Profile: Fifth Street Finance Corp (FSC.OQ)
13 Mar 2014
Fifth Street Finance Corp., incorporated on October 9, 2007, is a specialty finance company that lends to and invests in small and mid-sized companies, primarily in connection with investments by private equity sponsors. The Company's investment objective is to maximize the Company's portfolio's total return by generating current income from its debt investments and capital appreciation from its equity investments. As of September 30, 2013, the Company consists of of 99 investments, 86 of which were in operating companies and 13 of which were in private equity funds. The 13 investments in private equity funds represented less than 1% of the fair value of the Company's assets at September 30, 2013 . The Company is externally managed and advised by Fifth Street Management LLC.
The Company generally invests in securities that are rated below investment grade by rating agencies or that would be rated below investment grade if they were rated. Below investment grade securities, which are often referred to as high yield or junk, have predominantly speculative characteristics with respect to the issuer's capacity to pay interest and repay principal. of September 30, 2013 , 77.5% of the Company's portfolio at fair value consisted of debt investments that were secured by first or second priority liens on the assets of its portfolio companies. Moreover, the Company held equity investments consisting of common stock, preferred stock or other equity interests in 44 of its 99 portfolio companies as of September 30, 2013 .The Company generally invests in companies with established market positions, seasoned management teams, products and services and regional or national operations.
The Company's deal originating efforts are focused on building relationships with private equity sponsors that are focused on investing in the small and mid-sized companies that the Company targets. The Company divides the country geographically into Eastern, Central and Western regions and emphasizes active, consistent sponsor coverage. The investment professionals of the Company's investment adviser have developed a network of relationships with these private equity sponsors. The Company estimates that there are approximately 1,500 of such private equity firms and its investment adviser has active relationships with approximately 240 of them.
Investment Underwriting Process and Approval
The Company makes its investment decisions only after consideration of a number of factors regarding the potential investment including, but not limited to: historical and projected financial performance; company and industry specific characteristics, such as strengths, weaknesses, opportunities and threats; composition and experience of the management team, and track record of the private equity sponsor l the transaction. The Company's investment adviser uses a proprietary scoring system that evaluates each opportunity. This methodology is employed to screen a high volume of potential investment opportunities on a consistent basis.
Private Equity Sponsor
A private equity sponsor is typically the controlling shareholder upon completion of an investment and as such is considered critical to the success of the investment. The private equity sponsor is evaluated along several key criteria, including Capacity and willingness to provide additional financial support to the Company through additional capital contributions, if necessary, and Investments. As of September 30, 2013 , 77.5% of the Company's portfolio at fair value consisted of debt investments that were secured by first or second priority liens on the assets of the portfolio company.
The Company tailors the terms of its debt investments to the facts and circumstances of the transaction and prospective portfolio company, negotiating a structure that seeks to protect its rights and manage its risk while creating incentives for the portfolio company to achieve its business plan. A substantial source of return is monthly cash interest that the Company collect on its debt investments. As of September 30, 2013 , the Company had directly originated a majority of its debt investments..
The Company's first lien loans generally have terms of four to six years, provide for a variable or fixed interest rate, contain prepayment penalties and are secured by a priority security interest in all existing and future assets of the borrower. The Company's first lien loans may take many forms, including revolving lines of credit, term loans and acquisition lines of credit. The Company's second lien loans generally have terms of four to six years, primarily provide for a fixed interest rate, contain prepayment penalties and are secured by a second priority security interest in all existing and future assets of the borrower. The Company's second lien loans often include payment-in-kind, or PIK, interest, which represents contractual interest accrued and added to the principal that generally becomes due at maturity. The Company's unsecured investments generally have terms of five to six years and provide for a fixed interest rate. The Company may make unsecured investments on a stand-alone basis, or in connection with a senior secured loan, a junior secured loan or a one-stop financing. The Company's unsecured investments may include PIK interest and an equity component, such as warrants to purchase common stock in the portfolio company.
The Company typically structures its debt investments to include covenants that seek to minimize its risk of capital loss. The Company's debt investments have protections, including default penalties, information rights, board observation rights, and affirmative, negative and financial covenants, such as lien protection and prohibitions against change of control. The Company's debt investments also have substantial prepayment penalties designed to extend the life of the average loan, which the Company believes will help to grow its portfolio.
Private Equity Fund Investments
The Company makes investments in the private equity funds of certain private equity sponsors the Company partners with in making investments in small and mid-sized companies. In general, the Company makes these investments where the Company has a long term relationship and is comfortable with the sponsor's business model and investment strategy. As of September 30, 2013 , the Company had investments in 13 private equity funds.
The Company provides managerial assistance to its portfolio companies as a general practice and the Company seeks investments where such assistance is appropriate. The Company monitors the financial trends of each portfolio company to assess the appropriate course of action for each company and to evaluate overall portfolio. The Company uses an investment ranking system to characterize and monitor the credit profiles and its expected level of returns on each investment in its portfolio. The Company uses a four-level numeric ranking scale. The Company determines that an investment is underperforming, or circumstances suggests that the risk associated with a particular investment has significantly increased, the Company will undertake more aggressive monitoring of the affected portfolio company. The Company generally invests in illiquid securities including debt and equity investments of small and mid-sized companies.
The Company performs detailed valuations of its debt and equity investments on an individual basis, using bond yield, income and market approaches as appropriate. In general, the Company utilizes a bond yield method for the majority of its investments, as long as it is appropriate. If, in the Company's judgment, the bond yield approach is not appropriate, the Company may use the market approach, income approach, or, in certain cases, an alternative methodology potentially including market quotations, asset liquidation model, expected recovery model or other alternative approaches. the Company uses bond yield models to determine the present value of the future cash flow streams of its debt investments. The Company review various sources of transactional data, including private mergers and acquisitions involving debt investments with similar characteristics, and assess the information in the valuation process.
Fifth Street Finance Corp
12th Floor, 10 Bank Street
WHITE PLAINS NY 10606