IPO Preview: WhiteHorse Finance

| About: WhiteHorse Finance (WHF)

Based in Miami, FL, WhiteHorse Finance (NASDAQ:WHF) scheduled a $101 million IPO with a market capitalization of $225 million at a price range mid-point of $15, for Wednesday, December 5, 2012.

Seven IPOs scheduled for next week, so far. The full IPO calendar is here.

N-2A filed November 27, 2012

Manager, Joint Managers: Deutsche Bank; J.P. Morgan; Citigroup; Barclays. Co Managers: Baird; RBC; Stifel Nicolaus Weisel; BB&T; Sterne Agee; Wunderlich.

WHF is a business development corporation with a junk bond portfolio of illiquid debt. WHF's investors (H. I. G. Capital) capitalized the operation with $177 million of equity as of January 1, 2012.

That initial equity was paid back on November 20, 2012 through a distribution funded by debt, but there was still $125 million of investor equity in the balance sheet, pre-IPO.

So HIG must have made another equity investment or loan transfer into WHF that is not reflected in the S-1 filing.

Annualizing WHF's initial distribution, stockholders would receive 9.47% at the price range mid-point of $15.

This compares to a 9.1% annualized return from Stellus Capital Mgt (NYSE:SCM). SCM IPO'd November 8, 2012 at $15, and is trades slightly above the offering price, in the range of $15.15.

On the positive side both WHF's initial annualized rate of return and current cash return are higher than SCM's.

On the negative side the base management fee and total annual expense percentages are higher for WHF than for SCM.

The average remaining portfolio life for WHF is 2.8 years.

After 180 days the stock lockup is due to end, so the WHF IPO is providing an exit strategy for the equity holders, whose holdings will be worth an additional $125 million post-IPO at the price range mid-point of $15.

Based on comparing WHF with SCM, IPOdesktop believes WHF will edge a little higher after the IPO.

WHF is a direct lender targeting junk bond debt investments in privately held, small-cap companies located in the United States.

WHF defines the small-cap market as those companies with enterprise values between $50 million and $350 million.

As of September 30, 2012, the portfolio managers who are primarily responsible for the day-to-day management of WhiteHorse Finance manage a total of 53 registered investment companies, pooled investment vehicles or other accounts with a total amount of approximately $34.1 billion in assets under management.

As of September 30, 2012, WHF"s existing investment portfolio consisted of senior secured loans and senior notes across twelve positions with an aggregate fair value of $288.9 million and a principal balance outstanding of $292.0 million.

As of that date, the majority of the portfolio was comprised of senior secured loans to small-cap borrowers. As of September 30, 2012, the portfolio had an average investment size of $24.3 million, with investment sizes ranging from $1.5 million to $62.0 million, a weighted average unlevered cash current yield of 13.9%, and a yield to maturity of 16.9%, with yields to maturity ranging from 9.7% to 30.4%.

Also as of September 30, 2012, the weighted average remaining term of WHF's debt investments was approximately 2.8 years, with remaining terms ranging from 0.8 years to 5.0 years.

WHF was formed on December 28, 2011 and began operations on January 1, 2012. WHF was originally capitalized with $176.3 million of contributed assets from H.I.G. Bayside Debt & LBO Fund II, L.P. and H.I.G. Bayside Loan Opportunity Fund II, L.P., each of which is an affiliate of H.I.G. Capital. These assets were contributed as of January 1, 2012 in exchange for 11,752,383 units in WhiteHorse Finance.

On November 20, 2012, WHF made a single, one-time distribution of $177.1 million to the Members.

This distribution was in the form of (NYSE:A) $145.4 million in cash funded by the proceeds from the Credit Facility and the Unsecured Term Loan as well as cash generated from the ordinary course of business and (NYSE:B) the distribution of all investments in two portfolio companies, which had a fair value of $31.7 million as of the distribution date.

Members received 100% their investment back.

The Distribution to the Members represents, in effect, a return of capital, a reduction in the amount of the Members' initial equity contribution and the partial replacement of such equity contribution with debt capital from unaffiliated third parties.

WHF's intends to declare a distribution of $0.00386 per share per day for the period commencing the day the IPO is priced and continuing through December 31, 2012, which equates to a quarterly rate of $0.355 per share payable early in the first quarter of 2013.

That's a 9.3% annualized return, but to earn a 9.47% return for stockholders WHF must distribute at a rate of 11.625% annually, see below.

INCENTIVE FEE - 2 components
First component
Hurdle rate of 7% annually - that's a low hurdle rate
The operation of the first component of the incentive fee for each quarter is as follows:

• no incentive fee is payable to the investment adviser in any calendar quarter in which the Pre-Incentive Fee Net Investment Income does not exceed the Hurdle Rate of 1.75% (7.00% annualized);

• 100% of the Pre-Incentive Fee Net Investment Income with respect to that portion of such Pre-Incentive Fee Net Investment Income, if any, that exceeds the Hurdle Rate but is less than 2.1875% in any calendar quarter (8.75% annualized) is payable to the investment adviser.

• 20% of the amount of such Pre-Incentive Fee Net Investment Income, if any, that exceeds 2.1875% in any calendar quarter (8.75% annualized) is payable to the investment adviser (once the Hurdle Rate is reached and the catch-up is achieved, 20% of all Pre-Incentive Fee Net Investment Income).

This graphic explains better than the above

Second component
The second component, the capital gains component of the incentive fee, will equal 20% of WHF's cumulative aggregate realized capital gains.

180 days after the IPO.

H.I.G. Capital is one of the leading global alternative asset managers focused on the small-cap market. H.I.G. Capital was founded in 1993 and, over the past 19 years, has grown by continually enhancing its strategic investment capabilities into additional asset classes within the small-cap market.

As of September 30, 2012, H.I.G. Capital managed over $10 billion of capital through a number of buyout, credit-oriented and growth capital funds, each of which is focused on the small-cap market.

As of such date, H.I.G. Capital operated through domestic offices in Miami, New York, Boston, San Francisco, Dallas, Atlanta and Chicago and international offices in London, Hamburg, Paris, Madrid and Rio de Janeiro, with 260 investment professionals with the operating, strategy and investing experience necessary to execute the firm's investment strategy.

Primary competitors that provide financing to small-cap companies include public and private investment funds, including other business development companies, commercial and investment banks, commercial financing companies, specialty finance companies and, to the extent they provide an alternative form of financing, private equity and hedge funds.

WHF expects to net $100 million from its IPO.

WHF plans to invest the net proceeds of this offering and the Concurrent Private Placement of 472,673 shares in accordance with WHF's investment objectives and strategies.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.