NEW MOUNTAIN FINANCE CORP NMFC
November 21, 2013 - 11:52pm EST by
creditguy
2013 2014
Price: 14.65 EPS $1.54 $1.37
Shares Out. (in M): 45 P/E 9.5x 10.7x
Market Cap (in $M): 657 P/FCF NM NM
Net Debt (in $M): 356 EBIT 0 0
TEV ($): 1,010 TEV/EBIT NM NM

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  • Asset Management

Description

Company/Investment Manager Description

 

NMFC’s portfolio is externally managed by New Mountain Finance Advisers BDC, L.L.C., which is an affiliate of New Mountain Capital, L.L.C., a leading private equity firm with more than $9 billion of assets under management and a consistent focus on “defensive growth” business building and deep fundamental research.

 

NMFC’s mandate is to primarily target businesses in the middle market that, consistent with New Mountain’s private equity platform, are quality, defensive growth companies, in industries that are well-researched by New Mountain

 

NMFC”is a closed-end, non-diversified management investment company that has elected to be treated as a BDC under the 1940 Act.  BDCs must pay out 90% of income as dividends.

 

On May 19, 2011, NMFC priced its IPO of 7,272,727 shares of common stock at a public offering price of $13.75 per share.

 

Investment Focus

 

NMFC’s investment objective is to generate current income and capital appreciation through the sourcing and origination of debt securities at all levels of the capital structure, including first and second lien debt, notes, bonds and mezzanine securities. In some cases, the Company's investments may also include equity interests such as preferred stock, common stock, warrants or options received in connection with the Operating Company's debt investments or may include a direct investment in the equity of private companies.

 

The Company makes investments through both primary originations and open-market secondary purchases. The Company primarily targets loans to, and invests in, United States middle market businesses, a market segment they believe continues to be underserved by other lenders. They define middle market businesses as those businesses with annual earnings before interest, taxes, depreciation, and amortization ("EBITDA") between $20.0 million and $200.0 million. The primary focus is in the debt of defensive growth companies, which are defined as generally exhibiting the following characteristics: (i) sustainable secular growth drivers, (ii) high barriers to competitive entry, (iii) high free cash flow after capital expenditure and working capital needs, (iv) high returns on assets and (v) niche market dominance. The Company's targeted investments typically have maturities of between five and ten years and generally range in size between $10.0 million and $50.0 million.

 

Strategy/Execution

 

Mandate achieved by utilizing existing New Mountain investment team as primary underwriting resource; team combines operating executives with financial executives

 

The Company targets loan to value ratios typically average less than 50% of both sponsor purchase price and NMC valuation.

 

Portfolio Composition/Yield

 

As of September 30, 2013, the Operating Company’s net asset value was approximately $641.8 million and its portfolio had a fair value of approximately $1,041.4 million in 57 portfolio companies, with a weighted average Yield to Maturity of approximately 10.4%. For the three months ended September 30, 2013, the Operating Company made approximately $87.1 million of originations and commitments.

 

On November 12, 2013 NMFC announced its financial results for the quarter ended September 30, 2013 and reported third quarter Pro-Forma Adjusted Net Investment Income of New Mountain Finance Holdings, L.L.C. of $0.35 per weighted average share. At September 30, 2013, net asset value per share was $14.32, unchanged from June 30, 2013.  The Company also announced that its board of directors declared a fourth quarter 2013 dividend of $0.34 per share, which will be payable on December 31, 2013 to holders of record as of December 17, 2013.

 

Selected Financial Highlights

 

                                                                                           September 30, 2013                    

Investment Portfolio                                                         1,041,432                  

Total Assets                                                                      1,077,294                  

Total Debt                                                                                           374,091                     

NAV                                                                                 641,805                     

 

NAV per Share/Unit                                                          14.32                        

Debt/Equity                                                                           0.58x                      

Pro-Forma Debt/Equity                                                        0.71x                      

 

Investment Portfolio Composition                                    September 30, 2013    Percent of Total

First Lien                                                                           533,259                      51.2%

Second Lien                                                                      431,113                      41.4%

Subordinated                                                                     46,865                        4.5%

Preferred Equity                                                               23,128                        2.2%

Common Equity and Other                                               7,067                          0.7%

Total                                                                                  1,041,432                   100.0%

 

September 30, 2013

 

Industry Type

 

Software 20.76 %

Business Services 17.40%

Education 16.61%

Federal Services 10.12 %

Distribution & Logistics 7.53 %

Healthcare Services 7.07 %

Media

 

