This 12% Dividend Yielding VC-Backed Tech Investor Will Likely Beat Q2 Estimates

Summary

• TPVG remains near the lower end of its targeted leverage 0.60 but has already invested $85 million and management is expecting increased portfolio growth included in the updated projections.
• However, TPVG's largest investment ($50 million in Ring, Inc.) will likely be repaid in Q2 due to being purchased by Amazon, resulting in meaningful prepayment-related income and beating Q2 expectations.
• This article also provides important updates for PSEC, AINV, BKCC, CGBD, MRCC, GLAD, PFLT, TCRD, OXSQ and FSIC.
• In February 2018, the SEC issued a public notice of exemptive relief application to permit co-investment with TriplePoint Capital that will likely provide TPVG increased opportunities for portfolio growth and diversification.

Quick BDC Market Update

As discussed in "3 Largest Business Development Companies Take Steps To Increase Returns To Shareholders":

Over the last few days, the largest business development companies ("BDCs") have released SEC filings showing that their Boards are seeking to take advantage of the recently relaxed regulations for the sector. I believe that this sends a strong message and the other ~40 BDCs will likely follow suit over the coming weeks."

Also discussed in the article was the potential for S&P downgrades which happened last week. Please see "7.6% Dividend Yield From This Sleep Well BDC" for a list of BDC that were subsequently downgraded (temporarily) to negative outlook.

Apollo Investment Corp. (AINV) Update:

AINV already had a "negative outlook" but recently announced the following.

On April 4, 2018, the board of directors (the “Board”) of Apollo Investment Corporation (the “Company”), including a “required majority” (as such term is defined in Section 57(o) of the Investment Company Act of 1940, as amended (the “1940 Act”)) of the Board, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, the asset coverage ratio test applicable to the Company will be decreased from 200% to 150%, effective April 4, 2019."

Source: SEC Filing

BlackRock Capital Investment Corp. (BKCC) Update:

BKCC also already had a "negative outlook" and recently announced the following.

The Company currently has not determined whether to take advantage of the additional leverage. If the Company chooses to take advantage of such additional leverage, it will mean that for every $100 of net assets, we may raise $200 from senior securities, such as borrowings or issuing secured stock. If this ratio declines below 150%, we may not be able to incur additional debt and may need to sell a portion of our investments to repay some debt when it is disadvantageous to do so, and we may not be able to make distributions."

Source: SEC Filing POS 8C

TCG BDC Inc. (CGBD) Update:

The Board unanimously recommends that the company’s stockholders approve the Asset Coverage Ratio Proposal. In consideration of the application of the 150% minimum asset coverage ratio to the Company, the Board considered the information it received relating to, among other things:

• the benefits of increased financial flexibility;
• the potential to increase and sustain returns on equity;
• the Company’s investment strategy and portfolio construction;
• the current middle market direct lending landscape;
• the risks relative to benefits associated with the use of increased leverage;
• impact on the base management and incentive fees payable to the company’s investment adviser (the “Investment Adviser”);
• limitations of current credit facilities;
• the company’s additional disclosure obligations.

The Board considered that, as a BDC and a regulated investment company (“RIC”) for tax purposes, the Company will benefit from increasing the maximum regulatory leverage, through significantly more flexibility for complying with the asset coverage requirements applicable to BDCs. Importantly, application of the 150% minimum asset coverage ratio would enable the Company to better withstand potential adverse market movements while still meeting its asset coverage requirements. For example, as of December 31, 2017, the Company’s asset coverage ratio was 235%, which, under the current 200% minimum asset coverage ratio, provided a 15% cushion based on fair value of investments. Under a 150% minimum asset coverage ratio, all else being equal, that cushion would be 36% based on fair value of investments."

Please see more details: SEC Filing

Monroe Capital (MRCC) Update:

On March 27, 2018, the board of directors (the “Board”) of Monroe Capital Corporation (the “Company”), including a “required majority” (as such term is defined in Section 57(o) of the Investment Company Act of 1940, as amended (the “1940 Act”)) of the Board, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act. As a result, the asset coverage ratio test applicable to the Company will be decreased from 200% to 150%, effective March 27, 2019."

