Investment Ideas From The Golub Portfolio

By Will Ashworth | October 22, 2010 AAA

One of the objectives of my articles is to provide readers with original thought. I do this because a majority of the stocks discussed at Investopedia and other investment sites are usually already familiar to investors, so I emphasize different ways to select stocks that are out of the ordinary. One interesting approach is to peruse the loan portfolios of business development companies. Usually there's one or two public companies in the mix that would make good investments and you're off to the races. In this article, I'll look at Golub Capital (Nasdaq:GBDC), a Chicago-based business development company (BDC) that went public in April.
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Golub's Business
I stumbled upon the mid-market lender while reading about a group of hedge fund managers that included Blue Ridge Capital. (To learn about hedge funds, see Hedge Funds: Higher Returns Or Just High Fees?) Upon closer inspection of the hedge fund's stock holdings, Golub Capital caught my eye. The fourth smallest holding out of 53, Blue Ridge owns 3.9% of Golub's stock. It's a small investment for a $5.7 billion portfolio. However, it's these smaller holdings where you find the best diamond's in the rough. With 79 loans outstanding for a total of $277.6 million in the third quarter ended June 30, and an additional $83.7 million in new investments originated in the fourth quarter, it now has over $350 million in loans outstanding. Of those, 12 are with public companies. The table below highlights their year-to-date performance.

Golub Capital Public Company Loans

Company YTD Return Company YTD Return
Golub Capital 9.1% DaVita (NYSE:DVA) 21.3%
Celanese (NYSE:CE) 1.9% MetroPCS Communications (NYSE:PCS) 38.1%
Community Health Systems (NYSE:CYH) (14.1%) Monotype Imaging Holdings (Nasdaq:TYPE) 0.0%
Compass Diversified Holdings (Nasdaq:CODI) 36.8% NRG Energy (NYSE:NRG) (13.3%)
Covanta Holding (NYSE:CVA) (13.3%) Open Text (Nasdaq:OTEX) 13.1%
Regal Entertainment Group (NYSE:RGC) (6.1%) S&P Mid-Cap 400 12.7%
Average of 11 6.7%



Mediocre Performance
The benchmark I've chosen for this example is the S&P Mid-Cap 400, which is up 12.7% year-to-date through October 19, beating the assembled group of companies by 600 basis points. My hypothetical portfolio is certainly taking it on the chin. The question is whether this will continue long-term. Excluding Golub Capital, which hasn't been a public company for an entire fiscal year, the remaining 10 companies generated combined net income of $2.6 billion in the latest fiscal year on revenues of $42.5 billion for a net margin of 6.1%. That's not a bad profit margin for a bunch of companies just thrown together. This speaks volumes about the kind of company Golub is and who it's willing to do business.

The only company with a net loss in the past year is Compass Group Diversified Holdings at $26 million, and if not for the $59.8 million in impairment charges from its 76.2% owned temporary staffing agency (Staffmark), a $44.7 million operating loss would have been an $15.1 million profit. But that's okay. Since the IPO in May 2006 to June 1, 2010, its total return is 36.3% compared to negative 7.6% for the Russell 2000. Even more impressive, it's sold three of the nine companies acquired since 2006 for a cumulative gain of more than $109 million. Golub Capital and Compass appear to be excellent allocators of capital. This bodes well for the future.

Diversified Portfolio
It's almost scary how diversified this portfolio is despite being a hodgepodge of companies. There's at least one company from seven different sectors, with only large caps missing from the group. Add a small/micro cap ETF and a large cap ETF and you have the makings of a strong portfolio. Golub not only makes loans to sound companies, but also in a diversified group of sectors and industries, thereby reducing risk.

Bottom Line
Although Golub and the rest of the companies mentioned above haven't fared as well as the S&P Mid-Cap 400 year-to-date, long-term I expect nothing less than a stellar performance. They're too good.

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