Prospect Capital Corp (PSEC) 2009 Q2 法說會逐字稿

Hello and welcome to the Prospect Financial's second fiscal quarter results conference call. (Operator Instructions).

Please note this conference is being recorded. Now I would like to turn the conference over to Chairman and CEO, John Barry. Mr. Barry?

Thank you, Ryan. Joining me on the call today are Grier Eliasek, our President and Chief Operating Officer, and Brian Oswald, our Chief Financial Officer. Brian?

Thanks, John. This call is the property of Prospect Capital Corporation. Unauthorized use is prohibited. This call contains forward-looking statements within the meanings of the securities laws that are intended to be subject to Safe Harbor protection. Actual outcomes and results could differ materially from those forecast due to the impact of many factors. We do not undertake to update our forward-looking statements unless required by law. For additional disclosure, see our earnings press release and our 10-Q filed previously.

Now I will turn the call back over to John.

Thanks, Brian. For the six months ended December 31, '08, our net investment income was $35.5 million, or $1.20 per share, an increase of $16.9 million or $0.34 per share from the results for the six months ended December 31, 2007.

For the quarter ended December 31, 2008, our net investment income was $12 million or $0.40 per share, an increase of $1.3 million from the same quarter in the prior year. Our December quarter results included an excise tax of $533,000 due to under distributing our dividends relative to net investment income for calendar year 2008. Excluding such non-recurring items, our net investment income would have been $0.42 per share.

Our net asset value per share on December 31, 2008 equaled $14.43 per share, a decrease of $0.12 per share compared to $14.55 at June 30, 2008. We estimate that our net investment income for the current third fiscal quarter ended March 31, 2009 will be $0.40 to $0.45 per share. We expect to announce our third fiscal quarter dividend next month.

Our business objective continues to be to generate long-term stable dividend growth as we have delivered to date with 17 consecutive quarterly dividend increases.

Now Grier Eliasek will comment on our investment activity.

Thanks, John. On December 31 the fair value of our portfolio of 31 long-term investments was approximately $555.7 million. As of December 31, our portfolio generated a current yield of approximately 16% across all of our long-term debt and equity investments. This current yield includes interest from all of our long-term investments, as well as dividends from certain portfolio companies.

During the quarter ended December 31 due to the market dislocation and the slowdown of market transaction activity, we did not complete any new investments but continue to evaluate a number of new investment opportunities in the primary and secondary markets.

On January 20 Diamondback Operating LP repaid Prospect's $9.2 million loan in full from the sale of 65% of Diamondback's Rock Springs oil and gas property interests. Prospect has realized an approximately 17% cash on cash IRR on the Diamondback investment. Prospect continues to hold the right to receive 15% of any future Diamondback equity distributions.

During the past year, we have ended discussions with multiple purchasers for Gas Solutions, but have not yet entered into a binding agreement. While we wish to liquify the value we see in Gas Solutions, we do not wish to enter into any agreement at anytime that does not recognize the long-term value we see in Gas Solutions. As a hedged midstream asset generating significant cash flows to us, Gas Solutions is a valuable asset that we wish to sell at a value maximizing price or not at all. We continue discussions with interested parties, but have a patient approach toward the process. The multi-year puts purchased early earlier in 2008 are substantially on the money, providing downs and protection against commodity price declines.

Gas Solutions have generated approximately $21.2 million of EBITDA during the 10-month period ended October 31, 2008. On an annualized basis, this represents an increase of 73.7% over the 2007 results. As discussed in our last investor update, we have seen a significant shift in the opportunity set for capital deployment from the primary to the secondary marketplace. Given our low leverage, we are in an attractive position to benefit from an environment in which distressed sellers look to deleverage their balance sheets by exiting positions. Given significant pricing volatility, we have in to past quarter chosen to observe the market rather than close new investments, and we expect to be rewarded by that discipline in the weeks in months ahead in the secondary market while still looking at primary opportunities.

Thank you. I will turn the call over to Brian.

Thanks. At December 31, borrowings under our credit facility stood at $138.7 million. We are currently seeking to increase our revolving credit facility from its present size of $200 million. Over the past few months, we have worked with the rating agencies to structure and expand the facility. We have not yet embarked on a formal syndication process for this facility due to the current credit environment, but we expect to initiate such activities in the future. The closing of the facility is subject to lender syndication and other conditions customary for a transaction of this type.

In the second quarter, we announced the authorization by our Board of Directors to repurchase up to $20 million of our outstanding stock. To date we have not made any such repurchases, but we have now made the required notifications to shareholders of our flexibility to make such repurchases.

Now I will turn the call back over to John.

Thanks, Brian. Time for questions.

