TAKING STOCK: Business development companies: Solid investments for the rest of us

Dear Mr. Berko: I have $90,000 from a CD that just came due, and the 1 percent that my bank offers me may be OK for the 1 percent of the public that doesn't need the interest income. But I do. Please enlighten me on business development companies, and tell me whether you think they'd be a good and safe investment. If so, I want to invest that $90,000 in them. My neighbor's broker told him about several of these investments that pay over 10 percent, and that return sounds very attractive. My neighbor has more than I do to invest, but he's as much in the dark about these business development companies as I am. We both agreed that I would write to your for information and recommendations. My only other investments are $70,000 in preferred shares of Wells Fargo, Citigroup, Bank of New York Mellon and JP Morgan, all of which you recommended in your column in 2008. And I have huge profits plus good yields in all of them. My neighbor and I look forward to your answer. RR, Fort Walton Beach, Fla. Dear RR: Venture capital (VC) firms are funded by qualified, high-net-worth individuals who can easily invest hundreds of thousands or millions of dollars. The number of investors may be limited according to the laws of the states in which they incorporate. Because of the enormous leverage they use (VCs are not held to the same reporting standards of a public company), they have returned obscene profits to their super-wealthy investors. Business development companies (BDCs), on the other hand, are public companies that were funded with an initial public offering by selling shares to the 99 percent of us who do not qualify as VC investors. And like their wealthier brethren, BDCs invest their money in private or public companies that need capital for inventory, acquisitions, mergers, expansion, loan consolidations, new machinery, investment or management advice. VCs, unlike their lesser brethren, can borrow $1,000 for each $100 of equity, but a BDC is usually limited to borrowing $50 for each $100 of equity. And unlike VCs, whose investors are often committed for the duration, BDC investors can sell and buy their shares anytime because they are publically traded on the nation's exchanges. BDCs have been on the scene since the late 1970s, and the market capitalization of the entire list of 40 or so BDCs is about $13 billion, which is smaller than the typical utility stock listed among the S&P 500. BDCs are taxed similarly to real estate investment trusts and master limited partnerships, in which a large portion of their income is not taxed but rather reduces the cost basis of the shareholder. And like REITs and MLPs, BDCs are required to distribute at least 90 percent of their income. The BDC sector has not performed well in the last few years, but their performance should be changing. Most trade at or near their book value, the payout ratios are high - typically 10 percent and up - and that inclueds return of capital. The following issues look attractive to me; each pays a handsome dividend, and each should increase its dividend in the coming dozen months. Triangle Capital (TCAP-$18.12) focuses on management buyouts and acquisition financing in lower- and middle-market companies. Its book value is $15.22, the dividend yields 10.2 percent, and modest growth is expected for 2012. Ares Capital (ARCC-$14.85) is one of the largest BDCs, with $13 billion in capital, a book value of $17.96 and a 9.6 percent yield. Management expects 2012 revenues to grow by 15 percent and should increase the dividend. Fifth Street Finance (FSC-$9.50) invests between $5 million and $60 million in first- and second-lien financing. Its book value is $11.06, and the dividend yields 13.20 percent. Good growth is expected in 2012. Kohlberg Capital (KCAP-$6.07) yields 10.9 percent and invests in equity with minority-control transactions. Its book value is $8.49, and management believes 2012 will be a good year. PennantPark (PNNT-$10.09) invests between $10 and $50 million in common and preferred stocks, warrants, options or subordinated and mezzanine loans. The yield is 11 percent, the book value is $11.28, and PNNT expects 20 percent growth in 2012. Finally, Hercules Technology (HTCG-$9.02) invests between $5 and $30 million in technology issues (drug discovery, software, advanced materials, communications, energy, etc.). Its book value is $10.13, it yields 9.80 percent, and it should grow by 20 percent in 2012. ---------- Please address your financial questions to Malcolm Berko, P.O. Box 8303, Largo, FL 33775 or e-mail him at mjberko@yahoo.com. Visit Creators Syndicate website at www.creators.com. © 2011 Creators Syndicate Inc. Published: Mon, Dec 26, 2011