Continued Volatility With This 11% Yielding BDC

Sep.21.17 | About: TriplePoint Venture (TPVG)

Summary

• As predicted in my previous article, TPVG recently rallied after beating Q2 2017 earnings expectations and then quickly declined after Q3 2017 earnings were downgraded.

• TPVG continues to struggle with staying fully leveraged and could have dividend coverage in the coming quarters after taking into account declining net interest margins.

• The company recently issued a Baby Bond that will likely result in higher effective borrowing rates (of almost 7%) due to 'commitment fees' on its facility during underleveraged periods.

TriplePoint Venture Growth (TPVG) recently reported results and as predicted in "This 11% Yielding BDC Will Likely See Volatility Soon":

"There is a good chance that the stock could rally after beating Q2 2017 earnings expectations, quickly followed by a decline as investors assess upcoming portfolio growth and dividend coverage."

"TPVG reports Q2 2017 results on August 8 (estimated) and will likely beat the current earnings estimates for Q2 of $0.32 per share due to higher prepayment-related income, similar to previous quarters."

Recent price volatility for TPVG:

• $12.37 - July 24 - 4 days after my previous article (see above) came out.

• $14.19 - Aug. 28 - 20 days after the company reported results.

• $12.75 - Sep. 11 - after recent earnings downgrades.

Change In Expected Earnings

Also mentioned in the article linked above:

"However, the company will miss Q3 estimates of $0.35 per share, and estimates will likely be downgraded in mid-to-late August. This means that we could see a rally after reporting Q2 quickly followed by a decline as investors assess upcoming portfolio growth and dividend coverage potential."

As shown in the chart below, that is exactly what happened and analysts are now expecting $0.24 per share compared to the previous $0.35 with a range of $0.16 to $0.28. Keep in mind that the current quarterly dividend is $0.36.

My primary concerns are mostly related to dividend coverage from recurring sources. The company has easily covered its dividend over the last two quarters due to prepayment-related income. However, for Q2 and Q4 2016, the company did not benefit from prepayments and only covered ~85% of its dividend as shown below. This was also due to the size of the portfolio and not using enough leverage, which continues to be an issue including my upcoming expectations for Q3 2017.

“We want to return to our targeted leverage ratio on the 0.6 to 0.8 range, and we want to drive our warrants in equity gains. And all of this is aimed at growing the portfolio to cover the dividend without the benefit of prepayments.”

For Q2 2017, TPVG beat my best-case projections and covered its dividend by 153% due to higher-than-anticipated one-time prepayment-related income.

“We also had $130 million in customer repayments and prepayments from five portfolio companies. Two of these representing $50 million of principal were from the acquisitions at Birst and Xirrus, which we announced last quarter. Another two representing $40 million of principal were some have CrowdStrike and Farfetch, both which closed massive equity rounds during the quarter. CrowdStrike raised more than $100 million and Farfetch raised more than $400 million. And finally one representing $40 million was due to a refinancing. As a result of the customer prepayments, our portfolio yield was a record 19.9%. Without customer prepayments, our portfolios yield is 13%, which was up from 12.5% last quarter, so equally impressive in our opinion.”

The large amount early repayments resulted in a portfolio of $254 million, the lowest since Q2 2015 as shown in the chart below.

Baby Bond Issuance:

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).

Negative impacts from the notes offering:

• Increased the amount of notes outstanding from $56.4 million to $74.8 million at 5.75% instead of using its lower cost credit facility at LIBOR + 3.00%

• Increases the likelihood of additional commitment fees for the credit facility during underleveraged periods for “unused borrowings.”

• Additional recurring amortization of fees and one-time expenses of $1.1 million in Q3 2017 associated with the early redemption of the previous notes “TPVZ.”

My primary concern is the need for the company to stay fully leveraged for adequate dividend coverage due to the impacts discussed above. TPVG had almost $84 million in cash as of June 30, 2017, “due to the timing of certain prepayments,” which is the difference between a debt-to-equity ratio of 0.53 and 0.14 (net of cash) as shown in the chart below. It will likely take a few quarters for the company to reach its target leverage and as shown in the Leverage Analysis (discussed later).

Another concern is lower net interest margins, which is critical for BDC dividend coverage and is basically the margin between rates for invested assets and borrowings. TPVG would have an effective borrowing rate of 6.85% with a debt-to-equity ratio of 0.60 (also shown in the Leverage Analysis), which is among the highest cost of borrowings for a BDC. This is due to the negative impacts from recent notes offering listed above.

“As of June 30, our total cash position was $83.5 million and we had $140 million available on our $200 million revolving credit facility, our higher than usual cash position at quarter end was due to the timing of certain prepayments that occurred on June 30. Subsequent to the end of a second quarter, we raised approximately $72.3 million of net proceeds from the issuance of baby bonds priced at 5.75%. The transition was upsized from a base deal of $55 million as result of strong institutional demand.”

Q. “Now you also mentioned that you’ll have in this coming quarter $1.1 million of accelerated unamortized costs from the call of the baby bond. There’s also going to be sort of interest crossover period, where both baby bonds are going to be outstanding at the same time. Do you know how much that sort of additional crossover interest is going to be? I mean, many BDCs just sort of said that that’s sort of a one-time transition cost that’s not repeatable. Do you have any sense for how much that’s going to be?”

A. “I’ve to do the math, but it’s essentially 30 days, right, so we gave the call notice that was 30 days to 40 days between when we gave the notice and when we actually paid off. It’s essentially a month and the six and three quarters is the double interest I guess is for the crossover period.”

Q. “The portfolio today is really concentrated, I think just 16 portfolio companies in total. And so growth is really needed to diversify and also improve recurring cash flow, also a less concentrated portfolio would leave you with less impact from individual repayments. But with the short duration of assets it seems that TPVG is always battling to fully leverage the portfolio. So would investment team growth help here or is the market opportunity really more niche rather than something that can be scaled?”

A. “I think first is a little bit of the challenge of our size and scale given our current market cap. So I’d say at the high level we see strong demand, strong market conditions, again, we have a $143 million of unfunded commitments, we have $115 million of the signed term sheets, we have several hundred million dollars of term sheets outstanding. And so we see, again, the ability to quickly grow and scale. I think our challenge has been we picked great companies. And when you work with great companies, other people, particularly, equity investors and acquires want to work with those same companies. And so to have 14 of our portfolio companies either acquired or closed make it around the financing, it’s a fact we’re very proud of. But at the same time, it causes the challenge that they’re either paying us off or there is lose in liquidity where the CFOs can do the math. And they’d say, great, that’s why I pay you 14-plus percent, so do I – well, I’m adding zero on the cash I have. And so I would say, again, these are good things, good reasons for why we had the prepaid, but we see strong demand, as Jim said, strong finish to grow the portfolio over the next couple of quarters.”

Sustainable Dividends

Starting October 1, 2017, I will be increasing the pricing for my "Sustainable Dividends" platform on Seeking Alpha. However, current subscribers will be grandfathered in at their current pricing, so sign up before then to lock in a lower rate.

The information in this article discussing TPVG was previously made available to subscribers of "Sustainable Dividends" along with:

• Target prices and buying points

• Projected dividend coverage and worst-case scenarios

• Rankings and risk profile

• Suggested BDC portfolio

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.