TPVG - Horizon Technology Finance: This 11% Yield Is A Hold For BDC Investors

2023-11-15 00:01:54 ET

Summary

• Horizon Technology Finance offers an attractive investment mix and has the potential for high total returns.
• The BDC suffered a deterioration in credit quality but still maintains robust dividend coverage and declared a special dividend.
• The stock is currently classified as a Hold due to the balance of pros and cons in its 3Q-23 results.

Horizon Technology Finance ( HRZN ) makes a good enough value proposition for passive income investors as the BDC is growing its investment portfolio, and has an attractive investment mix, including Equity and Warrant positions that could boost the company's total return potential and Horizon Technology Finance managed to cover its generous dividend pay-out with NII in the third quarter.

Horizon Technology Finance also declared the payment of a special dividend in the amount of $0.05 per share. On the flip side, the BDC suffered a deterioration of its credit quality in the third quarter as the amount of non-accruals rose. Balancing the pros and cons of the BDC's 3Q-23 results, my stock classification for HRZN remains Hold.

My Rating History

I modified my stock classification for Horizon Technology Finance to Hold in August because the BDC's stock was no longer trading at a discount to NAV.

Truth be told, I initially leaned towards a Sell recommendation, for reasons of prudence, because the BDC suffered a deterioration of loan quality in the third quarter. Taking into account that the BDC also declared a special dividend and maintained robust dividend coverage, however, I have decided to maintain my Hold stock classification for now.

Horizon Technology Finance's Portfolio Breakdown, Credit Quality

Horizon Technology Finance's portfolio, as of the end of 3Q-23, was concentrated in technology and life science investments which together accounted for 80% of the BDC's investments.

Other investments included companies operating in the Sustainability (12%) and Healthcare Information Services (8%) industries. From a sector analysis point of view, investments in the Software business dominated Horizon Technology Finance's portfolio mix.

Horizon Technology Finance owned 56 different debt investments in the third quarter, representing 93.2% of total portfolio investments. The BDC's investments included Equity and Warrant positions equal to 5.6% of portfolio value. Horizon Technology Finance's total portfolio was valued at $729.1 million, reflecting a QoQ increase of 1.9%.

Three investments were on non-accrual status in the last quarter (two in 2Q-23) representing a fair value of $17.2 million . This represented a non-accrual ratio of 2.5% compared to 2.2% non-accrual ratio in the second quarter.

The increase in non-accruals is not a good development. If it weren't for Horizon Technology Finance's robust dividend coverage ratio and the declaration of a special dividend as a means to distribute excess portfolio income, I would have rated HRZN a Sell.

Best-In-Class Dividend Coverage

Horizon Technology Finance's quarterly dividend, which is paid monthly, was well-covered by NII in the third quarter: The BDC earned $0.53 per share in NII while paying out a cumulative $0.33 per share, resulting in a dividend payout ratio of 62%.

Because of the BDC's strong NII in 3Q-23, Horizon Technology Finance decided to pay a $0.05 special dividend (record date: 17 November 2023).

Hercules Capital, Inc. ( HTGC ) had a third quarter dividend payout ratio of 77% whereas TriplePoint Venture Growth ( TPVG ) had a dividend payout ratio of 74% in 3Q-23. Put simply, in the niche sector of tech-focused BDCs, Horizon Technology Finance offers, based on its latest dividend pay-out, the safest dividend, in my view.

Horizon Technology Finance's 16% Premium To NAV And Peer Comparison

Tech-focused BDCs trade at premiums to NAV primarily because they have upside potential related to the exit of Equity and Warrant positions in case one of their portfolio companies hits a smashing home run.

As a consequence, Horizon Technology Finance sells for a 16% premium to NAV. This is the second highest premium to NAV in the niche sector, after Hercules Capital which is presently priced at a 47% premium to NAV.

TriplePoint Venture Growth BDC is selling at a 3% discount to NAV and may be the riskiest of the lot due to a large percentage of bad loans in the BDC's investment portfolio.

Why Horizon Technology Finance Could See A Higher/Lower Valuation Multiple

Horizon Technology Finance is a floating-rate BDC (95% of the outstanding principal amount of the BDC's debt investments were floating-rate) meaning the BDC will see a reset in the loan rate if interest rates change. Thus, an end to the present rate-hiking cycle poses a threat to Horizon Technology Finance's NII performance.

Taking into account that the BDC produces robust dividend coverage, I don't see any immediate dividend risks emanating from Horizon Technology Finance's portfolio.

My Conclusion

Horizon Technology Finance offers passive income investors a best-in-class dividend pay-out ratio of 62% which is substantially lower than the comparable dividend pay-out ratios of its BDC peers Hercules Capital and TriplePoint Venture Growth BDC.

Horizon Technology Finance did see an increase in non-accruals QoQ, but the deterioration in credit quality is offset, in my view, by robust dividend coverage and the declaration of a special dividend.

The 11% yield remains covered by NII and I maintain my stock classification of Hold.

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