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ABDC: New Management Continues Alcentra’s March To Higher Returns
We believe the stock should trade at $8.00 per share based on increasing NAV, successful progress made in the portfolio pivot and efforts to decrease the discount to NAV.
Current Price (03/13/19) Valuation
10 S. Riverside Plaza, Chicago, IL 60606
Alcentra Capital is a business development company (BDC) with a disciplined portfolio approach and the benefit of an affiliation with BNY Mellon, its single largest shareholder. The company’s target market is the lower middle-market, which management believes traditional lenders underserve. ABDC shares, which provide 9.4% dividend, trade at a 31% discount to the company’s $11.13 NAV (net asset value) / share.
SUMMARY DATA 52-Week High 52-Week Low One-Year Return (%) Beta Average Daily Volume (sh) Shares Outstanding (mil) Market Capitalization ($mil) Short Interest Ratio (days) Institutional Ownership (%) Insider Ownership (%) Annual Cash Dividend Dividend Yield (%) 5-Yr. Historical Growth Rates Sales (%) Earnings Per Share (%) Dividend (%)
KEY POINTS ➢ Alcentra Capital is a business development company (BDC) with a disciplined portfolio approach and the benefit of an affiliation with BNY Mellon. ➢ As of December 31, the company’s $235 million portfolio was composed of 30 investments, comprised of 28 companies, one broadly syndicated loan (BSL), and one rated CLO debt instrument. It was invested 91% in debt and 9% in equity. ➢ The company originally targeted the lower middle-market, but new management is rotating the portfolio to larger middle-market private equity backed transactions. It considers the middle market $15 million - $75 million in EBITDA. Management believes this is a more prudent place to invest this late in the credit cycle. It is also beginning to invest overseas where it can take advantage of the company’s strengths and network and its President is now located in London. ➢ To mitigate its risk, the company conducts substantial due diligence, seeks rigorous financial covenants and diversifies its investments across a broad range of sectors and portfolio companies. Its largest sector is business services at 20% of the total investment portfolio followed by healthcare services at 19%. ➢ Only one company is now on non-accrual: Southern Technical Institute. There are seven others on the watch list: Alarm Capital, Battery Solutions, Conisus, Envocore, IGT, Palmetto Moon, and XGS. The weighted average yield on the company’s debt portfolio was again 11.0% this quarter. ➢ Alcentra is suffering from increased competition in the lending market that is pushing down rates. It also had a number of investments that went sour. These investments have been written down to where there most could provide upside in the future or completely eliminated. ➢ At $7.69, the shares trade at a 31% discount to the company’s $11.13 NAV (net asset value) per share. NAV has declined from the $14.63 per share at the time of its May 2014 IPO, but has been on the rise for the past two quarters since new management took over. The company is actively working to revamp the portfolio and decrease the discount of the stock price to the NAV. At its current price, Alcentra’s current dividend yield is 9.4%, below the average of 10.2%. ➢ While past dividend cuts have stung investors, new management has rapidly culled the losing investments from the portfolio, which should lessen the chance for future declines in NAV. With assets redeployed there is the potential for higher earnings, which could lead to an increased dividend in the future and thus further price appreciation. Stock buybacks are also still in effect increasing NAV. These efforts should lead to stock price appreciation going forward.
WHAT’S NEW Alcentra Capital's reported Q4 and full year 2018 earnings. The new management team continues to execute on its strategy of rotating toward a larger middle market, senior secured debt portfolio. Its goal is to both improve earnings and to decrease the discount of the stock price to NAV. In pursuit of that goal it is also buying back stock which also increases NAV. Since January 1, 2018, Alcentra has repurchased 1,280,111 shares of its outstanding common stock under its share repurchase programs, or approximately 9.0% of the shares outstanding as of January 1, 2018. As of January 14, 2019, it has approximately $6.2 million of repurchase authority remaining under the current repurchase program.