Investment Recommendation

 

I am recommending NMFC as an attractive income investment – a stock that has an attractive 9.3% dividend yield, a dividend that’s fully covered, and a stock that trades a slight discount to the group (P/B and earnings yield) despite a significantly higher quality and less risky investment portfolio vs. their peers.  I consider the yield very attractive on an absolute risk adjusted basis.  The stock is also very attractive vs owning the Barclays high yield bond index (ticker JNK) at 6.2%.  I would much rather own NMFC at a higher yield, significantly lower risk, and higher quality portfolio than the JNK spider.  NMFC has sectors that they tend to focus on which help to drive their superior credit selection and low historical loss rate.  They have also managed their balance sheet well in terms of adding leverage to maximize net investment income and been relatively conservative in raising new equity.   Most BDCs are serial equity issuers to grow their investment portfolios and maximize incentive fees but NMFC has historically been a much less frequent issuer than their peers and better utilized balance sheet leverage to grow the investment portfolio.  I would view any future share price offering as an opportunity to buy on the “dip.”

 

Why am I recommending NMFC?

 

Defensive/High Quality Portfolio

 

Why do I deem it do be defensive?  I look at several measures to assess a portfolio’s risk:  % of senior vs. sub debt, weighted average coupon, and industry exposure.  On all three measures NMFC scores highly – their investment portfolio is equally weighted between senior and sub debt (rather than owning a preponderance of sub/mezz debt as some BDCS do like PNNT), an average weighted portfolio coupon yield  of 9% is the second lowest average coupon in the Group -- which indicates a lower risk, higher quality portfolio, all else equal, and because the industry exposures the Company is weighted towards (see table above) non-cyclical industries. 

 

The strength of the Operating Company’s unique investment strategy – which focuses on acyclical “defensive growth” companies – is underscored by continued strong credit performance. The Company has had only one portfolio company, representing approximately $5.9 million of the cost of all investments made since inception in October 2008, or less than 0.3%, go on non-accrual.

 

Portfolio Transparency/Composition

 

One thing I like about BDCs is their portfolios are very transparent.  The 10Q/10K provide a position by position listing of the underlying investments.  Many of New Mountains investments trade or are “quoted” on leveraged loan desks providing price and information transparency to me as an investor.  As a high yield/distressed/special situations investor I have first or second hand knowledge of many of the Company’s investments and it is my opinion the portfolio is a high quality one based on a position by position review (at least tops of the waves) of the portfolio.  I assess the credit risk of the profile as low and consistent with the high quality portfolio of an Ares or Golub and much lower risk than issuers who tend to invest to a greater degree in subordinated debt like Pennant Park, Solar or in unsponsored deals like Medley.

 

 

Attractive Valuation/My Price Target

 

At $14.65 the stock is only trading at ~3% premium to book – the BDC group is trading at a P/B multiple of >1.05x.  On a dividend yield basis the stock is trading at a 9.3% dividend yield which is approximately in line with the peer group.  However, given the significantly more defensive portfolio profile of NMFC’s book and their better historical credit quality (as measured by investments that have gone on non-accrual) I believe the Company should trade at a premium multiple (lower dividend yield) than their peers.

 

My price target is $15.25 which is a blended average of my price targets that are based on an 8.75% dividend yield ($15.50 stock) and 1.05x price/book ratio ($15.04 stock).  So I’m forecasting ~4% price appreciation on top of an attractive 9.3% dividend yield for what I deem to be a high quality/low risk portfolio.   I think my price targets may prove to be very conservative.   Further, I believe the Company’s stock price in a weak market should hold up significantly better than the peer group given my expectations of significantly better than average underlying credit performance of the corporate credit of the investment portfolio.

 

Value Opportunity

 

I frequently observe pricing anomalies in the BDC market in terms of observed yields/multiples.  BDCs are typically owned by equity income funds.  The buy and sell side analysts covering the names have minimal to zero credit/leveraged finance experience and prices are derived from an narrow focus on trailing dividend yield.  Little consideration is given to credit quality – at least in the short term – until defaults occur and/or dividends are cut.  Of course over time the market tends to reward higher quality managers with higher multiples to reflect their superior credit selection abilities.  The value opportunity here is that New Mountain is still relatively unknown and the market has not fully priced it the significant outperformance of its manager – over time as the Company proves out its distinguished track record I believe the stock will re-rate higher to my target price (if not significantly higher).

