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Friday, June 18, 2010

Fifth Street Finance Raises New Equity

Fifth Street Finance Corp (FSC) announced just after the Tuesday close that it has commenced a public offering of 8,000,000 shares of its common stock. According to the company's press release:

Fifth Street plans to grant the underwriters for the offering an option to purchase up to an additional 1,200,000 shares of common stock to cover over-allotments, if any. All shares will be offered by Fifth Street. Wells Fargo Securities, Morgan Stanley, UBS Investment Bank and RBC Capital Markets will act as joint book-running managers for the offering.

Fifth Street intends to use substantially all of the net proceeds from the offering to make investments in small and mid-sized companies in accordance with its investment objectives and strategies described in the prospectus supplement and accompanying prospectus and for general corporate purposes, including working capital requirements. Fifth Street may also use a portion of the net proceeds from the offering to repay its outstanding borrowings under its three-year credit facility with Wells Fargo Bank, N.A.

We're not surprised that Fifth Street Finance is raising more capital. The watchword in the BDC industry is raise money while/when the going is good. FSC has been having a good run of late, booking myriad new deals, (see our post of May 24, 2010) increasing its Revolver limit and reducing the pricing paid to its lenders (see our post of May 27, 2010).

This is a major offering, with the total stock being sold equal to 20% of the existing shares outstanding. FSC should raise $110mn at today's closing price. That's more than enough to pay off any borrowings under the Wells Fargo line (all of which has occurred since month end). The stock price is at a decent premium to the latest NAV : 13%, which is good for existing shareholders. The most obvious downside might be a delay in further dividend increases (most recently the quarterly distribution was up to 32 cents), but that's not for sure. FSC has been willing in the past to get the distribution up ahead of its Distributable Earnings Per Share and Net Investment Income Per Share.

Certainly, the balance sheet of the company seems recession proof. When we recently about the pro-forma impact of a double dip recession (see post of June 1, 2010) and wrote that half of the BDCs we track had virtually no debt, FSC was already on that blue chip list. This additional fillip of equity will only enhance a balance sheet which has only begun to grow. Total equity should be around $600mn after this equity offering closes, and with debt at less than zero, Fifth Street is sitting pretty from that standpoint.

The BDC Reporter, true to our name, seeks to avoid opining on whether or not a stock is a good value or a Buy or Sell. We leave that to the investment banks. However, we can say that the company's $1.28 annual dividend represents a 10.6% yield on today's closing price, and that the stock is trading just 11% below its 52 week high (using Yahoo Finance), which is also its all-time high. The analysts consensus for next fiscal year's earnings are $1.33 a share, which means FSC is trading a multiple of 9.1x.

Disclousre I am long FSC shares.

Wednesday, June 16, 2010

Why Wal-Mart Is Still a Growth Company

Wal-Mart Stores Inc. (WMT) has perhaps the largest “army” in the world when it comes down to people in uniform. With 2.1 million employees, 700,000 of which are employed internationally, Wal-Mart no doubt represents a centerpiece of the global economy. However, this giant is still growing and to no surprise, quite successfully.

The discount retail business only allotted Wal-Mart a 3.5% profit margin for the fiscal year ended Jan 31, 2010; however, the company returned 21% to shareowners’ equity. This indicates that Wal-Mart effectively leverages its cost-efficient structure and distribution capability to achieve very high asset and inventory turnovers. In fact, management even measures its performance by Wal-Mart’s cost structure, as the most recent Form 10-K states,

We believe growing operating income at a faster rate than net sales growth is a meaningful measure because it indicates how effectively we manage costs and leverage operating expenses. Our objective is to grow operating expenses at a slower rate than net sales.

From 2001 to 2010, net sales increased an average of approximately 11% annually while operating income grew an average of 15% annually. From this metric alone, it seems that Wal-Mart’s management is meeting its operational goals.

Moreover, the Wal-Mart growth story has yet begun. Currently, Wal-Mart is harnessing growth by expanding its geographic reach through its Asda discount chain subsidiary in the United Kingdom. In addition, Wal-Mart continues to move into grocery retail. The company derives 51% of all net sales from grocery already, while continuing to convert more discount stores to supercenters in order to widen its grocery reach. Wal-Mart’s Neighborhood Market, which began in 1998, also already has 158 stores and only a few closures in the twelve year period.