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Q4 2019 Earnings NAV again increased in Q4 over Q3 and the stock price to NAV discount decreased to 31% from 43% last quarter. This was aided by the buying back of 411,939 shares, at an average price of $6.62, for $2.7 million during the quarter, all of which were in December. Given the large discount of the stock price to NAV, buying back stock is now low risk way to provide return to shareholders. For the fourth quarter of 2018, the company reported total investment income of $7.0 million versus $8.2 million last year, a decline of 15%. Net investment income was $3.0 million, or $0.27 per share versus $4.0 million and $0.28 per share last year. Of the 28 portfolio companies, there were eight write-downs this quarter totally $5.6 million: Battery Solutions ($1.3 million); Champion One ($0.1 million); Envocore ($1.3 million); IGT ($0.1 million); Metal Power Products ($0.1 million); Palmetto Moon ($0.3 million); XGS, based on closing of sale of the company, ($2.3 million), and Goldentree Loan Management (CLO) ($0.2 million.) Four positions were written up totaling $3.3 million: Black Diamond ($1.7 million); FST ($1.4 million); Tunnel Hill ($0.1 million) and Virence ($0.1 million.) The portfolio value decreased to $235 million from $249 million in Q3 2018. Net asset value (NAV) was $11.13 per share as of December 31, 2018 versus $11.08 per share, on September 30, 2018. During Q4 the company exited or received proceeds from repayments, loan dispositions and amortizations on investments of $75 million and invested or committed to invest $60 million. These include the following investments, which have closed: •
$4.4 million senior secured loan (LIBOR+8.00%) to Sandvine Corporation, a networking equipment company that provides policy control solutions and intelligence to fixed, mobile and converged communications service provider networks;
$19.9 million senior secured loan (LIBOR+6.25%) to Impact Group, LLC, a leading sales and marketing agency with expertise in the retail brokerage and consumer packaged goods industry;
$6.3 million senior secured loan (EURIBOR+7.00%) to Clanwilliam Group, an international healthcare technology and services company based in Dublin, Ireland;
the conversion of the Company's senior secured loan in Xpress Global Systems, LLC into an equity investment in connection with the sale of Xpress to a new private equity sponsor; and
the conversion of the Company's various debt positions in Black Diamond Equipment Rentals into one senior secured loan in connection with the recapitalization by its existing financial sponsor.
Subsequent Events On January 3, 2019, Alcentra paid a dividend to shareholders of record as of December 29, 2018 of $0.18 per share. On January 15, 2019, Alcentra funded $5.0 million of the second lien loan for Cambium Learning Group, Inc. at L + 8.5%. On January 31, 2019, Epic Healthcare Staffing Intermediate Holdco, LLC repaid $3.6 million of its revolver with the Company. On February 4, 2019, Alcentra funded $2.4 million to Aegis Toxicology Sciences Corporation, a first lien loan at L + 5.5%.
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On February 8, 2019, Tunnel Hill repaid its escrow shares for $0.8 million. On February 8, 2019, FST Technical Services, LLC repaid its debt and equity for $13.6 million (consisting of the principal amount of $13.4 million plus accrued interest) and $3.1 million, respectively. On February 11, 2019, VVC Holding Corp. repaid its debt plus accrued interest in the amount of $6.0 million, plus a prepayment penalty of $0.1 million. On March 4, 2019, ABDC was allocated a $3.0 million position in the first lien loan at L + 4.5%, and a $2.0 million position in the second lien loan at L + 8.5%, for Institutional Shareholder Services Inc. The second lien loan was funded on March 8, 2019. On March 11, 2019, it approved its 2019 first quarter dividend of $0.18 per share, payable on April 4, 2019 to stockholders of record as of March 29, 2019. From January 1, 2019 through March 11, 2019, Alcentra repurchased an additional 229,729 shares under its share repurchase program. As of March 12, 2019, Suhail A. Shaikh became the CEO and Peter Glaser is now Alcentra’s sole President.
INVESTMENT PORTFOLIO Alcentra has one investment on non-accrual: Southern Technical Institute has three campuses in Florida where it teaches healthcare through four programs to train certified nursing assistants: home health aide, phlebotomy technician, patient care assistant, and hemodialysis technician. The value was written down zero from an original $15.8 million. The company is awaiting resolutions of issues outside of its control. There are another seven companies on the watch list: Alarm Capital Alliance was founded in 2000 is headquartered in Newton Square, Pennsylvania. It is a security and alarm monitoring company. ACA services households and small commercial businesses across the United States through its security services and home automation technologies. Battery Solutions was written down during Q4 by $1.3 million based upon recent financial performance due to weather related shipment problems. The company, established in 1992 and headquartered in Wixom, MI, is North America’s largest provider of battery recycling solutions. With three locations, two in Michigan and one in Mesa, AZ, BSL offers customized battery recycling solutions which include program design, collection systems, logistics, disassembly, chemistry identification, battery sorting, material recovery, regulatory compliance, and documentation to corporations, governments, municipalities, and households. Conisus was founded in 1999 in Atlanta. It is a leading outsourced medical service provider specializing in promotional drug marketing and continuing medical education (“CME”) services to the oncology and hematology biopharmaceutical industry. Envocore Energy Solutions equity was written down by $1.3 million during Q4 due to an earnings miss. It was founded in 1991 and is located in Gambrills, MD. It is the leading provider of custom energy (lighting & water) efficiency services to Energy Service Companies (ESCos) and utility clients. The company acts as a sub-contractor to these clients and performs design, engineering, and installation.
