We started off yesterday with our look at Bryan Perry’s teased Business Development Companies for his Cash Machine newsletter … and, as is perhaps expected, his headlines were reserved for the pick he teased most fully and touted most aggressively, the Big Daddy of BDCs, Ares Capital (ARCC).
But he also hinted at three others, and I promised to unmask those for you as well (assuming the Mighty, Mighty Thinkolator is up to the job) … so let’s just jump right in, shall we?
“You don’t need a few million bucks to join this Silicon Valley venture group — all it takes is one share of stock. This team of 13 directors — with 274 years experience between them — specializes in tech and life science financing, where this economy’s real growth is. Current yield: 8.5%.”
There are now a few BDCs that focus on high tech and venture capital-type companies, including Horizon Technology Finance (HRZN for the stock, HTF for their listed debt) and TICC Capital (TICC), but this time he appears to be teasing the oldest of these targeted BDCs, Hercules Technology Growth Capital (HTGC for the stock, HTGZ for the listed debt). HTGC, which is what you would want for that higher and possibly growing BDC income (HTGZ is a senior note with a 7% coupon, matures 2019), pitches itself as providing “venture debt” to help startups balance their financing when they’re in the early stages of relying on “venture capital” before they go public or get taken over or otherwise stop being “ventures” or “startups.”
You can see the portfolio of companies that Hercules has invested in/lent to over the years here, some you’ll have heard of, and many no one has heard of that are either very early stage projects or never grew enough to get attention. I haven’t taken a look at this one in quite a long while, but it was teased during the financial collapse by Carla Pasternak, so she gets credit for a pretty decent pick — at the time she suggested the stock it was around $8 and carried a near-20% yield, but the dividend has been cut a couple times over the last three or four years and the stock has risen, so the current yield is indeed about 8.5%, right in line with Ares, but HTGC, with their focus on venture stage companies, definitely conjures up a riskier image.
Is that fair? Well, not necessarily — they did cut the dividend a few years ago, but investors didn’t give up en masse because there’s still plenty of hope for outsize returns from their portfolio investments, since equity in a startup tech or biotech company always offers up that little bit of potential for a dramatic profit to juice returns, and they do seem to get in on pretty decent deals … but more interestingly, you can get an idea of just how tied together these stocks are by checking out a five year chart — ARCC has done a bit better than HTGC over five years (up a few percent vs. down about 5% over that time — not including the dividends), but they clearly move up and down on the same waves.
“This new addition to our Cash Machine buy list is flying under Wall Street’s radar right now — followed by only two analysts — and that often creates huge opportunity. Its three-pronged business strategy is clicking on all cylinders — as evidenced by its recent 33% dividend hike. Current yield: 12.1%.”
This one, sez the Mighty Thinkolator is almost certainly (OK, 90% sure) KCAP Financial (KCAP). It does indeed currently carry a 12.1% yield, and they did just raise the dividend by 33% in the second quarter of this year (though, to be fair, we will also note that this just gets the dividend back to where it was in late 2009 — in the middle of a couple years of slashing the dividend as their world was falling apart.
KCAP is attached to one of the more storied names in private equity, Kohlberg (as in Kohlberg Kravis Roberts, KKR, stars of the “Barbarians at the Gate” leveraged buyout of RJR Nabisco in the 1980s .. though it’s actually Kohlberg who’s behind KCAP and he left KKR just before the Nabisco takeover), and I suppose that you can say it does have a “three pronged” business strategy. They have a traditional BDC business, the middle market mezzanine debt, secured debt and equity that most BDCs specialize in, and they also have two asset management businesses that generate fees and sometimes investment gains (Trimaran and Katonah Debt Advisors).
This is one of the smaller BDCs, with a market cap of just over $200 million, and they are not all that levered (debt of $80 million — the basic limit for BDCs is that debt has to be less than equity, so they could conceivably borrow quite a bit more if they wanted to). They have done well lately, with some analyst upgrades to go along with that nice dividend raise, and you can really see with this one the impact that the dividend has on the share price — they were doing worse than the average BDC for the early part of the year, and trading at a bit of a discount to net asset value as they bottomed out under $6 back in June, and then they raised that dividend and the shares have jumped sharply in the last few months and handily outpaced the average, and now trade at about 1.1X book value. KCAP was one of the worst BDCs during the financial crisis, with a stock price that collapsed, albeit very briefly, from the low teens to just over a dollar as they were in dispute with their bank … but they still paid a dividend even as the stock cratered, albeit a smaller one, in part because they had a diversified enough asset base to keep some cash flowing.
I do like the asset management business as a bit of ballast for the typical BDC lending portfolio, and it was the addition of another asset manager (Trimaran) that gave them the wherewithal to raise that dividend, so that’s positive and may make this firm more stable than the relatively small market cap would imply (I haven’t looked at them all that closely, to be clear, think of me as the guy on the next barstool doodling on a napkin for you). Like many BDCs, KCAP hasn’t actually booked earnings lately — they have a loss over the past year — so it always looks like they’re paying out big dividends without actually making any money. That’s a bit misleading, since the earnings number is impacted heavily by non-cash charges like writedowns of their equity investments, but, as you might imagine, even if it’s OK for a BDC to report losses for a while while still paying good dividends, they can’t keep that up forever — accounting rules and writedowns aren’t always particularly sensible or clear, but eventually losses do catch up with you if portfolio values don’t recover or loans don’t perform over time.
“A more aggressive play in this sector really pays off big — a whopping 14.9% current yield! This is a leveraged play on government-mandated high yields — backed by one of the m