Replies to post #501 on Prospect Capital Corp (PSEC)

[redfairway]

Avoid PSEC: Street Authority:

""Another company with problems in the C-Suite is Prospect Capital Corp. (Nasdaq: PSEC). Prospect Capital is a business development company, or BDC, whose primary business is to make loans to mid-size companies. Such loans are generally higher-risk and most banks prefer to avoid them.

Like Freeport-McMoRan, the management of Prospect Capital has made rewarding themselves a priority over rewarding shareholders. Unlike Freeport, the management team of Prospect Capital aren't actually employees of Prospect Capital.

A common management structure for BDCs is to have an "external manager" to control the assets and make investment decisions on behalf of the company. For its services, Prospect's external asset manager charges a hefty 2% fee based on assets under management.

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As you can imagine, a manager paid based on assets under management is incentivized to increase assets under management, regardless of whether their actions make economic sense for shareholders.

Prospect Capital's is notorious for issuing shares when the stock is trading below net asset value. A BDC is a lot like real estate investment trusts in that it is required by law to pay out nearly all of its investment income as a dividend. This means BDCs have to issue shares to grow.

BDCs that are well managed and create value for shareholders usually trade at a level equal to or greater than net asset value. When the BDC issues shares at face value and use the cash to make additional profitable investments, both the new and old shareholders win.

However, when a BDC has assets worth $12 per share and issues new shares at $11, current shareholders are essentially subsidizing the new shareholders.

Such action could be justified in rare circumstances. For instance, if there was a tremendous investing opportunity that the potential returns would justify the dilution. However, Prospect Capital's management has not delivered much in the way of gains for investors: net asset value and net investment income have languished since 2010.

So despite diluting the stake held by existing shareholders several times over the last few years (including three separate instances in 2014), Prospect's investing performance hasn't justified the dilution and has simply created a larger asset base on which to collect its hefty fee.

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Prospect Capital's most recent misstep was to completely mislead shareholders about the safety of its dividend. After announcing Q3 2014 results, many investors spotted a payout ratio in excess of 100% for five straight quarters and realized that a dividend cut was inevitable.

That cut was finally announced in December 2014, just a month after declaring on the Q3 conference call that a cut wouldn't be needed. The announcement was also just days after the annual shareholder meeting in which management obviously knew that it would soon be cutting the dividend. The deception by management around this event is just the latest in a long line of moves that have little regard for the owners of the company.

Just as high quality managers like Warren Buffett and Tom Malone make their shareholders rich over time, it also works the other way. Low quality managements will lose money for investors as Freeport-McMoRan and Prospect Capital have done.""