(Operator Instructions). James Shanahan, Wachovia.

First, I wanted to say thank you to Amir Friedman. He was very helpful with quite a few of the questions that I had this morning. But there really is just kind of one question I would like to put back to the group there. Does it seem odd to you or should it seem odds to us as outside observers that more than half of your portfolio company investments are either fair valued above historical costs, equal to historical costs, or were there really isn't meaningful unrealized depreciation taken like for example, say, less than 2%, 3%, 4%? Given what has happened in recent quarters in the leverage loan markets and the equity markets and the lack of unrealized depreciation, it really sticks out relative to the group, and I would like to get your perspective on that.

All right, Jim. Actually there are three people here who have something to say, and I'm just going to go first. You will get three perspectives on that.

My perspective is that we have not been participating in the fashion of the month or the fashion of the year or the fashion of the decade in the credit markets. When we observed that multiples for lending and for buyouts had moved well above historic means, we stood aside. That is one thing.

Related to the corollatively, we have originated the vast bulk of our own portfolio on our own with boots on the road in far off regions that are ordinarily not visited by the denizens of Wall Street. The result of doing that is both good and bad.

What is good about it is, typically if you do a good job underwriting, you can make a good value loan to a good value company at a yield that is commensurate with the risk and avoid the bubble economy, which we think we largely did. The negative to that is every so often, you are going to be stubbing your toe doing business with people who are, to choose a word carefully, difficult.

And so in the coal area, we have had difficulties. In the power area, we have had difficulties. So those offset some of the benefits. Fortunately the benefits of our strategy staying off the beaten path where everybody else is have outweighed the costs, and I think that is what you're seeing.

Now Grier has another perspective.

Sure. Jim, a couple of responses to that. First, we may be the only company in our peer group which has employed a third-party valuation firm for every single company, every single quarter since inception of our Company's history. So we think we have a pretty robust process relative to the peer group that you referenced.

Secondly, these are Level III assets, and as such, the valuation methodology under FAS 157 for assets is to look at appropriate comparable discount rates for a similar type of transactions and to compare those with the returns that we are generating off of those assets. Our portfolio, because of the reasons that John mentioned as largely a directly originated pool as opposed to buying paper "from the streets" or from whatever sponsors wanted people to except in the go go years of '05, '06, first half of '07. Our portfolio is much, much higher yields than the peer group as we announced today our weighted average unlevered asset yield is 16%, which is several hundred basis points above the peer group. And, as a result, even if discount rates have risen in the marketplace, in many cases if we're getting a higher yield or equivalent or higher yield than the appropriate benchmark discount rate, then we would not be taking any unrealized depreciation.

In addition to the disciplined reason that John mentioned, we have also been disciplined about interest rate protection. As folks know, LIBOR has plummeted -- one month LIBOR to below 50 basis points. And there were a fair number of people out there, our peers and not ourselves, writing a significant part of their book as pure floating rate, which may work okay if you are in a highly leveraged spread business like a banker, what have you. It does not work too well in a lower leveraged business that has an objective of growing a dividend stream over time. The vast bulk of our book is either a fixed or high fixed-rate or the greater of fixed or floating. So we have not been hammered by a declining LIBOR as has been the case with a number of our peers.

Having said all that, we have taken some unrealized depreciation in the past quarter. It has not stood absolutely still for those deals whose weighted average yields were below the appropriate discount rates.

Brian, anything to add?

Just Grier pretty much touched on the debt side. I will touch quickly on the equity positions. We have seen some real strong performance by our portfolio companies that we have equity positions in, which has helped to stabilize their values also.

Thank you for those comments and a follow-up if you don't mind. Typically with regards to portfolio company, WEPI, for this company there was some -- it has been on nonaccrual. There was some unrealized depreciation this quarter, but there was also an incremental investment there. Can you talk about why you're putting more capital to work in WEPI over the last, say, three or six months in the face of continued write-downs?

We're positioning that company for sale, and that means that you probably -- you might paint your house or repave your driveway when you're getting ready to sell something, and so that is what we're doing there. If anybody -- we ran into somebody the other day who was very disappointed supposedly who was not on the list to bid for that asset. If anybody on this call wants to put in a bid, we would be happy to entertain it. We are significantly down the road in the process, but it is not too late for other people to join in and buy a very nice biomass facility in the current political environment.

Jasper Birch, Fox-Pitt Kelton.

I was just wondering if we could have a little bit more color on the process of refinancing your debt facility? Do you have any timetables and when can we expect announcements and at what stage are you with the rating agencies? Is it already rated for the type of debt that you are looking for?

