Alcentra Capital Corporation (NASDAQ:ABDC) Q4 2018 Earnings Conference Call March 12, 2019 9:00 AM ET
Vijay Rajguru - Chairman
Suhail Shaikh - Chief Executive Officer
Peter Glaser - President
Ellida McMillan - Chief Financial Officer, Chief Operating Officer
Conference Call Participants
Leslie Vandegrift - Raymond James
Robert Dodd - Raymond James
Chris Kotowski - Oppenheimer
Ryan Lynch - KBW
Good day ladies and gentlemen, and welcome to the Alcentra Capital Corporation Fourth Quarter 2018 Earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question and answer session and instructions will follow at that time. If anyone should require assistance during the conference, please press star then zero on your touchtone telephone. As a reminder, this conference call may be recorded.
I would now like to introduce your host for today’s conference, Ms. Ellida McMillan. Ma’am, you may begin.
Thank you, Joelle. Good morning and welcome everyone to Alcentra Capital Corporation’s fourth quarter 2018 earnings call. I’m joined this morning by Vijay Rajguru, Chairman of Alcentra Capital Corporation and Global Chief Investment Officer of the Manager, Alcentra. Also joining us today are Suhail Shaikh and Peter Glaser. As we announced in our earnings release, Suhail has assumed responsibility of Chief Executive Officer from Vijay, and Peter has become the sole President of Alcentra Capital Corporation.
Before we begin, please note that this call is being recorded. Replay information is included in our February 15 earnings announcement press release that will be posted on the Investor Relations section of Alcentra Capital Corporation’s website, which can be found at www.alcentracapital.com. Please note that this call is the property of Alcentra Capital Corporation. Any unauthorized rebroadcast of this call in any form is strictly prohibited.
Today’s call may include forward-looking statements and projections. We ask that you refer to our filings with the SEC for important factors that may cause actual results to differ materially from those anticipated in any forward-looking statements and projections. We do not undertake to update our forward-looking statements unless required by law. To obtain copies of our SEC filings, please visit our website or call Investor Relations at 212-922-8240.
The format for today’s call is as follows. Vijay, Suhail and Peter will provide an overall business and portfolio summary, and I will then provide an overview of our results summarizing financials, followed by a Q&A.
I will now turn it over to Vijay.
Thank you, Ellida. Good morning. Thank you for joining us to discuss our results for the fourth quarter. Before turning to those results, I’d first like to elaborate on our recent management changes.
We’re delighted to announce that Suhail has been appointed CEO and Peter as President of ABDC. We believe this is the right time for these appointments as both Suhail and Peter have been instrumental in rotating the legacy assets into our new strategy and in leading the investment team. Moving forward, I will remain Chairman of the Board and will continue to provide strategic direction for ABDC.
In addition to serving as President, Peter will also be taking over as co-head of our European direct lending effort where he will work closely with Suhail, who will continue to lead our direct lending business in the U.S. As mentioned on our previous earnings call, we’ve been deploying a portion of our European direct lending fund into U.S. dollar-based investments, which are also allocated to ABDC in accordance with the terms of the co-investment exempted relief that we received from the SEC. The management changes will bring further coordination between our European and U.S. direct lending teams in a way that will accelerate the growth of ABDC’s rotation to upper middle market private equity backed transactions that will be deployed in both vehicles.
We’ve also made significant progress this quarter towards rotating our portfolio into our new strategy and continued to make accretive repurchases of our shares under our buyback program, specifically we were able to buy back 411,939 shares in the fourth quarter under our share repurchase program approved by the board in the fourth quarter of 2018.
Since the first of 2019, we have bought back an additional 229,729 shares and since the beginning of last year, the company has bought back approximately 9.5% of the shares outstanding on January 1, 2018. We will continue to buy back shares until the board authorized amount of $10 million is exhausted. Since the buyback commenced in the fourth quarter of 2018, ABDC has expended approximately $4.2 million.
With respect to rotating our portfolio, to which Suhail and Peter will comment in more detail, we have exited approximately $100 million positions and redeployed approximately $70 million into new investments in the fourth quarter and shortly thereafter. These actions have contributed positively to our recent results and have put us on a stronger course for continued success.
