HTGC - Horizon Technology Finance: You Can Get A 10.9% Yield On Your Buy

Summary

• Horizon Technology Finance is a unique, tech-focused BDC.
• The company has a debt-focused investment portfolio with warrant exposure that provides income upside.
• Horizon Technology Finance covers its dividend with net investment income.
• HRZN recently raised its dividend by 10%, and the stock could trade at a larger NAV premium.

Horizon Technology Finance Corporation ( HRZN ) is a well-managed business development firm specializing in technology firms.

The portfolio is performing well, the dividend is well-covered, and the BDC recently increased its monthly dividend by 10%.

Horizon Technology Finance, I believe, is an appealing BDC to consider for passive income investors, owing to its focus on a market niche.

The stock is trading at roughly book value, but it has the potential to expand its premium valuation if the Fed continues to raise interest rates in 2023.

Horizon Technology Finance Operates In The Venture Capital Market

Horizon Technology Finance is distinct from other business development firms in that it focuses on providing venture debt capital to growing companies.

Most BDCs invest in companies in the middle market, which consists of companies that have difficulty obtaining financing from traditional banks. The majority of middle-market firms are established, mature businesses with long operating histories and stable, recession-resistant cash flows.

Horizon Technology Finance, on the other hand, focuses on the venture capital niche, with a particular emphasis on technology, life sciences, and healthcare technology companies.

The total addressable market for this type of investment strategy is $49 billion, and it is served by a small number of specialized BDCs such as Horizon Technology Finance and Hercules Capital, Inc. ( HTGC ) .

Horizon Technology Finance's portfolio is primarily comprised of debt investments made to companies in a variety of industries, the majority of which are biotechnology (24%), medical devices (18%), consumer-related technology (18%), and software (17%).

At the end of the September quarter, debt investments made up 96% of the BDC's portfolio, with warrants accounting for the remaining 3.5%.

Horizon Technology Finance gains additional upside potential from warrant (but also equity) investments if a particular borrower's business takes off.

As of September 30, 2022, the BDC's investment portfolio was valued at $634.6 million. According to Horizon Technology Finance's most recent quarterly 10-Q report , there were no non-accrual investments.

Dividend Coverage And Dividend Growth

Horizon Technology Finance earned $1.06 per share in net investment income between January and September 2022, while paying out a total of $0.90 per share. The quarterly dividend was $0.30 per share and was paid on a monthly basis throughout 2022.

The pay-out ratio for 2022 based on the data available so far was 84.90%, indicating that the dividend is very well covered.

Because of its strong dividend coverage, the company announced a 10% increase in its monthly dividend to $0.11 per share, giving investors who buy HRZN today a 10.9% dividend yield.

Horizon Technology Finance also has portfolio income upside from its floating rate investments. Horizon Technology Finance's outstanding principal amount of debt investments had floating rate interest rates as of September 30, 2022, implying that a hawkish central bank in 2023 could result in investment income tailwinds for Horizon Technology Finance.

According to BDC projections, a 100-basis-point increase could result in $5.85 million more investment income and, potentially, an increase in the base dividend or the payment of a special dividend.

Premium Valuation Possible

Horizon Technology Finance is trading at a 4% premium to net asset value, which, in my opinion, has the potential to grow into a higher premium, especially given the BDC's excellent portfolio quality.

The BDC's portfolio is performing well, and the floating rate investment exposure strongly implies portfolio income upside that investors may not have fully factored into Horizon Technology Finance's valuation.

Hercules Capital, for example, achieves a much higher net asset value premium, and Horizon Technology Finance, in my opinion, deserves a similar 30%+ NAV premium.

Why Horizon Technology Finance Could See A Lower/Higher Valuation

Horizon Technology Finance, I believe, has a more appealing growth profile than other business development companies due to the BDC's primary focus on technology companies.

Horizon Technology Finance is similar to Hercules Capital in that it has the same target market and core investment focus. In light of the BDC's long history of producing strong financial results, I strongly recommend HTGC .

My Conclusion

Horizon Technology Finance, in my opinion, is a well-managed business development firm with potential in the venture capital niche as well as upside in portfolio income and valuation.

The BDC's stock is currently trading around book value, but I believe HRZN's valuation premium will grow as long as the portfolio performs well (no new non-accruals).

Given that the BDC recently increased its dividend payout by 10%, I believe the 10.9% yield available here is one that passive income investors will be able to enjoy for quite some time.

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