Expect More Consolidation Among U.S. BDCs

A wave of consolidation could well sweep through the community of U.S. small business lenders as the beleaguered industry seeks to take advantage of low valuations to combine with rivals or larger, stronger companies in a bid to survive.

Once a dominant player in the business development company, or BDC, industry, American Capital Ltd., which recently restructured its debt, may be the next big target for acquisition in the space, analysts say. Smaller BDCs like Kohlberg Capital Corp., MCG Capital Corp. and GSC Investment Corp., among others, could also be on the buying list for bigger players.

“I think to the extent business development companies remain undervalued, with a lot of them trading [in the] 60 percent range of the net asset value, it presents an opportunity for a buyer to come in and buy the assets at a substantial discount and enjoy good returns,” Analyst Scot Valentin of FBR Capital Markets said.

BDCs make debt and equity investments in small- and mid-sized companies in return for equity stakes. They have been struggling to raise capital as the financial crisis reduced the value of their portfolio companies to which they make loans. With the cost of capital remaining high, smaller business lenders think it makes more sense to partner with a larger company, analysts say.

“I think the catalysts for consolidation are attractive entry price, ability to solve a need whether it be capital or liquidity, and the ability of deriving or providing scale,” said analyst John Stilmar of SunTrust Robinson Humphrey.

Recently, in the biggest deal to date in the BDC segment, Ares Capital Corp. agreed to buy its struggling rival Allied Capital Corp. in an all-stock deal valued at $648 million, providing relief to the debt-laden company. Distressed private debt funds may also be interested in buying a BDC as they have raised significant amount of money recently, analyst Greg Mason of Stifel Nicolaus said.

New York-based GSC Investment is trading at a price-to-book value of 0.38, while Arlington, Va.-based MCG Capital is trading at 0.54 as of Nov. 17, according to Thomson Reuters data. A price-to-book ratio below 1.00 indicates that the market capitalization is less than the value of assets on the company’s books. American Capital, with a price-to-book value at 0.37 as of Nov. 17, is looking attractive following the troubled company’s agreement to restructure its $2.4 billion of unsecured debt with its lenders.

Analyst Ross Demmerle of Hilliard Lyons said the company’s board would have to address any “significant offer” from a potential acquirer. “If you’ve been selling at 50 percent of book value for months, you better be pretty certain you can increase the stock price without selling, if you turn it down,” he added.

Stifel Nicolaus’s Mason said that while a lot of investors are speculating that American Capital will take the same route as Allied Capital, he cautions that the conditions affecting both the companies are different. American Capital, which was removed from the Standard & Poor’s 500 index in February, had breached its covenants and was selling assets at distressed prices to raise cash. American Capital did not respond to queries seeking comment.

Heavyweight BDC Apollo Investment Corp., which raised $157.5 million in a public offering in August, said it is eyeing acquisitions, although it’s not clear if the firm would entertain buying another BDC.

Earlier this month, New York-based Prospect Capital Corp. said it is evaluating a pipeline of potential additional portfolio and investment opportunities and hopes to seal a deal before the end of the year. The company may even consider making a “hostile offer” to a potential candidate, its Chief Operating Officer Grier Eliasek said on a call with analysts. In August, Prospect Capital, a closed-end investment company, agreed to buy its smaller rival Patriot Capital Funding Inc. for $197 million.

—Archana Shankar is a correspondent with Thomson Reuters. Brenton Cordeiro is a trainee correspondent with Thomson Reuters