Our NAV per share has continued to stabilize, increasing by $0.05 per share since Q3 2018. This improvement, which is partially due to stock buybacks, occurred despite challenges in the broader loan and equity markets in the fourth quarter, and while we recognize it will take time to prudently rotate the portfolio into upper middle market senior secured loans, we expect our strategy will continue to yield stability.
We are pleased with the growing stability of our NAV but also recognize that our progress may not be linear. We need to continue to be mindful of legacy positions from our prior lower middle market strategy and managing those early positions out of the portfolio as prudently as possible. We will continue to experience volatility in those names given the size of the business mix and the equity co-investment component of those investments. Our board and management team are acutely focused on narrowing the gap between ABDC’s share price and the portfolio net asset value, and I am encouraged by the progress we have made to date. We regularly review all options available to us and are highly confident that we will have the right team and strategy in place to maximize shareholder value.
Suhail, Peter and Ellida will take you through some of the highlights of our quarter. Suhail?
Thank you, Vijay. Good morning everyone. I’m pleased to be addressing you in my new role as the Chief Executive Officer of ABDC. As Vijay mentioned, we are very satisfied with the stability of the book and have been working diligently to rotate our legacy assets into upper middle market senior secured investments. We still have a lot of work ahead of us in rotating the book.
Let me start by sharing some views on the market. The overall leveraged lending market experienced significant volatility in the fourth quarter led by concerns of global slowdown and uncertainty regarding Fed policy. Since year-end, technicals have stabilized with lower prices attracting investors to leveraged loans, particularly in the broadly syndicated loan market. In this backdrop, we remained very active in the fourth quarter and shortly thereafter.
Given our platform’s significant presence in the broadly syndicated loan market, we were able to leverage our insights in an expeditious fashion. Based on these insights and our prior experience, we find periods of volatility in the broader liquid loan market to be a healthy environment to deploy capital in our direct lending strategy. We believe fundamentals remain solid, however we remain cautious in our investment approach. As mentioned in our prior calls, we will continue to focus on businesses with minimum $15 million of EBITDA and ones backed by a strong private equity sponsorship.
We ended the quarter with $234.8 million in fair value of our investment portfolio with 30 positions, including 28 companies, one broadly syndicated loan, and one rated debt security in our CLO. As noted in our quarterly filings, we have since exited all but one of those broadly syndicated loans and CLOs in order to redeploy the capital into our new strategy. Our NAV per share has improved from $11.08 to $11.13 when factoring in share buybacks during the fourth quarter. Our regulatory debt to equity ratio of 0.57 times was below our targeted area given timing of deals which closed in early 2019.
We have made fair value adjustments this quarter to 12 names based on company specific circumstances, resulting in a slight net increase in unrealized depreciation of investments during the quarter. Most of the downward adjustments to the portfolio were in values to our equity positions based on company specific issues and equity market related adjustments. Write-downs in the quarter included Battery Solutions by $1.3 million, Palmetto Moon by $0.3 million, Envocore’s equity by $1.3 million, Champion One’s equity by $0.1 million, IGT’s equity by $0.1 million, and Metal Power Products’ equity by $0.1 million. Our Goldentree Loan CLO debt position was written down by $0.2 million due to the broadly syndicated loan market decline during the quarter.
Write-ups were as follows for Q4: Black Diamond by $1.7 million to reflect the final structure of the recapitalization which closed in December; FST by $1.4 million based on final proceeds received from the sale of the company; Tunnel Hill by $0.1 million based on the final proceeds received from the sale of the company; and Virence by $0.1 million based on prepayment fees paid as part of refinancing.
The average portfolio investment on a cost basis was $8.7 million and $6.9 million on a fair value basis. Measured on a fair value basis, first lien debt comprised 71.6% of the portfolio, a substantial increase from 62.4% last quarter, with second lien positions at 18.1% versus 16.5% in Q3, and subordinated debt at 0.5% versus 9.5% in Q3. Equity positions comprised approximately 9% versus 10.8% in Q3 of fair value of the portfolio.
As you see, our portfolio rotation to senior secured risk continued at a decent pace on Q4. We received proceeds from prepayments, loan dispositions, and amortizations of approximately $100 million while new investments and add-ons totaled approximately $70 million during the quarter and shortly thereafter. Our weighted average yield stayed consistent with our last quarter at approximately 11%. We had only one investment on non-accrual versus four in Q3 as we worked through the legacy portfolio. That investment is Southern Technical Institute, which was marked down to zero on a fair value basis a few quarters ago.
