Business Context and Reporting Period
Company: EQUUS TOTAL RETURN, INC. (EQS)
Filing Type: Form 10-Q (Quarterly Report)
Period Ended: June 30, 2016
Business Overview: A Delaware corporation operating as a Business Development Company (BDC) and a Regulated Investment Company (RIC). The Fund invests in debt and equity securities of companies with enterprise values between $5.0 million and $75.0 million, focusing on growth, leveraged buyouts, and special situations. As of June 30, 2016, the Fund held 12,673,646 shares of common stock outstanding.
Key Financial Metrics
| Metric | Six Months Ended June 30, 2016 | Six Months Ended June 30, 2015 |
|---|---|---|
| Total Investment Income | $365,000 | $133,000 |
| Total Expenses | $1,550,000 | $1,801,000 |
| Net Investment Loss | $(1,185,000) | $(1,668,000) |
| Net Realized Gain (Loss) | $(3,000) | $(2,483,000) |
| Net Change in Unrealized Appreciation | $3,198,000 | $5,782,000 |
| Net Increase in Net Assets from Operations | $2,309,000 | $1,784,000 |
| Net Asset Value (NAV) per Share | $3.13 | $2.94 (Dec 31, 2015) |
| Market Price per Share | $1.78 | $1.90 (June 30, 2015) |
| Total Assets | $67,723,000 | $52,530,000 (Dec 31, 2015) |
| Total Liabilities | $28,106,000 | $15,222,000 (Dec 31, 2015) |
| Cash and Cash Equivalents | $13,250,000 | $17,036,000 (Dec 31, 2015) |
| Borrowings (Margin Account) | $27,986,000 | $15,000,000 (Dec 31, 2015) |
Material Changes vs. Prior Period
- Investment Income: Increased significantly from $133,000 to $365,000 (six months), driven by new income-producing investments, specifically a loan to Biogenic Reagents, LLC, and dividends from MVC Capital, Inc.
- Expenses: Decreased from $1.8 million to $1.55 million, primarily due to the absence of officer and employee bonuses paid in the first quarter of 2015.
- Net Investment Loss: Narrowed from $(1.67) million to $(1.19) million due to higher income and lower expenses.
- Unrealized Appreciation: Net unrealized appreciation increased by $3.2 million, largely due to a $4.7 million increase in the fair value of PalletOne, Inc. and a $0.3 million increase in MVC Capital, Inc. This was partially offset by a $1.5 million decrease in Equus Energy, LLC due to lower oil and gas prices.
- Liquidity and Debt: Borrowings under the margin account increased from $15.0 million to $28.0 million. This increase was a strategic move to purchase U.S. Treasury bills to maintain RIC diversification requirements. These borrowings were repaid in July 2016.
- Portfolio Composition: Investments in portfolio securities grew from $19.4 million to $25.1 million. The "Shipping products and services" sector (PalletOne) now represents 36.1% of net assets.
Guidance, Outlook, Risks, and Unusual Items
- Reorganization Plan: The Fund is pursuing a reorganization with MVC Capital, Inc. (MVC). This involves a potential merger or consolidation. If not merged with MVC, the Fund intends to consolidate with an MVC portfolio company, terminate its BDC election, and restructure as a publicly-traded operating company focused on energy and/or financial services.
- Equity Incentive Plan: Shareholders approved a 2016 Equity Incentive Plan on June 13, 2016, allowing for the award of restricted stock and options to attract and retain talent. No awards have been granted yet.
- Market Conditions: Management notes that the Fund's stock trades at a significant discount to NAV (43.1% as of June 30, 2016). Strategies have shifted from originating new debt/equity to preserving liquidity and monetizing assets.
- Risks:
- Concentration Risk: The Fund is "non-diversified." PalletOne, Inc. represents 36.1% of net assets, making the Fund highly sensitive to the performance of this single entity.
- Valuation Risk: A significant portion of the portfolio ($21.5 million) consists of Level 3 assets (unobservable inputs), requiring significant management judgment and subject to volatility.
- RIC Status: The Fund relies on margin borrowings to maintain RIC tax status. Failure to access these funds could result in corporate income tax liability.
- Unusual Items: The Fund recorded a $2.8 million realized loss in the prior year (2015) from the sale of Spectrum Management, LLC. In the current period, realized losses were negligible ($3,000).
Investor Verification Checklist
- Reorganization Status: Verify the current status of the proposed merger/consolidation with MVC Capital, Inc. and the likelihood of terminating BDC status.
- PalletOne Concentration: Assess the financial health and valuation methodology of PalletOne, Inc., which comprises over one-third of the Fund's net assets.
- Equus Energy Valuation: Review the impact of continued low oil and gas prices on the valuation of the Equus Energy, LLC investment, which has seen a $1.5 million decline in fair value.
- Margin Loan Usage: Confirm the Fund's ability to continue utilizing margin accounts to maintain RIC status and the associated interest costs.
- NAV Discount: Analyze the widening discount between the market price ($1.78) and NAV ($3.13) and management's strategy to address it.