BDC Market Snapshot: Week Ended July 22, 2022
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BDC Market Snapshot: Week Ended July 22, 2022

Up, But Not Away

As discussed in the BDC Reporter's BDC Common Stocks Market Recap for the week ended July 22, 2022, investors are in an optimistic frame of mind. All the indices were up, both for the last 5 days and for the month and the BDC sector followed suit. How long this lasts - or whether there is nothing but blue skies ahead - nobody knows.  However, we do point out in the Recap that BDCs - almost without exception - still have a long way to go before returning to prior price heights or to be deemed over-valued by the standard measures of price to net book value per share, price to future earnings or dividend yield.

Slimmer Pickings

That's good news for prospective BDC investors still looking to "go long" regardless of the endless speculation about a coming devastating recession. The bad news is that this week's upward price momentum has reduced the number of BDCs that - according to our model - offer very high 5 year returns of 100% or higher. This category has dropped from 12 names, down to 9. Likewise, the next category down - offering prospective annual returns of 15%-20% - has fallen to 18 names from 20.


Nonetheless, by comparison with all of 2021 and 2022 up to May, there are plenty of bargains around. That's if you agree with our premise that BDC earnings and balance sheets are not in for a major beating if and when the Waiting For Godot recession plays out, either in late 2022 or in 2023. (If you believe otherwise, run the other way).

Still Number One

Anyway, still top of the charts in term of potential return is Cion Investment (CION) - last week's Best Idea when the 5 year return was deemed to be 205% when the stock closed at $8.20. We invested in CION on Monday in our Best Ideas portfolio on Monday at $8.27 and the stock closed the week at $8.63. Obviously that's a good start, but with 259 more weeks to go we're keeping the champagne in a cool place in the garage. Currently, CION still promises a 190% return, far and away the highest prospect in the 43 common stocks and 18 Baby Bonds we track.


Given that we're already invested in CION, we're looking around for our next Best Idea. In that top category - leaving out CION - there are 8 names to choose from: AINV, CSWC, FCRD, HRZN, PFX, SLRC, TRIN and TPVG.  It's an interesting mix of BDCs in differing segments of the leveraged lending market and of historically high performers and under performers.

One Amongst Several

We've chosen Horizon Technology Finance (HRZN) as the Best Idea this week for a variety of reasons. In the short term, we expect the venture debt segment in which the BDC operates to thrive. This is counter-intuitive giving the headlines about doom in venture capital; the drop-off in the number of IPOs this year and the multiple lay-offs occurring in technology companies that were previously deemed the next best thing to sliced bread. However, technology and life sciences are not going anywhere; there's plenty of capital waiting on the sidelines as capital does in times of uncertainty and plenty more to be raised in the years ahead. Right here, right now BDC lenders like HRZN are much in demand as equity alternatives shrink and new activity volume is high.

Plus And Minus

In the immediate future, earnings may be hurt by less repayments, which normally result in so-called End Of Term Payments, which boosts yields, but HRZN and its ilk will be benefiting from higher interest rates:

As we've consistently noted, 100% of the outstanding principal amount of our debt investments bear interest at floating rates with coupons that are structured to increase as interest rates rise

Thanks to Baby Bonds

The BDC's own debt is increasingly fixed rate, giving HRZN both the benefit of higher rates (and even wider spreads on new loans) and only a modest increase in borrowing costs as rates move up several percentage points.

Envelope Not Pushed

Also a positive is that the BDC's debt to equity is relatively low at 0.9x, versus a target of 1.2x and way off the regulatory limit of 2.0x. This should keep HRZN out of trouble if the markets freeze up, which they are far from doing at the moment.

Long Streak

Also, the BDC has been paying a very steady regular distribution of $0.10 per month since the IVQ 2016, and has built up a "reserve" of undistributed taxable income of $0.47 per share, available to "top up" the distribution on occasion when earnings - always volatile in venture debt - falls short.

Headed Higher

Earnings seem to be in good shape if you ask the 4 analysts that cover this BDC, despite a weak IQ 2022. For the IIQ of this year, the consensus is $0.34 and IIIQ is pegged at $0.36. For all of 2022, the EPS is estimated at $1.34, jumping to $1.49 in 2023. Like us, the analysts seem to have drunk the kool-aid about the prospects for higher income going forward.

Pulling Back

Yet, in our model, we are only envisaging distributions - both the $1.20 in "regular" payments and $0.05 of "specials" - of $1.25 per annum in 2022 through to 2026. We're holding back on the assumption that i) interest rate benefits may come and go relatively quickly as the Fed raises and then drops rates to finagle a "soft landing"; ii) credit losses will creep in and cause some loss of income. Admittedly, the situation at the moment is pretty clear on the credit front with only one portfolio company on non accrual with a FMV of $5.5mn. Total underperforming assets amount to a low 4% of the portfolio, and that includes the non accrual.


In the past, though, HRZN has tripped up a few times with credit losses and not booked much in the way of offsetting realized gains from its myriad small equity stakes. Over its history, $340mn in equity capital has been raised and "Distributable Losses" have amounted to ($60mn). We hope this might change going forward but hope is not a strategy so we're assuming some losses that would erode profitability. Maybe that's overly conservative...


Where our model is aggressive is in the terminal multiple use to come up with the Target Price: 15.0x the dividend of $1.25 in Year 5. That results in a price of $18.75, versus $12.42 today. Not so long ago, though, HRZN was an investor darling and reached an all-time of $19.08. Based on 2020 and 2021's total distributions of $1.25, that implied a price to dividend of 15.4x - hence our "aggressive terminal multiple".

Less Loved

Thankfully - from a buyer's perspective - HRZN has currently lost its sheen and its stock price has dropped (35%) from its height - a much greater fall than BDC stocks on average. At this price - and assuming we're right about a $1.25 annual payout - the yield is just over 10% per annum and paid mostly monthly.

Lower Multiple

If we're wrong that HRZN will eventually trade back at a superior multiple and only reaches 12.5x - the estimate we have for venture debt market leader HTGC - the model indicates the total return drops to 76% over 5 years - still a superior, albeit less exciting, return. The target price would be $15.63.


On a pro-forma basis, assuming both that 12.5x multiple and a drop in the annual distribution to $1.0 per annum - a 20% reduction, the model calculates a target price of $12.50 - essentially unchanged from the current level and a total return of 41%. That's not a worst case scenario because terrible things can happen to any company but this pro-forma dividend reduction scenario seems both unlikely to occur and still offering an OK return if matters do not go as we have anticipated.

All In All

By no means is HRZN a flawless BDC: the management fees expenses are higher than they should be; as are its cost of debt capital and there are those occasional credit mis-steps and minimal equity gains to figure in. We also worry about whether the frenetic portfolio growth of recent years might be cause for regret in the future. In a BDC sector with 5 venture debt players, HRZN is the smallest in size, partly because the advisor chose to set up a separate private fund to book some of the assets that might have gone to the BDC and without offering the public shareholders much in the way of compensation.

Ending On A Positive Note

Nonetheless, the BDC has been around for twelve years and has been expanding and improving its platform and bringing on additional professionals; its two Baby Bonds and regular equity raises ensures the portfolio is well funded with longer term capital and there's that steady dividend to point to. Most of all, HRZN is trading at a two year price low, providing an excellent "entry point". According to Seeking Alpha, the BDC has returned its shareholders 73% over the last 5 years. We project HRZN will earn 101% over the next 5 years.