We were able to successfully restructure two of our legacy assets, Black Diamond and Express Global. Both investments have been on our watch list and on non-accrual as of Q3. In the case of Black Diamond, we agreed to recapitalization of the business with the sponsor whereby the sponsor injected fresh capital into the business, and we were able to refinance our [indiscernible] to a first line senior secured tranche being a component LIBOR plus 6.50. In the case of Express Global, the company was sold to Aterian, a private equity firm, as part of a broadly optioned sale process. We received value for our investment in the form of an equity-like instrument as part of that transaction.
In summary, we believe that our continued focus on portfolio rotation should result in long-term value creation for shareholders. Vijay, Peter, Ellida and I remain confident about our ability to reshape this portfolio and continue to stabilize and grow NAV per share as we use the broader Alcentra platform to benefit ABDC while we remain aware of the challenges of shifting some of these lower middle market positions into more stable investments.
Peter will now take you through some of our portfolio originations and how his new role as co-head of European direct lending will continue to benefit Alcentra Capital Corporation. Peter?
Thank you, Suhail. Good morning everyone. I’m pleased to have recently relocated to London to co-head our European direct lending business. Our leading EDL platform of approximately €10 billion in AUM is one of the largest in Europe and the U.K. Its significant middle market and sponsor expertise will help us deploy capital for ABDC into what we believe will be attractive investments. I’ll take you through some examples of this ability to utilize the broader Alcentra platform and leverage our global credit expertise on behalf of ABDC shareholders.
On the origination front, we continue to be active and use Alcentra’s broader platform to benefit ABDC, as both Vijay and Suhail mentioned. In fact, most of the recent new originations in Alcentra Capital Corp. were a result of a coordinated effort using the European direct lending fund to invest in tranches where Alcentra can have substantial voting control in the tranche.
For example, some of the new investments that were made during the quarter and subsequently include the following. Clanwilliam is a $6.3 million investment in a unitranche loan that refinanced the existing capital structure of an Irish software company in the healthcare sector. The Clanwilliam transaction was led by our European direct lending team and ABDC was offered to participate in the transaction in accordance with the terms of our SEC co-investment exempted relief.
Another example is Sandvine. Sandvine was a $4.5 million investment in the second lien of a Francisco Partners portfolio company. We announced Sandvine as a subsequent event in Q3 as well. Our European fund made a large investment in this security, allowing us to be relevant to the borrower and secure a co-investment position for ABDC consistent with its available capital. In addition, our CLOs participated in the broadly syndicated first lien loan.
WeddingWire, a $4.95 million investment in the second lien is a premier portfolio company. The second lien was part of a transaction to acquire XO Group, a public company that manages The Knot, which is a wedding planning site. Similar to Sandvine, Alcentra’s European fund made a significant investment in the security, thereby providing ABDC with the opportunity to take a small investment in the company. Our CLOs again also participated in the broadly syndicated first lien.
Another example of CLO is a $9.8 million investment in a unitranche loan to support Premier’s acquisition of a recruiting outsourcing business. Again, our European fund co-invested in the tranche alongside ABDC in this one as well.
Cambium, another one, $3.8 million in the first lien and $4.7 million in the second lien in a take-private transaction by Veritas Capital of an education software business. Our European fund and other funds managed by Alcentra invested alongside the BDC in this investment.
These names that I’ve gone through - Clanwilliam, Sandvine, WeddingWire, CLO and Cambium are all examples of transactions that allow ABDC to benefit from the strength of the broader global Alcentra platform.
Other new investments during the quarter include Impact Group $19.9 million investment in a unitranche transaction, $12.9 million was announced as a subsequent event at the end of Q3 of that $19.9 million. Impact is a CI Capital portfolio company in the sales and marketing sector. Finally, Aegis is a $2.4 million investment in the first lien term loan of an ABRY Partners portfolio company. This was a secondary purchase of a transaction that some of our principals had familiarity with from their prior experience.
In summary, we continue to use the broader Alcentra platform to provide for attractive positions for ADBC. I will continue from London to work closely with Suhail from my new role as co-head of European direct lending and help facilitate such opportunities going forward.
