Checking Out Gladstone Investment (GAIN)

One of our readers had asked about what we thought about Gladstone Investment (NASDAQ:GAIN) so we thought we should do a quick run through of their recent financials since we own a substantial position in their term preferred shares.

Remember that given that we are interested primarily in their preferred stock we don’t feel a dramatic need to do a real deep dive on research of most issues. Certainly some like to do a deep dive in every case of investment, but for our needs and from experience we don’t need to do this deep of a dive on a Gladstone company.

Gladstone Investment is a business development company (BDC) and as a BDC they operate as a private equity fund looking to invest through debt or equity in market leaders in stable industries that are profitable with strong management.

The company has been around since 2005 and as such is becoming a fairly seasoned company, but as BDC’s go they are only a modest sized company with around $580 million in assets. As a BDC they are required to maintain an asset coverage ratio of 200% of their senior securities (debt and preferred stock). The company had $101 million of debt and $135 million in term preferred stock which means they easily are within requirements for a 200% coverage ratio. NOTE that the board of directors has voted to lower the asset coverage ratio to 150% effective in April, 2019 as allowed in recent legislation.  We disagree with this move, but all the BDC’s will go there so we may as well as get used to it.  We will simply have to keep our eyes on the financials in the future and certainly when the economy begins to soften at some point in the future.

Investors have to remember that assets of BDCs are valued by management as the investments are not in public companies–thus BDC investors have to “trust” management for the value of assets–of course we never fully trust the numbers, but David Gladstone, the chairman has been around quite a while and we tend to have a bit more trust in him.

The company has had increasing earnings and net asset value in recent quarters and they just announced an increase in the monthly distribution to common holders–from 6.5 cents/share to 6.7 cents/share. Additionally they declared a special dividend of 6 cents. The net investment income doesn’t quite cover the dividend, but the way they calculate the coverage is net investment income PLUS gains in net asset value. NAV gained 53 cents/share in the last reported quarter while net investment income was 23 cents/share for a total of 76 cents per share with dividends paid of 26 cents/share. The company paid two 6 cent special dividends last year.

As can be seen below the common shares have been strong and now carry a current yield of around 7.28%.

A quick review of the company financial statements show that GAIN is carrying little bad debt and we found no investment on non accrual.  The company targets to have 75% of their assets in debt with 25% in equity investments and all in all they have done an excellent job of managing assets.

From our quick review of the financials we think GAIN is in excellent financial condition and until such time as the economy softens it is likely their good performance will continue. It is noted that they will release 1st quarter results on 5/15/2018.

Of course we have no interest in owning GAIN as we don’t buy BDCs but we have a keen interest in the MONTHLY PAYING term preferreds.  Term preferreds, like debt, have a mandatory redemption date.

Term preferred GAINO had an early optional call date starting on 12/1/2017 and an ultimate mandatory redemption on 12/1/2021.  Shares carry a coupon of 6.75% and trade around $25.25 where we would expect they will continue to trade because of the potential of them being called at any time.

Term preferred GAINM carries a coupon of 6.25% and will have an optional redemption date starting 9/30/2018 with an ultimate mandatory redemption date of 9/30/2023. Shares are trading at $25.33 at this time which is where they will likely to continue to trade for now. With 5 years to mandatory redemption shares could trade below $25, but it is unlikely they will go massively below $25.

Term preferred GAINN has a coupon of 6.50% with an optional redemption period starting 5/31/2018 and a mandatory redemption date of 5/31/2022. Shares are trading at $25.36 and like the other 2 term preferreds is unlikely to trade higher because of the fear of redemption.

We find each of term preferred as buyable–at slightly lower prices–like 10 or 15 cents.. Whether GAIN is able to call these is kind of a close call. GAINO which is now callable has the 6.75% coupon and to make the early call worthwhile will require at least 1/4% and normally closer to 1/2% lower coupon and we are not certain they can achieve this level of coupon now–BUT investors need to realize that there is no clear and certain answer as to whether these can be redeemed. It is POSSIBLE that they would call them even if they had to issue 6.75% shares to do the redemption. While they would save nothing on the redemption the move would be a move to refinance at this level instead of waiting until 2021 and very possibly having to pay a much higher rate.

