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Goldman Sachs BDC: Why The Price Is Down.

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NEWS

On Wednesday March 28, 2018 Goldman Sachs BDC’s (GSBD) stock price intra-day dropped to a new 52 Week Low of $18.91.


ANALYSIS

GSBD has been as high as $25.40 in the past 52 Weeks. (The 5 Year High is $25.60).

The new low is (26%) off the 52 Week High.

The stock price has been in descent mode since May 2017.

However, the BDC is still trading at a premium to its IVQ 2017 book value of $18.09.

Only 7 BDCs out of 45 tracked by the BDC Reporter are trading above book value.

At $18.91 GSBD is trading at a level not matched since late February 2016.

The All Time Low for the BDC, which came to the public market in 2015 but which operated several years before that as a private fund, is $17.50.

That was reached during the market meltdown that culminated in February 2016.


VIEWS

Based on the historical price performance of GSBD – which has often traded at a huge premium to book – this drop in price may seem surprising.

The BDC Reporter would like to take this opportunity to discuss the factors which might be affecting Mr Market’s apparent loss of faith in what has been a Market Favorite for the past 3 years.

We’ll end by discussing our own investment approach.

Let’s start with the positives about GSBD:

Regular Payer

From a dividend payout perspective, GSBD has maintained the same $0.45 quarterly distribution since going public, or 13 consecutive quarters.

Accretive

Moreover, GSBD undertook its first post IPO secondary offering of shares in May of 2017 at a substantial premium to book of $22.50.

Decent Earnings

Earnings-wise, Net Investment Income Per Share was $2.07 in 2017, down only slightly from $2.10 in 2016.

Much of that reduction can be attributed to the impact of the new shares issued, as in absolute terms Net Investment Income was sharply up.

Low Non Accruals

Moreover, GSBD closed 2017 with only 1 loan out of 56 in portfolio on non-accrual with a de minimis value.

The portfolio yield – during a year of intense spread compression – was 10.8% versus 10.3% in 2016.

Unlike some of its peers who grew or maintained EPS by growing their portfolio assets, GSBD remained relatively flat.

Stable Portfolio

Total investment assets ended 2017 at $1.258bn, compared with $1.179bn the year before, a 6.7% increase and lower than the increase in par capital during the year.

Furthermore, the BDC continued its policy of not distributing a substantial portion of its earnings, as discussed on the most recent Conference Call:

The company had $32.1 million in accumulated, undistributed net investment income at quarter end, resulting from net investment income that has exceeded our dividend in past quarters. This equates to $0.80 per share on current shares outstanding.

Now For The Negatives

Of course there were a few setbacks during the year.

Credit

Portfolio company Bolttech Mannings, to whom GSBD had made a $40mn loan had to be restructured into a smaller amount debt and equity and a Realized Loss of $25.1mn booked

Likewise, there were two other major write-offs during the year: Iracore International Holdings ($14.4mn) and Washington Inventory Service ($23.7mn).

Iracore was restructured during the year, with GSBD’s $21mn in debt outstanding being converted into debt and equity, and a Realized Loss.

Washington Inventory Service was a major blow-up. GSBD had $25mn invested at cost and only recovered $1.3mn. Not pretty.

(THL Credit was the only other BDC with exposure to the Company, also in the second lien).

The year before GSBD had its first major credit misstep with Hunter Technologies (discussed by the BDC Reporter at the time), which caused a ($22.17mn) Realized Loss.

Consequences

In total GSBD has racked up ($86mn) in Realized Losses on $800mn of equity capital.

That has caused a permanent reduction in the BDC’s earning power.

Very roughly that’s about 7% of the Investment Income that GSBD has achieved, and an even greater proportion of its Net Investment Income.

Set-Back

Also not firing on all cylinders is GSBD’s Joint Venture with Cal Regents.

In 2017 the JV went nowhere with total assets flat and the number of borrowers decreasing.

Although there were no loans on non-accrual in the JV at year end one investment (GK Holdings) was written down substantially.

At December 31, 2017 the first and second lien advances to GK were written down by ($5.2mn) over cost.

In aggregate the JV recorded Unrealized Depreciation of ($8.6mn), compared with Unrealized Appreciation of $4.1mn the year before.

That Unrealized Loss is equal to 5% of the JV’s equity.

Analysts were very much aware of this set-back on the last Conference Call, which came up in the Q&A.

[Looking Forward

Nonetheless- and even though the maturity of the JV Agreement with Cal Regents has only been extended till March of this year – GSBD remains optimistic.

The Investment Advisor suggested on its Conference Call that refinancing the JV’s debt would boost earnings in 2018.

Moreover, we may see an expansion of the JV. “Stay tuned” said the Investment Advisor].

$64,000 Question

So why is GSBD’s stock price down so much ?

Of course we don’t know but here are our speculations.

Less Profitable

First, the potential earnings power of the BDC has been reduced by its multiple credit losses.

Even though these are to be expected in a lender, the market was previously pricing the stock as if losses would never occur and earnings would move higher.

How High ?

In the past, the market was valuing GSBD at 12.5X projected current year recurring earnings per share or higher

How Low ?

Instead – judging by the projections of National Securities for 2018 of $1.91 Net Investment Income Per Share (down from $2.01) – both earnings and the multiple have come down.