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IGT had a slight write down of equity of $100,000. It is a global provider of maintenance, repair and operations (MRO) services and parts for the industrial gas turbine market. IGT primarily serves the power generation, industrial, and aerospace end-markets and was formed from the acquisition of two companies: PAS IRE and TRS Services, one in Ireland and one in Houston. Palmetto Moon, LLC was valued down by $300,000 based upon its recent financial performance. It is a specialty retailer of outdoor active lifestyle apparel and accessories, college lifestyle apparel, and state & local-themed apparel headquartered in Mt. Pleasant, South Carolina. Its stores are located in traditional malls, power centers, and outlet malls primarily in South Carolina (one unit in Georgia). Xpress Global Systems XGS is 40-year-old transportation company that serves the needs of the floor covering industry as a trucking company and logistics supplier. It is located in Chattanooga, Tennessee. XGS was written down in Q4 by $2.3 million based on the closing of sale of the company.
Investment Mix On December 31, 2018, $235 million was invested in 30 investments. The portfolio then was 72% senior secured first lien debt, 18% senior secured second lien debt, 1% mezzanine debt, and 9% equity investments and 1% CLO. 13.1% of the investments were fixed rate, with the balance floating rate, and the cost of company’s average investment was $6.9 million. The value of the largest portfolio company, CGGR Operations (Carlton Group), was $23 million and it is 10% of the portfolio. It provides turnkey solutions addressing employee incentives/rewards program administration (Power2Motivate) and reward fulfillment and logistics (Global Reward Solutions) and is based in Toronto. The largest industry sector is business services at 20% of the portfolio.
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Table 1: Investments as of December 31, 2018
Company Battery Solutions BayMark Health Services Black Diamond Rentals Cambian CGGR Operations Champion ONE Clanwilliam Group Ltd Conisus Envocore Holding Epic Healthcare Staffing FST Technical Services Goldentree Loan Mgt CLO Healthcare Associates of Texas Impact Group IGT Lugano Manna Pro Products Medsurant Holdings, LLC Metal Powder Products Alarm Capital Palmetto Moon PharmaLogic Holdings Pinstripe Holdings Sandvine Corp Superior Controls Tunnel Hill VVC Holding Wedding Wire Xpress Global Systems Total
DIVIDENDS In order to maintain preferential tax treatment, BDCs such as Alcentra must distribute a minimum of 90% of their income to shareholders. Since August of 2014, the company had paid a regularly scheduled quarterly dividend of $0.34 but has cut that to $0.18. It expects the dividend to remain at that level for the foreseeable future. The $0.18 quarterly dividend equates to a $0.72 annual dividend and a current yield of 9.4%
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COMPETITION The company competes primarily with traditional and alternative lenders that are also targeting the middle to lower middle markets. The other lenders it frequently sees looking at the same deals as it are OFS Capital Management, Fidus Investment Corp (FDUS), Triangle Capital Corp (TCAP) and Saratoga.
Alcentra had been underperforming the BDC index but since new management has arrived, it is outperforming. As noted on the following table, on an NAV basis, BDC industry shares trade at an average 2.7% premium to share price. There is a wide valuation gap among the BDCs as shown below. Alcentra stock currently trades at a lower than average dividend yield of 9.4% versus the average at 10.2%, but the highest discount to NAV at 31%. Management is working to close that discount. BDCs Ticker Company Alcentra Capital
Apollo Investment Corp AINV Ares Capital Corp ARCC BlackRock Capital Investment BKCC Fidus Investment Corp. FDUS Garrsion Capital Inc. GARS Gladstone Capital Corp. GLAD KCAP Financial KCAP Main Street Capital Corp. MAIN Newtek Business Services NEWT TriplePoint Venture Growth TPVG BDC Corp.
