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Horizon Technology: IQ 2018 Preview

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NEWS

As every quarter, Horizon Technology Finance (HRZN)  provided a number of highlights from the just completed quarter in advance of earnings.

See the press release above.

(Several BDCs – including Hercules Capital have adopted this form of regular shareholder communication by press release).

3 new transactions were added to the portfolio for a total of $11mn advanced.

By contrast $20.8mn was repaid or refinanced.

There were also 3 so-called Liquidity Events.

Notably Digital Signal was sold, which repaid its debt oustanding

Portfolio company Le Tote was repaid, which allowed fees to be booked and HRZN still owns warrants.

Lantos Technologies  $2.6mn loan due in 2019 was refinanced by a new $4.0mn from the BDC. Various fees were booked but the warrants in the company remain.

New loan commitments during the quarter totaled $8.2mn, down by 85% from the prior quarter.

The Committed Backlog dropped by a third to $22.5mn.


ANALYSIS

Shrinkage

While we don’t know what happened to portfolio values, the chances are HRZN’s investment portfolio shrunk in the period as repayments outstripped new investments.

New investment activity was lackluster at $11mn when  compared to IVQ 2017 when $73mn in new loans were funded.

We estimate total investments may have dropped by about 5% from the $222mn reported in the IVQ 2017.

Yield bearing investments – which ended 2017 at $202mn- are likely to have dropped to around $190mn.

Taking A Breath ?

That follows a year of growth in total investments during 2017 from $194mn to $222mn.

Moreover, new loan commitments and Committed Backlog metrics are weaker than in recent periods.

No Harvest

While the press release mentions Liquidity Events, there is no evidence of any harvested equity gains being achieved from the 78 companies in which HRZN holds equity stakes.

What We Don’t Know

No word on any changes in HRZN’s credit quality, which was improving late in 2017 following several major Realized Losses being taken during the year.

(HRZN’s aggregate Realized Losses doubled in 2017 to reach $41.7mn.

To date as a public company HRZN has incurred losses equal to 22% of its equity capital raised).

At year-end, HRZN listed 3 investments in the lower rungs of its portfolio asset quality.


VIEWS

Poor Preview

There has been an active debate amongst investors about whether HRZN is on the mend.

The BDC has reduced its distribution 3 times since 2011.

The last time was in December 2016 by (13%).

Over the past 12 months, the BDC’s stock price has been highly volatile, ranging between $9.66 and $11.88, a nearly 20% differential.

Here is a chart showing how investors views have changed – for the better and worse – on multiple occasions in the period.

We count 7 material price declines followed by bounce backs:

In our view, the data provided in the portfolio preview does not bode well for first quarter 2018 earnings, and the rest of the year.

The results only add to concerns about both the dividend and the stock price that the BDC Reporter has had for some time.

Noodling

We’re surmising that a lower loan balance and few repayments, as well as the still high cost of borrowing on HRZN’s Baby Bond at 6.25% and its Revolver (which is tied to a rising LIBOR rate) will be negative for earnings.

(Admittedly the IVQ 2017 results were impacted by the once-in-a-while costs of refinancing the prior Baby Bond with an even higher coupon and both issues being outstanding for a period),

Although bottom line results vary widely from quarter to quarter,  HRZN may be pressed to even maintain the $0.21 of Net Investment Income Per Share achieved in the IVQ of 2017 ( once we adjust by 6 cents or so for the one time costs)

Dividend Outlook .

With the quarterly distribution level (albeit that dividends are paid monthly) at $0.30, we continue to question whether a reduction in the pay-out will occur.

The BDC Reporter has had a Dividend Outlook of AT RISK for HRZN in 2018 for several months.

We’re not yet ready to re-rate HRZN to a clear cut DECREASE projection, but we’re one step closer.

Management’s Case

In this regard we are at variance with HRZN’s management which has made the case on its last Conference Call that “covering the dividend” is likely.

Here’s what the CFO said in response to a question from an analyst:

“Q…So I mean I’m just trying to see how you get from $0.21 to $0.30 even with lower incentive fees earned ?

Dan Trolio

A. So there is just a couple of things that were details in the script, first of all the $0.21 was net of $0.03 for higher interest expense from the bond offering. So $0.21 — $0.24, we expect the savings from the bond offering during all of last — all of this year to be on the order of magnitude of $0.03 a share from — just from the lower coupon on the 2022 notes replaces it. We do also expect the impact of rising interest rates on that portfolio to be on the same sort of order of magnitude depending on how far rates go, but because our rates our portfolio was entirely floating up or down of course but and our debt is partially fixed and partially floating, we expect there to be increased top-line income as well as increased interest spread. So that coupled with a normal level of prepayments is what we look forward to and our board considered as we set our distribution level for April, May, and June.

Unconvinced

The above notwithstanding, barring a series of successful investment exits and a much larger balance sheet, the BDC Reporter can’t envisage how HRZN may be able to earn $1.20 or more in Net Investment Income on a recurring basis.

Spread compression is gradually decreasing recurring interest income and lowering the portfolio yield, despite the offsetting benefits of higher LIBOR.

HRZN has had little success in stemming bad debts for more than a short time and an equally hard time converting its potential treasure trove of equity investments into cold hard cash.

Once the remaining spill-over Taxable Income which HRZN has from more profitable days gets distributed – which may occur by the end of the second quarter- management may have to take a scalpel to the distribution.

We wouldn’t be surprised to see the dividend cut from $1.20 to $1.00. Or even lower, if any new credit troubles pop up. 

The cut could occur as early as the third quarter 2018 distribution, given that the BDC has already announced unchanged pay-outs for the second quarter through June.

Market Doubts

Investors seem to be having similar doubts despite the protestations of the Investment Advisor that recurring earnings can be maintained at $1.20 a year or higher.

The stock price of HRZN peaked recently at $11.81  intra-day in January of 2018 and has since descended to close at $10.43 as of Thursday April 12, 2018.

That’s a (12%) decrease.

However, should HRZN reduce the annual dividend to the $1.0 a share we envisage the stock could drop to a range between $8.0 – $10.0.


INVESTMENT RATING

Given the uncertainties about HRZN’s earnings and distribution – only enhanced by the sparse data in the press release, as well as the recent price movement we have an internal SELL rating on the common stock.

We maintain the Dividend Outlook for 2018 as AT RISK

We’ll provide our internal rating on HRZN’s only Baby Bond in a future article. 

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