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Horizon Technology Finance: Another Dividend Cut ?

BDCs:
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The BDC Reporter is hop scotching among the myriad IIQ 2017 earnings releases for the most market moving stories out there. We’ve already pointed out Triangle Capital (TCAP) seems to be in line for a pay-out reduction. Another BDC that has just reported its results also seems headed for a dividend cut, as we discuss below, along with our own investment approach with that prospect in mind: 

CHALLENGED

After reviewing the latest earnings from Horizon Technology Finance (HRZN) (and reading the Conference Call transcript, the challenge the BDC faces is clear: maintaining the recently reduced dividend.

HRZN pays out $0.10 per share a month, or $0.30 a quarter. Last quarter Net Investment Income Per Share was $0.24. (Even much of that is in non-cash form). Will the BDC be able to make up that deficit ?

NOT WHAT YOU WANT TO HEAR

The odds don’t look good, even though there are a few positive aspects. Spill-over Taxable Income available to pay-out to shareholders is only $0.08 per share, just over one more quarter before getting to return of capital status.

Yes, HRZN is under-invested and the Investment Advisor is bulking up on staff to identify a greater number of opportunities. Here is a quote from the CC:

“Since last December, we have substantially enhanced our capabilities including the hiring of several professionals. Most recently, we added Todd McDonald as Managing Director for the Mid-Atlantic and Southeast Technology markets. Further, we have added additional talent in key areas such as portfolio management, business development, accounting and finance”.

Still, in this frothy lending environment getting all one’s capital invested is no easy task and one which might take HRZN many quarters to achieve, if ever.

Yes, the BDC has made progress reducing the total number of non-performing loans on its books, which is freeing up capital. At year end 2016 there were 10 investments in HRZN’s most troubled internal rating categories with a FMV of $25mn. Half way through 2017 the number of troubled investments was down to 6 and $15mn at value. Here is what the CC said about non-accruals specifically:

“At December 31st, there were four loans on nonaccrual. Since that time, two of these loans were settled and two remain pending resolution”.

However, management admitted on the Conference Call that portfolio investment Interleukin was facing big problems and losses were expected.

“An additional impact to NAV in the quarter resulted from Interleukin, which is pursuing an orderly liquidation of its assets. Early in the quarter, we have been working with the company’s equity sponsors to provide financial support as Interleukin pursued the financial — clinical services agreement related to its proprietary technology. As time progressed, it became apparent that company would be unable to obtain a clinical services agreement in its suitable timeframe. We continue to work with Interleukin’s management during the liquidation process to achieve an outcome that generates the greatest value for our shareholders”.

Two steps forward, one step back.

OUR VIEW

Although HRZN plans to add another $60mn in portfolio assets, which will raise earnings everything being equal, the chances of another dividend cut within the next 12 months are high in our view.

Our very initial estimate is that the distribution may be reduced to a $1.0 annual level, from $1.20 currently. NAV too, already down in the IIQ to $11.87 from $13.27 a year ago, could be headed further down.


INVESTMENT STRATEGY

Common Stock

We have no position in HRZN’s common stock. Some time ago we lost confidence in the BDC’s business model and its ability to generate consistent earnings over the long term in a difficult and specialized industry where HTGC already dominates. From the perspective of our long term Income Strategy, why invest in a BDC prone to periodically paring down its distributions, and which has not yet been able to demonstrate an ability to offset credit losses with equity gains from its numerous warrant positions ?  This quarter’s results have only confirmed our doubts. Not helping is that HRZN does not have access to inexpensive, long term capital from the SBIC and Realized and Unrealized Losses to date have exceeded 20% of par capital. We will need to see a considerable change in the BDC’s performance before adding HRZN to our Buy List.

Nor does HRZN figure as yet in our Special Situations portfolio. Sometimes when distributions get cut – as we expect will happen – markets over-react to the downside, opening an opportunity for a Buy. That may occur when – if we are right – HRZN cuts its distribution again. However, the market is unlikely to be much surprised by the coming cut, so we’re not holding our breath. From our standpoint the stock price remains substantially over priced so the downward drop would have to be substantial to perk our interest.

Given that the BDC pays a monthly distribution and BDC stock prices – even for under-performers like HRZN – remain stubbornly high, we have no plans to short HRZN. In any case, thin trading makes shorting difficult at the best of times.  Still, we expect HRZN to trade below $10.0 before too long.

Baby Bond

We are Long HRZN’s 7.0% Baby Bond with the ticker HTF in our BDC Note oriented Fund.  With only $23mn in Revolver outstandings senior to HTF, and $12mn in cash on the balance sheet and $150mn in 31 performing investments, the Baby Bond’s credit quality remains strong.

As is the case with many other BDCs, the risk of early redemption exists. However, we wonder whether HRZN – given its small size , middling to poor financial performance and other issues distracting management – will be able to refinance the Baby Bond much in advance of its ultimate maturity date. Still, HTF comes up for repayment in March 2019 so a refinancing in early to mid 2018 is probably as far as Note holders should expect to go. The Baby Bond trades at $25.51, twenty cents above our cost. We are holding for the moment but expect the price to drop as we get closer to the likely redemption date.

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