TPVG - TriplePoint Venture Growth: Tech Investing With A 14% Yield

2023-06-30 07:30:00 ET

Summary

• TriplePoint Venture Growth is a business development company that lends to small and medium-sized tech companies, generating profits from the spread interest income, which are mostly paid to shareholders.
• Due to its low share price and strong business fundamentals, TriplePoint Venture Growth is able to offer a significant 14% dividend yield to its shareholders.
• Despite potential risks, the company's dividend payout appears to be secure for the foreseeable future.

Article Thesis

TriplePoint Venture Growth ( TPVG ) is a business development company that is focused on tech companies and other young and fast-growing businesses. Due to a low share price and attractive business fundamentals, TriplePoint Venture Growth is able to pay out a hefty 14% dividend yield to its owners. While there are some risks to consider, the dividend looks solid for the foreseeable future.

TriplePoint Venture Growth: A Tech-Focused BDC

TriplePoint Venture Growth is a business development company or BDC. BDCs lend money to small and medium-sized businesses that have a hard time accessing debt markets directly. Business development companies generally finance the loans they make via a combination of equity and debt usage -- in some sense, they thus have a business model that is not too different from a bank. Borrowing money and lending it out at a higher rate generates spread interest income that allows these BDCs to generate profits, which are mostly paid out to shareholders. Some BDCs offer additional value-add services to their portfolio companies and/or make non-debt investments, e.g. by buying preferred shares or equity in their portfolio companies.

Some BDCs are active across different industries, while some are more focused. TriplePoint Venture Growth belongs to the second group, as it is largely doing business with tech companies.

The company describes itself like this [emphasis by author]:

Externally Managed BDC Focused on Providing Customized Debt Financing With Warrants and Direct Equity Investments to Venture Growth Stage Companies in Technology and Other High Growth Industries Backed by a Select Group of Venture Capital Firms.

External management, generally, is a negative for BDCs, I believe. External managers sometimes have an incentive to grow the company at all costs without being focused on generating value on a per-share basis. The same principle also holds true with other types of companies, such as REITs. In TriplePoint Venture Growth's case, however, management has been pretty strong in the past, delivering ample value for the BDC's shareholders:

Over the last three years, TriplePoint Venture Growth managed to generate a total return of more than 60%, which is highly attractive. In this case, external management is not an issue, as shareholders are still benefitting from attractive total returns. The company has easily outperformed its peer group of externally managed BDCs, as those delivered a ~20% total return over the last five years, according to TPVG (see link above), while TPVG itself delivered a total return of more than 70% over the same time frame. TPVG thus seems like a way better investment compared to the average externally managed BDC -- where investors have a good chance of experiencing sub-par returns.

The focus on venture-style investments and younger tech firms has some investors worried about portfolio companies' ability to pay back loans, but TriplePoint Venture Growth seems to have strong underwriting, as credit performance has been pretty strong in the past. The company seems to be able to successfully identify companies with lots of potential, as its past investments include companies such as CrowdStrike ( CRWD ), Facebook (part of Meta ( META )), or YouTube (part of Alphabet ( GOOG )( GOOGL ).

TriplePoint Venture Growth's portfolio companies' credit quality can be seen in the following table from its most recent earnings release :

We see that the vast majority of loans that the company made aren't especially risky -- around 85% of loans are in either of the top two categories ("Clear" and "White"). No loans are in the worst category, and just 5% of loans are in the second-worst category. It is worth noting, however, that the ratio of loans in the second-worst category has increased meaningfully over the last quarter, although the same can be said about the ratio of loans in the best category. If this trend continues and more loans get downgraded from "Yellow" to "Orange", that could signal a potential increase in credit losses going forward. That being said, TriplePoint Venture Growth has a very high average portfolio yield of 14.7%, thus even if all of the loans in the "Orange" category would be wiped out entirely -- which seems pretty unlikely to me -- that would eat up just around four months' worth of portfolio-wide interest received.

Of course, when one makes loans with a yield this high, some credit losses have to be expected, similar to what happens when credit card companies make loans -- the very high interest rates do generally account for some losses in the loan portfolio.

The venture-stage companies that TPVG primarily lends to oftentimes are heavily financed via equity -- the weighted average loan-to-value of TPVG's debt portfolio is just 7.6% as of the end of the first quarter. This means that equity investors in these tech companies have to experience massive losses before TPVG is hurt at all, thereby providing a major "security layer" for TPVG's debt investments.

Looking at risks from another perspective, TriplePoint Venture Growth operates with a leverage ratio of 1.49. That's not very low for a BDC, but not overly high, either. While TPVG is not a riskless investment, of course, it does not look dramatically risky at all. The not-overly-risky balance sheet explains why TriplePoint Venture Growth has a very solid BBB credit rating (from DBRS).

Over the last one and a half years, interest rates have risen substantially, as the Fed tries to combat inflation running well above the target range of 2%. These interest rate increases have been positive for TriplePoint Venture Growth, which has experienced substantial net investment income growth over the last year.

This, in turn, allowed the company to increase its dividend from an already very attractive level, which brings us to the next point.

TriplePoint Venture Growth Offers Hefty Shareholder Returns

TriplePoint Venture Growth currently pays out $0.40 per share per quarter, following an 8% dividend increase earlier this year. The annual payout of $1.60 pencils out to a dividend yield of 13.6% at current prices. While investors should be cautious when it comes to the safety of 10%+ dividend yields, it looks like the payout is sustainable for the foreseeable future: TriplePoint Venture Growth is forecasted to earn $1.94 per share this year, which makes for a dividend payout ratio of 82%. That's not low, but not very high for a BDC, either, as BDCs generally operate with payout ratios that are higher than those of the average non-BDC company. Since TriplePoint Venture Growth has already earned a pretty sizeable $0.53 per share during the first quarter, an earnings slowdown is already baked into the earnings per share estimate for the current year -- and the dividend would still be covered. If TPVG was able to generate profits on a level like what we have seen during the first quarter for the remainder of the year, the payout ratio would improve to a pretty strong 75%.

There is no guarantee that the dividend will be maintained forever, and in case we get a big recession and some of TPVG's portfolio companies run into trouble, a dividend cut seems possible. But due to the track record, the low loan to value ratios, the solid dividend coverage, and the fact that management has just upped the payout -- which they likely would not have done if they saw major problems on the horizon -- I do believe that the dividend cut risk is relatively small. And yet, even if it were to happen, a dividend reduction likely wouldn't be a disaster -- if TPVG were to cut the payout by one-third, the yield would still be at a pretty substantial level of 9.1% (although there would possibly be a lot of selling if a dividend cut was announced).

To sum things up, the dividend looks rather sustainable to me, and even if it was cut meaningfully, investors that buy at the current price could still see a lot of income going forward.

Today, TPVG trades at $11.77, while the company's net asset value per share stands at $11.69 (as of the end of the first quarter). That means shares can essentially be bought at net asset value. For a company that has historically managed to generate pretty attractive returns for shareholders, that seems like an undemanding valuation to me. Overall, while TPVG is not a risk-free investment, I like the BDC at current prices and believe that there is a good chance that investors will be happy holding this high-yielder in the long run.

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