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đšTroubles at Main Street Capitalđš
Main Street Capital (NYSE: MAIN â $1.15 billion) is a Houston-based Business Development Company that invests in lower-mid-market debt and equity with a focus on the oil and gas sector. Until recently, MAIN was viewed as the golden child of BDCs and typically traded at a 40-70% premium above NAV (almost unprecedented for a BDC). I believe recent market events could impair MAINâs investments and expose its questionable accounting.
MAIN is the type of company that will be hit hard by the coronavirus crisis and low oil prices. MAIN uses leverage, invests in small companies that tend to have weaker balance sheets, and has relatively high exposure to the oil and gas markets. In its 10-K risk factors MAIN discloses the following:
âa decline in oil and natural gas prices would adversely affect the credit quality of our debt investments and the underlying operating performance of our equity investments in energy-related businesses.â
The market understands this and MAIN currently trades for 25% discount to its 2019 year-end NAV of $23.91. In my opinion, what makes MAIN interesting at current prices is its questionable accounting that could unwind during this downturn. Among other red flags, MAIN does not use a big four auditor, has delayed writing down impaired assets, and had an Enron executive as its first Chief Accounting Officer.
Two examples of delayed write-downs at MAIN are its loans to Glowpoint and AAC Holdings.
In October 2013, MAIN gave Glowpoint, a small publicly traded videoconferencing company, a $9 million secured loan. From year-end 2013 to year-end 2015, Glowpointâs revenue fell 24%, the company lost $4.9 million, and the stock fell ~80%. Glowpoint said in its 2015 10-K that it would likely violate the loan covenants and said,
â[We have] substantial doubt as to our ability to continue as a going concern.â
Despite all these problems, at 2015 year-end, MAIN carried the Glowpoint loan at cost. Today the debt carries no value.
A more recent example is MAINâs $14 million loan to AAC Holdings in June 2017 with a June 2023 expiration. At the time AAC stock traded for around $7/share. AACâs financial results deteriorated and by December 31, 2018 the stock was below $2/share and AAC stated,
âThe uncertainties associated with the factors described above raise substantial doubt about our ability to continue as a going concern.â
Despite AACâs difficulties, MAIN Street carried its loan to AAC $1,000 above cost! Today AAC trades on the pink sheets and MAIN carries its loan at a 33% discount.
With these valuation marks you might be wondering who is charge of MAINâs accounting. Rest assured, you are in good hands. MAINâs first Chief Accounting Officer, Michael S. Galvan, worked at Enron:
MAINâs current Chief Accounting Officer, Lance A. Parker, served as an auditor for Arthur Andersen from 1993 to 2003. Four of MAINâs board members, including its CEO, all worked at Arthur Andersen as well.
In addition, unlike most large BDCâs, MAIN does not use a big four auditor. Instead MAIN uses Grant Thornton, which was fined $3 million by the SEC for deficient audits.
Two other factors that further hurt MAIN are lower interest rates and the inability to issue equity at a NAV premium. As of December 31, 2019, approximately 74% of MAINâs debt investment portfolio bore interest at floating rates, meaning lower interest rates would lead to less interest income for MAIN.
Most troubling is that MAIN can no longer issue shares at a premium to NAV. In the past MAIN had aggressively issued shares. In fact, MAINâs shares outstanding are up seven-fold over the last twelve years. These share issuances were the primary driver of NAV increases at MAIN, but are no longer an option.
In sum, MAIN is invested in distressed sectors, can no longer grow NAV through equity issuances, and will have its accounting tested in the coming months. Caveat Emptor.
Bridgewater Underwater?
Bridgewaterâs Pure Alpha fund is down 21% as of Monday, March 16th, according to the WSJ. In a note to clients, Dalio said that the performance was ânot what I would wantâ but was âconsistent with what I would have expected under the circumstances.â He also criticized those who spread rumors about Bridgewaterâs financial health and wrote,
 âI think we might have identified the rumor monger which we will pursue legally and disclose publicly if we are able.â
Bridgewaterâs losses come amidst much bad publicity. In January, the Wall Street Journal published a blockbuster investigation into Dalio and Bridgewater. Hereâs an excerpt:
âSeveral years ago, Mr. Dalio arranged a conversation with Russian President Vladimir Putin to discuss economic policy, said some of these employees. Employees expressed concerns about engaging with the autocratic leader, and Mr. Dalio told one that âif youâre so smart, why arenât you rich?â according to people who heard the comment.â
Dalio responded to the WSJ investigation with a LinkedIn post titled, âThe Wall Street Journalâs Fake and Distorted News.â
In 2017, Grantâs Interest Rate Observer published a critical piece of Bridgewater. After a litany of serious charges, Grant concluded his report,
âMany are the mysteries and contradictions of the worldâs largest hedge fund. We will go out on a limb: Bridgewater is not for the ages,â
Jim Grant later apologized for his reporting and said, âwe were wrong.â You can read all about it here. Â Â
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Contact: edorsey@stanford.edu / (718) 873-2362 / @StockJabber