RISKS We believe the company faces risks that confront the overall BDC sector. These include: ➢
➢ ➢ ➢ ➢
Interest rate risk: We believe the company faces the risk of a rising interest rate environment, although management believes that as it continues to rebalance some of the equity in its portfolio to debt and continues to expand the debt portfolio, it could benefit from a potential increase in interest rates in terms of net investment income. Credit risk: Alcentra could make investments into companies that are not as creditworthy as management believes or some of the investments in its existing portfolio could experience deteriorating fundamental business results. Default risk: Potential deterioration in the underlying fundamentals of a portfolio company or companies could lead to a default on loans that Alcentra expects repaid. Dividend sustainability: If the company experiences some deterioration in its underlying performance, it might be forced to reduce its dividend. Competitive risk: The company competes with alternative lenders such as other BDCs and, in some cases, with traditional lenders. Competition within its target lower middle market has increased and the company anticipates future deals will have lower yields.
Stillwell Group Caxton Corp. San Bernadino County Employees Retirement Association Mellon Investments Corp Paul Hatfield Pacific Ridge Capital Partners UBS Securities LLC Confluence Investment Mgt BNY Mellon Wealth Management Other
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Dollars in Millions
$5,374,814 226,519 377,071 30,661
$5,350,763 279,585 653,286 83,853
$5,742,386 199,650 1,507,304 30,756
$5,865,711 45,481 611,812 30,756
$5,676,759 107,164 94,668 30,756
$5,450,756 151,844 738,206 30,756
$5,400,000 151,844 300,000 30,756
$5,300,000 160,000 300,000 30,756
$5,200,000 170,000 300,000 30,756
$5,100,000 180,000 300,000 30,756
$25,178,890 3,182,683 2,475,976 82,777
$23,917,956 1,156,486 2,228,104 171,083
Non-controlled, affiliated investments: Interest income from portfolio investments Paid in kind int inc. from portfolio investments Other income from portfolio investments
251,778 387,036 -
594,972 63,345 -
405,892 609,854 -
66,282 1,149,183 -
77,453 123,126 -
129,080 90,004 -
58,881 96,816 -
40,790 96,676 -
60,000 100,000 -
70,000 100,000 -
70,000 100,000 -
80,000 100,000 -
2,742,054 2,365,373 2,352,766
From controlled, affiliated investments: Interest income from portfolio investments Paid in kind int inc. from portfolio investments Other income from portfolio investments
405,835 166,445 -
411,262 174,448 -
275,243 343,236 -
Capital gains incentive fees Professional fees Valuation services Interest and credit facility expense Amortization of deferred financing costs Director's fees Insurance expense Organization expense Amortization of deferred note offering costs Consulting fees Other expenses TOTAL EXPENSES
Net Realized gain Non-controlled, non-affiliated investments Non-controlled, affiliated investments Controlled, affiliated investments Foreign currency translation Net realized gain from portfolio Net change in unrealized Non-controlled, non-affiliated investments Non-controlled, affiliated investments Controlled, affiliated investments Foreign currency translation Net change in unrealized Benefit for taxes on unrealized Net realized gain Net increase in Net assets
TOTAL INVESTMENT INCOME Yr-to-yr growth Costs and expenses: Management fees % of Sales Income-based incentive fee
$7,004,677 348,192 609,965 27,520
Non-controlled, non-affiliated investments: Interest Income from portfolio investments Paid in kind int inc. from portfolio investments Other income from portfolio investments Dividend income from portfolio investments
ASSETS Portfolio investments, at fair value Non-controlled, non-affiliated at fair value Non-controlled, affiliated at fair value Controlled, affiliated at fair value Cash Dividends and interest receivable Receivable for investments sold Deferred financing costs Deferred tax asset Income tax asset Prepaid expenses and other assets
NET ASSETS Common stock 13,105 Additional paid-in capital 198,594,662 Distributable earnings (accumlated loss) (52,805,235) Undistributed net investment income Net unrealized appreciation on investments, net Total Net Assets 145,802,532 Total Liabilities and Net Assets 253,778,428 Net Asset Value Per Share
Net increase in net assets resulting from operations Adjustments: Net realized (gain) loss from portfolio investments Net change in unrealized (appreciation) depreciation of port inves Deferred tax asset Deferred tax liability Paid in-kind interest income from portfolio investments Accretion of discount on debt securities Purchases of portfolio investments Net proceeds from sales/return of capital of portfolio invest. Amortization of deferred financing costs Amortization of deferred note offering costs (Increase) decrease in operating assets: Dividends and interest receivable Receivable for investments sold Income tax asset Prepaid expenses and other assets Increase (decrease) in operating liabilities: Payable for investments purchased Other accrued expenses and liabilities Due to affiliate Directors' fees payable Professional fees payable Interest and credit facility expense payable Management fee payable Income-based incentive fees payable Unearned structuring fee revenue Income tax Net cash used in operating activities Cash Flows from Financing Activities: Issuance of common stock Financing costs paid Offering costs paid Proceeds from credit facility payable Repayments of credit facility payable Proceeds from notes payable Distributions paid to shareholders Repurchase of common stock Capital contributions received from partners Cash distributions paid to partners Net cash provided by (used in) financing activities Effect of exchange rate changes on foreign cash Increase (decrease) in cash and cash equivalents Cash at beginning of period Cash and Cash Equivalents at End of Period Supplemental and non-cash financing activities: Cash paid during the period for interest Accrued offering costs Accrued distributions payable
