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Horizon Technology: Insights From the IIIQ 2017 Results

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With the beginning of earnings season, the BDC Reporter will be reviewing all the latest earnings releases and quarterly filings, and writing about as many as we can on these pages.  Rather than than seeking to cover everything we’ve learned about a reporting BDC, we will seek to summarize our key insights shortly after review.( If necessary, we’ll take a deeper look at a later date). Moreover, we will provide our Dividend Outlook for each BDC in turn, assessing the sustainability of their current distribution for the next 12 months. As usual, we’ll also share our own investment approach with our readers. We begin with Horizon Technology Finance (HRZN):


In Place

Paradoxically, despite recording a significant increase in recurring earnings per share for the quarter over the prior period’s results, HRZN continues to tread water. Yes, investment income was up from $5.9mn to $6.8mn in just 3 months, leading to Net Investment Income Per Share of $0.33 in the most recent quarter versus $0.24 at the end of the June period. That’s a 37.5% jump, and higher than analyst expectations by a considerable margin ($0.33 versus $0.28 projected). However – both from a positive and negative perspective – HRZN remains virtually  unchanged, starting with total investment assets at cost which barely shifted in aggregate size from $190mn in June to $188mn in September.  Total debt moved up slightly because of the recent issuance of a new Baby Bond (HTFA), which temporarily left the BDC with two unsecured notes outstanding and slightly higher cash. However, with the redemption of October 20 of the older Baby Bond (HTF) , total debt looks almost identical to the amount and mix (part Unsecured Note, part Revolver) that was in place at the end of June. NAV Per Share, too, is very similar. At the end of September NAV was 0.5% lower than the quarter before.

Same Old Credit

Also unchanged are HRZN’s troubled credits. Amongst the 37 borrowers on its books, the same 3  non-performing names pop up: Digital Signal Corporation, Scorebig,Inc. and Interleukin Genetics. These 3 names aggregate $15.6mn at cost, or 9.3% of HRZN total debt outstanding and have a remaining fair market value just under $6mn.  The individual value of these 3 companies varied, with ScoreBig unchanged, Digital Signal up and Interleukin being marked down materially, but the aggregate impact – as reflected in the NAV – was minimal. Moreover, and even though there was much activity in the portfolio during the quarter with investments funded and repaid, not much happened to the value of the 78 different warrant and equity positions (twice the number of loans on the books) which HRZN holds.

Pay-Offs

At the end of the day, the only real change over the last 3 months was that “liquidity events” were higher in the third quarter than in the second, which resulted in booking more pre-payment fees and “End Of Term Payments” from departing borrowers. That’s why HRZN’s average yield jumped to 16.5% from 14.7% in three months.

The Never Ending Question

The same question continues to hover over the BDC: will HRZN be able to maintain its current distribution level for an extended period ? The BDC has just announced monthly dividend of $0.10 for the first quarter of calendar 2018. That brings to 5 quarters in a row HRZN will have been able to maintain the $1.20 distribution level, after cutting back from $1.38. However, Net Investment Income Per Share for the first 9 months of the BDC’s fiscal year is still running below the distribution level at $0.86, and (25%) below the same 9 months last year. As we’ve seen, much of the investment income which the BDC generates comes from “liquidity events” over which it has no control and which fluctuate widely from period to period.

Two Issues

HRZN’s short to medium term future will depend on two factors now that its new debt structure has been reset: i) the ability to successfully expand its portfolio, and thus its income; ii) credit quality.  Both items have been challenging for HRZN historically. At the moment, boosted by $37.5mn in new unsecured Notes, HRZN nominally has over $90mn to spend. More realistically, HRZN could yet increase total investment assets by a net $30mn or more, which would materially help achieve a more sustainable earnings profile. However, market conditions are such – with fewer “good deals” around and plenty of competition that increasing assets is not a forgone conclusion.

To Be Blunt

Nor is decent credit quality. After 7 years as a public BDC, HRZN’s credit track record to date is mediocre. As a glance at the balance sheet will show you, HRZN has suffered ($31.6mn) in Realized Losses over the years, more than one-third of which was booked this year. As we’ve seen, the 3 non-performing credits have a value of about $6mn and the aggregate Unrealized Depreciation on all investments is ($11.2mn). For every dollar of equity capital issued at par by the BDC, $0.24 has resulted in Realized and Unrealized Losses.  Notwithstanding high hopes by management and investors to the contrary, the huge number of non-income producing warrants and equity investments on HRZN’s books have failed to offset credit losses. In fact, the aggregate value of those assets at September 30, 2017 is slightly less than cost.


DIVIDEND OUTLOOK

As we prepare to launch our Dividend Outlook Table for every BDC – to coincide with earnings season – we still rate HRZN At Risk of having to reduce its distribution by November 1, 2018. That’s the mid-rating we employ and suggests the BDC could yet manage to sustain the current distribution for several quarters more. With plenty of liquidity, and no pressure from BDC asset coverage rules  and all the existing underperforming borrowers already on non-accrual status the greatest challenge to HRZN’s dividend will be what happens in credit. If the BDC can keep a clean slate going forward, the chances of shareholders receiving an unchanged distribution through 2018 are high. If HRZN’s credit underwriting  stumbles again, chances are we’ll see the distribution cut for the third time since the BDC went public.


INVESTMENT STRATEGY

Common Stock

Given HRZN’s crummy credit track record; small size and history of reduced distributions, the BDC is not on our Long Term Income list, even as a prospect. 

We do have HRZN on our Special Situation Watch List given the uncertainty surrounding the direction of the dividend. With these results – and with no immediate catalyst for a reduction – we expect the stock price might move up in the short to medium term.

We purchased a position at $10.8893 with a short term perspective.  The yield is 11.0%.

We’ve updated our Investment Disclosure Table and our Investment Watch Lists. Check out the Tools section. 

Fixed Income

We have a position in the new Baby Bond with the ticker HTFA in our Fixed Income strategy. 

This quarter’s results reaffirmed our underwriting from a credit standpoint. 

As we do every quarter we undertook our proprietary  Stress Test evaluation to determine if the current portfolio could withstand a pro-forma Recession and still be able to repay note holders in full.

Our calculations suggest HTFA would be “covered” more than 3 times over – even after the deductions and reserves in our Stress Test, and after deducting out any debt owed to more senior lenders in the BDC’s capital structure.

As a result, we are holding our position in HTFA. 

We’ve also updated the Fixed Income Table for our Premium subscribers by removing HTF from the list, leaving 34 issues by 26 BDC issuers. Check out the Tools section. 

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