Blue Owl Capital Corporation

Moat: 2/5

Understandability: 4/5

Balance Sheet Health: 2/5

Blue Owl Capital Corporation is a business development company (BDC) focused on providing capital solutions primarily to middle-market companies through private lending and related investment activities.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview

Blue Owl Capital Corporation is a business development company (BDC) that is externally managed by Blue Owl Credit Advisors, which is an affiliate of Blue Owl Capital. BDCs act as investment vehicles that lend to and invest in small- and mid-sized companies that do not have access to capital markets and/or do not qualify for conventional credit.

OBDC focuses on first-lien senior secured loans to private companies. These loans, which have a higher priority in repayment in a credit event, represent the majority of OBDC’s investments. The primary stated goal of the business is to create an investment return and a source of yield for shareholders through regular dividend payments.

Revenue Distribution:

OBDC primarily generates revenue through net investment income, consisting of interest and dividends from its investments, minus funding costs (e.g. borrowing costs). It also realizes gains or losses through sales of its equity investments. In addition, they may receive fees, such as incentive compensation, from the management of their investments.

Interest Income: This income makes up the bulk of their earnings and is generated from the company’s debt investments, with floating rates which move along with the benchmarks.
Dividend Income: This income is generated from equity and preferred stock investments.
Fee Income: Income from loan origination and other services.
Other Income: From various sources that are not included in the other revenue categories.

Industry Trends:

The BDC industry is currently undergoing a period of volatility caused by the recent increases in interest rates. This rate increase environment has impacted the debt repayment capacity of borrowers, and caused many banks and institutional investors to sell and reduce their overall exposure in the lower-middle market. However, the increased rates result in increased income for floating rate lenders and those with access to debt funding. As more private companies struggle to obtain financing, lenders like OBDC are receiving increased deal flows and opportunities to generate additional returns.

Competitive Landscape:

The private credit lending landscape is very fragmented. While there are large BDCs like OBDC, there are dozens of smaller players, with competition for each deal at times fierce. The industry remains highly fragmented, because borrowers are often looking for customized debt packages and have other characteristics specific to their industry and or situation. In the lower middle market, which is where OBDC is focused, relationships and speed of execution often matter much more than a slightly better interest rate. Large BDC companies are generally more constrained by federal regulations, while smaller ones have more flexibility.

What Makes OBDC Different: OBDC operates primarily as a direct lender, rather than a purchaser of debt on the secondary market. Their direct lending strategy combined with their scale allows them to be more competitive in the private lending space. Furthermore, they focus on first-lien senior secured loans to increase the safety and stability of their portfolio in a downturn. Their external management by Blue Owl Credit Advisors gives them access to the Blue Owl Capital ecosystem, which includes a team that is focused on analyzing private deals and allocating capital in the best way possible.

Recent Concerns and Controversies:

Increase in Non-Accrual Loans: The company has seen a mild increase in non-accrual loans in recent quarters, indicating some of the borrowers are having trouble servicing their debt. Although management is actively working to resolve such situations, these instances increase risk in the overall portfolio.
Increased Interest Rates: While interest rates have increased the borrowing costs for some companies, they have also provided a higher interest rate yield to companies like OBDC with floating interest rate assets and access to debt funding. They have also caused some volatility, making borrowers hesitant to make deals.
Changing Regulatory Landscape: There could be a change in federal regulation, which are currently under scrutiny, and that could substantially change the overall landscape of BDCs in ways that are not easily predictable.

Financials

ROIC and Financials:

OBDC’s ROIC(Return on Invested Capital) as at March 31, 2024 stands at 12.3%. Their returns come mostly from loans to mid-market companies which are also floating in nature. The company’s financial leverage, measured by assets to equity is low at 1.62, which has been rising. As a BDC, OBDC seeks to increase returns to shareholders through leverage, so the higher leverage can help to boost returns, but may result in greater volatility of their returns. The company’s management notes that it does not anticipate any material leverage changes in the next few years due to the changing economic conditions. Furthermore, the company recently increased its quarterly dividend per share to 0.33.

Balance Sheet Health:

OBDC’s balance sheet shows some signs of weakness. The cash balance is only 1.3%, which is quite small, and as a BDC they take a lot of their financing through debt rather than equity. Their debt-to-equity is 1.62x which is high, but typical of a BDC business model that uses debt to enhance returns. The increase in non-accrual loans shows an increased risk to their overall investments. The combination of these items means their balance sheet can not be rated high, and they will need to focus on reducing risk. The company itself says that a majority of their loan portfolio is first lien senior secured debt, implying that in a bankruptcy situation, these loans would be repaid first before any others. This should give some protection from their investments going to zero.

Based on the latest report, the company has $15.6 billion in invested capital and $1.7 billion of cash on hand. They have $7.1 billion in total debt. The company’s net asset value is at $15.47 per share.

Understandability: 4 / 5

Blue Owl Capital Corporation’s business model is generally quite easy to understand for anyone with basic knowledge of finance, however some aspects make it a little more complex:

The nature of BDCs and their dependence on borrowing capital and generating return from their investment portfolio is quite complex.
Understanding all the different credit instruments they invest in takes some expertise and effort.
Understanding the interplay between interest rates and their investment book value takes some time to understand.
It is not easy for normal investors to judge if the specific loans that are given out are quality investments or not.

Moat Rating: 2 / 5

OBDC does not possess a wide moat.

Scale Advantage: The scale advantage of OBDC, being a large player with direct lending, is somewhat of a moat, however they still have to compete with other BDCs that are also large players in the space. The smaller players also have some advantages with local knowledge, faster decision making, etc.
Relationship with Blue Owl Capital: The connection to Blue Owl Capital is also a potential source of moat as it provides the company access to a network of private transactions and gives them a larger ecosystem of deal flow. However, it is not insurmountable because other BDCs can gain access to deals through different networks.
Switching Costs: The company has good relationships with their borrowers, but these relationships do not necessarily give it any sort of moat. Borrowers are ultimately looking for the best deal, which means that even companies with very good reputations may find other funding sources.
Intangible Assets/Regulations: Intangible assets such as brands, patents, etc. are not applicable to the loan origination space. Furthermore, BDCs are regulated, but that regulation does not serve as a moat, instead, there are some limitations.

Risks

Key Risks to Moat and Business Resilience:

Credit Risk: The most significant risk that OBDC faces is the creditworthiness of its borrowers. An economic downturn may impact borrowers and result in more non-performing loans.
Interest Rate Risk: While higher rates improve its net interest margin, they also make the repayments of loans by borrowers more difficult, and may increase the number of defaults.
Competition Risk: The private credit sector is increasingly fragmented, leading to more competition for investment opportunities. A lack of deal flow and increased competition can drive prices down and have negative impact on yields.
Regulatory Risk: BDCs are heavily regulated. A change in the laws or regulations can drastically alter their business model and reduce their returns.
Management Risk: As OBDC is externally managed, the quality of the managers who allocate capital is important. If that management performs poorly, or is not well suited for navigating turbulent times, that would severely impact OBDC.
Concentration Risk: The company’s success depends heavily on continued relationships and access to the private markets. A significant change there could impact their ability to access deals and maintain returns.

In conclusion, while OBDC benefits from a high-quality management team, their current portfolio strength, which consists mostly of high-yielding floating rate loans, has a high credit and volatility risk that could materially impact their net assets. In the future, BDCs will continue to play an important part in the middle market, but they still need to operate within a complex and high risk environment.