Nancy Zambell has managed to build up a big marketing push for hew newsletter as quickly as anyone I’ve seen since Jeff Clark at Stansberry & Associates — I guess, if you’ve got a “hook” for your letter and can make the sale, the publishers are still willing to pour a lot of money into building a readership for you.
Her Buried Treasure under $10 newsletter hasn’t been around that long — I’ve been noticing the ads for most of this year, but that’s about it. And she’s got a folksy style (or at least, her copywriters do) that makes you think of the old man who sits on the front porch of the general store and has a two sentence solution for the world’s problems — you kind of wish he was right, but can it ever be that simple? (And are there general stores anymore?)
Anyway, the main thing Zambell is teasing in her latest ad is a promise that she’s found the “anti-bank” — a “bank that reinvents lending,” and that it’s on the way to a “quick double.”
I’ll take a double at any speed these days, so let’s take a look and see if we can pull the curtains aside for you, shall we?
Here are the clues we get:
“If you are sick of megabanks screwing up your life, you’re gonna love this. I’ve found a “mini-bank”—almost a micro-bank—trading at $7, that is rewriting the rules.
“That’s right: Bank that Benjamin Graham would approve of that lends to entrepreneurs whom they believe in.
“What a wild concept.
“I’m Nancy Zambell, and I find gold where others see rocks.”
(OK, that last bit isn’t a clue, really, but who can resist that kind of language?)
She goes on, of course — though she generally follows the “less is more” ad letter strategy, which seems to be standard for all her fellow Investorplace editors (Louis Navellier, Robert Hsu, Tobin Smith, etc.) — their ads all have short-attention-span paragraphs, big colorful headlines and crazy claims, of course, but they’re a lot shorter than typical ads from the Motley Fool or the folks in the giant Agora-plex.
That’s not to say she doesn’t squeeze in a few more clues to tantalize, of course.
“Banks, frozen solid in this capital crisis, are still unable to operate as banks. But micro-banks can trickle out money to nourish promising ventures.
“In so doing, they enrich themselves and their investors.
“The risk of these loans is clear—transparent—and so are the rewards. A restaurant in Tulsa, a web concept in Oakland, a healthcare IT initiative in Ellicott City. These small innovations are the building blocks of America’s comeback. When the story of this comeback is told, megabanks won’t figure in the tale. But my mini-bank will.”
And she finally tells us that, yes, this is a Business Development Company (BDC), not really a bank — and she gives the final clues:
“The BDC I’ve found has deep pockets and a sharp nose for promising new businesses.
“Earnings, just released, show a 200% increase.
“Add in an eye-popping dividend yield of 22%.
“Top it off with a double on the stock, as it rockets from $7 to at least $15.”
So who is it? Well, you might be a little surprised that there is a BDC that reported a 200% earnings increase in the last quarter — most of them have reported pretty massive losses as they write down their portfolios of debt and equity. But the clues are, in fact, real — this is …
Ares Capital Corporation (ARCC)
As with many Business Development Companies, which are regulated lending entities that get a similar tax-free structure to REITs and pass through their earnings as dividends, this one was launched by a private equity/asset management firm, Ares Management.
And yes, the yield is close to 20% — slightly under 22% now, with a bit of a climb in the share price. The shares are at almost exactly $7 after a small pop this morning. And the earnings did climb exactly 200%, from 12 cents in the first quarter of 2008 to 36 cents in the most recent quarter.
So — is this kind of thing for you? They did just cut the dividend (to $1.40, now 20% — it had been a bit higher), but they said in the conference call that the 35 cents/quarter dividend now paid is more sustainable, so perhaps they won’t have to cut again (though you never know). It seems like the cut wasn’t as steep as investors feared, and the net asset value of the portfolio may not have fallen as much as expected, because the shares performed quite nicely after the release (though the real climb was from the March lows, when it got down to near $3).
I don’t know a lot about Ares — they’re not as big a name in this space as the more long-established players like Allied Capital or American Capital Strategies, both of which have been clobbered over the last year, or even Apollo Investment or Gladstone.
