Great Elm Capital Corp. (NYSE:NASDAQ: GECC) (the “Company“) is a externally managed business development company (“BDC”) under the Investment Company Act of 1940, as amended. The BDCs, like the Company, are in the business of lending to small and medium enterprises. Its external manager is Great Elm Capital Management. The Company is the surviving company of a 2016 merger. At the time of writing (end of August), the common stock of the Company has lost more than a third (1/3) of its value since the start of the year and more than 40% of its value compared to the previous year.
I’m bearish on the company for a variety of reasons, including poor quarterly financial results for the last quarter (June 30, 2022); a significant decline in net asset value per share for the quarter and consistent declines in net asset value throughout its history; the shift in incentives associated with external management; the current market environment (ie, rising rates and increased credit risk); the Company’s inability to pay a consistent dividend (recently cut, as discussed below); and the company’s unimpressive track record.
In addition to its common stock, the Company has publicly traded “baby bonds” outstanding, including not guaranteed listed bonds due June 30, 2024 (GECCN), January 31, 2025 (GECCM) and June 30, 2026 (GECCO) (collectively, the “Banknotes in circulation“). At current prices, I find none of the outstanding Bonds offering sufficient value relative to the risks. Furthermore, I do not believe that the Company will be able to refinance the Bonds without increasing its cost of capital. .
According to its recent 10Q filing for the quarter ended June 30, 2022 (page 3), the Company seeks to generate current income and capital appreciation through income-producing debt and equity investments, including investments in specialized financial activities. Specifically, the Company invests in secured and senior debt securities of middle market companies, as well as income-generating equity investments in specialty finance companies.
Management presents itself as a value-oriented manager, investing in investments that offer sufficient downside protection and have the potential to generate attractive returns. The Company generally defines mid-market companies as companies with an enterprise value between $100 million and $2 billion. The Company will make investments in other parts of a company’s capital structure, including (but not limited to) subordinated debt, mezzanine debt and equity/equity-linked securities.
Details regarding the Company’s investment portfolio can be found in the Company’s second quarter slides below. presentation of the results.
Since the merger in 2016, it is fair to say that the Company is, if nothing else, among the worst performers in the BDC space. The Company has been destroying value at a staggering rate, as shown in the table below.
PAINTING SOURCE: Bashar Issa
Recent financials and earnings
The Company’s unaudited balance sheet included in its most recent quarterly filing with the SEC (10-Q linked above; page F-22) shows a decline in total assets during the six-month period ended 30 June 2022, approximately $80 million; a decrease in total liabilities of approximately $103 million for the period; and net asset value per share decrease significantly (more on that below) for the period.
Shares of the company were trading around $12.20 at the time of writing. The company’s earnings call for the quarter ended June 30, 2022 highlighted, among other things, the following:
Our NAV per share was $12.84 as of June 30, 2022 compared to $15.06 as of March 31, 2022 and $23.40 as of June 30, 2021. Net asset value per share at the end of the quarter was impacted by the approximately three million shares issued under the rights offering in June. Details of the change in net asset value from quarter to quarter can be found on slide 7 of the investor presentation.
As of June 30, 2022, GECC’s asset coverage ratio was approximately 166.9%, compared to 147.5% as of March 31, 2022. GECC recorded a net loss of $0.87 per share in the second quarter, compared to a net loss of $1.12 per share in the prior quarter. NII per share was $0.23, compared to $1.31 in the prior quarter, which included the impact of the incentive bonus waiver.
All per share amounts are based on weighted average shares and have been adjusted for the 6 to 1 reverse split which became effective on February 28, 2022. As of June 30, our total debt outstanding was approximately $145.9 million, comparable to the debt outstanding as of March 31, 2022. Our $25 million line of credit dollars remains entirely unused.”
A few notable things. First, the external manager has waived part of the management fees owed to it by the Company; however, if the Company does well in the future, the Management Company is likely to recoup the waived fees. According to 10Q (page 16), recent changes to the management agreement also appear to make it easier for the external manager to collect incentive (non-shareholder friendly) fees. Second, the reverse stock split earlier in 2022 is a clear sign of weakness. Third, the declines in net asset value made by management have been breathtaking, dropping nearly 50% from the prior year. Fourth, asset coverage must be 150% or more under applicable regulations of the Investment Company Law; this will result in future dilutive share issuances unless the Company can improve its financial performance and asset coverage, among other things.
In terms of cash flow, according to the 10-Q linked above (page F-25), net cash flow from operating activities was approximately negative 9.6 million as of June 30, 2022 compared to approximately $15 million as of June 30, 2021; net cash from investing activities was approximately negative $37 million as of June 30, 2022 and June 30, 2021, respectively; and net cash provided by financing activities was approximately negative $30 million as of June 30, 2022 compared to approximately $43.1 million as of June 30, 2021. Cash and cash equivalents are less than $2 million as of June 30, 2022. Due to liquidity issues, the Company has was forced to issue shares under a right offering during the quarter, and this offering was found to be dilutive in the earnings call (transcript linked above). In addition to the dilution, the Company reduced the quarterly dividend from $0.60 per share to $0.45 per share. If the Company cannot increase its cash, future dividend cuts may be necessary. The Company may also be required to sell assets at inopportune times.
Overall, the company is performing poorly (the company had investment losses of $27 million through June 30, 2022), has historically performed poorly (see table above), and is now looking to focus on investments in the area of specialized finance (see the slide below presenting the results call). I doubt this change of direction will prove transformative.
For the reasons stated above, I am bearish on the company’s common stock.
At current prices, I’m also bearish on the company’s outstanding notes. Income investors may want to consider Great Ajax Corporation (AJXA) baby bonds instead (see my article on this company here).
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