March 6, 2023
Frankly, Great Elm Capital (GBDC) has been a disastrous place to invest for years. Just look at this lifetime stock price chart that only dates back to October 2016 to get your 1,000 words:
Although the BDC is part of our coverage universe, we've not written about them before. However, in an attempt to be comprehensive, here is the current situation.
Everything New Again
A year ago new capital was raised; a new management team was brought in and a new strategy was proposed. On a small scale, GECC wants to replicate SLR Investment's (SLRC) approach - both making loans and owning a number of specialty finance companies.
However, those new managers have to contend with huge losses left over from prior periods. In the past 3 years, the BDC has booked net realized losses of ($146mn). Much of that was associated with its huge position in Avanti Communications, which was foisted on the BDC at the outset. As we fretted about at the time, Avanti was set to fail from day one but many years had to pass before the loss was taken. That was ($111mn). To put that into context, the BDC's nominal par capital at the end of 2016 - when GECC began its new journey - was $219mn. Talk about "concentration risk".
The BDC has undertaken repeated Rights Offerings and a 6 for 1 reverse stock split in these last few years. In the latest round of capital raising back in June last year, $37.5mn was raised, which followed another $50mn Rights Offering in March of that same year. Now, all that money has been spent and we're left with investment assets with a cost of $251mn and an FMV of $224mn.
No Such Luck
We'd love to tell you that the foray into specialty finance has been an unqualified success. Unfortunately - and judging by the latest 10-K - that does not seem to have been the case. GECC controls Lenders Funding LLC- see below for a corporate bio – and has invested $18.8mn at cost. As of December 31, 2022, the $7.250mn invested in the equity of the business has been written down by ($5mn) - mostly in the latest quarter. No explanation is forthcoming from management, but this is disconcerting.
Then there's Sterling Commercial Credit - in which GECC has invested $16.3mn in subordinated debt and equity and in which they own an 80% equity stake. This quarter, the equity was written down (20%) for the first time. Sterling was only acquired a year ago and paid for - partly - in GECC stock.
Only GECC's investment in Prestige Capital in 2019 appears to have borne fruit. The $7.8mn equity invested at cost is being valued at $11.6mn, but even that valuation is headed southward of late.
The specialty finance entities account for a quarter of GECC's investment assets. The remainder is a motley number of loans and bonds - both floating and fixed rate. We count half a dozen whose value to cost suggests they are underperforming expectations and a huge number of tiny investments in SPACS, which in the aggregate are carried at a loss. It's hard to tell how this will all work out but one suspects not too well.
As of IQ 2023, the BDC has reduced its quarterly distributions to $0.35, as we expected. Currently, EPS does not even "cover" the distribution but management is optimistic that higher rates will push up recurring earnings to meet its dividend. The 3 analysts who cover the BDC are projecting 2023 NIIPS of $1.46 so maybe that's realistic. However, we can't help but feel this might not be sustainable. Estimating how much the dividend might have to be cut is difficult but we've chosen to assume (5%) per annum for 2024-2027 in our projection.
At the moment, GECC is priced at $9.55, way off its 52-week high of $15.66 but also well above its 52-week low. The yield on offer is 14.7%. However, given the unproven nature of the new strategy; the high leverage (which could cause an interruption of future cash dividends if the 150% coverage limit is broken), and the prospect of future dividend cuts, we can't think of a rationale for investing in GECC at this time. Those repeated failures in the past - and the strained balance sheet - should outweigh any slim hope that "this time will be different".
Open-Minded But Not Optimistic
If management can demonstrate that they have truly turned GECC around, we'll report back. For the moment, though, our total return for the next 5 years in the Expected Return Model - although positive - is one of the lowest out there. Only the bravest souls should consider buying the stock at this point.