KCAP Financial Targeted by an Activist; What the Smart Money Thinks about the Stock?

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According to a recent 13D filing with the U.S. Securities and Exchange Commission, Dov Gertzulin’s DG Capital Management holds an ownership stake of 1.15 million shares in KCAP Financial Inc. (NASDAQ:KCAP), accouting for 3.1% of the company’s outstanding common stock. This marks an increase of 43,723 shares from the position reported through the fund’s latest 13F filing. All these shares were acquired through open-market transactions during the period of April 9 – October 5, 2015. DG Capital outlined that the shares of KCAP represent an attractive investment opportunity and pinpointed potential alternatives of how to unlock shareholder value. The following article will discuss in greater detail DG Capital’s letter to KCAP’s Board of Directors and the actual performance of the company over the last year or so.

We track hedge funds and prominent investors because our research has shown that historically their stock picks delivered superior risk-adjusted returns. This is especially true in the small-cap space. The 50 most popular large-cap stocks among hedge funds had a monthly alpha of about 6 basis points per month between 1999 and 2012; however the 15 most popular small-cap stocks delivered a monthly alpha of 80 basis points during the same period. This means investors would have generated 10 percentage points of alpha per year simply by imitating hedge funds’ top 15 small-cap ideas. We have been tracking the performance of these stocks since the end of August 2012 in real time and these stocks beat the market by 60 percentage points (118% return vs. S&P 500’s 57.6% gain) over the last 36 months (see the details here).

Prior to proceeding with the discussion on the DG Capital’s activist target, we will provide a brief introduction to this investment firm. DG Capital Management is an even-driven hedge fund established by its current managing member Dov Gertzulin in 1996. The Boston-based investment firm primarily invests in core and growth stocks of mid- and large-cap companies. DG Capital manages capital for high net-worth individuals, foundations, pensions, and family offices. As stated by its latest 13F with the SEC, Dov Gertzulin’s investment firm manages an equity portfolio with a market value of $113.07 million as of June 30.

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Let’s now turn our attention to KCAP Financial Inc. (NASDAQ:KCAP), an internally-managed business development company that specializes in mid-market, buyouts, and mezzanine investments. The shares of KCAP have been riding a downtrend since early-March and have lost 23% year-to-date. However, it seems that the stock is bouncing back at the moment, thanks to the broader market rally and to DG Capital’s activist stance. When it comes to the hedge fund sentiment, KCAP Financial did not receive too much attention from the hedge fund industry during the second quarter, as the number of investors with positions in the stock decreased to five from six quarter-over-quarter. However, the value of these positions increased to $8.66 million from the $2.06 million reported at the end of the first quarter. The handful of hedge funds invested in the stock accumulated 3.90% of the company’s outstanding shares at the end of June. Meanwhile, John Fichthorn’s Dialectic Capital Management acquired a 127,000-share position in KCAP Financial during the June quarter.

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