MCG Capital (MCGC) – Part 3 - Outlook

Below is a comparison of MCGC’s Price to Net Asset Value (NAV) ratio over the years:

Year	Net Asset Value	Share Price	Price To NAV ratio
2003	11.98	19.83	1.66
2004	12.22	17.13	1.40
2005	12.48	14.59	1.17
2006	12.83	20.32	1.58
2007	12.73	11.77	0.92

MCG Capital’s NAV at EOY 2007 was $12.73 and currently the stock is trading under $6, more than 50% below the NAV. As a Business Development Company (BDC), MCG Capital shareholder approval is required to issue equity at a price below NAV. The other available choice for the company to raise capital is to offer rights. The associated dilution along with confusion about the details of the offering has sent the stock tumbling 40% in the last month.

MCGC’s debt is structured by maturity level as follows as of EOY 2007:

Maturity	Amount	Percentage of Total Debt
Less than 1 year	168.9M	22.17
1-3 years	175.8M	23.07
4-5 years	4.3M	0.56
After 5 years	412.9M	54.19

More than 45% of its debt is due in the next three years. MCG Capital is finding it increasingly hard to issue debt to restructure some of this debt in this tight credit environment. The company has already paid a heavy price for its current tough liquidity situation. Management was short-sighted in choosing short-term debt maturing in 1-3 years, not anticipating the tough credit environment. MCG Capital has plans to alleviate the situation by liquidating some of its debt and equity in portfolio companies. MCG Capital’s ability to sustain dividend levels is directly associated on their success in raising funds. Further, without new funds, originations will also decline.

The management is entrusted to make the right choices in both capital requirements and portfolio selection. Looking back, it is evident that MCG Capital was overly aggressive in both acquiring capital and originations. Also, some of the investment choices were mediocre and the timing was less than optimal.

Investment in a BDC is a good proxy to investing in small private companies. The sizeable yield compensates well for some of the risks associated with investing in a basket of small private enterprises and their debt. An investment in MCG capital fits this profile well. Even with the problems and management missteps, one has to recognize the sizeable discount to NAV. It must be understood that the investment will under perform the overall market in an extended downturn in the economy. Allocating a small amount of the small-cap portion of ones diversified portfolio in MCG Capital should provide good overall returns over the long-term.

Related Posts:

1. MCG Capital (MCGC) - Part 1 - Introduction.
2. MCG Capital (MCGC) - Part 2 - Business Issues.
3. MCG Capital (MCGC) - Part 3 - Outlook.