The House bill H.R. 529 and the Senate bill S. 2136 would allow smaller BDCs to increase their leverage if passed, allowing these small companies to increase their investments and make changes in preferred stock, says Jasper Burch, Research Analyst at Macquarie Group Limited.
“Right now, BDCs are limited to levering their portfolio one-to-one to equity, and that would increase it to two-to-one and also have some other changes in preferred stock and allow them to invest in more investment advisors subsidiaries. But that bill could materially change the game if that were to go through. It’s still in the very early stages, but that’s a potential game changer for them, which would be a positive,” Burch said, of H.R. 529.
Burch also said the Senate bill S. 2136 could increase the maximum amount of borrowing or debentures that SBICs can take on. This bill would allow some BDCs to increase their borrowing from a maximum of $225 million to $350 million.
“There are probably eight BDCs that have SBIC subsidiaries. There’s Fifth Street (FSC), Golub (GBDC), Hercules (HTGC), Main Street (MAIN), PennantPark (PNNT), Triangle Capital (TCAP), a couple more. That would positively benefit those BCDs, but not have an impact on the rest of the space,” Burch said.
Randgold Resources Ltd. (GOLD) has cut through the noise and focused on the key fundamentals for gold mining: strong management, a focus on minerals and assets, and then finally a look at the capital, says Douglas B. Groh, Portfolio Manager and Senior Research Analyst at Tocqueville Asset Management LP.
“They’re a lean team in that regard, and I think they’re a cohesive group of people, and because of that cohesion they’ve had a lot of success. So here if it’s the management, it’s also the overall culture of the company that’s really been a successful adjuvant for them. Additionally, I think they’re focused on geology and recognizing that that’s where the ultimate value comes from, it’s from the ore deposit and focusing in a disciplined way on ore deposits that have fantastic upside potential,” Groh said.
Groh says Randgold has established credibility and respect with the investor community through the prudent use of capital, by not issuing equity for the sake of issuing equity, only doing so when it enhances shareholder value.
“What’s exemplified in Randgold’s success is a very strong management team, very focused, very disciplined on what their skill set is all about in various geologies in Western Africa. They have South Africans as operators in Africa. They understand very well the continent they work in and how to operate in the various countries where they do operate from their experience,” Groh said.
Horizon Technology Finance Corp. (HRZN) recently began trading at a discount to net asset value, creating an entry point into the BDC space for investors, says Casey Alexander, Senior Vice President at Gilford Securities Incorporated. HRZN is a venture-debt business, and the company invests in businesses that have already attracted capital from investors like IBM Ventures and Kleiner Perkins.
“We are actively helping investors accumulate a position in Horizon Technology Finance as we speak. We’re talking to investors on a regular basis about increasing their exposure to Horizon Technology Finance because we believe that at the current price with a yield, a current yield of 10%, that when it hopefully repeats its history and trades back towards net asset value in excess of $16 that we will receive the 12% current yield and 12% to 15% appreciation, thus giving us a total return of something between 20% and 30%, an above-average total rate of return for our investors,” Alexander said.
Horizon Technology Finance provides a little slice of debt on the back end of venture capital deals that involve large capital investors for working capital, says Alexander, which in his opinion partially protects the investment since there are large amounts by the likes of IMB Ventures and Kleiner Perkins. The deals are more diversified too, he says.
“In a business development company with a market cap of $140 million or so, their deals are cut into 4, 5, 6, 7 million dollar slices. Also, venture debt deals tend to amortize or pay down faster than the average business development company middle-market deal does, so the overall risk exposure to each loan declines fairly quickly over the life of the loan, which in general is only four to five years to begin with,” Alexander said.
A focus on gold companies with capital-deployment and equity-issuance discipline, while moving away from companies with a poor track record, leads Greg Orrell, Portfolio Manager at Orrell Capital Management, Inc., to choose Goldcorp (GG) and Gold Fields Ltd. (GFI) as his favorite gold mining companies.
