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Prospect Capital Corp. - Initiation Note

Prospect Capital Corp.

NEUTRAL (PSEC, $6.05)

Despite a Strong Origination Platform, Fees Are Far Too High, 30% Basket Likely to Weigh on NAV Multiple - Initiating With A NEUTRAL Rating And $7 Price Target.

January 29, 2016

Christopher R. Testa

212.417.7447

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Investment Conclusion. We are initiating coverage of Prospect Capital Corporation (PSEC) with a NEUTRAL rating and $7 price target. Prospect has a diverse portfolio which includes sponsored and direct originations, CLO equity, real estate, and online lending. PSEC has 18.2% of the portfolio by fair value in CLO equity, with another 50 bps of the portfolio by fair value in CLO debt. Additionally, the company has investments in a REIT (real estate investment trust) in the portfolio which is primarily focused on multifamily assets. Prospect has for some time discussed spinning off portions of its CLO book, real estate portfolio, and the online consumer lending. While the spinoff would assist in the valuation of the BDC, as the market has made it clear that assets like CLO equity should not be in a BDC (despite our belief that CLO equity is a great asset class), the spinoffs are not ridding PSEC of the non-BDC assets in their entirety. Additionally, fees at PSEC need to be reduced substantially. The base fee is near the high end of the sector at 2.00% and the incentive fee hurdles are towards the lower end with no lookback feature. Base and incentive fees have increased significantly in fiscal years where NAV/share and NII/share declined. We think that absent a complete spinoff of non-qualifying assets and significant fee reductions, Prospect will continue to trade at sizable discounts to NAV. NIM (net investment margin) has decreased the past three fiscal years from 14.72% in fiscal 2013, 10.73% in fiscal 2014, and 9.55% in fiscal 2015. Our $7 price target implies an estimated fiscal 2017 P/NII (Price/NII) of 6.8x, dividend yield of 14.3%, and P/NAV (Price/NAV) of 0.70x compared to the BDC sector averages of 7.0x, 14.7%, and 0.71x, respectively.

PSEC

Source: S&P Capital IQ, National Securities Corporation Estimates


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