This is not a headline I ever thought I’d write.
If a week ago you asked me to rank business development companies (BDCs) in order of which are most likely to own bitcoin or other cryptocurrencies, I would have ranked Main Street Capital (NYSE:MAIN) dead last. As it turns out, I would have been dead wrong.
Main Street Capital’s fourth-quarter earnings report was buoyed by cryptocurrency exposure, an interesting twist for a generally pretty boring accounting period. The company effectively pre-announces its fourth-quarter earnings in January of each year, so by the time February rolls around, there aren’t many surprises when it reports earnings.
Except, I guess, there were surprises — like that Main Street owns cryptocurrencies.
Really?
Look, Main Street isn’t looking to become the next over-hyped bitcoin stock. It’s still a major investor in private debt and equity, though at least one of its portfolio companies also owns some cryptocurrencies on the side.
On its conference call, Main Street Capital executives said its investment in CBT Nuggets, a company I’ve talked about a lot, benefited from the rising price of cryptocurrencies, which was the primary driver of its increasing valuation this quarter.
The CBT Nuggets gain is actually a pretty material number, amounting to about $0.30 per Main Street Capital share. It goes a long way to bridge the gap between how much Main Street Capital earned in net investment income ($0.64 per share) and net income ($1.05 per share) in the most recent quarter. Net income includes capital gains or losses, whereas net investment income does not.
I suspect that the cryptocurrency CBT Nuggets owns is bitcoin, since the company started accepting bitcoin as payment in 2013, but I’m just speculating. Main Street Capital didn’t say which digital currencies were responsible for the gain on CBT Nuggets this quarter.
Back to the “boring” BDC business
Cryptocurrencies are just an interesting sidebar in a quarter otherwise devoid of big developments. Main Street Capital reported net investment income of $0.643 per share during the quarter, slightly above its estimated range in January, and easily covering its dividends ($0.57 per quarter) it pays to shareholders. Net asset value (book value) stood at $23.53 per share at the end of the quarter, right in the middle of its expected range detailed in January.
Time is best spent looking through its portfolio for any credit-related developments. After the quarter ended, Main Street Capital sold its debt investment in GST Autoleather at a $3 million loss. That’s better than I had expected, given GST Autoleather filed for bankruptcy last October, and reports suggested that senior lenders were slated to recover 20% of what they were owed. Main Street Capital, a senior lender, recovered about 80% of what it was owed.
The BDC has very few truly problematic investments in its portfolio, but there are some positions worthy of additional scrutiny. In all, about 6.3% of Main Street Capital’s book value is tied up in investments in the retail industry, according to data compiled by Thomson Reuters BDC Collateral. Some of its biggest exposures, which have been on my watchlist for some
time, are included in the table below.
| Portfolio Company | Fair Value as % of Par | Investment as % of Net Asset Value |
|---|---|---|
| Staples Canada | 94.5% | 1.4% |
| Guitar Center | 92.5% | 1.1% |
| Bluestem Brands | 70.4% | 0.6% |
| Charlotte Russe | 41% | 0.6% |
| TOMS Shoes | 59.5% | 0.2% |
Valuation remains high
Though investors turn to BDCs for high yields — many yield 8% or more per year — total returns are what really matters. Last year, BDC investors earned a high yield, but total returns were dismal, as dividends mostly papered over capital losses. The VanEck Vectors BDC Income ETF was basically flat for 2017 as dividends were offset by declining share prices.
Main Street Capital shares are well off their highs, but it remains the market’s most expensive BDC. Shares trade at a 53% premium book value in an industry where the median BDC trades at a double-digit discount to book.
Sure, Main Street Capital’s results have been better than most, a function of better underwriting and a low-cost operating model. But don’t ignore the impact of portfolio composition. Whereas the prototypical BDC tends to dedicate 10% or less of its portfolio in equity investments, Main Street has approximately 30% of its portfolio tied up in equity investments.
The equity investments that have been a major tailwind in a nine-year bull market are likely to be a headwind should tides turn.
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