PSEC - 4 Reasons To Dump TriplePoint Venture For Prospect Capital

2023-12-14 18:00:00 ET

Summary

• Business development companies have been a popular asset class as the Fed has raised interest rates.
• We compare two popular high-yielding BDCs today.
• We give you four good reasons to make a switch between Prospect Capital Corporation and TriplePoint Venture Growth.

Investing decisions are hard. Balancing personal needs with what is available in the buffet of investing choices is a complex task. Emotions need to be kept in check, and what billionaires say needs to be tuned out. Switching between two companies in the same sector, though, can be a relatively easier choice. Especially when there is such a glaringly obvious setup as the one we are about to present today. The setup is for Prospect Capital Corporation ( PSEC ) & TriplePoint Venture Growth ( TPVG ).

Why These Two?

We did not pick random companies out of a hat. These are two business development companies, or BDCs, that in our opinion are among the lower tier of BDCs, based on their long-term records. Generally, these tend to trade in line, and historically there has been little to choose between them. But there has been a notable divergence recently between fundamentals and prices, and hence we are writing this to tell you why PSEC deserves a Buy and TPVG deserves a Goodbye.

1) Size

In the BDC space, size definitely does matter. Whether it comes to financing their own debt or finding the best deals, the smaller companies just don't carry the same heft. PSEC, whether looked at from an Enterprise Value or Market Cap, dwarfs TPVG.

Total assets on the balance sheet show a similar picture, with PSEC sporting close to 8X the assets that we find with TPVG . Now, this is not a big game changer by itself, but it is a small piece of the puzzle, and we will go on to show that PSEC wins in every category.

2) Leverage

All BDCs use leverage, and the bulk of them tend to stay well within their mandated guidelines. That is no different between these two, either. But there is still a difference, and it goes in favor of PSEC. Total assets are near $7.86 billion for PSEC.

Total liabilities are just $2.6 billion, or about one-third of total assets. PSEC, unlike most other BDCs, uses preferred shares to boost leverage.

But this preferred stock never needs to be refinanced, and this substantially reduces the risk that leverage brings. Now, even if you count this as pure leverage, total debt plus preferreds would be about $4.1 billion, or 52% of total assets.

This same number works out to about 62.5% for TPVG.

When you take into account how PSEC's leverage is set up, there is no question that PSEC is in a better position here.

3) Realized Losses

It has been hard to lose money in the BDC loan business over the last 5 years, as the ZIRP bubble bailed out many poor prospects. But there have been losses, and TPVG has had a lot of them. This has been the backbone of the short-seller theses that have come out over the last year. In fact, you can get that straight from TPVG's change in tangible book value per share.

You can see the converse in PSEC's non-accrual ratios as well.

So, no question who has done better out of these two. Even today, we give PSEC the edge in asset quality. So PSEC wins and continues to win.

4) Pricing

With all of this in place, you would expect PSEC to get some premium pricing over TPVG. That would make sense. But unfortunately, markets don't always make sense. The best measure for a rough screening for BDCs is always price to tangible book value, and these numbers below make zero sense when comparing these two stocks.

TPVG still trades at a small premium and PSEC at a massive discount. Shown above is the spread between their price to tangible book values over the last 10 years. One thing to note here is that this is really the upper end of the range, and we have had four separate periods where the spread collapsed to zero.

In 2020, PSEC actually traded more expensive relative to TPVG. One reason here may be that TPVG still yields more (15.4%) than PSEC (12.6%). But if you have lower quality assets and dial up leverage, you will produce more yield, even at a higher price to tangible book multiple. We think the next recession likely brings this current pricing discrepancy to an end.

Verdict

One thing that misleads investors is focusing on total returns without understanding valuation changes. So, by that measure, TPVG looks better and PSEC looks rather poor.

But the sharp eye will spot that 106.8% and 64.05% have an eerie familiarity. If you were able to correlate that to the relative ratios of their price to tangible book value, you deserve a teddy bear. If PSEC traded at the same price to tangible book value as TPVG, their total returns would be virtually identical. So here, there is a lot of catch-up (or catch-down from TPVG's point of view) to do.

We like PSEC here, and think we can make a buy case relative to junk bonds even this late in the cycle, thanks to the massive discount. The company bought back some of its preferred shares, Prospect Capital Corporation 5.35% CUM PFD A ( PSEC.PR.A ), recently. That tender price likely sets a floor on it, and that issue might be a choice for defensive investors. We rate TPVG common stock a "hold," as the 15% yield (plus borrowing costs) is a hard hurdle to battle against on the short side. But investors would likely be better served exiting it and buying PSEC - or looking for one of the many far better BDCs that trade near NAV.

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