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Prospect Capital Corporation (PSEC), Fifth Street Finance Corp. (FSC): How Main Street Capital Corporation (MAIN) Makes Money

Since its IPO in 2007, Main Street Capital Corporation (NYSE:MAIN) has paid out more than one-third of its current value in dividends, never cut its dividend, and more than tripled every dollar invested in the company at its public debut.

No other BDC has a track record like that — and it all comes down to the unique way Main Street Capital Corporation (NYSE:MAIN) makes money. Let’s dive deep into a rising star in private equity stocks.

Main Street Capital Corporation (NYSE:MAIN)

Main Street’s day-to-day business
Main Street Capital Corporation (NYSE:MAIN) is in the business of money — it’s an investment company best described as a private equity fund. Naturally, Main Street seeks to borrow cheaply and lend expensively.

You might call it borrowing low and investing high.

Unlike a mutual fund or hedge fund, Main Street Capital Corporation (NYSE:MAIN) works exclusively with smaller, unlisted companies, pooling funds into four portfolios:

  • Lower middle market (50% of portfolio) — Main Street Capital is one of the few BDCs that will make debt and equity investments in lower middle-market firms. Portfolio companies classified as “LMM” have annual revenue between $10 million and $150 million, and each investment totals $5-$25 million in size.
  • Middle market (40% of portfolio) — As one of the smaller BDCs on the market, it seeks out smaller $3 million-$15 million investments in companies with revenues of up to $1.5 billion. Middle-market investments are all debt — no equity.
  • Private loans (7% of portfolio) — Private loans are loans in which Main Street participates, but does not originate. Typically, these loans are made in conjunction with a private equity partner.
  • Other (3% of portfolio) — Includes portfolio investments in companies that don’t fit criteria for lower middle-market or middle-market investments.

Many investment flavors
Investors have the choice to invest in the debt and equity of a business. Main Street Capital Corporation (NYSE:MAIN) invests primarily in debt, but it also makes equity investments in its lower middle-market portfolio. This differentiates the company from commercial banks, which avoid equity investments to moderate their investment risk.

Lower middle-market investments drive the bulk of dividends and capital appreciation. As of the last quarter, debt investments in lower middle-market companies had a weighted average yield of 15.1% compared to 7.9% for middle-market debt investments, and 12.2% for its private loan portfolio. You read that right: The company generates returns credit card companies would envy.

Source: Main Street Capital’s 2Q 2013 earnings presentation.

As of the last quarter, Main Street Capital Corporation (NYSE:MAIN) had an 80-20 split between debt and equity. Routine debt payments from its portfolio companies allow it to maintain its high regular dividend yield while equity investments create “chunky” upside when it sells its equity stakes to collect gains from appreciation. The company reports that 75% of its portfolio companies are paying dividends.

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