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Investment Thesis

Too many unknowns leave Portman Ridge Finance Corporation (PTMN) unsuitable for the risk-averse investor. Recent management changes and the anticipated merger with Garrison Capital (GARS) add a considerable amount of uncertainty for future performance. This is especially true given the new management’s lack of experience and PTMN’s disappointing historical performance.

Dividend Sustainability

Currently, PTMN pays $0.24 per share in dividends, annually. That translates to an 18% forward dividend yield. The sustainability of this dividend relies on two conditions:

  1. Affordable payout ratio
  2. Healthy portfolio

PTMN historically distributed more cash to shareholders than it earned. As a result, PTMN lowered its dividends every year since 2013 to try to match the income it brings in with the dividend it pays out to investors. At a $0.06 quarterly dividend, PTMN seems to have finally found its balance.

Source: Graph created by the author. Data is sourced from the company’s financial statements.

PTMN Portfolio

PTMN’s dividend sustainability depends on more than a payout ratio that is below 100%. A healthy portfolio is paramount to that end. PTMN manages $281 million worth of investments. Below is a portfolio breakdown by type and product mix.

Source: Investors’ presentation

PTMN has a relatively small stake in equity, which is a good thing. Equity is riskier than debt securities. Gladstone investment corporation’s (GAIN) revenue decreased by 40% in Q2, as portfolio companies suspended dividend distributions during the pandemic. During the same period, PTMN revenue increased by 6% because of limited exposure to equity and the expansion of the investment portfolio through borrowing.

CLO investments are also extremely risky. This is demonstrated by the ~50% decrease in PTMN’s revenue from these vehicles in Q2 as shown below:

Source: Company financial statements

Second lien loans constitute 40% of PTMN’s debt investments. This is a high percentage. Second lien debt is subordinate to senior notes in terms of interest payment and asset recovery in case of bankruptcy.

Finally, healthcare and business services industries constitute 38% of the portfolio. This is a high industry concentration.

The verdict on PTMN portfolio:

The large stake in second lien debt, industry concentration, and CLO exposure counter the safeness gained from the smaller stake in equity investments.

Discount to NAV

PTMN shares are trading at $1.38 as of October 9th. This translates to a 48% discount to NAV ($2.71 per share, as of June 30th). Still, the company has a disappointing track record regarding NAV.

NAV per share decreased from $5.94 in December 2015 to $3.4 in December 2019 and decreased further during the pandemic. This is part of a broader downward trend that extends to 2010. You can find the data here.

New Adviser

In April 2019, PTMN’s management and its board changed. Currently, PTMN is managed by Sierra Crest Investment Management LLC, an affiliate of BC Partners LLC. The jury is still out on the performance of Sierra Crest, given that they assumed their roles only recently. Having said that, there are differences between the former and the current management that investors need to be aware of.

Dayl Pearson the former President, CEO & Director of PTMN had significant experience in the U.S middle market. This is an excerpt from the 2018 annual statement.

During the past 27 years, Mr. Pearson has focused almost exclusively on the middle market and has originated, structured and underwritten over $7 billion of debt and equity securities

The rest of Mr. Pearson’s team also had significant experience in the U.S middle market. On the other hand, Sierra Crest “the Adviser” is new to town. Here is an excerpt from the 2019 annual statement

The Adviser has limited experience managing a BDC or a RIC and may not be able to successfully operate our business or achieve our investment objective

The adviser retained the services of Edward (Ted) Gilpin, PTMN’s former CFO. Ted Goldthorpe, PTMN’s current CEO also has experience in the BDC industry. He was the CIO of (AINV) from 2012 – 2016. Still, the change in management adds to the uncertainty of risks arising from the merger, especially in the absence of experienced administrative and back office teams

Ted Goldthorpe Performance Record

During Ted Goldthorpe’s tenure as president and CIO, NAV per share decreased from $ 8.55 in March 2012 to $7.28 in March 2016 (-~15%). AINV’s total return significantly underperformed the market and its peers during the period.

ChartData by YCharts

The Merger

PTMN is getting bigger. On June 24, 2020, PTMN announced plans to merge with GARS. PTMN will be the surviving entity after the merger.

The merger will enable PTMN to engage in larger deals, increasing the origination pool, and providing more options for the company regarding its portfolio composition. Still, this comes at a price. Both PTMN and GARS are highly leveraged.

Alternative Investments

Better alternatives for income investors are Oaktree Specialty Lending Corporation’s (OCSL), Solar Capital (SLRC), and Saratoga Investment Corp (SAR).

OCSL has an outstanding management team. Since taking management of OCSL in 2017, NAV per share increased by 5%. This includes write-offs caused by the COVID pandemic.

SLRC has an excellent portfolio that enabled the company to endure the disruptions caused by COVID. In Q2, the company had ZERO non-performing loans on its balance sheet.

SAR recently gained a Small Business Administration “SBA” license that gives the company access to low-cost capital.

Below is a comparison of total returns from December 2017 (to exclude OCSL former management) until December 2019 (to exclude COVID disruptions).

ChartData by YCharts

Summary

Recent management changes and the anticipated merger with GARS add a considerable amount of uncertainty for future performance. This is especially true given the disappointing track record of PTMN, Ted Goldthorpe, and the inexperienced new back office team of the new adviser.

While PTMN has finally found its balance regarding dividends, the large stake in second lien debt, industry concentration, and CLO exposure increase risks regarding dividend sustainability.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: This is not investment advice. All information contained herein is for informational purposes only.

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