Gladstone Investment: New Acquisition

                                        Many roads lead to Rome

NEWS

MCLEAN, VA / ACCESSWIRE / May 22, 2023 / Gladstone Investment Corporation (GAIN) (“Gladstone Investment”) announced today that on May 12, 2023, it partnered with Xyresic Capital (“Xyresic Capital”) to acquire Home Concepts Holdings, LLC (“Home Concepts”), together with its executive management team. Gladstone Investment provided senior secured debt and the majority of the equity to complete the transaction.

Headquartered in Santa Barbara, CA, Home Concepts is the largest independently owned home improvement advertising publication in the United States. Home Concepts focuses on connecting homeowners to high-quality residential repair and remodeling businesses by publishing and distributing advertising magazines throughout its footprint of more than 3.8 million homeowners across California, Texas, Arizona, Nevada, Washington, Colorado and Tennessee.

“Home Concepts is a market leader in an interesting niche of the direct mail marketing industry, serving as a valuable advertising partner to highly rated residential contractors across several major metropolitan areas. We are very excited to partner with this talented team and look forward to helping the company as it continues to expand into new markets and other advertising channels,” said Peter Roushdy, Executive Vice President and Managing Director of Gladstone Investment.Gladstone Investment – Press Release May 22, 2023

ANALYSIS

Routine

A number of BDCs – especially those operating in the lower middle market (LMM) and in venture debt – like to announce investments, or even add-ons – in portfolio companies.

In this case, we’re hearing from GAIN after a similar type of announcement last week from Main Street Capital (MAIN) last week, which was carried in the BDC News Feed.

In neither case do we learn much from these occasional press releases that move the needle in any direction.

A Little Deeper

In this case, though, we’ve done some digging in the public record and can offer a little more color than one might get from reading the press release alone.

First, this seems to be the first time GAIN has linked up with the nominal “sponsor” – Xyresic Capital – on an acquisition.

Who Is Who

Xyresic seems to be a two-person buyout group based in Chicago with – as far as we can see – only one prior buyout to their name.

Their website offers no bio information about its principals or any other meaningful information.

Here is a link to the website.

We poked around in the public record and found that the principals of the firm are Brad Eden and Christopher Kipley, according to a source.

According to Crunchbase, Mr. Eden is a very busy man: holding “3 current jobs including Principal at Xyresic Capital, Managing Member at Eden Capital, and Global Head of Marketing and Investor Relations at Highland Capital Management“.

(We don’t know if that information is up to date or not).

History

Unclear is whether the sponsor has committed capital to invest or is what is called a “fundless sponsor“

We also learned that Xyresic previously joined forces with Capital Southwest (CSWC) on a transaction in 2021.

The two joined forces to finance the acquisition of Tele-Town Hall late in 2021.

CSWC provided both first and second-lien debt, as well as cost-less equity.

As of IQ 2023, the BDC had advanced $14.9mn and values its investment at a slight premium – suggesting Tele-Town Hall is performing at or above expectations.

Founded in 2003 and headquartered in Arlington, VA, TTH is a leading provider of mass communication service solutions that allow its customers to engage and manage large-scale audiences simultaneously using ultra-high-capacity, real-time voice and messaging products that provide significantly greater functionality than traditional webinar and conferencing services.Press Release

Same But Different

From the sparse details available to us, we get the impression that the approach of CSWC and GAIN differ where partnering with firms like Xyresic is concerned.

In their 10-Q, CSWC carries its position in Tele-Town Hall as a “Non-Control/Non-Affiliate investment”. These are defined by the Investment Company Act of 1940 “as investments that are neither control investments nor affiliate investments”.

Bite Sized

To generalize, CSWC likes to take relatively small equity positions – along with debt – in their portfolio companies.

This has been a winning strategy for the BDC, which indicates that “At December 31, 2022, approximately 80.8% of the Company’s investment assets were non-control/non-affiliate investments. The fair value of these investments as a percent of net assets is 165.4%”.

We count 69 CSWC portfolio companies in this category out of 81 (only 1 of which is considered a Control investment).

Big Bites

By contrast, GAIN has far fewer portfolio companies and tends to take much larger equity stakes in its companies.

As mentioned in the press release, GAIN provided the “majority of the equity” in the just-announced Home Concepts transaction.

We would suppose that the investment will show up as an “Affiliate” or “Control” investment when we see the calendar second quarter Consolidated Schedule Of Investments.

VIEWS

Different

All the “analysis” above is to illustrate the different strategic approaches that BDCs have chosen to address the LMM.

CSWC has deliberately chosen to own a relatively diversified portfolio, with small equity stakes in a large number of businesses.

By contrast, GAIN has a much smaller portfolio (one-quarter the number of portfolio companies of CSWC) but tends to own much larger positions.

About 10% of CSWC assets are in the form of preferred and common stock positions in portfolio companies while GAIN’s is closer to a third.

CSWC aims at harvesting smaller, more frequent equity gains while GAIN’s successes are likely to be individually larger, but less frequent.

Results

These are long-term approaches that need to be appraised over multi-year periods.

As this chart shows, both BDCs have performed well over the past 5 years from a price standpoint – both well in excess of the sector as a whole, measured by BIZD – the only BDC ETF:

From a price standpoint alone GAIN – which had several equity home runs in this period – performed the best.

All In

On the other hand, Seeking Alpha calculates that over the same time period, CSWC generated a “total return” – thanks to including dividends paid out – of 117% (23.4% per annum).

GAIN’s total return was 71% or 14.2% per annum.

That’s also an above-average return, but lags behind CSWC, which itself was the third-best public BDC by this metric over this time period.

Bigger Picture

Tellingly, of the BDCs with the best total returns over the last 5 years, 5 (including CSWC and GAIN) are LMM-focused, investing in both debt and equity – each with a different strategic method.

The top LMM player – and second in the top ten table – is Fidus Investment (FDUS) – whose approach is more similar to CSWC than GAIN – with a return of 142%.

(The most popular LMM-focused BDC – MAIN – is ranked 11th, with a 70% return).

Lest We Forget

At a time when most BDCs – by number and AUM – are involved in the middle market (MM) and upper middle market (UMM), it’s good to remember that there are superior returns to be had in what was the original fishing grounds for the BDC sector: the fragmented and often under-appreciated LMM.

As we’ve tried to show in this article, though, there are different approaches to choose from.

The best news, though, is that most of the LMM-focused BDCs in this market have managed to offer their shareholders above-average returns over time.