To say that the financial crisis changed the landscape of the
banking industry would be a bit of an understatement.
One of the biggest dangers to capitalism was the interruption
of the investment flow that technological innovators require. As
the banking behemoths teetered on the verge of collapse, capital
market liquidity and business lending in the traditional banking
channels pretty much evaporated.
Luckily, many business development companies (BDCs) stepped up
to the plate.
Basically, BDCs are simply pools of money that take investor
money, lend it to businesses as some combination of debt and
equity, and reward investors based on the performance of the
BDC's investment portfolio.
Most of the companies that BDCs work with are what are
referred to as mid-market companies: too big to be small, too
small to be big. But many of these companies become bigger and
often go public. That's when the true value of the equity stake
the BDC takes is unlocked.
One of the more interesting names on my radar is
Hercules Technology Growth Capital (Nasdaq HTGC)
. With a market cap just shy of $1 billion, Hercules has set its
sights on fast-growing technology and biotech businesses.
As I've said many times, I am NOT a technician. However, I
don't deny the validity of certain chart patterns. Typically, a
double-bottom formation can be a bullish signal. The stock has
recovered an impressive 18% from that bottom after falling 23%
from its high. But I'm more interested in the underlying
In February, S&P Dow Jones Indices said it would be
removing all BDCs from its U.S. indices due to concerns regarding
reporting requirements, internal fees and expenses, and certain
investment restrictions. No surprise, then, that the BDC sector
as a whole was knocked back some due to rebalancing and selling
by shortsighted investors.
Moves like these -- that create short-term weakness in prices
due to nothing more than an administrative housecleaning -- give
investors a chance to get more for less... and in the case of
Hercules, that's a great opportunity.
HTGC's latest quarterly earnings report was a barnburner.
First-quarter earnings per share (
) came in at $0.30, handily beating expectations of $0.27.
Originations (meaning loan/equity transactions) also knocked the
cover off of the ball: Estimates called for $92 million, but HTGC
beat that by over 20%, writing $112 million worth of new
Pre-payments, loans being paid off before their term ends,
were also much lower than expected: pre-payments for the quarter
came in at only $19 million, less than half the $39 million
expected by analysts. This means that the company can maintain
steady cash flow generated by interest income in order to support
the 7.7% dividend yield.
In addition, the company has $230 million in cash ready to be
deployed in new investments. A look at its portfolio shows HTGC
knows how to put capital to good use.
The portfolio is primarily focused on information technology
and life sciences. One of HTGC's most successful equity stakes
have included is
Merrimack Pharmaceuticals (Nasdaq:
, which has risen nearly 40% since its IPO in 2012.
Going forward, current EPS estimates call for $1.20 for 2014
and 10% growth to $1.32 in 2015. The $230 million in cash the
company is looking to put to work should be the driver of that
Risks to Consider:
On a company specific level, the biggest risk facing HTGC
involves its exposure to high-tech and biotech. Both sectors have
fallen under considerable pressure so far this year, and further
weakness could put pressure on the performance of the company's
underlying portfolio. For the BDC sector collectively, the
biggest risk always facing them is a slowdown in the larger
Action to Take -->
Currently, HTGC shares trade around $15.70, which is a 9%
discount from their previous high. The stock has an incredibly
cheap forward price-to-earnings (P/E) ratio of 12.5 and strong
dividend yield of 7.7%. Based on the current valuation and
high-growth portfolio, a 12- to 18-month price target of $20 is
reasonable. The result would be a total return, when factoring in
the dividend, of nearly 35%.
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