Description

CSWC is an internally-managed BDC that trades at 78% of NAV and 0% dividend yield. It is also the ugly twin that was separated from its bigger and more glamorous sibling, CSWI, presenting a special situation.

Background: CSWC has been written up before on VIC, most recently in January 2015. More details are also available at its 9/23/2015 presentation. The company began in 1961 with a SBIC license. Over the years, it transformed itself, made some hugely successful equity investments and converted to a BDC in 1988. I never understood why it became a BDC because it made more equity investments and paid very little in dividends over the years.

Spin-Off on 9/30/2015: Since 2013, the company made significant changes, resulting in the tax-free spin-off of the industrial products companies as CSW Industrials (CSWI). The split was one share of CSWI for each share of CSWC. CSWC retained no interest in CSWI. However, CSWC is smaller, currently with a $217 million market cap compared to CSWI's $573 million.

Portfolio: With the spin-off, CSWC ended up looking like a just launched BDC, with $184 million in cash and $93 million in investments. The current portfolio consists of 16 investments, split as $49 million equity and $44 million debt. 70% of the equity portfolio is in one company, Media Recovery, where the company has over $25 million of gains.

$68 million of the cash is being committed to a JV with MAIN called I-45 SLF. MAIN will contribute $17 million. This special purpose entity (SPE) does several things. It allows CSWC to generate investment income so it can support a dividend but is classified as non-qualified. The significance of non-qualified investments for BDC's is that normal BDC regulations do not apply, so it plans to use 2:1 leverage in I-45. BDC's have to pass the 200% asset coverage ratio test, which essentially means no more than 1:1 debt-to-equity. Since 2009, most BDC's have tended to max out between 0.7X and 0.8X debt. Although CSWC has had the SBIC license for over 50 years, it is now seeking approval for $150 million in SBA debentures. It will also look at add $50-$100 million of balance sheet leverage. Combining all the pieces, CSWC anticipates growing assets under management (AUM) to $600 - $650 million. The company plans to pursue a variety of debt in senior loans, middle market and lower market, but not equity.

Earnings/Dividends:  Since CSWC is going to be ramping up, we have to do some guess work as to what the earnings, and hence dividends, will be. In the presentation, the company provides all the inputs to do the calculation. Here is the income side:

On the expense side, management expects to reach an expense level of 2.5% of AUM or about $15.0 million. This is in-line with other internally managed BDC's. Assuming 90% distribution over 15.6 million shares, potential dividends are $2.12/sh. If AUM reached $650, it could be $2.33/sh.

I think CSWC will eventually trade to around 11% yield and 110-120% of NAV. That translates into a share price of $19.30 to $21.15. Add in some dividends and the potential returns are  45-60% over the next two years.

Management: Top management has been brought in over the past two years. Looking at the three top executives, CSWC could be called American Capital South. The CEO is Bowen Diehl who joined CSWC in 2014 after spending 13 years at ACAS. CFO Michael Sarner came in 2015 after serving 15 years at ACAS. Finally, Managing Director Douglas Kelley joined the company in 2015 after being at ACAS for 10 years. The chairman of the board is Joe Armes, who was hired in 2013 as the CEO of CSWC but became the CEO of CSWI at the spin-off.

Institutional Ownership: It will be interesting to see how the ownership changes. The spin was completed 9/30/2015, so I expect to see some changes. There appears to have been a lot of year-end selling in the name. Anyway, here are the top 15 holders as of 9/30/2015:

Good news, bad news, it looks to be a bit of a hedge fund hotel.

Catalyst

- Start deploying capital and making loans

- Set SBA borrowing

- Pay dividends