Hercules Technology Growth Capital (HTGC), currently the only Business Development Company focused on lending and investing in technology and life science companies, has just crossed a threshold. After eight consecutive dividends of 30 cents a share pegged above the Company's Net Investment Income Per Share ("NIIPS" for short), HTGC recorded a 31 cent NIIPS in the 3Q of 2007. We're predicting that we'll be hearing about a dividend increase to 35 cents (or more) very soon. For the year ending September 2007, distributions were 98% ordinary income. Given the recent ramp up in earnings, this suggests Taxable Income is outrunning distributions. Ergo, HTGC will have to increase its dividend shortly to keep within the BDC tax rules.
First, though, let's go back to the numbers. HTGC achieved record Revenues and Net Investment Income for the period, blowing away the prior year comparables. Despite nearly tripling the shares outstanding in a year, the Company still managed to rack up an 8 cent increase in diluted NIIPS. That's a 34% increase in twelve months. The balance sheet remained very strong, with debt outstanding only accounting for 13% of equity capital. Credit quality-always a concern with a BDC which invests (partly) in early stage venture deals at the senior level-with only 2% of investments in the lowest 2 portfolio grades.
Going forward, HTGC seems poised for substantial income growth. Management has hinted that no new (dilutive) capital raising is planned, and there is up to $500mn of untapped debt capacity. Add to that, the nearly 13% yield the Company has been achieving on loans (14.9% when fees and prepayments are taken into account), and a moderate 27% of non-interest expenses to Total Investment Income, we estimate that HTGC can generate an additional 12.5 cents per share of NIIPS a year on just $100mn of new loans (assuming no change in bad debts). The challenge just might be getting the money lent out fast enough. During the third quarter repayments of existing loans exceeded new fundings by a slight margin. Management,though, pointed out that they have recently penned $133mn in possible future commitments with 9 companies and have up to $108mn to spend on previously committed lines of credit. So, a boost in total investment assets seems likely in the short run (6-9 months).
Then there is the enticing prospect of equity gains from the Company's increasingly diversified portfolio of technology companies. Out of 82 portfolio companies on the books, HTGC enjoyed warrant positions in 75 of them (up from 51 a year ago). The Company still predicts at least 12 "liquidity"events for its portfolio companies (such as an IPO or a sale)in 2007, which can (and has) result in unrealized or realized equity gains. We note that the Company is planning to put more of its dollars into equity (as opposed to debt with warrants), which should result in more "pops" down the road.
The real fly in the ointment for HTGC is a meltdown in the technology sector. Should new capital into the sector freeze up many of the portfolio companies could fold, with little residual value to HTGC. The opposite is happening right now, with technology companies enjoying renewed popularity from Wall Street and corporate acquirors, but these things can turn on a dime. The meltdown risk, should it come to pass, remains in the mid-term future. In the next two or three quarters we should see a ramping up of NIIPS and the dividend. On November 5th's closing price of $12.5 (only 4% over NAV per share), the current yield is 9.6%. At the anticipated new dividend rate of $1.40 a year, the prospective yield is 11.2%. Seems like a good buy for a stock which could be paying a (still growing) dividend of 14% within 3 years.
Disclosure: Author has a long position in HTGC