Wal-Mart is one of the world’s most powerful and largest retailers. However, there is more room to grow as they only operate 434 stores in Brazil and 279 in China. Perhaps India, where Wal-Mart operates just one store, will be the next focus for even more expansive growth.

Disclosure I am long WMT shares.

BP WATCH: BP's US Shares Close Higher On Dividend Cut, $20B Fund

BP PLC's (BP, BP.LN) American depositary shares rose Wednesday after the oil giant said it won't issue further dividends this year and confirmed an agreement to set aside $20 billion to help pay for claims as a result of the Gulf oil disaster.

BP's U.S. shares closed with a gain of 45 cents, or 1.4%, to 31.85. News of the dividend cut and the escrow fund helped bring some clarity to investors who had wondered whether the company would continue paying the dividend and what BP's liabilities might be. The market is seeing the moves as positive indications that BP is working with the Obama administration in a cooperative manner that could help it in the long run, both financially and from a sentiment standpoint.

The dividend cut represents "a gesture of goodwill and a [public relations] positive," said Nick Kalivas, strategist and vice president of financial research at MF Global. "The fact that they cut the dividend, that shores up the idea that they'll be able to service their debt."

Kalivas added, "the fact that they've put $20 billion into escrow, it's kind of helping the market get its hands around what the company and the government seem to think the liability's going to be. It's removing a little bit of the uncertainty that's been hanging over the stock."

Investors "see this as an end to the financial bleeding," with the $20 billion helping investors get a better idea of what BP's total liabilities might be, said Jason Weisberg, senior vice president at Seaport Securities. In addition, he said, "the way Wall Street perceives this is that it's pretty tough to penalize a company when they're going above and beyond what they're legally bound to do."

After the cost of protecting BP's debt soared to its highest level ever, it pared on the news of the dividend cut and escrow fund. BP's bonds also bounced on the news Wednesday afternoon, helped not only by BP's announcements of the dividend cut and escrow fund, but also by a statement on CNBC from Bill Gross, co-investment chief for Pacific Investment Management Co., that his bond-fund firm has recently begun buying one-year bonds issued by BP.

However, options traders said BP's decision to cancel the previously-announced dividend hurts investors who traded May options assuming the dividend would be paid and have already re-invested the 84 cents a share they assumed would arrive.

"When a CEO cancels a dividend after shareholders have approved it and the stock has traded 'ex-dividend' for a month, option investors can only throw their hands up in disbelief," said Justin Golden, strategist at Macro Risk Advisors. "Dividends are an important input to the formula used for pricing options and it is difficult enough to price them accurately when dividend streams are uncertain. Canceling an approved dividend throws traders' profits and losses off because it violates the pricing formula."

Wednesday's announcement from BP came after a meeting with President Barack Obama, who said the $20 billion is not a cap, and that BP will pay the full costs of the cleanup, including environmental damage. Still, he added, "BP is a strong and viable company and it is in all of our interests that it remain so."

Many investors, however, are still wary.

"I think BP is attractively priced, but it's a different type of investment than a blue chip," says Keith Amburgey, a financial planner in Cresskill, N.J., who began selling BP stock in early May, about two weeks after the rig explosion. "It's not something I would recommend for my typical client."

A number of bond investors are voicing similar concern.

"It's an unanalyzable situation," said W. Frank Koster, chief investment officer at Dwight Asset Management, which focuses on fixed-income investments. Koster said he felt fortunate that the firm exited its bond positions in BP and other companies connected with the Deepwater Horizon rig "at the front end of the spill."

Still, Wednesday's news isn't changing the BP holdings of the Florida State Board of Administration, which still has holdings in BP bonds and equities that amounted to about $103 million in BP bonds and equities on June 11. "We're pension managers," said Dennis MacKee, its spokesman. "We're looking at this from the risk and investment return stand point."

Disclosure I am long BP shares.