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Triage

BDCs:
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TRIAGE

As more and more Business Development Companies file second quarter earnings there is an abundance of materials for the BDC Reporter to read and write about. We’re still working our way through the self congratulatory press releases; semi-candid Conference Call transcripts and disclosure stuffed 10-Qs realizing that we cannot report about each and every single one on these pages in the short term. So there had to be a triage system involved.

So far we’ve been focusing on the BDCs which have disappointed the market (shocked is too strong a term because most of the funds involved have been struggling with issues of one kind or another for months or even many quarters). Here’s what the BDC Reporter has been writing about for our subscribers, what our own investment approach looks like and what we might be doing differently in the days ahead for both our premium and free subscribers:

 

Credit Woes

 

Triangle Capital (TCAP) started having problems with its credit process and under-performing loans two years ago and has not been able to successfully demonstrate that the problems have  been successfully tackled. Now the distribution level is at risk and more investors are abandoning ship. We’re far from the troubles at BDCs like Fifth Street Finance (FSC) or OHA Investment (OHAI) but it’s a depressing fall from grace of what used to be one of the premier public funds operating in the lower middle market, and one of only 4 BDCs (out of 21) that managed to get through the Great Repression without cutting its distribution. TCAP may still have the benefit of a lower cost structure thanks to being internally managed, but that provides no protection against the ravages of bad debts. The stock price continues to slide ever lower. We started earnings season with an article for subscribers about TCAP’s  latest mishaps. We’re going to undertake a new “deep dive” into the portfolio before we invest in TCAP (although we do own their Baby Bonds). There’s no need to hurry here because these are issues that will take some time to come into focus.

 

Ambition

 

Hercules Capital (HTGC) has also been on our radar. There, the controversy is entirely of its own creation and a reminder that these may be financial vehicles but they are run by real people, each with their own motivations and ambitions which can affect shareholder returns as much as any bad loan. HTGC has been performing well – as is mostly always the case- but its CEO has big plans for the BDC and for himself. We discussed the subject a couple of days ago as shareholders balked again at the news that a switch to an external management structure is still on. This story – as journalists like to say – is going to run and run. Where it might end neither the BDC Reporter, nor the CEO nor the market knows. Interesting to read and write about when you’re outside looking in – as we are -but more disconcerting if you invested a year or more ago on the expectation of facing market risks at this long standing fund, but did not factor in the human element. We sympathize, but we also appreciate the drama to come. We don’t like to invest until we convince ourselves that we have some idea of what to expect and that the management and strategy we’re backing with our capital will be there tomorrow and the day after. In this case this could go anywhere so we’re keeping our capital in our pocket, however interesting this might be as an observer.

 

Stumbling

 

Horizon Technology Finance (HRZN) might never admit as much, but it’s a more recent and less tried and tested version of HTGC, operating in similar markets and with similar financial dynamics. However, the BDC has not been able to make the venture lending and investing model work for them since going public and even before. By no means is HRZN a disaster as yet from an investors standpoint but there’s an element of one step forward, two steps back to the fortunes of the fund. As we wrote to subscribers about a couple of days ago, the latest numbers suggest HRZN – which moderately cut its distribution not so long ago – might have to reduce its pay-out again. A bullish market and hope which dies hard has kept the stock price off prior lows, but we wouldn’t be surprised if another drop in the price might not be in the cards as Mr Market makes the necessary adjustments. For our own account, we like to invest where we’re reasonably confident in the BDC’s business model. Where HRZN is concerned, we don’t have that confidence so we’re limiting ouyrselves to sitting high up on its balance sheet in its public Baby Bond.

 

Reversion

 

If HRZN has been under-performing, higher risk BDC Alcentra Capital (ABDC) has been performing very well on a fundamental basis prior to the latest quarter. With a big name parent and an unchanged $0.34 quarterly distribution since going public, ABDC’s stock price was on the ascent from 2016 to May this year. This gave the Investment Advisor’s parent an opportunity to raise capital and take some of its investment off the table and make some other changes. Unfortunately – as we noted in our latest article- the market giveth and taketh away. In this case – and as became clear in the IIQ 2017 results – there are a few credit problems in the portfolio and the previously unbreakable distribution may be in some danger of going lower. ABDC’s brief popularity on a price basis with investors has passed and the stock now trades well below its NAV. What happens next will be very interesting. Will the market go from over enthusiasm to over pessimism (if that’s a term) and open up a buying opportunity for new investors deterred previously ?  We’ll be watching with our own chequebook open…(We do hold ABDC’s very, very thinly traded Inter Notes).

 

Good Guys ?

 

Mostly (with the exception of KCAP Financial or KCAP which we’ll discuss at another time), most of the results coming in from reporting BDCs have been as the market expected. Even if there was a set-back here or there, bullish BDC investors have been contented with what they’ve seen in such diverse players as Ares Capital (ARCC), Gladstone Capital (GLAD) ,Main Street Capital (MAIN), Stellus Capital (SCM), BlackRock Investment (BKCC), THL Credit (TCRD), Apollo Investment (AINV) , TPG Specialty (TSLX) and Goldman Sachs BDC (GSBD) . All these BDCs reported durinbg the week ended August 4th.

 

Switch

 

The BDC Reporter having reported on the obvious trouble spots amongst the BDCs, now swings to calling out from amongst the names above which we believe are getting too lenient a treatment by the market, and which investors might want to take a second, more skeptical look at. (We’re excluding Gladstone Investment – GAIN – which we’ve already reviewed last week for subscribers). It’s not very controversial to point out that TCAP has credit problems or that Alcentra’s stock price is dropping. We’re looking for material that will – hopefully – result in howls of protests from true believer shareholders of these securities and a debate that all our readers might benefit from.

 

TWO-FER

 

There are 2 names amongst the 9 above which we have a “contrarian” view about, and which we would the common stock of if we owned them. Both are – in our view- at risk of cutting their distributions in the year ahead AND are trading at prices that are unwarranted by their likely future cash flows. Both may fall in price – and given the recent buoyancy in sector valuations – could tumble several years worth of pay-outs before hitting bottom.

 

We’ll be reviewing both names in our BDC News Of The Day postings for subscribers in the days ahead, and re-post them with a one week delay for the rest of our readers. We don’t expect these calls will make the BDC Reporter very popular but we hope to bring fresh perspective and analysis drawn from the IIQ results, as well as all the years of accumulated research that has come before.

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