The GAINM and GAINN issues which become callable in later 2018 probably can’t be refinanced for a coupon saving–but again the longer term forecast will affect whether they are called or not.

Each of the term preferred will have 10 or 15 cents of call risk in them–but on a 1000 share purchase that is $100-$150—so it takes just 1 month of dividends to be at breakeven.  So does one buy the 6.75% issue, the 6.25% issue or the 6.50% issue?  Toss a coin and go with it.

As most readers know we like all term preferreds from the Gladstone Companies, which means Gladstone Investment, Gladstone Capital (both BDCs) and Gladstone Land (a REIT). We DON’T care for the Gladstone Commercial preferreds as they are perpetual preferreds and do not provide the level share price and monthly dividends that the term preferreds provide.

10 thoughts on “Checking Out Gladstone Investment (GAIN)”

  1. Actually I think GAINN, GAINO, GAINM are now almost certain to be called within say a year and replaced with new preferreds without the contractual requirement to maintain 200% coverage. You see these preferred issues were unique among all the BDC prospectuses that I’ve read because they have a “Mandatory Redemption for Asset Coverage” clause that reads:

    “If we fail to maintain Asset Coverage (as defined below) of at least 200% …then we are required to redeem, within 90 calendar days of the Asset Coverage Cure Date, shares of Preferred Stock equal to the lesser of (1) the minimum number of shares of Preferred Stock that will result in our having Asset Coverage of at least 200%… The Preferred Stock to be redeemed may include, at our sole option, any number or proportion of the Series A Term Preferred Stock, Series B Term Preferred Stock, Series C Term Preferred Stock…”

    The clauses in those preferreds stand in their way to increased leverage so I’d imagine they’ll be called and replaced by issues without that language.

    It sucks but thats the way it is. All the other BDC prospectuses that I read simply make reference to adhering to the legal requirement. They seem to have been written by the same lawyer who made sure they didn’t tie themselves down.

    1. Hi Blue–thanks for the info. We will have to see if they have a different out on those–i.e. what does the board resolution say about this item?

      This means that buyers should stick to as close to the $25 liquidation preference as possible.

    2. Good job BlueJoseph–you are spot on in your analysis on the prospectus.

      The following comment was submitted via the Gladstone Investment Corporation website.
      Hello–I am wondering if the recent change in the asset coverage requirements in 2019 (from 200% to 150%) will be applied to the currently outstanding term preferred stock issues? The original offering prospectus specifically states 200% (versus a more generic wording such as “as required by law). Thanks for your help. Tim McPartland

      Gladstone Investment Reply.

      Good morning Tim
      The change does not impact the currently outstanding term preferred stock.

      1. Thanks for posting this, Tim. Does this materially change your view on the Gladstone offerings you hold?

        Still thinking that one should stay as close to par with new buys – hypothetically speaking?

        1. No change for me GW–I already hold a 1000 or 2 shares, but will just be careful in the future.

          The coverage ratio is concerning to me if we start to head toward a bad economy or recession–then I will have to rethink Gladstone BDC’s.

  2. Outstanding article Tim, so thank you. One of the most important points you made IMO was this:

    “While they would save nothing on the redemption the move would be a move to refinance at this level instead of waiting until 2021 and very possibly having to pay a much higher rate.”

    I believe this discussion is happening in quite a few board rooms around the world.

    Question is, will this concern cause an avalanche of redemptions?

    I guess the Fed will provide some clarity to us over the next few days with what they have to say with regards to interest rates. I still believe that they will do what they always do, which is cue up the wrecking ball by raising too darned fast. Personally, I think we are just fine now and could do just fine if they waited until September to raise again and then that was it for the year and then pick up with another raise next April. But that won’t happen…

  3. Yeah, seems most of the time they trade +2 monthly dividends. Best time to buy is x-div day. Within a day or 2, they jump up again. With a finite maturity date, I like these as well.

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