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Stock Spotlight: Fifth Street Financial (FSC)

Fifth Street Financial (FSC) is classified as a Business Development Company whose mission is simple enough to understand:

Our mission is to continue to build a leading alternative asset management firm 
with a core focus on credit solutions and to be admired in the marketplace for our ideas, 
talent and integrity. We foster a culture of dedicated and innovative professionals 
who strive to deliver impeccable service and create value for both our investors and clients.

Essentially Fifth Street Financial focuses on maximizing it’s revenue stream from debt-based investments, by lending to companies in the small to mid-size range. Additionally a small portion of the companies fair value is composed of equity holdings, though this has not added a significant difference to Fifth Street’s bottom line. According to the Reuters FSC Company Description as of September 30, 2013 Fifth Street Financial’s equity holdings were composed of 13 private equity funds, as opposed to it’s 86 debt-based investments in operating companies.

The Fifth Street Business Model and Competitive Advantage

In Bloomberg’s interview with Fifth Street’s CEO Leonard Tannenbaum was happy to announce that Fifth Street was focused heavily on the healthcare sector because of it’s consistent performance and exceptional income generating potential in Fifth Street’s Portfolio. Tannenbaum shows remarkable confidence in the company in addition to clear, concise views on what the company was made to do.

What I found interesting was Tannenbaum’s theory on the modern BDC. When talking about the role of a BDC in today’s economy he describes Fifth Street as an intermediary between the large Bank’s, which details quickly as Morgan Stanley, UBS, and ING Bank. Additionally he describes the relationship between both Fifth Street and these large bank, and Fifth Street’s relationship with the businesses it lends to as a more personal relationship where the large banks find comfort in lending to larger more stable companies like FSC and the smaller companies reap the benefit of dealing with a more personal lending experience from FSC.

What I took from the interview was that Fifth Street has positioned itself as a salesman for debt to smaller companies that might be overlooked by the large banks when applying for loans. All while Fifth Street reaps the benefits of preferred lending from these big banks based on their assets and credibility as a BDC over time.

Fifth Street Leaders

After looking through Reuters Director Bio’s I found a list of directors who seem to be exceptionally qualified for the jobs they hold. CEO Tannenbaum has sat on several boards, held positions with large investment firms like Merrill Lynch where he gained analysis experience as an equity analysts. President and former Chief Compliance Officer also has experience on the boards of other profitable companies and gained experience practicing corporate law after graduating from Boston College Law School.

The rest of the board is equally impressive and boasts many designations and experience in notable positions throughout many credible businesses. What I enjoy most about the Reuters data though, is the insider trading.

In terms of the board’s confidence in the company I would say it’s a safe bet to assume those in charge of leading this company to greater profitability are most definitely bullish on FSC’s future. When looking at the Reuters Insider Trading chart you can see there has been nothing but buying from the inside since 2012.

FSC’s Financials

In terms of financials, Fifth Street seems to be doing very well. When looking explicitly at the Fifth Street Finance s://finance.yahoo.com/q/bs?s=FSC+Balance+Sheet&annual | balance sheet over the last 3 years you’ll notice healthy growth in Net Tangible Asset’s averaging an impressive 37.75% growth over said timeframe.

The income statement is no different, with impressive growth in net income year over year for the last 3 years as seen on Yahoo Finance. Over the 3 year time frame FSC has seen growth in Net Income from $30,207 to $101,821, a change of 337.1%

Sales General and Administrative Expenses have grown consistently over the past three years but at a much slower rate than that of sales revenue which is a good sign. After all, it does take money to make money. Though I would keep an eye on liabilities, as on the balance sheet linked to earlier does show substantial growth between 2012 and 2013 but admittedly no where near the growth seen in assets also on the balance sheet.

FSC shows strength in key indicating ratios as well. With a relatively high Market Cap for it’s industry at 1.32 Billion, it is still showing a price to book ratio of 0.96 which is a great sign that the stock is cheap. It’s P/E ratio of 10.96 is relatively good for it’s industry and it’s earnings ratios are exceptional. Revenue is calculated at 221.61 and Earning Before Interest, Taxes, Depreciation and Amortization is 148.42.

Competitors

i.imgur.com_tw5oke0.jpg Two of the leading competitors MCGC and TINY, recommended for comparison by Yahoo Finance and Google Finance respectively, show strengths as well, but overall seem to be lacking in comparison to FSC.

The MCG Capital Corporation (MCGC) provides a service very similar to that of Fifth Street. They specialize in lending capital and advisory resources to middle and small-size companies. MCGC differs from FSC in that it is highly diversified and paints a much different picture in it’s makeup of it’s portfolio. The number of industries in which MCGC invests in comes in at 22, where in contrast FSC shows a much more focused approach. The Harris and Harris Group, Inc. (TINY) is more specifically a venture capital firm that specializes in lending to companies that offer potential for innovation in the nanotechnology space. TINY takes a much more focused approach of conducting business similar to that of FSC. Where they differ is their focus, TINY is heavily focused on disruptive technologies, where as FSC is a lender who focuses on consistent, more “vanilla” investments like healthcare.

The ratios used to measure FSC applied to MCGC and TINY are as follows:

Ratio MCGC TINY
Price to Book 0.75 0.83
P/E N/A N/A
Revenue 50.48 0.47
EBITDA 31.41 -7.97

Though price to earnings ratios for MCGC and TINY both outperform that of FSC, they are lacking in terms of revenue and EBITDA quite a bit. The balance sheet for both MCGC and TINY show losses in Net Tangible Assets year over year in addition to consistent losses in assets. This is in stark contrast to the growth and potential seen in the statements of FSC.

The income statements for both MCGC and TINY also show numbers that aren’t very promising for the future. Revenues for both companies have decreased dramatically over the last 3 years. MCGC began to show promise when posting a profitable year in 2012, but since has seen a drop in Net Income. Even worse, TINY has posted a consistent loss in Net Income over the last 3 years which is far from promising for investors.

Final Thoughts

What I like most about FSC currently is the potential to earn monthly dividends if you buy shares. As Reported by Reuters FSC is now paying monthly dividends to shareholders which offers fantastic opportunity for reinvestments. When considering the time value of money, reinvesting share dividends automatically in a stock that pays monthly as opposed to quarterly, portfolio growth over time will occur much quicker.

Aside from the dividend potential though, I find the strong financials FSC shows as a good sign to buy in currently. Shares are still trading below a market price of $10 which is great news for anyone looking to grow their income generating portion of their portfolio. Though I don’t think there will be any significant appreciation in stock price any time soon, I do see great potential for share count growth through dividend reinvestment in addition to small appreciations in market value over time if it’s financial state persists.

Lastly, I have to emphasis how impressed I was with the interview with CEO Tannenbaum on FSC and it’s state at the time. Hearing a CEO confidently say that he has a substantial portion of his own net worth in the company is a very good sign in my opinion. From a business standpoint, it takes a massive amount of confidence to risk personal net worth on a company that has outside sources of funding. I commend Tannenbaum on this decision and would add that I’m confident in FSC in part by his confidence. I personally currently have, and will be adding to my stake in FSC, so do take research in to your own hands before investing in FSC. Always keep in mind how important it is to evaluate companies yourself before purchasing them to make sure that they fit your investing style.


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