But they do appear, from a look at their conference call transcript and releases, to be a bit more conservative and steady than most — their debt is not outrageous and it’s well under the regulatory limit (debt is rarely high for these companies — they’re usually only allowed to lever up 1:1, meaning they can only borrow an amount equal to their equity capital, which is why some companies, like CapitalSource, do the same kind of business but structure themselves as REITs instead of BDCs to allow them to use more leverage).
And if you look at their portfolio companies, they do look like they’ve got a good diverse list of investments, with many of them in senior, secured debt or equity — management says that they tend to be active in helping to restructure or recapitalize their investment portfolio companies, so they must often be senior or controlling lenders.
Business Development Companies have been terrible investments for the past two or three years, but most of them have not done as badly as the headline names American Capital and Allied Capital — over twelve months, Apollo Investment (AINV) and Gladstone (GLAD) have come close to keeping pace with ARCC, with stock prices that are down perhaps 60% or so over two years, as opposed to the 80-90% drops of ACAS and ALD. They’re just about the only ones who had nice earnings growth in this past quarter, but that’s not necessarily the most important consideration right now — each of these firms is on a different strategy for writing down assets, raising new money, etc. etc., so at any given time they might perform quite differently from one another.
And Ares is also trading at a bit closer to their net asset value or book value these days than most of them are — if you look at book value, which reflects how they value their assets, American Capital is trading at one quarter of book value, ARCC is at about 60% of book. Still tough if they have to issue new capital in this environment, since they’d be diluting current shareholders considerably with that discount to book value, but not as bad as some of their competitors. And of course, they’re a BDC so they can’t retain earnings to protect their balance sheet very easily, they’re required to pay out 90% of earnings as dividends if they want to maintain their tax advantage.
BDCs are a key part of the lending universe for our economy, since they focus on small and medium sized businesses that are too big or risky for bank loans and too small to go to the bond markets and get much attention — restaurant chains, retailers, small manufacturers and service companies, many of them companies that depend heavily on debt to grow or even, in tougher times, to break even. That’s the big risk with all of these BDC lenders — that their portfolios collapse if they lend to too many companies that can’t afford to pay them back. They counteract that risk by diversifying, and by being careful lenders, and often by getting senior positions in the capital structure, preferably loans that are secured by company assets. Of course, those assets are often worth a lot less than they might have been two or three years ago.
Because they are restricted to only using 1:1 leverage, some argue that BDCs actually seek out and make riskier loans than most other lenders, because they need high interest rates to profit with that relatively low leverage and continue to pay out high dividend income to please investors. They also do much better when they can sell shares at a premium to their net asset value (close to book value, usually), because that gives them more ability to distribute cash to existing shareholders — and share sales above net asset value seem very unlikely for any BDCs at any point in the foreseeable future.
These companies don’t always make the right decisions, but it does seem like the firms like Ares, (which just renewed it’s own debt and should have good access to capital for a couple years now unless their portfoio collapses), might have a good business opportunity ahead because there are going to be a lot of small and medium-sized businesses looking for capital, and many fewer banks, hedge funds, or private equity firms willing to supply it.
Of course, they also depend on a healthy credit market and a reasonable economy to allow their borrowers to make payments — which means there always exists that fear that BDCs in general could go extinct if the credit tightness or the downturn persist for a couple years. As you might expect with a 20% dividend based on a business that requires fairly healthy credit markets, there’s certainly some risk here. And just to throw one more log on the fire, they are externally managed — so, like Apollo and unlike ACAS or ALD, they have to pay fairly hefty hedge-fund-like annual management fee and performance bonuses to their management — not a lot of performance fees to be paid in the year ahead, perhaps, but it’s worth considering as you make your decision.
So … on the surface, Ares looks like it might be a relatively strong company in an industry of headline-gathering fallen titans … and it is, at least, Nancy Zambell’s pick for stock that should double in short order. What do you think? Let us know with a comment below.
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