OWL - Owl Rock: Dip Buyers Shouldn't Miss This Bargain

2023-06-26 15:51:45 ET

Summary

• Owl Rock Capital suffered volatility last week, which some investors could link to its impending name change.
• Despite negative reporting by the financial media, I don't expect material risks to arise from the change.
• ORCC buyers who braved the pessimism since its lows in October 2022 have been duly rewarded.
• The recent banking crisis has also provided the impetus to the direct lending space, benefiting leading players like Owl Rock.
• With ORCC still priced at a wide discount against its historical valuation, dip buyers shouldn't miss the recent pullback.

Holders in leading middle-market business development company, or BDC, Owl Rock Capital Corporation ( ORCC ) experienced market volatility last week, as ORCC applied for a name and ticker change effective from July 6. As such, Owl Rock will be renamed Blue Owl Capital Corporation with OBDC as its new ticker symbol.

While directly linking the event to last week's pullback is impossible, I assessed that ORCC investors shouldn't have much to worry about. Bloomberg reported Owl Rock's changes amid a tussle within its founding team. Accordingly, " Co-founders Marc Lipschultz and Doug Ostrover, who serve as co-CEOs of Blue Owl ( OWL ), have reportedly asked Dyal Capital founder Michael Rees to resign."

However, I don't expect a material impact on the management of Owl Rock, which is helmed by CEO Craig Packer and his team at ORCC. Moreover, Owl Rock presented in a late May Investor Day highlighting the depth of its BDC team, externally managed by Blue Owl's best-in-class structure. The company showcased its "deep expertise in every aspect of the investing process, including origination, underwriting, portfolio management, and exit."

Moreover, I gleaned that dip buyers have returned to support ORCC's pullbacks since it first fell into a multi-year low in October 2022. As a reminder, I urged ORCC investors to buy aggressively then, as ORCC has recovered remarkably.

My caution in January 2023 was also timely, as ORCC didn't manage to break its critical resistance level of $13.90 in late February 2023 before the rally petered out. The recent banking crisis in March exerted more pressure on holders to bail out as they worry about a contagion effect on BDCs, which provide direct lending to potentially higher-risk companies.

However, the initial pessimism has proven to be unfounded as the banking crisis has subsided. Treasury Secretary Janet Yellen's recent remarks also corroborate that we have likely seen the worst in the crisis, even if near-term headwinds are expected to remain. However, investors expecting a rapid recovery in BDCs need to be cautious about turning much more optimistic.

Howard Marks, an experienced investor in distressed credit at Oaktree Capital Management, argued in a recent commentary that the market is at a crossroads. Marks articulated that the " transition to a new investment environment is still in its early stages." However, he also cautioned that "there is no definitive evidence to support the shift yet."

Moreover, there are lingering concerns about whether regulators could look further into BDCs, as the industry is set to continue growing its influence in the lending space. According to a Bloomberg report, the private credit space " could reach $2.2T by 2027 , up from $1.5T globally as of September 2022."

As such, I believe Owl Rock management recognized that the market needs more transparency over its investing process to bolster more confidence about the industry's sustainability. Management also highlighted that credit rating agencies are "not as sharp in their underwriting compared to direct lenders." However, the market often reacts to the assessment of these rating agencies, as a downgrade could "have a negative impact on a company's access to capital."

I believe it shows that Owl Rock's focus on shedding more light on helping investors and the market better understand its structure and decision-making process is beneficial. It demonstrates that Owl Rock believes that its scale and size of focusing on scalable middle-market companies are pivotal to its investment thesis, as it generally avoids companies in cyclical industries.

Despite that, the near-term regulatory overhang and the uncertainty over macroeconomic factors could necessitate a wider discount against its average valuation. Therefore, while the forward dividend yield of ORCC is relatively attractive, investors are urged to assume a higher margin of safety to account for these risks.

Despite that, I gleaned that ORCC buyers have aptly rejected the pessimism surrounding the uncertainty over BDCs. Moreover, its market-leading position suggests it is well-primed to navigate the treacherous waters even if we could fall into a deeper downturn.

The regional banking crisis has turned the market's focus toward direct lenders like ORCC, given their ability to provide access to liquidity and credit in the current regional banking malaise.

As such, I'm not surprised that dip buyers returned robustly at its March 2023 lows, as ORCC recovered to re-test its February highs before the pullback last week.

While I would usually encourage investors to wait for a steeper pullback before revising my rating, I ascertained ORCC's attractive forward dividend yield of 12.2% (Vs. an average of 10.1%) remains constructive.

Moreover, price action investors will likely support the pullback in ORCC as it has moved back into a bullish bias since mid-April. As such, momentum investors will likely return to underpin its nascent uptrend, giving more firepower to dip buyers looking to add exposure.

With that, I assessed that ORCC holders awaiting a pullback should prepare to step back into the fray.

Rating: Buy (Revised from Hold).

Important note: Investors are reminded to do their own due diligence and not rely on the information provided as financial advice. The rating is also not intended to time a specific entry/exit at the point of writing unless otherwise specified.

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