TCPC - BlackRock TCP Capital: Upcoming Merger Undervalued 12% Discount

2023-11-05 09:15:00 ET

Summary

• BlackRock TCP Capital yields 12%-plus, with 1.15X coverage, and a history of good dividend coverage.
• An upcoming merger in Q1 2024 will add scale to its operations.
• BlackRock TCP Capital sells at a 12% discount.

In this "higher for longer" rate era, it appears that Business Development Companies, or BDCs, should continue to benefit from higher rates, in that the majority of their investments are usually floating rate, while a large share of their debt is at fixed rates.

The management of BlackRock TCP Capital ( TCPC ) included this table below of the effects of rising rates in its latest presentation. Management estimates that TCPC will gain $.21 in annual NII/Share for each 100 basis point increase in rates, and correspondingly lose $.21/share for each 100 basis point drop. BDCs have the ability to counter dropping rates' negative effects via ramping up their portfolios.

Company Profile:

BlackRock TCP Capital Corp. is an externally-managed specialty finance company focused on middle-market lending. TCPC's investment objective is to achieve high total returns through current income and capital appreciation, with an emphasis on principal protection. We invest primarily in debt of private, middle-market companies with enterprise values typically between $100M and $1.5B. ( TCPC site .)

Holdings:

76% of the portfolio is held in 1st Lien investments, with 13% in 2nd Lien. There is also 11% in Equity investments. 95% of the investments have floating rates.

As of 9/30/23, the weighted average annual effective yield of the debt portfolio was ~14.1%, and the total portfolio yield was ~13.2%.

As of 9/30/23, TCPC's 4 top industry exposures comprised 48% of its portfolio, led by Internet Software & Services, at ~15%; with Financial Services and Consumer Services, both at 12%, and Software at 9.4%, down from 12% as of 6/30/23.

Over 90% of TCPC's portfolio companies each contribute less than 2% to its recurring income

Earnings:

Q3 '23 earnings were strong, with 12.45% top line growth, 16% NII growth, and 16.7% NII/Share growth. As seen elsewhere, Interest expense continued to rise, up 19%, but was outstripped by NII. The share count remained flat.

Realized Gains were -$.13M, a minimal amount, improved vs. a year ago, and much improved vs. Q1-2 '23, which showed a ~$31M realized loss.

Q1-3 '23: Total Investment Income rose 18%, while NII and NII/share were up 24.27%. NAV/Share was $12.72 as of 9/30/23, down 9.9%, with $1.47/share attributable to dividends paid.

Realized Gains were -$31.15M, (i.e. losses), up dramatically vs. the -$18.23M in 2022.

TCPC reported that Debt investments in 3 portfolio companies were on non-accrual status as of September 30, 2023, representing 1.1% of the portfolio at fair value and 1.7% at cost. That should be ~ $17.6M. There was no further detail given.

Proposed Merger:

On September 6, TCPC and its affiliated BDC, BCIC, entered into a definitive agreement pursuant to which BCIC will merge with and into a wholly owned, indirect subsidiary of TCPC, subject to shareholder approval, customary regulatory approvals, and other closing conditions.

"The proposed merger is expected to result in a combined company that benefits from more efficient access to capital, the potential for improved trading dynamics, combined operating efficiencies, enhanced scale, and a base management fee reduction in conjunction with a successful closing of the transaction. The merger combines two very similar portfolios, and TCPC’s investment team will continue to manage the combined portfolio

In connection with the signing of the Merger Agreement, TCPC also entered into a fee waiver agreement with the Advisor. The Fee Waiver Agreement provides that the Advisor will waive all or a portion of its advisory fees to the extent the adjusted net investment income of the Company on a per share basis is less than $0.32 per share in any of the first 4 fiscal quarters." (TCPC site)

Following the merger, TCPC will continue to trade on the Nasdaq Global Select Market.

New Business:

In Q3 '23, TCPC invested ~$92.4M, primarily in 8 investments, comprised of 4 new and 4 existing portfolio companies. These investments were 99% senior loans. It received ~$125.6 million in proceeds from sales or repayments of investments.

New investments during the quarter had a weighted average effective yield of 14.8%, while investments that TCPC exited had a lower weighted average effective yield of 12.7%.

Dividends:

At its 11/2/23 $11.20 closing price, TCPC yielded 12.14%. Its most recent quarterly distribution was $.34, plus a supplemental payout of $.10.

TCPC has a -2.32% 5-year average dividend growth figure, due to decreasing its quarterly payout from $.36 to $.30 in Q3 2020, during the Covid pandemic.

NII/Distribution coverage has been historically strong since TCPC's IPO in 2012, with total trailing coverage of 1.18X, including the 2 special dividends.

It should go ex-dividend next on ~12/18/23, with a ~1/2/24 pay date.

Profitability & Leverage:

ROA, ROE and EBIT Margin all continued to improve in Q3 '23, remaining well above BDC industry averages. Debt/NAV also improved a bit, dropping to 1.32X.

TCPC's Asset/Debt ratio and EBIT/Interest ratio were both stable in Q3 '23:

Debt & Liquidity:

TCPC's funding is split between Unsecured Debt, 34%, Equity, 43%, Credit Facilities, 14%, and Small Business Association Debentures, 9%.

As of 9/30/23, TCPC had liquidity of ~$353M, including $91.7M in cash. Its earliest maturity is in August 2024, when its 2024 Senior Unsecured Notes come due.

On August 4, 2023, the Funding Facility II was amended to extend the maturity date from August 4, 2025 to August 4, 2027. As part of the amendment, the interest rate was revised to SOFR plus a credit spread adjustment of 0.15%, plus a margin of 2.05%.

TCPC's unsecured debt continues to be investment grade rated by both Fitch and Moody.

Performance:

TCPC has lagged the BDC industry, the Financial sector, and the S&P 500 (SP500) over the past quarter, year, and so far in 2023.

Analysts' Price Targets:

At its 11/2/23 $11.20 closing price, TCPC is 6.7% below Wall St. analysts' low price target of $12.00, and 13.85% below their average price target of $13.00.

Valuations:

At its 11/2/23 $11.20 closing price, TCPC was selling at an 11.95% discount to its9/30/23 NAV/share of $12.72, a much deeper discount than the 4% average BDC industry discount. Its P/Sales of 2.54X was also much lower than the 3.99X industry average.

TCPC remains cheaper than average on an earnings multiple basis - its trailing P/NII of 6.20X is 26% lower than the BDC average of 8.37X, while its forward P/E is also lower than average, as is its EV/EBIT. Its 12.14% dividend yield is higher than average.

Parting Thoughts:

The upcoming 2024 merger should be a positive for TCPC, giving it more scale. Although they're still a small 1.1% of assets, the realized losses need to be watched - they'll be an indicator of how the underlying companies are coping with higher rates.

We rate TCPC stock a buy, based upon its well-covered 12% yield, its undervaluation, and the potential for increased scale from the proposed merger.

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