“Our top holding in the fund is Goldcorp. The company has shown an ability to expand. Its production profile with lower-cost, higher-grade mines in jurisdictions that are politically safer for the most part; and the management, though they’re in a capital-intensive phase at the moment, their management still understands that shareholders need to participate in cash flow,” Orrell said.
Orrell says Gold Fields can grow off from the current perception of low value in their assets relative to their peers. Orrell likes GFI, and he says the negative valuation of the South African assets provides the company with a good opportunity to revalue going forward.
“Number two, Gold Fields in South Africa, listed on the New York Stock Exchange, is a company that has just announced the split up of the company with two of their South African operations being spun off into a separate company while their non-South African assets except for one operation will stay in Gold Fields,” Orrell said.
Smaller business development companies like Triangle Capital (TCAP), Medley Capital (MCC) and THL Credit (THL) play to the lower end of the middle market and obtain a better risk/reward relative to their BDC peers in the upper end of the middle market, says Greg Mason, CFA, Managing Director & Senior Equity Analyst at Stifel, Nicolaus & Co., Inc.
“Triangle’s main focus is on companies that have EBITDA between $5 million and $15 million, which we think is a sweet spot for the lower end of the middle market,” Mason says. TCAP has a sucessful track record, capital to invest and a lower expense ratio than many of its peers, and Mason expects meaningul earnings growth.
He also says Medley and THL, besides playing to the lower end of the middle market, are interesting because of the potential for a SBIC license. He says the process is nearing its end, and once the process is finished, the companies are small enough for this catalyst to be meaningful for their earnings and ability to grow the dividend.
“We think both of those companies with the combination of good management teams focused on the lower end of the middle market with the potential of the SBIC catalyst for earnings and dividends creates a pretty compelling story as well,” Mason said.
Eldorado Gold Corp. (EGO) and Yamana Gold (AUY) are high-quality quality miners with lower production costs and strong management teams, providing investors with an entry point to gold equities if the sector sees a decrease in what currently appears to be full valuation, says Joung Park, CFA, Equity Analyst at Morningstar.
“They are not trading at big discounts to our fair values given that Yamana is up almost 30% this year and Eldorado is also up, but not as much as Yamana. But these two are definitely names to keep an eye on if we see another big pullback in gold-mining equities,” Park said. “Our fair value for Yamana is $20 per share, and our fair value is $15 per share for Eldorado.”
Park says there aren’t as many opportunities in the sector given the current valuation levels, and he also says he doesn’t expect much M&A activity given large caps’ newfound capital discipline. In the current environment, Park prefers midtier miners over small caps, which can’t diversify the production base, and large caps, which have a more difficult time finding growth.
“You want a company that’s not too big and not too small. And I think the sweet spot for investors is midtier miners where you have a solid diversified production base, but you still have a lot of room for growth,” Park said. “I think a midtier miner is really at the sweet spot of the corporate life cycle.”
Ares Capital Corp. (ARCC) is one of the easiest ways to play into the business development companies, or BDC space, in the current environment of good technical drivers, fundamental and macroeconomic drivers, and the BDC placement in the investment cycle, says Jasper Burch, Research Analyst at Macquarie Group Limited.
“[ARCC is] the largest, probably the BDC with the best reputation, definitely one of the best management teams, very well established track record. It’s a fundamentally safe company to investors. That doesn’t mean you won’t get share price volatility, and there is always risk whenever you’re investing in equities, but the fundamental driver of the company makes it a very attractive easy way to play the space,” Burch said.
Another name Burch likes on valuation is Apollo Investment Corp. (AINV). AINV is a turnaround story, he says, and the company has brought in new management to move from lower-yielding securities into more senior, higher-yielding securities. The company currently trades on a lower valuation than peers, near book value.
“What I like about it is it’s a story where there’s a greater growth story in that name than I think lot of its peers, and the reason I say that is the major theme is recycling of the portfolio from a more of a liquid portfolio into a more high-touch middle market portfolio that should give better risk-adjusted returns,” Burch said.