Reasons to Decrease the Required Asset Coverage Ratio

We believe that the increased flexibility that would be available to us after adoption of the modified asset coverage ratio would allow us to deploy more capital and thereby potentially increase overall returns to our stockholders. Further, we believe that increased leverage would permit us to invest in a segment of the middle market comprised of lower risk and lower yielding loans without sacrificing return to our stockholders. Any decision on our part to use leverage will depend upon our assessment of the attractiveness of available investment opportunities in relation to the costs and perceived risks of such leverage. The use of leverage to finance investments creates certain risks and potential conflicts of interest."

Source: SEC Filing

PennantPark Floating Rate Capital (PFLT) Update:

On April 10, 2018, PennantPark Floating Rate Capital Ltd. (the “Company”) issued a press release, included as Exhibit 99.1 to this Form 8-K, announcing that on April 5, 2018 the board of directors of the Company (the “Board”), including a “required majority” (as such term is defined in Section 57(o) of the Investment Company Act of 1940, as amended (the “1940 Act”)) of the Board, approved the application of the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act, as amended by the Consolidated Appropriations Act of 2018 (which includes the Small Business Credit Availability Act). As a result, the Company’s asset coverage requirements applicable to senior securities will be reduced from 200% to 150%, effective as of April 5, 2019."

Source: SEC Filing Pre 14A

Gladstone Capital (GLAD) Update:

On April 10, 2018, Gladstone Capital issued a press release, filed herewith as Exhibit 99.2, announcing that Board, including a “required majority” (as such term is defined in Section 57(o) of the Investment Company Act of 1940, as amended (the “1940 Act”)) of the Board, approved the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act, as amended by the Small Business Credit Availability Act. As a result, the Company’s asset coverage requirements for senior securities will be changed from 200% to 150%, effective one year henceforth on April 10, 2019."

Source: SEC Filing

THL Credit (TCRD) Update:

Although we have been able to access the capital necessary to finance our investment activities, in the event there is a period of disruption, uncertainty and volatility in the capital markets, capital may not be available to us on favorable terms, or at all. BDCs like the Company must comply with the asset coverage requirements mandated by the 1940 Act in order to incur debt or issue senior securities, which requires the Company to finance its investments with at least as much equity as debt and senior securities in the aggregate. Recent legislation has modified the 1940 Act by allowing BDCs to increase the maximum amount of leverage they may incur from an asset coverage ratio of 200% to an asset coverage ratio of 150%, if certain requirements are met."

"Notwithstanding the legislative change, the Company’s revolving credit facility with ING Capital LLC (the “Revolving Facility”) requires that it maintain an asset coverage ratio of greater than 200%. Because BDCs must determine the fair value of the assets in their portfolio quarterly, an unfavorable shift in market dynamics or the existence of underperforming assets may lower that determination of fair value and therefore proportionately increase the value of balance sheet debt compared to assets. Going below the 200% asset coverage ratio provided by our Revolving Facility could result in the breach of debt covenants. BDCs like the Company must be able to access equity capital in order to build the Company’s investment portfolio thereby increasing the value of net assets in order to realign its debt to equity ratio and avoid any negative consequences."

Many investors ask me how they should vote when a BDC asks permission to issue shares below net asset value ("NAV") and it comes down to the quality of management. TCRD does not have history of dilutive offerings and the following wording is part of the above statement:

As a result, BDCs like the Company seek to obtain approval to issue shares of common stock at a price below the current NAV in order to maintain consistent access to capital. Stockholder approval of this proposal will provide the Company with the flexibility to make investments in accordance with the Company’s investment objective."

Source: SEC Filing

Oxford Square Capital (OXSQ) Update:

On April 6, 2018, the board of directors (the “Board”) of Oxford Square Capital Corp. (the “Company”), including a “required majority” (as such term is defined in Section 57(o) of the Investment Company Act of 1940 (the “1940 Act”)) of the Board, approved the modified asset coverage requirements set forth in Section 61(a)(2) of the 1940 Act, as amended by the Small Business Credit Availability Act. As a result, the Company’s asset coverage requirements for senior securities will be changed from 200% to 150%, effective as of April 6, 2019."

Source: SEC Filing

Prospect Capital Corp. (PSEC) Update:

PSEC has reversed course and released the following:

On April 6, 2018, the Board of Directors of Prospect Capital Corporation (the “Company”), as a result of new industry guidelines set forth by Standard & Poor’s on April 3, 2018, determined to no longer modify, beginning March 25, 2019 (one year from prior board determination), the asset coverage ratio test applicable to the Company under Section 61(a)(2) of the Investment Company Act of 1940. As a result, the Company’s asset coverage ratio test remains and is expected to remain at 200% instead of 150%."