We have been in the process for several months of working on converting our existing revolving facility into a rated revolving facility. Adding additional bells and whistles, rating each credit in the pool and then having a wrapped rating for the entire facility probably dual-rated with Moody's and S&P. That is an extremely time-consuming process that we are nearing the tail-end of now and expect to be embarking shortly upon a formal syndication process with other lenders beyond Rabobank, our existing lead lender. So we expect to have additional updates on that in the coming weeks and months. It is an important priority.

As folks on this call may recognized, we are among the least levered companies, perhaps the least levered of any meaningful size, of our peer group. And so we would like to expand the size of our credit facility. The exact expansion will be a function of what the market tells us. It is obviously not an easy market; it is a tough market. But given our performance to date and our low leverage, we are I would say cautiously optimistic in that arena, and we will be very focused on that in the coming weeks and months.

Okay. And somewhat of a follow-up, should we look at the fact that you did not make new investments in new portfolio companies this quarter, especially given your commentary on the secondary markets as a strategic strategy based on to preserve capital for your refinancing process, etc., or is it more that you did not see opportunities that really fit your portfolio?

Well, I would say in the December quarter, it was more a function of tremendous volatility in the marketplace and a significant downdraft happening for a lot of the quarter. Deflation, hairy type downdraft, and why buy something if you think it is going to be worth less 24 hours later with a significant driver of that. The marketplace, the leveraged loan marketplace appears to be stabilizing a bit at least as it pertains to pricing. And so it is on perhaps firmer footing, and we're actively exploring a number of opportunities in that arena, both individual, multiple seller credits, as well as more opportunistic portfolios. So we are hard work on that front.

Robert Dodd, Morgan Keegan.

I have got several questions. First, a simple one on guidance. Does the guidance for the next quarter include any excise tax, or is it just as in prior periods kind of guidance without tax?

The guidance for the next quarter does not have any excise tax in it.

Moving on to there is just the performance of the portfolio, I think we have covered debt with everything else. Any additional non-accruals in the portfolio this quarter? It did not look like it to me but just checking.

No, there were no new non-accrual loans.

And then just going through a couple of the particular assets, obviously on the coal side, we have been seeing some level of improvement in those businesses over the last couple of quarters, but then obviously spot coal prices have now come off pretty sharply and you were shifting to more spot sales if I remember right in those businesses.

I mean what is the status of those businesses currently, and what is the positioning over the next year or so to mitigate kind of the decline in coal prices?

Well, we are reevaluating our approach to those businesses, and there is a debate internally. My position is that we have significant leases with significant permanent permitted reserves and with I believe it is 25 million tons of unpermitted reserves. We understand that the process of taking unpermitted reserves, which are worth maybe $0.50 a ton and permitting them where they could be worth maybe, and let me underlie maybe, maybe up to $4.00 a ton is a great business compared to the business of maintaining all this equipment, managing a labor force, taking on all the risks and perils of mining coal, being blamed for harming the environment, which is what my daughter keeps talking to me about.

And so my position is that we should move in the direction of being a resource owner and permitting company, and we have a management team there that is very, very good at that.

And then the question is, if we continue to maintain all the equipment that we have, of course, it breaks down, it wears out. There's outages and so on, headaches. If we maintain that equipment and if we maintain the work force, is it for very low hanging fruit where something comes along every so often that we cannot resist mining it because the margins are so good, or do we maintain a larger workforce and then need to be in the business of always looking for work for the people? Which is not easy to do because for one thing the availability of unpermitted and permitted reserves is down. The speed with which permits are being issued is down.

So what that means is that the person with the labor force and the equipment is on the wrong end of the terms of trade suddenly. That is how I see it. But the person with $25 million of -- 25 million tons of unpermitted reserves who has no reason to believe that they cannot all be permitted. Now granted this is under the ground. So you do not know if it is 25 million or 2.5 million. It is probably somewhere in between. But that seems to us at least to me to be a good business, and that is the direction that I have recommended we go with that company. Because as Prospect gets bigger, we cannot spend the amount of time that managing coal businesses take. Plus, we're not there in Kentucky. We're not there in West Virginia. We're not at all expert in managing those kind of businesses. We got involved as lenders. We did not want to be involved as owners.

So we're looking to reduce our ownership and control there. One way is to become a resource company as I have suggested. The other way is to combine with other companies and allow ourselves to become a mere lender again.

Got it. And then on Gas Solutions, it looks like you put in an extra $5 million in debt in the quarter. Are you looking to expand that business, or is that just regular CapEx, or what is going on there?

