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Fifth
Street Finance - Profile:
Fifth Street Finance Corp. is a specialty
finance company that lends to and invests in small and mid-sized companies
in connection with an investment by private equity sponsors. Fifth Street
Finance Corp's investment objective is to maximize its portfolio's total
return by generating current income from its debt investments and capital
appreciation from its equity investments.
BIO:
Greg Mason
President and Senior Equity
Analyst
Specialty Finance Sector
Stifel, Nicolaus & Company, Inc.
Mr. Mason is a
Vice President and Senior Equity Analyst at Stifel Nicolaus with a focus on
the specialty finance sector. Prior to joining Stifel Nicolaus in 2007, Mr.
Mason was an equity analyst for six years with A.G. Edwards and has followed
a number of financial sectors including life insurance, P&C insurance, asset
management, mortgage REITs and credit cards. He received a Masters in
Business Administration from St. Louis University in May 2007. In 2001, Mr.
Mason graduated from Southwest Baptist University with a B.A. in Business
Administration with concentrations in finance, economics, management &
marketing. Mr. Mason holds the Chartered Financial Analyst (CFA) designation
and is a member of the St. Louis Society of Financial Analysts. |
Financial
Specialty Finance
Stifel, Nicolaus & Company, Inc.
One South Street
Baltimore, MD 21202
Click here for
CEO interview:
Fifth Street Finance Corp.
(FSC-NYSE)
445 Hamilton Avenue, Suite 1206
White Plains, NY 10601
Phone: 914-286-6800 |
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Interview conducted by: Lynn
Fosse, Senior Editor, CEOCFOinterviews.com, Published – January 16, 2009
CEOCFO:
Mr. Mason, please tell us about the universe that you cover.
Mr. Mason: “I cover Business Development
Companies and these companies were created to provide investments to small
businesses. The government wanting to encourage investment into small
businesses, created the BDC structure, so that as long as made investments
to U.S. small businesses and they paid out all of their earnings as a
dividend, they would not have to pay federal income taxes. Therefore, it was
a way to develop a structure that would encourage both debt and equity
investments to private companies.”
CEOCFO: How does Fifth Street Finance
fit in with the group that you cover?
Mr. Mason: “We try to cover the entire
BDC industry. Fifth Street Finance went public back in June of 2008 as a
Business Development Company and we wanted to include it in the 18 Business
Development Companies that we follow.”
CEOCFO: Why does Fifth Street Finance
stand out from the crowd?
Mr. Mason: “We remain very concerned
about debt and equity investments that were made during the peak of the
credit cycle, which we define as mid-2006, through mid-2007. During that
time, we saw the debt and equity values not account for the risk that were
inherent in those investments. We saw debt investments charge very low
interest rates, have weak covenants, and have excessive leverage well above
historical norms. One of the things that is unique to Fifth Street Finance
is because of the timing of their IPO, June 2008, as well as the time that
they raised capital prior to their IPO, which was in mid-2007, most of the
investments in their portfolio have been made after the credit markets began
to crack in July of 2007. Because of the timing of its capital raises Fifth
Street Finance has the ability to put its capital to work, making
investments in businesses, after the credit cycle had cracked. Therefore, we
think that provides an attractive opportunity for investors to invest in a
portfolio of debt investments that is substantially built after the credit
bubble had popped.”
CEOCFO: What do you like about the
management team at Fifth Street?
Mr. Mason: “What we like is that in our
view, the president and CEO, Leonard M. Tannenbaum, has really focused on
surrounding himself with very good and very smart people. While we recognize
that the leadership and vision of the company comes from the top,
particularly with a company that is making numerous investments into many
small businesses, it takes a team to be able to effectively underwrite those
investments. Mr. Tannenbaum recognizes that a CEO isn’t underwrite and
monitor all of these companies by himself, so he has built what we believe
is a very strong team around him. Mr. Tannenbaum himself is a very smart
individual and has a good track record, but he isn’t afraid to hire smart
people and build a solid team.”
CEOCFO: How are they weathering the
current situation and why do you think they are in a good position in
today’s economy?