With that, Ellida will now take you through the detail of our Q4 operating results.
Thank you, Peter. For the three months ended December 31, 2018, total investment income was $7 million, a $1.2 million decrease over the $8.2 million of total investment income for the three months ended December 31, 2017. This was due largely to the continued transition of our portfolio into senior secured loans. The net management fee of $0.8 million was a decrease of $0.5 million from the three months ended December 31, 2017 due to lower average total assets and a temporary 25 basis point reduction from May 1, 2018 to May 8, 2019. There were no incentive fees earned for this quarter nor the comparable period in 2017, although there was a $0.3 million write-off attributable to a previously earned fee in regards to legacy portfolio companies.
Interest and financing expenses for the three months ended December 31, 2018 were $1.8 million, a decrease of $0.3 million from the $2.1 million for the three months ended December 31, 2017. Professional fees and other general and administrative expenses totaled $1.1 million, an increase of $0.3 million from the three months ended December 31, 2017, which was partially attributable to non-recurring consulting fees. There were no consulting fees for the similar period in 2017. Net expenses after the waiver of management fees per the amended advisory agreement were $3.3 million, which was an increase of $0.9 million from the three months ended December 31, 2017.
Net investment income for the three months ended December 31, 2018 was $3.7 million, a decrease of $0.4 million from the prior year. The net realized loss this quarter from portfolio investments was $15 million and the net change in unrealized appreciation from portfolio investments was $12.5 million due largely to the reversal of the unrealized loss for Show Media, Southern Technical, and Express Global Systems. As a result of these events, our net increase in net assets resulting from operations during the three months ended December 31, 2018 was $1.1 million.
As of December 31, 2018, Alcentra had $11 million in cash and $55 million outstanding under the--I’m sorry, of the inter notes, and $28.5 million outstanding under the credit facility.
I’d now like to turn the call back over to Vijay.
Thanks Ellida. Before we begin our Q&A, I want to reiterate that while we have work to do to execute our plan, we’re confident we’re on the best path to maximize shareholder value. We have a very strong team in place both in terms of management and the board and look forward to making continued progress against our plan over the coming quarters.
We’d now like to open the lines for Q&A.
Our first question comes from Leslie Vandegrift with Raymond James. Your line is now open.
Hi, good morning. I have a couple modeling questions for you on the portfolio questions. On Black Diamond, you mentioned the restructure in the quarter, and in the notes it discusses a $2.855 million residual cost that’s rolling off in the quarter. Can you give more detail on that restructure and then that residual cost, what’s going on there?
Yes, let me take the first part of that question and Ellida will handle the second part. The restructuring was--I think as we had mentioned to you at the end of the third quarter, we were in dialog with the sponsor to recapitalize the business and that process concluded in December, whereby the sponsor was able to inject fresh capital into the business. Our security going into that restructuring was a junior security. We were able to restructure into a first lien senior secured dollar one best position. We went from being on non-accrual to a current base structure being LIBOR plus 650 basis points on this paper, and with ample liquidity to see the business execute on its plan. We’re pretty pleased with the outcome of that restructuring and the way it happened, and some of the gain associated with that was largely a function of where we had the [indiscernible] at the end of Q3, and we ended up doing better than that in the actual restructuring.
And that’s the footnote to that extent, Leslie, is that the--it was an accreted cost that we ended up using as a value to restructure it, which was different than what we had marked it at a fair value, so that’s kind of the residual from the old tranche that the footnote is referring to.
Okay, thank you. Then on Cambium, you discussed the broadly syndicated loans and they’re rolling off quickly as you transition into different, more senior secured loans like you did this quarter. So Cambium is a new investment, you did the second lien as well. What should we expect for the duration of that investment, given that it’s another broadly syndicated?
Yes, so Cambium was part of an investment thesis that we had where we took a strip of the first and the second lien, and I think as I mentioned in my remarks, that was one of those situations where we were tracking the loan in the broadly syndicated market and took advantage of the dislocation in the marketplace, and we were able to pick that up at a very attractive yield at a price substantially below VAR. We felt like between that and the privately negotiated transaction that we entered into to buy the second line, we stripped our investment for the BDC in the first and the second lien, so that’s on the side.