We had a senior lender in there, Robert, and that was the required amount on a net debt basis net of cash available to pay that off and to move power our loan to Gas Solutions into a senior secured basis, which is a significant positive for future borrowing base optimization. You get higher advanced rates against senior secured paper as opposed to any type of junior debt instrument.

Got it.

Robert, while we are on that topic because I'm sure someone is going to ask the question, are you selling -- did you sell it yesterday? Did you sell it tomorrow? How about tomorrow afternoon? Why does selling this take so long?

Well, I think anyone who has not been living under a rock knows that the MLPs have traded down substantially. The credit markets have gone through a period of difficulty, and the M&A market is falling off significantly. Lastly, multiples have compressed substantially.

So when you are selling an asset with all those four winds at your back, you may not be in such a rush to sell it because you may perceive that this is not the best environment to get the full value. That is the case here.

Notwithstanding our perception that those headwinds diminish the kind of value that we have been expecting to see there, liquefied, we are still in discussions, and we have not broken off discussions. But we are not as -- we are not as believing that a liquefication is as imminent as we thought nine months ago.

So we are also looking at other things that could enhance the value of the assets, such as expanding the operation, making acquisitions, driving more volume. And for us with any asset and when we're looking to sell it, it is always an alternative to expanding and improving the business, and as the terms of trade change, it just may be that what six, nine, 12 months ago was an obvious sale becomes more of well, maybe we should be expanding it and building it up and waiting for the credit and the M&A cycle to return. So we examine these things on an ongoing basis.

One last question if I can on Gas Solutions. We see that earnings have done very well over the last 12 months. I mean what proportion of that, if any at least until recently, came from realized gains on the puts you sold in the middle of the year given that obviously oil prices and natural gas liquids, you know the prices have come down pretty sharply?

The numbers that we announced were through the end of October on that. I do not think our puts became in the money until November after that time period. So virtually none of that was because of the puts.

James Bellessa, D.A. Davidson & Co.

This is actually Mike Bates. Just a follow-up -- what was that?

Is Jim sleeping in today?

No, he is just on another call. Following up with the question on the Gas Solutions puts, you mentioned in your filing that you have got multi-year puts in place. Can you give an idea of when these puts will be expiring?

We have the specific breakouts in our 10-Q. Mike, you can see if there on the exact prices and the volumes and the dates that go into 2010.

Okay, great. I will get it there. One other question is, I was curious about why you elected to accrue the excise tax of $533,000 when you still have funds available in your revolver?

Well, it would have involved needing to make a distribution north of $10 million in order to secure that, and we decided given the opportunity set that is available in the marketplaces, we're looking to go on offense in a pretty significant way that that 4% excise tax to us looked like pretty cheap financing.

Okay, great. And one last question is, I was wondering why it is that you have been issuing additional shares for the dividend reinvestment instead of purchasing shares in the open market while via the shares are trading at a steep discount to NAV?

Well, the DRIP participation is a fairly modest participation. I think it is somewhere in the order of 10% to 15%. It is not a significant number, and we arrived at that again because of the opportunity set of where we can deploy capital. We think about that on a sort of net accretive basis of where we can put assets on the books relative to that DRIP issuance.

Sean Jackson, Avondale Partners.

Can you go into a little more detail on your fee income during the quarter and specifically what you call structuring fees? It looked like it was down significantly from last quarter and last year.

Sure. It was down for a pretty simple reason. We did not close really much in the way of any new transactions, and structuring fee type income is driven by new transactions activity. As a result, you would have seen more in the September quarter than the December quarter.

And also the investments that you have been looking at, are they still in the energy sector? Are you looking at other verticals trying to diversify a little bit? What is the status of those?

As you know, we changed the name of our company two years ago from Prospect Energy Corporation to Prospect Capital Corporation as part of the stated strategy of not moving away from energy industrials per se but to add to it for increasing diversity, scale, borrowing base, maximization, opportunity set, maximization and the like. And, as a result, we're looking at opportunities across the spectrum, both within energy industrials and beyond at all verticals, and have expanded the team significantly over the past couple of years as well to make sure we have got both the bandwidth, as well as the experience base to capitalize on all these opportunities.

[James Pursely], [Gaye Capital Management].

I wanted to just check out as you are looking to expand, can we talk a little bit about how your field underwriters work, your boots on the street work, and how you are deploying them and maybe in what industries?

Sure. I will just say a couple of words about that. We have I think it is eight people that originate transactions for us. Mark Hull is in Houston. The rest of us are in New York. They use their personal networks. The company is sufficiently well-known that we get a lot of direct response. We do continuous outreach through press releases, through e-mails, conferences in all the normal ways. And so as a result, we're not terribly dependent upon and shy away from so-called auction financings, auctioned by financial intermediators by Wall Street where we might be invited into a room and be served a free lunch, which is anything but free, and be given the opportunity to bid against maybe 12 other lenders for the opportunity to be in some deal. So that is our methodology. Grier has a lot to add because he runs a lot of that.

