Concerning the acquisition of Crystal Financial by SLRC, it is difficult to evaluate the buyout because Crystal is a private company and we know little about the terms of the merger and less about the Crystal portfolio of investments. So judge carefully my comments that follow.
On the other hand, Mike Gross (CEO) and Bruce Spohler (COO) have proven track records and both have been in the leveraged lending business for twenty five years. We have to believe this buyout will serve SLRC well.
We think we know that SLRC will pay the $275 million acquisition cost from available liquidity including draws on its credit facility, possibly increasing its total borrowings to about $526 million or a debt to equity ratio of around .60 from the recent .28. Note that one analyst suggested that SLRC could add about $.10 per share to its' quarterly NII if it increases its debt to equity to .65.
Also, in the news release, SLRC said: "Solar Capital expects its investment in Crystal Financial to generate a cash yield consistent with other assets in its portfolio". The words "cash yield" may have a primary affect on the "investment income" level, while the "investment cost" levels between SLRC and Crystal may differ somewhat. The operating costs could be higher at Crystal, but also could be lower. So we may not be able to say that the NII brought to SLRC from Crystal will be brought at the same rate of return that SLRC earns NII. Nevertheless, and because Crystal earns higher loan yields than does SLRC, I am going to present some numbers which assume Crystal can deliver NII to SLRC at the same return rate on portfolio size. Because this may not be the case, I will call it the "maximum maybe" theory.
We know that in Q3, SLRC brought 1.9% of the loan portfolio value to NII. ($22.258 million NII divided by $1171 million portfolio value = 1.9%). If the $400 million Crystal loan portfolio brings a similar 1.9% to NII, it will add $7.6 million to the quarterly NII ($400 million x 1.9% = $7.6 million) or about $.20 on a F/D 38.7 million shares. Using the SLRC current price of $23.66, the dividend yield with a $.80 quarterly dividend is 13.52%. To match the recent run rate average yield (10.5%), the stock would have to move up to $30.48 or 29% higher than $23.66.
But let's switch from the "maximum maybe" theory and get conservative and say that SLRC will add just $.10 per share from this merger and in time increase the dividend by $.10 to $.70 per share. Then the yield based on the current price of $23.66 would be 11.83% ($.70 x 4 divided by $23.66). More importantly, if the stock price moves up to reduce the SLRC dividend yield to its average run rate (again 10.5%) then the price will have to advance to $26.67 ($.70 x 4 divided by .105) or 12.72% above the current $23.66. That kind of a potential capital gain coupled with a ten per cent plus dividend yield, will make for an extraordinarily attractive investment.
I find a great deal of comfort with the positive aspects of this acquisition when I read things from the SLRC news release like:
a) Solar Capital expects the acquisition to be immediately accretive to NII.
b) "We expect that our Crystal Financial investment will move us toward our target debt-to-equity ratio while increasing Solar Capital's net investment income."
c) Solar Capital expects its investment in Crystal Financial to generate a cash yield consistent with other assets in its portfolio.
Also, following the news release, Ladenburg Thalmann reiterated their "Buy" rating and increased the target price from $23.50 to $25.00.
Evercore Partners, while reiterating their "Overweight" rating and increasing their 2013 earnings estimate to $2.55 per share, made the following comments:
a) Large Accretive Deal Supports Dividend Growth.
b) The deal will 1) increase leverage to enhance SLRC's profitability; 2) be accretive to earnings immediately; 3) support our above-consensus NII estimates; and 4) indirectly diversify SLRC's investment portfolio towards senior secured lending from a sub debt focus.
c) Crystal is an asset-based lender to private middle market companies, but commands higher than normal yields due to its market focus and structuring.
My notes to the Evercore comments: 1) The FY 2013 $2.55 estimate takes into account the cost of the November $100 million note offering and includes the effect of a Evercore projected equity offering in 2013, an equity offering which may or may not happen. 2) If Crystal indeed commands higher than normal investment yields, that may lend some support the "maximum maybe" theory of the earlier paragraph, which does not include an equity offering in 2013.
We should also remember that not only does this acquisition provide a significant, immediate thrust to the growth of SLRC, but the pre-acquisition growth strategies of SLRC are still in place, and are now enhanced by a meaningful new, continuing (and hopefully growing) income stream from Crystal.
All of this good stuff may take a quarter or two since there may be some onetime costs associated with the acquisition. We will know more as more details of the terms are available. But if the above valuations are near correct, we as investors have been handed a nice year end gift. And because details are lacking, and the market place cannot yet grasp the full impact of this buyout, the stock price may not yet reflect what is occurring. Therefore, it is a gift that may keep on giving well into the future. In the meantime, we will continue to collect a handsome dividend while the rest of the world gradually comprehends the value of this acquisition.
Just one opinion, as always.
Jan and The Shadow.
Never forget, "The Shadow Knows".