I do not hold a position of employment, directorship, or consultancy with the issuer.
Neither I nor others I advise hold a material investment in the issuer's securities.

Catalyst

 
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    Description

    Company/Investment Manager Description

     

    NMFC’s portfolio is externally managed by New Mountain Finance Advisers BDC, L.L.C., which is an affiliate of New Mountain Capital, L.L.C., a leading private equity firm with more than $9 billion of assets under management and a consistent focus on “defensive growth” business building and deep fundamental research.

     

    NMFC’s mandate is to primarily target businesses in the middle market that, consistent with New Mountain’s private equity platform, are quality, defensive growth companies, in industries that are well-researched by New Mountain

     

    NMFC”is a closed-end, non-diversified management investment company that has elected to be treated as a BDC under the 1940 Act.  BDCs must pay out 90% of income as dividends.

     

    On May 19, 2011, NMFC priced its IPO of 7,272,727 shares of common stock at a public offering price of $13.75 per share.

     

    Investment Focus

     

    NMFC’s investment objective is to generate current income and capital appreciation through the sourcing and origination of debt securities at all levels of the capital structure, including first and second lien debt, notes, bonds and mezzanine securities. In some cases, the Company's investments may also include equity interests such as preferred stock, common stock, warrants or options received in connection with the Operating Company's debt investments or may include a direct investment in the equity of private companies.

     

    The Company makes investments through both primary originations and open-market secondary purchases. The Company primarily targets loans to, and invests in, United States middle market businesses, a market segment they believe continues to be underserved by other lenders. They define middle market businesses as those businesses with annual earnings before interest, taxes, depreciation, and amortization ("EBITDA") between $20.0 million and $200.0 million. The primary focus is in the debt of defensive growth companies, which are defined as generally exhibiting the following characteristics: (i) sustainable secular growth drivers, (ii) high barriers to competitive entry, (iii) high free cash flow after capital expenditure and working capital needs, (iv) high returns on assets and (v) niche market dominance. The Company's targeted investments typically have maturities of between five and ten years and generally range in size between $10.0 million and $50.0 million.

     

    Strategy/Execution

     

    Mandate achieved by utilizing existing New Mountain investment team as primary underwriting resource; team combines operating executives with financial executives

     

    The Company targets loan to value ratios typically average less than 50% of both sponsor purchase price and NMC valuation.

     

    Portfolio Composition/Yield

     

    As of September 30, 2013, the Operating Company’s net asset value was approximately $641.8 million and its portfolio had a fair value of approximately $1,041.4 million in 57 portfolio companies, with a weighted average Yield to Maturity of approximately 10.4%. For the three months ended September 30, 2013, the Operating Company made approximately $87.1 million of originations and commitments.

     

    On November 12, 2013 NMFC announced its financial results for the quarter ended September 30, 2013 and reported third quarter Pro-Forma Adjusted Net Investment Income of New Mountain Finance Holdings, L.L.C. of $0.35 per weighted average share. At September 30, 2013, net asset value per share was $14.32, unchanged from June 30, 2013.  The Company also announced that its board of directors declared a fourth quarter 2013 dividend of $0.34 per share, which will be payable on December 31, 2013 to holders of record as of December 17, 2013.

     

    Selected Financial Highlights

     

                                                                                               September 30, 2013                    

    Investment Portfolio                                                         1,041,432                  

    Total Assets                                                                      1,077,294                  

    Total Debt                                                                                           374,091                     

    NAV                                                                                 641,805                     

     

    NAV per Share/Unit                                                          14.32                        

    Debt/Equity                                                                           0.58x                      

    Pro-Forma Debt/Equity                                                        0.71x                      

     

    Investment Portfolio Composition                                    September 30, 2013    Percent of Total

    First Lien                                                                           533,259                      51.2%

    Second Lien                                                                      431,113                      41.4%

    Subordinated                                                                     46,865                        4.5%

    Preferred Equity                                                               23,128                        2.2%

    Common Equity and Other                                               7,067                          0.7%

    Total                                                                                  1,041,432                   100.0%

     

    September 30, 2013

     

    Industry Type

     

    Software 20.76 %

    Business Services 17.40%

    Education 16.61%

    Federal Services 10.12 %

    Distribution & Logistics 7.53 %

    Healthcare Services 7.07 %

    Media

     

    Investment Recommendation

     

