IT’S BEEN A PROBLEM for small and midsize businesses since the credit crunch began: finding loans. But one answer to the problem could turn out to be a bonus not just for the firms but also for investors.
More and more, smaller companies have been turning to publicly traded business-development firms, which either loan to or take an equity stake in the companies. While many regional banks have tightened their purse strings when it comes to loans for small companies, development firms have been opening their vaults.
Ares Capital, for example, closed 11 transactions averaging more than $31 million per deal in the last three months of 2009. That’s double the number of deals—and value per deal—the firm reported in the same period in 2008. As long as credit remains tight, business developers can find plenty of customers, says Michael Toporek, chief investment officer of Brookstone Partners Asset Management, which manages $70 million.
Development firms issue their own shares, and also borrow to raise money for their loans to others. Some of their loans have turned out to be pretty good investments too. Analysts say some of PennantPark Investment’s recent investments have earned it about 15 percent.
“This is a good time to be a lender if you have the capital,” says Scott Valentin, an analyst at investment bank FBR Capital Markets. The development firms—set up much like real estate investment trusts, or REITs—are paying out at least 90 percent of their profits each year in dividends. Many of the firms are paying attractive yields. “If the share price is flat for the year, we still collect our 10 percent yield,” Toporek says.
Of course, the prospects of these business developers often depend on the prospects of the companies they loan to. And since the loans are typically to smaller, less-established companies, development-firm stocks can be volatile. In 2008, when the economy soured and wiped out many small companies, the value of the loans made by business-development firms likewise fell, and their stocks tanked.
Their stocks have since rallied, but some analysts warn that a double-dip recession could be particularly hard on the business developers. Indeed, with their high risks but high potential rewards, development-company stocks are more like high-yield bonds, says Greg Mason, senior equity analyst with Stifel Nicolaus.
A Developing Situation
PennantPark Investment (PNNT)
Analysts say this New York–based firm is generating good returns off many of its recent loans.
Apollo Investment (AINV)
Focuses on lending to midsize companies, from restaurant operators to insurance providers.
Ares Capital (ARCC)
Recently bought rival Allied Capital, a move that makes it the nation’s largest business-development company.
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