“Those are the two that really stand out to me right now. Ares is a really large, safe, well established company, and then Apollo is a little bit more of turnaround in growth story, but still a very strong company,” he said.
Las Vegas Sands (LVS), Wynn Resorts (WYNN) and MGM Resorts (MGM) provide opportunities for investors looking to participate in Macau gaming, says Harry C. Curtis, Managing Director and Senior Analyst at Nomura Securities International, Inc. He says he expects growth the Macau market to grow in 2013 with increased profit margins.
“Notably, the gaming volumes and growth have continued to be very strong in the mass segment, and the mass segment is important because it’s got a 35% margin as opposed to 12% margin for the VIP business. But the VIP business has been stuck in neutral. Our sense in 2013 is that there should be mid-single digit growth in the VIP segment as the Chinese economy reaccelerates, and that the mass segment will continue to grow at about 20%,” Curtis said.
Curtis says his favorite stock is Las Vegas Sands. “That’s mainly an Asian gambling company, generating 75% or 80% of its EBITDA between Singapore and Macau. They just raised their dividend and they’re generating $2 billion to $2.5 billion of free cash flow annually, over and above their maintenance capex and dividend requirement. They could return even more capital to shareholders if they wanted to,” he said.
“We also like Wynn, which is a free cash flow story. The stock’s yielding nearly 4%. And at some point, investors are going to begin giving them credit for a new casino under construction in Macau,” he said.
Curtis also likes MGM, which has exposure to the Macau gaming story. “At around $9.50 a share, it’s really not getting any credit for the value of its cash flows in Macau. All of the value ascribed to the equity is found in Macau, and there is really no value investors are according it in the U.S.,” he said.
Microsoft Corp. (MSFT) may see upside associated with its Windows 8 operating system, as many investors and the news media misunderstand the story behind this platform, says Mark Moerdler, Senior Research Analyst at Sanford C. Bernstein & Co., LLC. Moerdler has an “outperform” rating on MSFT based on the Windows 8 operating system for tablets, its potentially growing market share and its cloud offerings, among others.
“As we go forward into next year and as Windows 8 continues to show success that parts of the mindset about Windows 8 will break apart, and that will help the stock. There’s also the attach to Windows 8 on every RT device. There’s revenue to Microsoft for Word, Excel and PowerPoint. Windows 8 lowers piracy. There are a lot of attaches to the sale of that product,” Moerdler said.
Moerdler says many of the investors who entered MSFT expecting Windows 8 to fall off a cliff and were planning to sell the stock before its release have already exited the stock. He also says many of the reviewers of the Windows 8 operating system tested it in computers that were not appropriate, fueling misunderstanding of the software.
“In addition, I think we’re going to hear a lot more from Microsoft about their cloud offerings and how successful those have been. Products such as Office 365, the Dynamic CRM Online and other Dynamic Online products as well as Azure, and I think as that data comes out, and the size and the growth and the economics of it start to be given by Microsoft, that people will see that positively.”
Convergys Corp. (CVG) and TeleTech Holdings (TTEC) are expected to have an advantage over smaller contact center vendors as the industry consolidates to serve customers in a more streamlined manner that also involves more expertise, scalability and global delivery capabilities, says Manish Hemrajani, Executive Director and Senior Analyst at Oppenheimer & Co. Inc.
“Enterprises are now actually starting to look at their contact center vendors and realizing that having six to 10 vendors is counterproductive and looking to consolidate these to two to three vendors with the right expertise, scale and global delivery capabilities,” Hemrajani said.
Hemrajani says that, although these companies have retrenched a bit due to macro overhang, he expects this experience to help with the consolidation of the industry as companies now rethink their outsourcing strategy and make it more unified.
“Vendors are also looking at their global delivery capabilities and are open to M&A to extend their global reach as well as add language skills, especially in Latin America, to expand their reach, or if they see a differentiating service or technology that they want to add to their portfolio. I expect the larger vendors, such as Convergys, TeleTech, Teleperformance (RCF.PA) and others to have a distinct advantage in a consolidation scenario,” Hemrajani said.