It is a heavy lifting program in which we look at a lot of transactions. In any given year, somewhere between 2000 to 3000 might be a typical number of opportunities, and our book to look ratio of what gets over the goal line versus what we originate on the front-end typically is well less than 1%. So very iterative process, one involving putting terms on the table oftentimes expeditiously in the front-end to suss out whether there is overlap economically and then a lot of hard work going into the diligence front with third-party accountants and lawyers and engineers and consultants and customized to the particular transaction opportunity in front of us. And then, of course, closing a deal is just the start. There is the whole activity of monitoring on the back-end, in which case we typically take board seats. If we own and control the Company or have observation rights, typically if we are a noncontrolled straight lender to the companies. So hopefully that gives you a little bit of flavor for some of the sausage factory.

Great. Say, well, you don't grow dividends without recurring income. That leads me to a question also about compensation. Your compensation is not heavily front-end loaded I trust?

It is not -- (multiple speakers)

Your compensation of the bankers?

It is not. We do not pay closing fees, success fees to our internal staff. People are motivated over long periods of time to perform. As companies pay off, so do our people.

Our observation is that a very significant percentage -- I do not want to say all but I'm tempted to -- of the Company's financial problems both in the private sector and in the government sector have resulted from the fact that it is always someone else's money. It is always -- we make this investment. We make this loan. We do this. We build that. And it never seems to be the person's money who is making the decision.

Well, at our company it is our money, and that just generates a completely different attitude towards all of these expenditures.

I believe we as managers bought somewhere in the order of $12 million worth of stock in calendar year 2008, approximately that amount.

That attracted me to the stock.

What was that?

That attracted me to the stock, the heavy insider buying.

Well, we also own our entire management company here ourselves, which means that if we allow something crazy to happen in the system, if we allow some person to race out there and do something imprudent, it can be very harmful to the public and the private company and our careers, and our reputations, and our capital, and our ability to care for our families.

So we just noticed when we talk to people around Wall Street that that old-fashioned attitude seems to have evaporated as all of these companies -- Lehman, Morgan, Goldman -- all went public. Merrill. They all went public, so suddenly they were playing with someone else's money.

Great. Concur. And just another observation. Your interest rate spread this year was to die for, 16% versus 4.95%. Did I read that right?

That is right. We borrowed money at LIBOR plus 250, and LIBOR has declined. Right now one month LIBOR is less than 50 basis points.

Looking out though as essentially your debt is on floating rate, what do you think if you are looking at your new facility? Are you likely to structure it in the same way? LIBOR is certainly not going to go down much lower.

You know, we are evaluating the possibility of interest rate caps and some other structures. Of course, you want to make sure if you buy a cap, that your facility is going to be drawn a certain amount for a certain period of time. You do not want to spend the money on that and then have it revolve downward such that you don't get the benefit of the cap should interest rates go up. But we are evaluating just those factors because of the low rate environment in which we find ourselves.

Great. Thanks so much.

(Operator Instructions). [Fred Knight], Dallas Capital Management.

Given your discussion with the credit rating agencies and potential lenders, what range are you looking at for the credit facility, and also what kind of debt-to-equity ratio would you see going forward?

Fred, a range referring to what exactly?

Of your new revolver.

A range of size or?

That is correct, yes.

We currently have a $200 million facility. As per my earlier comments, we don't know exactly how large of an upsizing it will be. We are targeting to maximize that. We are allowed to go up to 1:1, which if we are able to do that would take us towards the $400 million level. That would be quite an achievement in the existing marketplace and getting any positive expansion we would be happy to have.

It is too early until we embark upon our formal syndication process, Fred, to speculate on what that would potentially be.

Okay. And going forward what kind of leverage ratio do you think you would feel comfortable running?

Sure. We're at about 0.3 debt to equity right now. We have noticed some of our peers have made the mistake of getting very close to the edge of 1:1, and then they take some marks and they bust their 1:1. Not a pretty place to be for either technical covenants under your facility or other regulatory factors that can come into play. So we are happy to live in a lower leverage world, maybe taking up to 0.5, 0.6 would be an appropriate objective. But being in that 0.8 to 1.0 red zone is not something we feel very comfortable with.

Okay. I like the answer. Thank you.

At this time there are no further questions. I would like to turn the call back over to our moderators for any closing remarks.

Sure. Thank you very much, everyone. If there are more no more questions, I think we're done. Thank you.

Thank you, all.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.