Source: SEC Filing

FS Investment Corp. (FSIC) Update:

On April 9, 2018, FSIC announced the closing of the previously discussed transaction to create the market’s largest BDC platform, with $18 billion in combined assets under management. Please see "FSIC Closes Deal - Updated Deep Dive Report: April 2018" for discussions of changes to fee agreement, etc.

Effective today, a new partnership, FS/KKR Advisor, LLC, will serve as the investment adviser to six BDCs: FS Investment Corporation (NYSE: FSIC), FS Investment Corporation II (FSIC II), FS Investment Corporation III (FSIC III), FS Investment Corporation IV (FSIC IV), Corporate Capital Trust, Inc. (NYSE:CCT) and Corporate Capital Trust II (CCT II). All of the BDCs are able to participate in the same transactions alongside each other and KKR Credit’s institutional funds and accounts.”

“We have been working closely with the KKR team over the past several months to prepare for this transition and are now looking forward to realizing the full benefits of our combined platform for investors,” said Michael Forman, Chairman and Chief Executive Officer of FS Investments. “Our focus will continue to be on optimizing the platform and enhancing performance as we also evaluate potential mergers of these BDCs to create value.”

Todd Builione, President of KKR Credit and Markets: “We have enjoyed working with our partners at FS over the past many months. We firmly believe that through our collective scale and complementary expertise, our combined BDC franchise is positioned to drive superior results for our investors – and holistic financing solutions to our sponsor and corporate clients.”

Source: SEC Filing

BDC Buzz Articles Update

As mentioned in "BDC Buzz Begins Purchases Of Higher Quality BDCs," I have recently been buying additional shares of higher quality BDCs, especially given the oversold conditions driving higher yields. Over the coming months, I will be focused on some of the positive changes in the BDC sector, including:

• Relaxed regulations and tax reform
• Rising interest rates and portfolio yields
• Recent insider purchases

Seeking Alpha has decided to make articles such as this one available for free for the first 10 days only. I highly recommend enabling the "get email alerts" for the contributors that you are actively following:

• Link to: Change Author Email Alerts

The following articles are still available (for free) to all readers:

• "Good News For This Best-Of-Breed BDC Yielding 9% Plus Upcoming Specials"
• "7.6% Dividend Yield From This Sleep Well BDC"
• "3 Largest Business Development Companies Take Steps To Increase Returns To Shareholders"
• "The High-Yield BDC Sector Gets A Boost From The Recent Spending Bill"

The following information discussing TriplePoint Venture Growth (NYSE:TPVG) was previously made available to subscribers of Sustainable Dividends, along with target prices and buying points, real-time changes to my personal BDC positions, updated rankings and risk profile, real-time announcement of changes to dividend coverage, and worst-case scenarios, and suggested BDC portfolio.

TPVG provides financing primarily to venture capital ("VC") backed technology companies at the venture growth stage, similar to Hercules Capital (HTGC) and Horizon Technology Finance (HRZN) with warrant positions in high growth sectors that could drive NAV per share growth and/or special dividends.

For example, on October 19, 2017, MongoDB, Inc. (NASDAQ:MDB) priced its initial public offering, raising $192 million and has appreciated since 2017 as shown in the following chart. However, this is a smaller investment for TPVG with a fair value of $1.0 million as of December 31, 2017.

TPVG Dividend Coverage Discussion:

For the quarter ended December 31, 2017, TPVG reported between my base and worst case projections only covering 83% of its dividend. As predicted in "It Might Be Time To Add This 12% Yielding BDC," TPVG was not expected to cover its dividend due to being underleveraged from previous early repayments. However, the company covered its dividend on an annual basis in 2017 thanks to one-time prepayment-related income during Q1 and Q2 as discussed next.

We're proud that our net investment income or NII of $1.61 per share for the year was not only up 18% over 2016, but even more impressively was 12% above and in excess of the yearly dividend that we paid to shareholders. In fact to our knowledge, TPVG was the only publicly held dedicated venture lending firm to cover its dividend in 2017 from NII.”

Source: TPVG Q4 2017 Results - Earnings Call Transcript

Also, the recent fundings were near the end of the quarter resulting in lower interest income for the quarter and I have taken into account with the update projections:

“As a reminder, fundings typically occur in the last month of the quarter and don't contribute meaningfully from an income perspective until the next quarter.”

