FS Investment Co (FSIC) went from being privately held to the fourth largest publicly traded company in its industry – overnight. FSIC was spun off from Franklin Square Holdings, a private investment company. FSIC is a Business Development Company BDC and supplies capital for smaller companies looking to raise equity and debt. By market capitalization, FSIC is the 4th largest BDC out an industry consider to total 41.
Before the Great Recession, BDCs were very popular with investors due to their high yields and unique expose to growing companies. However, as many businesses began to fail, BDCs ran into severe trouble and were unable to collect on their debts. Most lost money, experienced rapid declining book values, and failed to make money for longer-term investors. A good example is American Capital LTD (ACAS). A $10,000 investment in 2004 would have been worth $416 or less during much of 2009. Currently, the $10,000 would be worth $15,000 vs. $22,000 if invested in the S&P 500.
A business description is found on their website:
FS Investment Corporation is a publicly traded business development company (BDC) focused on providing customized credit solutions to private middle market U.S. companies. We seek to invest primarily in the senior secured debt and, to a lesser extent, the subordinated debt of private middle market U.S. companies to achieve the best risk-adjusted returns for our investors. In connection with our debt investments, we may receive equity interests such as warrants or options.
FSIC is advised by FB Income Advisor, LLC, an affiliate of Franklin Square Capital Partners, a leading manager of debt-focused alternative investment funds, and sub-advised by GSO/Blackstone Debt Funds Management LLC, an affiliate of GSO Capital Partners, the credit platform of Blackstone.
Of interest to investors is the connection between FSIC and Blackstone (BX), one of the largest investment, hedge fund and private-equity managers. The majority of FSIC loans (76%) are variable rate with an average maturity of 2020 and the average credit rating of its 125 portfolio companies is B3.
FSIC could be substantially overpriced if the 9.3% current yield is unsustainable. The monthly dividend is $0.88 annualized, and a $0.10 special dividend was recently announced. The dividend is supported by the company’s portfolio of loans with an average interest rate of 9.9%.
As the overall interest rate environment remains low, these loans are at risk of being refinanced at lower rates, reducing income for FSIC. In addition, the advisory fees charged by Franklin Square and BX are around 2.0%, expensive for the assets managed - $4.2 billion.
BDCs with longer operating histories include Triangle Capital (TCAP) with an 8.1% yield and PennantPark Investments (PNNT) with an 11% yield. While their industry was collapsing around them during the financial crisis, these two companies did not cut their dividends. All BDC investors should appreciate this important trait.
The bottom line for FSIC is that there may be better avenues for generating above average income and the risks associated with FSIC are not necessarily fully compensated by a 9.3% yield.
More information on FSIC can be found in their investors presentations:
First published in the Sept 2014 issue of Guiding Mast Investments newsletter, Thanks for reading, George Fisher