Based on the 52 Week low price GSBD just hit, the PE multiple for 2018 is now 10.0X.

Hardly a bargain basement valuation but much more in line with the BDC Sector as a whole.

More Credit Blows 

Second, the market may be concerned about additional credit losses.

Besides the restructured Bolttech Mannings and Iracore International, on the Watch List (both ours and theirs) is semi non performing Kawa Solar Holdings.

Untangling what’s happening at this credit requires “a better man than I am Gunga Din”.

However, we do know that some of the debt to the company is on non accrual and written down to virtually nothing.

However, there is another Senior Debt facility to the same company on GSBD’s books with a cost of $9.6mn and a FMV of $8.9mn.

We worry because i) the non paying nature of the other debt to Kawa; ii) the interest is being paid in PIK only at a rate of 9.69%.

TCP Capital (TCPC) is also a lender/investor in Kawa and has valued its performing debt at par, which is slightly reassuring.

Nonetheless what happens at Kawa going forward bears watching and at related name: Conergy Asia Holdings.

NTS Communications

Otherwise, NTS Communications – which is performing and valued at a modest discount to cost – is rated CCR 3 by the BDC Reporter.

That’s our least concerned Watch List rating.

However, we note that the 10.7% interest rate being charged is all being paid in PIK and the exposure is high at $56mn of cost.

Probably going to be OK, but worth watching as well.

In General

Otherwise, though, GSBD’s credit portfolio seems in pretty good shape right now with just 5 names on our Watch List out of 56.

Except for the remaining Kawa debt, which involves interest income of about $1.0mn a year, there does not seem to be any immediate risk of income loss from new non-accruals or write-offs.

With Net Investment Income at $80mn in 2017 that’s a very minor risk which the BDC might be able to make up from other sources.

RISK PROFILE

Moreover – rarely discussed but always important for every BDC – the overall risk profile of GSBD’s portfolio remains in the Medium Risk category by BDC standards.

In the BDC Reporter’s way of thinking that means we expect a 20% decrease in recurring EPS over the next 5 years.

Most BDCs are in this Medium Risk category.

Here’s the rough and the smooth.

Smooth

The portfolio is well diversified by company and by sector.

Unlike some other players GSBD does not take Big Risks on individual names most of the time.

Moreover, there are very few loans (besides those already mentioned) at very high yields or with heavy PIK components.

Rough

However, there are very real risks when lending at double digit yields which need to be called out.

Only a third of the portfolio is in First Lien Secured Debt.

Most of our long term worries are that 60% of the portfolio is in First Lien debt but in a Last Out position or in plain Second Lien.

As we’ve seen in GSBD’s recent history, trip up in these types of loans and recovery rates can be very low.

Mixed Messages

Furthermore, while we have no immediate concerns for the JV, the asset coverage of the debt outstanding is already only 172% and could go lower as the partners leverage up.

In a crisis a 10% write-off or write down of assets is not inconceivable and that could result in a 25% loss of the $100mn in capital committed to the vehicle.

As importantly, the JV’s lenders might cut off distributions from the entity to its owners which could – in one fell swoop – result in a 10-15% reduction to net recurring earnings.

Mixed Feelings

Analysts are very bullish on BDC JVs generally – and GSBD’s in particular.

As always, the BDC Reporter has a more jaundiced view.

(We were called a “curmudgeon” yesterday by a reader and we don’t know if we should be taking that as insult or compliment).

We’re less certain that tying up 12% of the BDC’s capital in one investment which is subject to income interruption at times of market stress is worth the slightly higher interest rate premium being achieved  over what GSBD might be able to earn from on balance sheet loans.

Moreover -while there is decent disclosure – there is no doubt that shareholders know less about what’s happening in the JV than to regular investment assets.

Today’s yield enhancing JV (which helps BDCs earn those juicy Incentive Fees) could be tomorrow’s outsized problem child.


INVESTMENT APPROACH

From our perspective, given the Medium Risk categorization of GSBD we’ve had since the BDC first came public, the stock has always traded at WAY too high a price to be interesting.

The Goldman name – in this case – has probably been the cause of the over valuation as well as issues such as a stable dividend; an aggressive automatic stock buyback program (never used but much touted) and 16% ownership by Goldman itself.

Out Of Reach

With the price dropping, we are perking up but the price still remains too high for our risk tolerance.

However, we continue to believe – given the relatively clean credit sheet at the moment and the rise in LIBOR obviating most of the spread compression – that the dividend should remain unchanged in 2018.

Earnings may even move up in 2019 over 2018, going by what analysts are saying.

However, our projected 5 Year Total Return at the current price is 40% (8% per annum), which is below our minimum target.

Aiming High

Others may find that projected return sufficient, but we aim for 10.0% per annum at a minimum and mostly get excited when our model is headed north of 15.0% per annum.

(We don’t get excited very often). 

After all, as mentioned at the top, GSBD may have dropped (26%) in price but still trades at a premium to book.

Everything is relative. 

Explicit

At $17.75 or below – and barring any unexpected developments – GSBD will be on our Buy List. 

That’s a slight discount to the current book value and would yield an immediate yield of 10.1%.

 

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