TPVG - TriplePoint Venture Growth: Buy This BDC For Strong Returns As It Increases Dividend

Summary

• TriplePoint Venture Growth’s third quarter earnings results exceeded expectations by a hefty margin, reporting record NII growth.
• Despite the NAV decline, investors should not be worried due to the rising interest rates and its positive effect on TriplePoint Venture’s NII.
• The management announced a dividend increase, and TPVG stock is yielding 11.8%.

Investment thesis

TriplePoint Venture Growth ( TPVG ) released its third quarter earnings results and the company exceeded expectations by a hefty margin. The company is flourishing in a growing interest rate environment and the net interest income is on the rise. TPVG will benefit from the further rise of interest rates in the next couple of quarters. The management announced a dividend increase and the stock is now even more attractive for income investors than before.

Internally managed by a great team

TriplePoint Venture Growth is a business development company specializing in investments in venture capital-backed companies at the growth stage investments. It's the 23rd largest publicly traded BDC among the 48, so we can say it is a medium-sized company. I prefer internally-managed BDCs over externally managed ones because I find them more effective and accountable from an investor's point of view. In addition, they tend to outperform their externally managed peers, just like TPVG did in the last five years.

Moreover, the management is not only experienced, but the CEO is one of the co-founders of TriplePoint Capital and the co-founders have worked together for more than 23 years. With this management team, the company's total return was almost identical to the S&P 500 but with a stable income stream for income investors. If an income investor invested in TPVG eight years ago, he received almost 85% of its initial investment purely via dividends. (And still a shareholder in the company.)

TriplePoint Venture Growth Q3 earnings results

If I have to describe TPVG with one word, it would be stability . What I mean by that is the stability of its business and its continuous growth over the years. The cumulative NII has always been more than the distributions since its IPO. The portfolio deals are still directly originated so no brokerage or agent commission needs to be paid, which lowers the expenses. On the other hand, the interest expense skyrocketed in the last two quarters and this trend is likely to continue in the next six months. But at the same time, it means that the interest income is growing as well. The company has reported record NII and well-exceeded analysts' estimates. TPCG could grow its interest income from investments by 8.2% Q-o-Q and by a staggering 56% Y-o-Y. The NAV has been heavily affected by the decline in asset prices and the company reported a NAV of $12.69 for the third quarter, 9.4% lower compared to the end of 2021 NAV.

I'm not too concerned about it because the fluctuation of the company's NAV is normal during interest rate hikes and economic downturns. As long as the portfolio companies are stable and the interest income increases, I'm fine. The company received record-low early prepays , only 0.1% of the total portfolio ($0.7 million), this is the lowest in the last four years. This will unlikely change in the future due to the further increases in interest rates, so the management does not have to worry about 10%-plus of the portfolio "disappearing" just because of prepayments.

Future of TriplePoint Venture

I expect exceptional fourth quarter results from the company and as long as the interest rates continue to climb the NII also will increase. The management has also started to use the Small Business Credit Availability Act's 2:1 maximum leverage ratio for BDCs, and the current leverage ratio is 15-20% higher than its three-year average, standing at 1.15x at the end of the third quarter. Interest expenses and leverage will likely increase as they borrow greater amounts under the Credit Facility, issue additional debt securities, and as interest rates increase.

The interest rate increases are playing into the management's hands and TPVG investors are rewarded. The Fed recently increased the base rate by 75 basis points, and the FOMC will very likely increase it again in December by another 50 points. This will result in an approximately $0.15 per share NII increase annually for TPVG, an increase of $0.0375 per share NII increase for the fourth quarter. In addition, the interest rate increases are not going to stop in the first quarter of 2023 and another 50-100 basis point increase in 2023 will further fuel the company's NII.

Risks

Investors have to take into consideration three things: How the sectors are going to perform where TPVG invests, how the leverage ratio changed the BDC market, and how the portfolio companies will perform. TPVG invests in mainly consumer products and services, e-commerce, business applications software, the fintech sector, and healthcare technology systems. Most of this sector has seen a slight slowdown in recent months, almost all of the major companies in these sectors have frozen hiring or planning some layoffs. This will affect middle-market companies as well. The question is how long this freeze will last. I believe that it can last for the next 6-9 months until inflation normalizes. Due to this, lending activity might slow down and TPVG's management will have a harder time finding suitable companies to invest in.

The consequences of the 2:1 leverage ratios are getting clear. Larger BDCs benefit from their management of bigger asset pools to attract a lower cost of debt funding compared with smaller rivals, handing them an advantage when pricing on individual transactions. As long as TPVG will remain one of the BDCs that have a relatively average market size, the advantage will be with the bigger players in the leverage field.

In terms of the portfolio companies, TPVG has direct investment in 50 companies. Most of them are fine, but one of them has some problems. On Nov. 1, 2022, TPVG received preliminary information regarding certain recent negative developments at portfolio company Medly Health Inc., which the management believes could result in a future credit rating downgrade of their outstanding loans.

TPVG stock valuation

The company is trading on a fair valuation, and at the moment investors can buy a quality company at a fair price. TPVG trades at 1.07x its book value, almost identical to its five-year average of 1.01x. The earnings multiple is lower than its five-year average by approximately 10% due to the decline in its stock price in the last months and due to superior earnings compared to its previous quarters.

In terms of the company's dividend yield, it trades at its best since the pandemic and has traded in the top 10% in the last 6-7 years. Investors could have only bought TPVG with a better dividend yield back in 2016. Thanks to the recent increase, the dividend yield is more attractive than a couple of months ago.

Finally, a dividend increase

I stand by my previous statement that TPVG's dividend policy is boring, however, this is still good news for income investors. Although what I meant half a year ago is that this boring policy means no dividend increases but stable payments. This has changed slightly because the management announced a dividend increase that I did not calculate previously. The growth of the NII lowers its payout ratio and makes the dividend coverage better than a year ago, even with the elevated quarterly dividend payments. The company's five-year average payout ratio is 93% but due to the interest rate hikes, the forward payout ratio stands around 88-90%. It also means that investors do not have to worry about share dilution, the dividend is well covered.

The company has not increased its shares outstanding significantly, instead, the management has issued five-year notes every February for years now, and I expect this trend to continue so fixed-income investors might get prepared for February's Note issue . In addition, because of the great quarterly results (and as I mentioned before the fourth quarter might be just as good as the third), management announced a dividend increase of $0.1 per share to the quarterly dividend and not only a special dividend at the end of the year as they did in 2018 and 2020.

With the new dividend, the stock is trading around an 11.8% forward dividend yield. The company has always been strong in returning cash to investors, since it went public in 2014, the management has paid out $12.60 per share in regular quarterly distributions and $12.95 with special dividends included. So, if an income investor invested in TPVG eight years ago, he received almost 85% of its investment via dividends and remains an owner of the company. (Its IPO price was around $15.6) Not a bad deal, isn't it for income investors?

Summary

TriplePoint invests in sectors that grow faster than the average, so that's why they could have delivered better results over the past years that their peers. I believe this trend will continue, and I also like the internally managed BDCs. Due to the dividend increase, its dividend, and earnings stability, TPVG might be a primary choice for income investors among business development companies.

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