Business to Business Spells Profits

08/14/2007 12:00 am EST


Bryan Perry

Editor, Cash Machine, Premium Income, Quick Income Trader, Instant Income Trader

Bryan Perry, editor of the 25% Cash Machine, finds some shining gems in the roughed-up financial sector.

Business Development Companies (BDC’s) have not escaped the selling pressure associated with the rest of the financial sectors. Apollo Investment (NASDAQ: AINV), Ares Capital (NASDAQ: ARCC), Hercules Technology Growth Capital (NASDAQ: HTGC), and Prospect Capital (NASDAQ: PSEC) are now trading at their trailing 12-month range with their dividend yields pushing right up against 10%.

Small- to medium-sized businesses still need to be funded and these BDC's do so by raising money through issuing equity, not debt. And there’s the difference. BDC’s issue stock in the form of secondary offerings and loan the money to rapidly growing companies that are generating strong top and bottom line growth. They package their loans to these thriving companies by issuing a secured-debt instrument backed by the borrowing company’s assets tied with stock warrants. This allows them to get an equity kicker when they exit the position by selling the company, once they believe it has reached maximum near-term value. Their target is to exit the position in three to five years.

On Aug. 1, one of our former holdings American Capital Strategies (NASDAQ: ACAS) reported earnings of 91 cents that beat Wall Street estimates by 13 cents, or 16% higher. MCG Capital (NASDAQ: MCGC), also a Business Development Company, reported 51 cents versus Wall Street estimates of 41 cents, a 24% upside surprise. Under normal conditions that’s huge, but in this market, the stock is not being rewarded. Until this separation of the wheat and chaff is complete, even the really good assets will find it hard to rally. But if ACAS earnings are a harbinger of what we can look forward to then I’m perfectly comfortable staying long our four BDC’s.

During the next month or so we should see the market differentiate between BDC’s and private equity, which Congress is debating raising taxes on. BDC’s are not private equity, but rather are Registered Investment Companies and are taxed like REITs. I don’t think they are immune from sympathetic periods of selling if the financial sector continues to struggle, but as healthy as their businesses are, I view the current pullback in our favorite names as an exceptional buying opportunity. Use the current softness in share prices to initiate and add to positions. These stocks are good BUYS.”

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