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PSECs future2 .pdf

Original filename: PSECs future2.pdf
Author: Jordan

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Doctor M,
I can’t keep arguing this back and forth. I think PSEC will continue to destroy shareholder wealth in
wholesale, through bad underwriting and asset growth that favors the manager over the common
When PSEC meets its maker after years of dismal returns, there will be many who say that it couldn’t be
foreseen. “Insiders were buying hand over first. Wall St. firms rated it a buy with high target prices.” And
so on. I’ve heard it for months.
All the people that you cite have been dead wrong on Prospect Capital. The simple truth is that all this
was predictable, and is just as predictable today. PSEC will continue to generate below-market returns,
and likely continue to trade at one of the widest discounts in the BDC universe.
Over the past two years, Prospect Capital has:
1. Inflated the values of several investments – Targus, Edmentum, Empire Today, and its CLO
equity, just to name a few. At the end of 2014, it egregiously purported to report some of the
best quarterly numbers in the BDC universe despite its aggressive CLO equity marks.
2. Conveniently inflated the value of control investments (Harbortouch at FYE 2015, for example)
to meet annual earnings. (Harbortouch’s equity value has been since written down after having
doubled in a single calendar quarter.)
3. Structured the sale of investments to generate outsize economics for the external manager.
4. Used control companies to “create” earnings, by paying Prospect Admin expenses directly from
portfolio companies, and by dividend recapping its control book (the issue that brought the SEC
to take a hard look at PSEC in 2014). It also uses/used PIK interest to create income in excess of
portfolio company earnings and profits.
5. Proposed “spinoffs” that enrich the manager at the cost of shareholders because it knew that it
could not sell its CLO equity at its mark. Notably, its plan called for involving institutional
investors, who would receive a fee (discount!) to purchase shares of newly spun off entities. It
knew its marks were not good.
6. Hides non-accruals with debt-for-equity swaps to report a better headline number.
7. Changed its non-accrual policy such that it has complete discretion over when an investment
qualifies for the non-accrual list.
Recently, you should have observed that:

1. Its head of its CLO business line left the company for another firm. He will need to manage
substantially more AUM to earn similar compensation. Why did he leave?
2. PSEC’s bonds now offer a 13%+ YTM. Creditors do not like Prospect Capital. Note that it had to
issue an expensive “baby bond” in 2015 to refinance debt even after it went on a roadshow to
court the debt capital markets. Even marginal, non-IG rated BDCs can float a baby bond.
Prospect Capital is not investment grade, period.
3. Prospect insiders had to dump $50 million into the stock to earn trust of shareholders to vote
for proposal 2 – the right to issue equity at prices below NAV. Note that PSEC insiders also
bought several million dollars of stock prior to the Dec. 2014 dividend cut. Insider buying is
designed entirely to fool the retail-heavy investor base who does not know better.
Here’s what I see happening this year:
1. Prospect Capital slowly writes down its book, particularly its oil-related investments.
2. Prospect Capital raises dilutive equity to fix a leverage problem, helped by the fact that its everchanging shareholder base granted it this power.
3. Prospect Capital’s NAV and earnings power plummet on a per-share basis as a result of a dilutive
equity raise.
4. More of the same. The company continues to pay outsize fees to management while destroying
shareholder wealth. The cheerleaders on StockTwits and SeekingAlpha will continue to deride
anyone who dare tells them that this BDC is a dog.
When Prospect Capital falters, it will be purely due to mismanagement, not the “shorts” or the critics.
Prospect Capital is a bad investment at any price. But we’ll revisit in a year or two. You’ll see.
When it happens, I hope that the permabulls can acknowledge that they missed some of the most
obvious signs of trouble. Best of luck to you.

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