Floating Rate asked its shareholders to approve sales below NAV in the summer of 2014. Weeks later, it issued so many shares on dilutive terms that its NAV per share fell 15%.Last month, thanks in large part to its dilutive stock sales, it had to cut its dividend by 25%.

To gain shareholder support, Prospect Capital noted in its proxy filings that during the last three years, its sales of stock have generally been at above-NAV prices. Issuing new stock during that period actually increased its NAV per share by $0.16. This is true.

But look a little further back, and you'll see the devastating impact of giving a company free reign to issue shares. The chart below shows the per-share change in net asset value as a result of issuing new shares over the past six years.

A little further back, you'll find that dilutive issuance in the year ended 2009 cost shareholders $2.06 per share in net asset value in a single fiscal year.

Even the most steadfast bulls should agree: Nipping dilutive equity issuance in the bud by voting down proposal 2 would be a fantastic result for shareholders. Prospect Capital should be buying back stock, not issuing new shares, when it trades below NAV. Voting down proposal 2 is the best way to force it into do the right thing for its owners.

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