Source: TPVG Q4 2017 Results - Earnings Call Transcript

Source: SEC Filings & BDC Buzz

My primary concerns are mostly related to dividend coverage from recurring sources without one-time prepayment-related income. As shown in the previous table, the company has easily covered its dividend during the first two quarters of 2017 due to prepayment-related income. However, for Q2/Q4 2016 and Q3/Q4 2017, the company did not benefit from prepayments and was not able to cover its quarterly dividend.

Source: TPVG Q4 2017 Results - Earnings Call Slides

Management estimates that un-distributed taxable income carry forward from 2017 into 2018 will be roughly $1 million or $0.06 per share “further solidifying our stable dividend projection.”

We estimate that un-distributable taxable income carry forward from 2017 into 2018 will be roughly $1 million or $0.06 per share further solidifying our stable dividend projection.”

Source: TPVG Q4 2017 Results - Earnings Call Transcript

As discussed in previous reports, there was a large amount early repayments in Q1 and Q2 resulting in a portfolio of $254 million and the lowest since Q2 2015. However, in Q4, the company funded $80 million in new debt investments, offset by lower repayments for total portfolio growth of around $61 million. The company is still at the lower end of its targeted leverage with a debt-to-equity ratio of 0.60. Also, its $50 million loan to Ring, Inc. will likely be repaid in Q2 2018 resulting in prepayment-related income (discussed next).

Sajal Srivastava, President and CIO: “The announcement by Amazon that it has agreed to acquire Ring marks a promising start for anticipated liquidity events and other strategic developments for our portfolio companies in 2018 and underscores the high quality of our portfolio. It again validates our unique and superior venture growth stage investment focus, our investment discipline and our strategy of working with companies backed by a select group of leading venture capital investors.”

Source: TPVG Press Release

My ‘base’ case projections use conservative assumptions including no benefit from prepayment-related activities in Q1 2018, but I am assuming that Ring will be repaid in Q2 with prepayment-related income driving quarterly net investment income (“NII”) of $0.45 to $0.50 and covering the dividend by 125% to 140%.

The good news is we have line of sight for portfolio growth and again with some of the developments already for the year that have been announced, great things from a dividend perspective and dividend coverage perspective.”

Q. “I mean if my math is right assuming that there is a prepayment with Ring it would currently drive around $0.11 a share of accelerated income, mid income, so that's obviously a real positive. Let me ask you different question, the 1.7 fair value adjustments that came in this quarter. Obviously the K came out while the call was going on so it's a little tough to run through this quickly but can you put a pin in sort of the source of the $1.7 million in fair value unrealized depreciation?”

A. “Yes, I mean this is Andrew here I can kind of speak to a little bit. Primarily it was kind of a little bit of a mixed bag, I mean there were couple individual positions on the debt portfolio that you’ll see there was a slight mark on and then a couple other one. In equity portfolio, there was nothing in terms of a specific portfolio company issue per se. It was more of - as we reach at the end of each quarter we run our valuations, we tweak assumptions that may drive kind of some incremental mark-to- market on the portfolio as a whole.”

Source: TPVG Q4 2017 Results - Earnings Call Transcript

I have used higher portfolio growth and yields in the ‘best’ case projections as management is expecting healthy portfolio growth for 2018 and has already closed $85 million in new investments subsequent to quarter-end:

Considering we ended 2017 with $100 million of unfunded commitments have closed $85 million of new investments so far in Q1 and have $100 million of signed term sheets. We have almost $300 million of potential funded assets right there but the exciting thing is that we expect signed term sheets and closed deals to come in greater than last year which again points towards meaningful portfolio growth in 2018. We expect that the core yield profile of our portfolio will be stable and will continue to be leading the industry in the 13% to 14% range again without the benefit of prepay's. With regards to prepay's, while they are part of business we haven't had any still far in Q1. Although we expect Ring to prepay at $50 million loan when the acquisition closes, we don't expect as much activity in 2018 as we saw in 2017.”

“Our expectation this year for quarterly investment fundings is in the $50 million to $100 million range on a gross basis up from our target in prior years of $30 million to $50 million per quarter. So on a full-year basis, we see the potential for between $200 million and $400 million of investment fundings.”

“As we speak today, our originations pipeline stands at the largest it has ever been with the same level of high quality. We're also continuing to see strong and growing yields. We’re very optimistic on the outlook for 2018.”