Mr. Mason: “I think that with the
businesses that they have invested in, there is no doubt that they are
feeling the effects of the economic slowdown, like many other businesses. As
we analyze in our last research report, we estimate that the EBITDA
(Earnings Before Interest Taxes And Depreciation) for their companies since
the investments were made, have declined about 15%. Therefore, the earnings
of their businesses are being impacted by the slowing economy. Having said
that, I think what Fifth Street Finance has been able to do is because their
investments have been made after the peak credit bubble, they have been able
to put in strong covenants, tight covenants for all of their debt
investments. They have been able to go into these investments with eyes wide
open, knowing that we are heading into a recession and that EBITDA values
are likely to decline. Therefore, even though we are seeing credit
deterioration in the portfolio, at this point, for most of the investments
it has not caught management by surprise and was not unexpected at the time
the investments were made.”
CEOCFO: What is their financial picture
like today?
Mr. Mason: “We actually view their
financial picture pretty favorably. Fifth Street has no debt right now.
BDC’s by law can be levered 1-to-1 debt:equity, meaning a BDC first raises
equity capital from shareholders, then for every dollar of equity capital,
they can actually go to a bank and borrow another dollar. Fifth Street
Finance has raised about $300 million in equity investments and by law, they
could go out to a bank and borrow another $300 million to make investments.
In fact, that’s what most of the BDCs have done. However, Fifth Street
Financial has not used any of that leverage potential. They have $50 million
that they could potentially borrow from Bank of Montreal, but they have not
borrowed from that credit facility yet. When we asked on the conference call
if they were going to seek additional credit facilities, so that they could
borrow up to another $300 million in debt, they said no, because right now
the market does not want exposure to companies that have employed a
significant amount of leverage.
We think operating with limited leverage helps out for a few reasons. Number
one is that they don’t have the concern of having to deal with a lender that
has provided them money to make a long term investment, who could decide
that they want their money back. In that case, what do you do with the
long-term investment that you need to liquidate today? In this environment
that leads to trouble. Second, it also provides them additional capital in
the future, if they so choose, because they can borrow $50 million from Bank
of Montreal and make new investments in a pretty attractive market today.
Finally, Fifth Street has the flexibility, if they deem that the time is
right to do so, to go out and get additional credit facilities, which would
provide them with even more capital to make new investments. Many of the
other BDCs we cover have a limited amount of excess capital that they can
use to make new investments.”
CEOCFO: What is your current rating for
Fifth Street and your target?
Mr. Mason: “We have a ‘buy’ rating, with
a $9.00 price target.”
CEOCFO: What else should potential
investors be aware of when they are looking at Fifth Street Finance?
Mr. Mason: “Investors have to get
comfortable with the business model, because you are investing in a
management team that has invested money in a pool of loans to small
businesses. To be honest, in the current environment, you tell investors
that you have an opportunity to own debt and equity investments in small
businesses, people shy away from that today. Therefore, that is one of the
reasons why Fifth Street and the entire BDC sector is trading at such a
significant discount to book values. Investors are concerned that as the
economy continues to slow down that there could be additional problems in
these portfolios, with small businesses that cannot make their interest
payments to lenders like Fifth Street. In our minds this is the biggest risk
associated with Fifth Street Financial and the BDC sector overall.”
CEOCFO: With that said, you do have your
‘buy’ rating for Fifth Street Finance; final thoughts, why should people be
looking to invest?
Mr. Mason: “We believe, if investors can
find good companies in industries where people are afraid to invest, they
can typically generate very strong returns. We like Fifth Street Finance
because it has no leverage on its balance sheet; it invested nearly all of
its equity capital after the credit market cracked and doesn’t have any
legacy debt investments from the bubble. In addition, you have a dividend
policy that is being developed as the portfolio grows that is rational and
sustainable. We think adding all of those together while being a contrarian
investor and investing in this sector when it has been beaten down provides
a good opportunity.”
Disclosures:
Stifel, Nicolaus & Company, Inc. or an affiliate managed or co-managed a
public offering of securities for Fifth Street Finance Corp in the past 12
months. Stifel, Nicolaus & Company, Inc or an affiliate has received
compensation for investment banking services from Fifth Street Finance Corp
in the past 12 months. Stifel, Nicolaus & Company, Inc. expects to receive
or intends to seek compensation for investment banking services from Fifth
Street Finance Corp in the next 3 months. Fifth Street Finance Corp is
provided with investment banking services by Stifel, Nicolaus & Company,
Inc. or was provided with investment banking services by Stifel Nicolaus or
an affiliate within the past 12 months. Fifth Street Finance Corp is a
client of Stifel, Nicolaus & Company, Inc. or an affiliate or was a client
of Stifel Nicolaus or an affiliate within the past 12 months.
disclaimers
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