    I am recommending NMFC as an attractive income investment – a stock that has an attractive 9.3% dividend yield, a dividend that’s fully covered, and a stock that trades a slight discount to the group (P/B and earnings yield) despite a significantly higher quality and less risky investment portfolio vs. their peers.  I consider the yield very attractive on an absolute risk adjusted basis.  The stock is also very attractive vs owning the Barclays high yield bond index (ticker JNK) at 6.2%.  I would much rather own NMFC at a higher yield, significantly lower risk, and higher quality portfolio than the JNK spider.  NMFC has sectors that they tend to focus on which help to drive their superior credit selection and low historical loss rate.  They have also managed their balance sheet well in terms of adding leverage to maximize net investment income and been relatively conservative in raising new equity.   Most BDCs are serial equity issuers to grow their investment portfolios and maximize incentive fees but NMFC has historically been a much less frequent issuer than their peers and better utilized balance sheet leverage to grow the investment portfolio.  I would view any future share price offering as an opportunity to buy on the “dip.”

     

    Why am I recommending NMFC?

     

    Defensive/High Quality Portfolio

     

    Why do I deem it do be defensive?  I look at several measures to assess a portfolio’s risk:  % of senior vs. sub debt, weighted average coupon, and industry exposure.  On all three measures NMFC scores highly – their investment portfolio is equally weighted between senior and sub debt (rather than owning a preponderance of sub/mezz debt as some BDCS do like PNNT), an average weighted portfolio coupon yield  of 9% is the second lowest average coupon in the Group -- which indicates a lower risk, higher quality portfolio, all else equal, and because the industry exposures the Company is weighted towards (see table above) non-cyclical industries. 

     

    The strength of the Operating Company’s unique investment strategy – which focuses on acyclical “defensive growth” companies – is underscored by continued strong credit performance. The Company has had only one portfolio company, representing approximately $5.9 million of the cost of all investments made since inception in October 2008, or less than 0.3%, go on non-accrual.

     

    Portfolio Transparency/Composition

     

    One thing I like about BDCs is their portfolios are very transparent.  The 10Q/10K provide a position by position listing of the underlying investments.  Many of New Mountains investments trade or are “quoted” on leveraged loan desks providing price and information transparency to me as an investor.  As a high yield/distressed/special situations investor I have first or second hand knowledge of many of the Company’s investments and it is my opinion the portfolio is a high quality one based on a position by position review (at least tops of the waves) of the portfolio.  I assess the credit risk of the profile as low and consistent with the high quality portfolio of an Ares or Golub and much lower risk than issuers who tend to invest to a greater degree in subordinated debt like Pennant Park, Solar or in unsponsored deals like Medley.

     

     

    Attractive Valuation/My Price Target

     

    At $14.65 the stock is only trading at ~3% premium to book – the BDC group is trading at a P/B multiple of >1.05x.  On a dividend yield basis the stock is trading at a 9.3% dividend yield which is approximately in line with the peer group.  However, given the significantly more defensive portfolio profile of NMFC’s book and their better historical credit quality (as measured by investments that have gone on non-accrual) I believe the Company should trade at a premium multiple (lower dividend yield) than their peers.

     

    My price target is $15.25 which is a blended average of my price targets that are based on an 8.75% dividend yield ($15.50 stock) and 1.05x price/book ratio ($15.04 stock).  So I’m forecasting ~4% price appreciation on top of an attractive 9.3% dividend yield for what I deem to be a high quality/low risk portfolio.   I think my price targets may prove to be very conservative.   Further, I believe the Company’s stock price in a weak market should hold up significantly better than the peer group given my expectations of significantly better than average underlying credit performance of the corporate credit of the investment portfolio.

     

    Value Opportunity

     

    I frequently observe pricing anomalies in the BDC market in terms of observed yields/multiples.  BDCs are typically owned by equity income funds.  The buy and sell side analysts covering the names have minimal to zero credit/leveraged finance experience and prices are derived from an narrow focus on trailing dividend yield.  Little consideration is given to credit quality – at least in the short term – until defaults occur and/or dividends are cut.  Of course over time the market tends to reward higher quality managers with higher multiples to reflect their superior credit selection abilities.  The value opportunity here is that New Mountain is still relatively unknown and the market has not fully priced it the significant outperformance of its manager – over time as the Company proves out its distinguished track record I believe the stock will re-rate higher to my target price (if not significantly higher).

    I do not hold a position of employment, directorship, or consultancy with the issuer.
    Neither I nor others I advise hold a material investment in the issuer's securities.

    Catalyst

     
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