CONSOLIDATED STATEMENTS OF CHANGES IN NET ASSETS Consolidated Statements of Changes in Net Assets Increase (decrease) in net assets resulting from operations Net investment income Net realized gain (loss) on investments Net change in unrealized appreciation (depreciation) on investments Benefits/(Provision) for taxes on unrealized gain on investments Net increase (decrease) in net assets resulting from operations
Capital transactions Offering costs Issuance of common stock Repurchase of common stock Net increase (decrease) in net assets resulting from capital transactions
186,069 (7,541,360) (7,541,360)
10,853,602 (342,510) 10,511,092
Distributions to shareholders from: Net investment income Realized gains Total distributions to shareholders
NA NA (9,892,415)
(17,816,654) (403,112) (18,219,766)
(18,351,553) (4,596) (18,356,149)
Total increase (decrease) in net assets Net assets at beginning of period Net assets at end of period
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HISTORICAL STOCK PRICE
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DISCLOSURES The following disclosures relate to relationships between Zacks Small-Cap Research (“Zacks SCR”), a division of Zacks Investment Research (“ZIR”), and the issuers covered by the Zacks SCR Analysts in the Small-Cap Universe. ANALYST DISCLOSURES I, Lisa Thompson, hereby certify that the view expressed in this research report accurately reflect my personal views about the subject securities and issuers. I also certify that no part of my compensation was, is, or will be, directly or indirectly, related to the recommendations or views expressed in this research report. I believe the information used for the creation of this report has been obtained from sources I considered reliable, but I can neither guarantee nor represent the completeness or accuracy of the information herewith. Such information and the opinions expressed are subject to change without notice.
INVESTMENT BANKING AND FEES FOR SERVICES Zacks SCR does not provide investment banking services nor has it received compensation for investment banking services from the issuers of the securities covered in this report or article. Zacks SCR has received compensation from the issuer directly or from an investor relations consulting firm engaged by the issuer for providing noninvestment banking services to this issuer and expects to receive additional compensation for such non-investment banking services provided to this issuer. The non-investment banking services provided to the issuer includes the preparation of this report, investor relations services, investment software, financial database analysis, organization of non-deal road shows, and attendance fees for conferences sponsored or co-sponsored by Zacks SCR. The fees for these services vary on a per-client basis and are subject to the number and types of services contracted. Fees typically range between ten thousand and fifty thousand dollars per annum. Details of fees paid by this issuer are available upon request.
POLICY DISCLOSURES This report provides an objective valuation of the issuer today and expected valuations of the issuer at various future dates based on applying standard investment valuation methodologies to the revenue and EPS forecasts made by the SCR Analyst of the issuer’s business. SCR Analysts are restricted from holding or trading securities in the issuers that they cover. ZIR and Zacks SCR do not make a market in any security followed by SCR nor do they act as dealers in these securities. Each Zacks SCR Analyst has full discretion over the valuation of the issuer included in this report based on his or her own due diligence. SCR Analysts are paid based on the number of companies they cover. SCR Analyst compensation is not, was not, nor will be, directly or indirectly, related to the specific valuations or views expressed in any report or article.
ADDITIONAL INFORMATION Additional information is available upon request. Zacks SCR reports and articles are based on data obtained from sources that it believes to be reliable, but are not guaranteed to be accurate nor do they purport to be complete. Because of individual financial or investment objectives and/or financial circumstances, this report or article should not be construed as advice designed to meet the particular investment needs of any investor. Investing involves risk. Any opinions expressed by Zacks SCR Analysts are subject to change without notice. Reports or articles or tweets are not to be construed as an offer or solicitation of an offer to buy or sell the securities herein mentioned.