As far as the refinancing of that first lien, our view is that that’s a buy and hold strategy for us; but as you probably are well aware that first lien loans in the broadly syndicated market tend to refinance at a much faster pace than privately held loans.
Okay, thank you. My last question to the equities, Envocore and Battery Solutions, those were the big movers on the equity side that I saw. Was there any specific news for either of those companies that led to those markdowns?
Yes, both of them are on our watchlist. Companies have, for a variety of reasons--you know, let’s take Battery Solutions first. It had some issues, weather-related issues on delay on shipments, etc. which caused some earnings softness which we had to take into account. In the case of Envocore, there were some other--you know, they missed their earnings for a variety of reasons and the company, while missing earnings, they both are on watch list and we are working very aggressively and very closely with the management and sponsors to monitor those situations on an ongoing basis. I don’t think, you know, what you seen in terms of marks are any reflection of [indiscernible] both the equity multiples coming down in some respects and then earnings missed based on what we had expected numbers to pan out at the end of the quarter.
Okay, thank you.
Thank you. Our next question comes from Robert Dodd with Raymond James. Your line is now open.
Hi everyone. We just tackle different topics. On the discussion, Peter, with you having some European domiciled assets, obviously the Irish software business, for example, can you give us any color on where you would like that to go as a percentage of the portfolio? Obviously in the presentation, non-U.S. domiciled assets looks to be [indiscernible] 13% right now, and that includes Goldentree and some other things, I think, and the cap’s at 30 on normal qualified as a percentage of assets. What’s the overall plan for those kind of other types of investment, same kind of style but different domicile, where it does look like they’ll maybe have more of an edge in that given the size of the Alcentra platform in Europe?
Just one thing to note, Robert, is that that 13%, the largest portion of that is really a Canadian investment in a company called [indiscernible], and then obviously Clanwilliam and the CLO that you mentioned. I’ll give you an overall and have Peter jump in.
Our view, and that’s part of this whole sort of ability to globalize our business on the direct lending side and the shift towards management changes is really driven by this ability for us to use all our resources to bear within Alcentra. To the extent we see greater opportunities coming out of Europe, we obviously have up to 30% of the asset pool to deploy in those opportunities, and we’ll continue to do that.
Peter, I’ll let you fill in as you’re seeing the opportunities as well.
Yes look, I think that’s absolutely right - we’re clearly mindful of and constrained by the 30% bucket. The way we view the U.K. and European-domiciled businesses is are they attractive, do they fit what the BDC is trying to accomplish, and there are a number of factors around that, and then ultimately the BDC obviously in the U.S. has its own IC process, so it has to pass muster that way regardless of the views of a particular credit in Europe. So it becomes very opportunistic, and when it’s good risk-return that happens to be domiciled in Ireland or England or elsewhere, the BDC will consider it. I don’t think there are any specific targets beyond that except for attractive risk-return investments, all things considered.
I think where you’ll see more dollars put to work on behalf of the BDC by virtue of the European platform is that list that I mentioned where we were able to get allocations because we were larger investors by using the European fund. Obviously the Clanwilliam investment this past quarter was just over $6 million, and if you look at the aggregate of those other investments that I mentioned, it’s something much closer to something like $20 million. I think that’s what you should expect to see potentially more of because those are U.S. domiciled businesses where we can be a major player in a tranche of a capital structure by virtue of the fact that we can combine together both our European fund that has a U.S. allocation as well as the capital from the BDC.
Okay, got it, thank you. I appreciate that color. One more, if I can. On the portfolio repositioning overall, which I recognize that it takes time, your portfolio has shrunk over the course of the last year, the number of investments down from 37 to 30. Your base management fee [indiscernible] goes back up to a [indiscernible] 1.25 right now, but 1.5 at the end of April if I remember right. Do you believe the portfolio is going to be sufficiently repositioned and of size such that that still is a base management fee where the dividend can be earned?
Let me break that question into two pieces. First, let’s give some high level numbers. I think that 50% of our portfolio currently on a fair value basis is what we’d deem to be legacy assets. Twenty percentage points out of that 50 are roughly on names that we actually like and they’re high performing, quality names that we’d like to keep in the portfolio. Another 9% is our equity positions which frankly we’d like to rotate out, but in most cases we are a minority equity holder and so we don’t drive the bus, if you will, on those decisions. That 9% will get redeployed into more income earning assets. Then the other roughly 20% are in names where we are focused very, very--you know, laser focused in trying to rotate out into these upper middle market, higher earning type of investments.
