Private Credit Is Making Investors Nervous. Here's Why Main Street Capital Still Commands a Premium.
Main Street Capital has a couple of additional value drivers.
By Matt Dilallo
The private credit market has been in the financial news a lot this year. Investors are worried that more borrowers will default on their loans following a string of high-profile bankruptcies in the sector. That's causing them to pull funds from private credit investments, including business development companies (BDCs).
Main Street Capital (MAIN 0.82%) hasn't been immune to these concerns. The BDC stock has lost about a quarter of its value from its 52-week high. Despite that, it still trades at a significant premium to its net asset value (NAV). Here's why investors continue to pay a premium for this BDC.
A look at Main Street's portfolio
Main Street Capital is an investment firm that provides capital (debt and equity) to lower-middle-market (LMM) companies ($10 million to $150 million in annual revenue). It aims to be a one-stop shop by providing customized debt and equity financing solutions to small private companies. Additionally, Main Street provides debt capital to companies (with $25 million to $500 million in revenue) owned by or being acquired by a private equity fund.
Main Street Capital has invested nearly $2.6 billion across 93 LMM companies as of the end of the first quarter and almost $2.1 billion across 85 private loans. However, its LMM investment portfolio had a fair value of over $3.2 billion, driven by gains in its equity investments (about 28% of the portfolio). Meanwhile, its private loan portfolio's value was under $2 billion due to changes in fair value. The portfolios currently have a weighted-average annual effective yield in the double digits, which helps support Main Street's dividends (it pays a monthly dividend and periodically pays supplemental quarterly dividends).
After subtracting its debt, Main Street Capital had about $3.1 billion in net assets at the end of the period, or $33.46 per share (up about 0.4% since the end of the fourth quarter). With its stock price currently above $50 a share, the company trades at a significant premium to its NAV.
What's driving the premium?
Main Street Capital differs from other BDCs in two ways. First, the company will also make equity investments in some of its LMM portfolio companies. These investments generate dividend income to support the BDC's dual dividend streams and provide capital appreciation. The company's equity investments have helped grow its NAV per share by 160% since its launch in 2007. The BDC has routinely harvested gains by selling its equity investments, providing additional capital to grow its portfolio. These value-enhancing equity investments are one reason why Main Street trades at a hefty premium to its NAV.
Additionally, Main Street Capital has a wholly owned asset manager, MSC Advisor. It manages investments for external parties, including MSC Income Fund, a public fund that invests in private loans and has $1.6 billion in capital. When including these managed assets, Main Street Capital has over $9.2 billion in investment capital under management. The company's asset management business generates additional investment income and shareholder returns, which also contribute to its premium value.
A premium BDC
While private credit concerns have eroded some of the premium, Main Street Capital still trades well above its NAV. That's due to the potential for value appreciation in its equity portfolio and the value contributed by its growing asset management business. Those additional value drivers set the BDC apart in the sector, as it can deliver growth in addition to its two dividend streams.