High Yields in Mezzanine Financing

08/25/2015 7:00 am EST

Focus: STOCKS

Adrian Day

Chairman and CEO, Adrian Day Asset Management

Adrian Day has long been an expert on business development companies—BDCs—which provide mezzanine financing to small- and mid-cap companies. Here, the editor of Global Analyst highlights two of his favorites.

Gladstone Investment (GAIN) reported higher Net Investment Income, though it declined on a per share basis due to an equity raise in March and April.

However, the company continues to put money to work, making new investments of $17 million (including in well-known Brunswick Bowling to support a management buy-out), only partially offset by exits.

With the equity raise and a new preferred issue, Gladstone Investment has cash for new investments, though it may take another quarter to catch up with the new share count.

Net asset value increased again, by 63 cents to $9.18 per share, commendable given the higher share count. GAIN is trading at a 14% discount to NAV and sports a yield of 9.6%.

We are more confident of the NAV continuing to increase and the ability to cover the yield, but with the stock trading at the upper end of its annual range, we would look for a pullback to buy.

Ares Capital (ARC) is far larger than the Gladstone companies, with a market cap over $5 billion.

Although core earnings (excluding incentive fees) came in a little down, the dividend remains well covered by overall income.

The NAV was up again, on portfolio gains. The company continues to recycle exiting loans into higher-yielding loans, up to 9.5% on new investments; it had one of the most conservative (and thus lower yielding) profiles of BDCs.

Trading at a 5% discount to NAV, the current yield is 9.5% (not counting the five special dividends it has paid over the past three years, boosting the yield to closer to 10%).

As one of the larger, more flexible and more conservative BDCs, we would continue to buy under $16.

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