Description

Gladstone Investment (GAIN) is one of several BDC’s brought low by the combination of market turmoil, uncertainty, in general, about venture debt investments, and recent rights offerings. It also suffered an unexpected stumble in the senior syndicated loan market. But at 6.40/share, it is trading at a remarkable discount (43%) to NAV and providing monthly distributions to shareholders at a rate of 15% on the current share price.

First, the book value: on March 31^st, the end of GAIN’s fiscal year, NAV was 12.47/share. A subsequent rights offering in April added 5.52 million shares at 7.48/share (40.6 million net), for a new share count of 22.08 million and an adjusted NAV of 11.19/share. Making no assumptions about changes in security values since 3/31, market price is at a 43% discount, wide by any measure.

As to the current .08/share monthly distributions, some is return of capital. In FY ’08, out of a slightly smaller total annual distribution, .79/share came from net investment income and .15/share was return of capital. The final quarter reported 21 cents in net investment income, so investment income is rising as new sub loan and mezz debt investments are funded by sales of lower paying senior syndicated loans. Of course, at the current discount, return of capital is arguably desirable (if they’d only distribute all the capital!)

The portfolio of 42 (at 3/31) senior secured syndicated loans proved an embarrassment to Gladstone. After GAIN’s 2005 IPO, proceeds were “parked” in these securities so that investment income could be earned while control/affiliate investments were sought. This supposedly safe and marketable asset class encountered unexpected turbulence, and by March 31^st the portfolio, $154 million at cost, was underwater by $23 million, a substantial nick against the value of the 16.5 million shares then outstanding. A few issues have been sold since, creating realized losses, but it would be reasonable to assume that the overall portfolio has strengthened a bit, as the end of March marked one of the low points (so far) in syndicated loan values. These loans must be up ~ 4-5% since then.

Gladstone hasn’t helped the share price with the current proxy seeking shareholder approval for, among other things, issuing new stock below NAV. If approved, this would be another way, besides rights offerings, of raising new capital. This one may not pass. It requires 50%+ affirmative votes of both outstanding shares and votes cast. Abstentions and broker non-votes count as votes against. Since GAIN does not seem to face liquidity issues (it applied the $40 million recently raised to borrowings under its credit line), a “no” vote on this proposal may help the stock. In any case, the company would be foolish to issue shares in this environment, and David Gladstone said as much on a conference call to discuss the proxy resolutions. But he wants all his options open for the future and is feeling stung by the extended volatility and share price impact arising from the rights offering.

The recent pay down of outstandings under a $200 million credit line leaves about $100 million in debt. The remaining portfolio of syndicated loans is worth $120+ million and is relatively liquid. Total assets at 3/31 were $336 million. Leverage is still modest with a coverage ration of 243% before the rights offering and better than 300% after. BDC’s are required to maintain at least 200%.

David Gladstone, himself, is a very important factor here, of course. There are other BDC’s selling at big discounts. Round291 called him an “investment legend” in a late 2005 write-up, and although he has had some PR bumps since leaving Allied Capital, he has a reputation for ability and success, to say nothing of experience. He went slow on making new control investments for GAIN, thinking EBITDA multiples were too high for the buyout & recap financings of middle market companies GAIN is aiming at. He has much better opportunities now. Probably he wants to remove any reputational dents arising from GAIN’s early disappointments. He owns 175,000 shares and ought to be buying more.

The history of BDC’s, in general, is not particularly inspiring, but GAIN may have the right combination of investment talent and discount to make it an attractive holding over the next couple of years. Being paid to wait certainly helps.

Catalyst