Source: TPVG Q4 2017 Results - Earnings Call Transcript

Part of management’s optimism is related to the large amounts of VC equity capital that has been raised and will likely be leveraged using debt capital from companies such as TPVG:

One of the drivers behind this business is the Venture Capital market. $32 billion of capital alone was raised by venture firms in 2017. This is the second highest year on record, more than $143 billion of total capital over the last four years alone, the highest four-year period ever. This all translates into long-term dry powder that the Venture Capital firms have for deploying into new and existing portfolio companies, all of which of course will be candidates for debt financing at large.”

“At the same time 2017 also turned into an all-time record for Venture Capital equity investing $84 billion of Venture Capital was invested last year, $300 billion in the past four years across 37,000 deals. Simply said, the Venture Capital asset class continues to attract significant amounts of capital to invest and the Venture Capital funds themselves are actively deploying it into new and current investments.”

Source: TPVG Q4 2017 Results - Earnings Call Transcript

In February 2018, the SEC issued a public notice of exemptive relief application to permit co-investment with TriplePoint Capital that will likely provide increased opportunities for portfolio growth and diversification.

As an important first step, the SEC issued public notice in February of our exemptive relief application and the actual event of orders expected to be issued after the notice period expires on March 26, 2018. We're very proud of the hard work of our team and of our counsel in making this happen and we look forward to sharing updates as they occur.”

“And so I think from a total leverage perspective I think shareholders should be happy given the strong pipeline and unfunded commitments that we have a near-term path to continue to grow and this just lets us allocate the larger transactions which clearly TPVG may miss out in general to the extent that we didn’t have the ability to allocate or put into with our partners or JV investments or co-invest.”

“We do however believe we'll diversify our portfolio in several ways, the simplest of course is by increasing total portfolio of size which we are very confident that will achieve this year. We also expect to diversify the portfolio through potential co-investment, joint venture and syndication partnerships among us, our sponsor TriplePoint Capital and our strategic partners.”

Source: TPVG Q4 2017 Results - Earnings Call Transcript

Management has been working to reduce its effective borrowing rates that most recently included reducing its unused facility fees from 0.75% to 0.50%. This is important during periods of lower leverage as TPVG would have an effective borrowing rate of 6.42% (was 6.68%) with a debt-to-equity ratio of 0.60 (as shown in the Leverage Analysis available to subscribers of Sustainable Dividends) which is still among the highest cost of borrowings for a BDC.

Given the direct cost of our credit facility, any incremental borrowings will lower our overall cost of capital and will be highly accretive to shareholders. Furthermore, in January 2018 we amended and renewed our credit facility which included an increase in the total commitment by $10 million, extended the maturity to 2021 and reduced the undrawn rates and applicable margin to improve economics.”

Source: TPVG Q4 2017 Results - Earnings Call Transcript

On July 11, 2017, TPVG announced the pricing and issuance of $65 million of 5.75% notes due 2022 trade on the NYSE under the symbol “TPVY” with the proceeds used to refinance the existing notes “TPVZ” at 6.75%, resulting in lower borrowing rates but one-time expenses in Q3 2017. The company ultimately issued $74.8 million of notes (includes over-allotment).

From a liquidity standpoint, we ended the quarter with total cash of $10 million and $133 million of undrawn availability under our $200 million revolving credit facility. That put us in a leverage ratio of 0.60x within our target range of 0.60x to 0.80x. We have ample liquidity and regulatory leverage headroom to give us runway for the strong demand and opportunity we see in the market.”

Source: TPVG Q4 2017 Results - Earnings Call Transcript

Insider Purchases & Ownership:

It should be noted that insiders were purchasing additional shares in Q4 2017 at prices ranging from $13.10 to $13.65, but have not recently purchased at lower prices. Previously, management was buying at prices closer to $12.00 which is where it is now.

Source: GuruFocus

To be a successful BDC investor

• Establish appropriate price targets based on relative risk and returns (mostly from dividends).
• Identify BDCs that fit your risk profile (there are over 50 publicly traded BDCs, please be selective).
• Diversify your BDC portfolio with at least five companies.
• Be ready to make purchases during market volatility and look for opportunistic buying points.
• Closely monitor your BDCs, including dividend coverage potential and portfolio credit quality.

Analyst’s Disclosure: I am/we are long TPVG. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.