Ares Capital is Making a $2.6 Billion Acquisition. Here’s What it Means for its 10%-Yielding Dividend.

Ares Capital (NASDAQ:ARCC) has agreed to acquire MidCap Financial (NASDAQ:MFIC) in a cash-and-stock deal valuing the fellow business development company (BDC) at $2.6 billion, including debt. The deal will further diversify and grow Ares Capital's investment portfolio, which is already the largest among publicly traded BDCs.

Here's a look at the deal and how it will impact Ares Capital's more than 10%-yielding dividend.

Image source: Getty Images.

Details on the deal

Ares Capital is paying $10.88 per share for MidCap Financial, a 30.1% premium to the closing price before the deal's announcement. It's paying $1.21 per share in cash and the remainder in stock. However, the actual stock consideration will be adjusted based on the special dividend that MidCap Financial expects to pay its investors before the deal closes. The BDC expects to distribute all of its undistributed taxable income as a special dividend at closing, which it anticipates will be meaningful. The stock consideration will fall dollar-for-dollar to account for that special dividend.

The merger will create an even larger-scale BDC. Ares Capital ended the third quarter with an industry-leading $29.2 billion investment portfolio across 636 portfolio companies. Adding MidCap will increase its portfolio to over $31 billion across over 800 portfolio companies. That greater scale and diversification will help lower its risk profile and strengthen its resilience.

What the merger means for its dividend

Ares Capital expects that the transaction will be modestly accretive to its core earnings per share. That will provide further support for its dividend. The BDC reported $0.46 per share of core earnings in the third quarter (down from $0.50 per share in the year-ago period), just below its $0.48 per share quarterly dividend.

However, that doesn't mean that the dividend is at any immediate risk of reduction. The transaction environment was slow during the quarter due to surging interest rates. Ares is already seeing stronger activity in the fourth quarter. Meanwhile, it has recorded net realized gains of $0.07 per share this year, providing further support for its dividend. Additionally, the company is carrying forward $1.37 per share of excess taxable income from last year, giving it even more cushion.

As a result, the company expects the MidCap Financial deal to further support its ability to maintain its current dividend rate. Ares has delivered 17 years of a stable-to-increasing quarterly dividend.

However, the deal does add some risk. MidCap Financial cut its quarterly dividend earlier this year (from $0.38 per share to $0.31 per share) due to changes in interest rates and other factors. It also reported a 3.2% decline in its net asset value per share in the second quarter, driven by credit-related weaknesses at some of its portfolio companies. Investors should monitor any further credit deterioration in MidCap's legacy portfolio.

Further fortifying its dividend

Ares Capital's acquisition of MidCap Financial should further support its high-yielding dividend. It will expand and diversify its already industry-leading portfolio and increase its core earnings per share. While the deal will introduce additional risk, it should further enhance Ares Capital's competitive position. As a result, it remains one of the best BDC's to buy for passive income.

Matt DiLallo has positions in Ares Capital and MidCap Financial Investment Corporation. The Motley Fool has positions in and recommends Ares Capital. The Motley Fool has a disclosure policy.