Business Context and Reporting Period
Ares Capital Corporation (ARCC) is a closed-end, non-diversified management investment company regulated as a Business Development Company (BDC) under the Investment Company Act of 1940. The company invests primarily in first and second lien senior loans and mezzanine debt of U.S. middle-market companies. This summary covers the fiscal year ended December 31, 2009.
As of December 31, 2009, Ares Capital managed approximately $8 billion of total committed capital under management, including available debt capacity and funds managed by its portfolio company, Ivy Hill Asset Management, L.P. (IHAM). The company is externally managed by Ares Capital Management LLC.
Key Financial Metrics
| Metric | 2009 | 2008 |
|---|---|---|
| Total Investment Income | $245.3 million | $240.5 million |
| Net Investment Income | $133.4 million | $127.0 million |
| Net Realized Gains (Losses) | ($19.4 million) | $6.4 million |
| Net Unrealized Gains (Losses) | $88.7 million | ($272.8 million) |
| Net Increase in Stockholders' Equity | $202.7 million | ($139.5 million) |
| Total Assets | $2.31 billion | $2.09 billion |
| Total Debt Outstanding | $969.5 million | $908.8 million |
| Stockholders' Equity | $1.26 billion | $1.09 billion |
| Net Asset Value (NAV) per Share | $11.44 | $11.27 |
| Weighted Average Yield (Fair Value) | 12.67% | 12.79% |
| Asset Coverage Ratio | 230% | 200% (implied) |
Liquidity: As of December 31, 2009, the company held $99.2 million in cash and cash equivalents. It had approximately $252.1 million available for additional borrowings under its credit facilities and debt securitization, subject to leverage restrictions.
Material Changes vs. Prior Period
- Portfolio Valuation Recovery: The company reported a significant turnaround in unrealized gains/losses. In 2008, the portfolio suffered $272.8 million in net unrealized losses due to market dislocation. In 2009, the portfolio recorded $88.7 million in net unrealized gains, driven by improved market conditions and the reversal of prior period depreciation upon the exit of certain investments.
- Investment Activity: New investments funded in 2009 totaled $465.6 million, a decrease from $735.2 million in 2008, reflecting a more selective approach due to market conditions. However, the weighted average yield on new investments increased to 13.42% (fair value) in 2009 from 12.57% in 2008.
- Expense Management: Total expenses decreased slightly to $111.3 million in 2009 from $113.2 million in 2008. Interest expense and credit facility fees dropped significantly by 34% to $24.3 million, despite higher average borrowings, due to a decline in the average cost of borrowing from 4.06% to 2.16%. This was partially offset by a 113% increase in professional fees, largely due to costs associated with the pending Allied Acquisition.
- Dividends: Cash dividends declared per share decreased to $1.47 in 2009 from $1.68 in 2008.
Guidance, Outlook, and Material Events
Pending Allied Acquisition
On October 26, 2009, Ares Capital entered into a definitive agreement to acquire Allied Capital Corporation in an all-stock transaction. As of February 24, 2010, the transaction was valued at approximately $778 million. The deal is subject to stockholder approval and other customary closing conditions. The company expects to complete the acquisition in the first quarter of 2010.
- Competing Proposal: Prospect Capital Corporation made three unsolicited non-binding offers to acquire Allied Capital in early 2010. Allied Capital's board unanimously rejected all offers, reaffirming its commitment to the Ares Capital merger.
- Legal Proceedings: Several lawsuits have been filed by Allied Capital stockholders challenging the merger, alleging breaches of fiduciary duty. These proceedings could delay or prevent the transaction.
Recent Developments (Post-Year-End)
- Debt Facilities: On January 22, 2010, the company amended its Revolving Credit Facility, increasing capacity to $690 million and extending the maturity to 2013. It also combined its CP Funding Facilities into a single $400 million facility.
- Equity Offering: In February 2010, the company completed a public add-on equity offering of approximately 23 million shares, raising approximately $278 million net of costs.
Risks and Contingencies
- Market Conditions: The company faces risks related to capital market volatility, which affects investment valuations and the ability to raise capital.
- Leverage: The company utilizes leverage to enhance returns. A decline in asset values could cause the company to breach asset coverage ratios, restricting further borrowing or dividend payments.
- Valuation Uncertainty: Approximately 172% of net assets are invested in private companies valued by the Board of Directors in the absence of readily available market quotations. These valuations are inherently uncertain.
Investor Verification Checklist
- Allied Acquisition Status: Verify the current status of the Allied Capital merger, including stockholder vote results and any updates on the competing Prospect Capital proposal or litigation.
- Portfolio Credit Quality: Review the distribution of investment grades. As of Dec 31, 2009, the weighted average grade was 3.0, with 2.51% of investments at amortized cost on non-accrual status.
- Debt Covenants: Confirm continued compliance with asset coverage ratios (230% as of year-end) and debt facility covenants, especially given the recent refinancing activities.
- Valuation Methodology: Scrutinize the independent valuation firm reports for the 50% of the portfolio (by value) subject to external review, given the significant unrealized gains recorded in 2009.
- Dividend Sustainability: Assess the company's ability to maintain dividend distributions given the requirement to distribute 90% of taxable income to maintain RIC status, particularly if non-cash income (PIK) remains high.