NEW YORK ( TheStreet) -- Prospect Capital (PSEC - Get Report) saw its price target lowered by National Securities analyst Andrew Kerai Monday after he hosted investor meetings with Prospect CFO Brian Oswald and sensed renewed investor skepticism would be a problem for the stock.
Kerai's report was published shortly before the market closed Monday, but shares of Prospect still closed slightly higher on the day, finishing near their highs at $9.86. Prospect is one of the riskiest bets in a space referred to as business development companies, publicly traded lenders that target small to mid-sized companies, pay few if any taxes and distribute large dividends to investors.
Kerai left his "buy" recommendation on the stock but lowered his price target to $11.50 from $13 arguing an accounting dispute with the Securities and Exchange Commission will continue to weigh on the shares as "some investors now view the company with an elevated level of scrutiny."
Prospect drew the SEC's attention for treating equity investments in seven of the companies in its portfolio as debt. Thus, when it receives a distribution from those companies, Prospect classifies the distribution as interest income. If the investment is classified as equity, as the SEC believes it should be, the distribution would be considered dividend income only if the portfolio company earns enough to cover the dividend. If earnings are insufficient, it must be classified as a return of capital.
If the distribution is a return of capital rather than an outgrowth of earnings, Prospect's net investment income would decline, which would force management to return incentive fees it gets based on that metric.
Prospect said May 7 it expected the issue would be resolved within a month. KBW analyst Greg Kelly called that timetable "aggressive" and thinks it may take six to eight weeks -- suggesting it could drag into early July. However, he expects Prospect will eventually give in to the SEC and restate its earnings.
The dispute has spurred several class action lawsuits from Prospect Capital shareholders.
In Monday's report, Kerai urged Prospect to "simply restate prior earnings and apply the recommended accounting methodology going forward, to put the issue to rest."
He continues to believe the stock is undervalued and that resolving the dispute with the SEC would "provide support for the stock." Still, he added, "we no longer believe a one-year price target of $13 is realistic given the renewed uncertainty surrounding the company and its quality of earnings."