Deep Discounts May Drive BDC Consolidation

(Reuters) – A wave of consolidation may sweep through U.S. small business lenders as the beleaguered industry seeks to take advantage of low valuations to combine with rivals or other large companies in a bid to survive.

Once a dominant player in the business development companies (BDC) industry, American Capital Ltd (ACAS.O), which recently restructured its debt, may be the next big target for acquisition in the space, analysts say.

Smaller companies like Kohlberg Capital Corp (KCAP.O), MCG Capital Corp (MCGC.O) and GSC Investment Corp (GNV.N), among others, could also be on the buying list for bigger players.

“I think to the extent business development companies remain undervalued, with a lot of them trading at 60 percent range of the net asset value, it presents an opportunity for a buyer to come in and buy the assets at a substantial discount and enjoy good returns,” Analyst Scot Valentin of FBR Capital Markets said.

Popularly known as BDCs, these business lenders make debt and equity investments in small- and middle-sized companies in return for equity stakes, and have been struggling to raise capital as the financial crisis reduced the value of their portfolio companies to which they make loans.

With the cost of capital remaining high, smaller business lenders think it makes more sense to partner with a larger company, as they can reap the advantage of economies of scale, analysts say.

“I think the catalysts for consolidation are attractive entry price, ability to solve a need whether it be capital or liquidity and the ability of deriving or providing scale,” said analyst John Stilmar of SunTrust Robinson Humphrey.

Recently, in the biggest deal till date in this segment, Ares Capital Corp (ARCC.O) agreed to buy its struggling rival Allied Capital Corp (ALD.N) in an all-stock deal valued at $648 million, providing relief to the debt-laden company.

Distressed private debt funds may also be interested in buying a BDC as they have raised significant amount of distressed debt recently, analyst Greg Mason of Stifel Nicolaus said.

GSC Investment is trading at a price/book value of 0.38, while MCG Capital is trading at 0.54 as of Tuesday, according to Thomson Reuters data.

A price to book ratio below 1 indicates that the market capitalization is less than the value of assets on the company’s books.


American Capital, with a price/book value at 0.37 as of Tuesday, is looking attractive following the troubled company’s agreement to restructure its $2.4 billion of unsecured debt with its lenders.

Analyst Ross Demmerle of Hilliard Lyons said American Capital looks appealing as it is selling at a discount to book value, and the company’s board would have to address any “significant offer” from a potential acquirer.

“If you’ve been selling at 50 percent of book value for months, you better be pretty certain you can increase the stock price without selling, if you turn it down,” he added.

Stifel’s Mason said while a lot of investors are speculating that American Capital will go the Allied way, he believes that this may not happen as the conditions affecting both the companies are different.

American Capital, which was removed from the Standard & Poor’s 500 index .SPX in February, had breached its covenants and was selling assets at distressed prices to raise cash. The company did not respond to queries seeking comment.


Heavyweight Apollo Investment Corp (AINV.O), which raised $157.5 million in a public offering in August, said it is eyeing acquisitions given the compelling options in the market.

Apollo has most likely reviewed all options, but it has not yet found one, meeting its business criteria, Stilmar said.

Earlier this month, New York-based Prospect Capital Corp (PSEC.O) also said it is evaluating a pipeline of potential additional portfolio and investment opportunities and hopes to seal a deal before the end of the year.

The company may even consider making a “hostile offer” to a potential candidate, its Chief Operating Officer Grier Eliasek said on a call with analysts.

In August, Prospect Capital, a closed-end investment company, agreed to buy its smaller rival Patriot Capital Funding Inc (PCAP.O) for $197 million.

(Reporting by Archana Shankar and Brenton Cordeiro; Editing by Gopakumar Warrier)