So hard for us to say exactly how the portfolio rotates and how quickly it rotates, but I think our goal is also to increase the size and basically grow the portfolio as we get through the next several through quarters, however some of it is just going to be through the capital that we free up from legacy assets, some of it is going to be from, to your point, shrinkage being reversed and us going back into sort of a steady mode.
Okay, got it. I appreciate that, thank you.
Our next question comes from Chris Kotowski with Oppenheimer. Your line is now open.
Yes, good morning. Most of my questions have been asked, but I just wondering on the new investments that you went through, most of them were in the kind of smallish, $4 million to $6 million size, but then Impact’s $20 million credit almost 14% of net assets. What size positions should we be expecting in the BDC, and Impact looks like a particularly large credit and was wondering why there’s so much of that one?
Yes, good question, Chris. So Impact is a unique situation. We have the ability to enter into a club with existing lenders, and frankly the way that transaction came about was sort of all or nothing, so we liked the underlying trends of that business, we liked the underlying quality, so we took a slightly outsized position in it.
With respect to our philosophy, I think we’re trying to keep everything sub-5%, so you’re spot on in sort of the 2 to 4% where we’d like to see our positions generally. That’s where we’re going to target. Frankly, besides in fact we have some legacy positions that are in that zip code as well of 14 to 15% that we’re looking to try and lessen, if you will, or decrease the size of.
Okay. All right, that’s it for me. Thank you.
Thank you. As a reminder ladies and gentlemen, that’s star then one to ask a question. Our next question comes from Ryan Lynch with KBW. Your line is now open.
Hey, good morning. Just had one question, kind of a broader question on your strategy. If I look at this quarter, the weighted average EBITDA grew pretty significantly to about $24 million from about $16 million last quarter. I know you guys are focusing on rotating the portfolio into more of an upper middle market strategy. I just wanted you guys to define, because everybody sort of has different definitions of middle market, can you kind of define what the upper middle market means to you all since that’s going to become your focus going forward, as well as can you talk about why you view that as a more compelling opportunity and where you guys believe you have a competitive advantage in that space versus other direct lenders?
Sure, great question, Ryan. We define upper middle market as sort of $15 million to $75 million of EBITDA, and that’s sort of the broad range. I think our view is that as you get to businesses that are in the $30 million, $40 million of EBITDA, they tend to have more staying power, there’s reason for them to exist, and they tend to have better visibility in their earnings. They also tend to be capitalized by larger sponsors with substantial amount of private equity backing behind them, so we like all of those features.
Frankly from our strength of Alcentra’s platform, really it resides in that area where, as Peter mentioned, we’re one of the largest direct lenders in Europe. That’s been our focus, has been focused on targeting upper middle market deal by and large, and most of our [indiscernible] capabilities come from that pool of deals, so we think that we’re well positioned for that sector. I think in terms of how we compete, Peter alluded to this, I think we provide a solution between our ability to write sizeable checks of $13 million to $15 million-plus per tranche today between our various pools of direct lending capital for U.S. dollar based investments. That number will grow as we raise other capital around the BDC, and in addition to that where there is a liquid credit portion attached to that deal, our liquid credit teams and CLO funds also participate on those deals, so you’re really going to the sponsors with a pretty holistic solution and that gives us a little bit of an edge relative to some of our competitors.
Then I think the final point is that we’re all sitting here late in the cycle and our view is that being associated with these larger companies with larger sponsors that have the ability to write checks, should things start to get a little bumpy along the way, that’s a much better place to be than being associated with some of the lower middle market companies with sponsors in many cases that don’t have the ability to write large checks [indiscernible].
Okay, understood. Appreciate the time today.
Thank you very much.
Thank you. I am not showing any further questions at this time. I would now like to turn the call back over to Vijay Rajguru for any closing remarks.
Thank you, Joelle, and thank you all for joining our call. We are here if you have any further questions or as you go through our earnings statement. If you’ve got any more questions, reach out to any four of us and we’ll make sure we are available to answer your questions. With that, thank you very much for taking the time to join us on this call.
Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program and you may all disconnect. Everyone have a wonderful day.