Description
We believe that TSLX offers shareholders ~50% upside potential with very minimal downside risk
BACKGROUND
TSLX is a specialty finance company structured as a business development company (BDC). TSLX lends to middle-market companies and invests at the top of the capital structure. We believe TSLX’s defensively positioned portfolio and limited leverage positions the company well to take advantage of the current market dislocation.
· TSLX Overview
o Specialty finance company
o Focused on lending to middle-market companies
o Direct originations of senior secured loans
o Began investment activities in 2011
o Operates as a business development company (BDC)
· Customer Profile
o Target EBITDA of $10mm to $250mm
o Avg Portfolio Company Revenue of $114mm
o Avg Portfolio Company EBITDA of $34mm
· Investment Profile
o Targeted hold size of $30mm to $100mm
o Avg Investment size of $33mm
o Largest investment is 4.3% of portfolio
· Risk Profile
o Focus on investing at the top of the capital structure
§ 97% First Lien
§ 32% Net Loan to Value (LTV)
o Virtually all investments are floating rate
§ 99% of investments are floating rate
§ 93% of investments have LIBOR floors
o Customers in 19 industries
§ largest three industries are Business Services (20%); Financial Services (15%) and Healthcare (11%)
§ Has significantly reduced Retail ABL exposure (from 14% to 9%), and much of that exposure is to essential businesses
o Modest financial leverage
§ Debt to equity of 0.96x
§ Company internal target of 0.9x to 1.25x debt to equity
§ BDC maximum allowable leverage of 2.00x debt to equity
· External Advisor
o Part of Sixth Street Partners
o Over $34bn of credit related AUM
o Established in 2009 as a strategic partnership with TPG
o 275 team members in 9 locations
o 8 different platforms, of which Sixth Street Specialty Lending (TSLX) is one
HISTORICAL PERFORMANCE
TSLX has experienced steady net asset value (NAV) per share since its IPO in 2014. Additionally, the company has paid $10 in cumulative dividends (~65% of the current share price). This has led to an 87% total shareholder return, beating the S&P 500 and trouncing the performance of the average BDC (outperformance of nearly 100% versus peers!).
· NAV Growth
o Since IPO in 2014, NAV per share has remained steady versus a -12% decline for avg BDC
o Current NAV includes a $1.30 per share reduction in Q1 2020 from credit spread widening
· Dividends
o $10 in cumulative dividends paid since IPO
o Stable / slightly increasing dividend over time
§ Dividend of 41c per qtr (annualized of $1.64)
§ Up from 38c per quarter at IPO
· Total Return
o 65% total return since IPO (dividends plus book value)
§ $15.60 of current NAV per share + $10 in Dividends compared to $15.50 of NAV per share at IPO
o 87% total return since IPO (dividends plus share price appreciation)
§ v 74% for S&P
§ v -12% for avg BDC
o Outperformance of nearly 100% versus the average BDC!
INVESTMENT THESIS
TSLX stock has significant upside over time from three sources. First, the company took significant unrealized losses in Q1 2020 as they marked their portfolio to market. We believe that these losses could likely reverse over time. Second, TSLX debt reprices on a lag to their investment portfolio, leading to latent net interest margin expansion, which will be seen in future periods. Third, TSLX has excess liquidity to make investments in a favorable environment, which will help their net investment income (NII) over time. We believe the combination of these factors lead to significant potential embedded NAV per share gains as well as NII accretion, which could cause the stock to re-rate back near (but still below) historical levels.
· Large unrealized loss in Q1 will likely reverse over time
o unrealized loss of $1.30 per share in Q1
o Due to marking to market their portfolio
o TSLX incorporates market spreads on their portfolio of securities
o Current NAV per share of $15.60
o PF NAV per share of $16.25 (65c accretion) if 50% of the Q1 mark reverses
o PF NAV per share of $16.90 ($1.30 accretion) if 100% of the Q1 mark reverses
· Potential for net interest margin (NIM) expansion
o TSLX has LIBOR floors on 93% of its investments
§ With rates at current levels, the floors are in-play
o TSLX has a one quarter lag on debt repricing versus LIBOR
§ As rates go down, the benefit they get from a reduced cost of debt lags the negative impact from their investment portfolio repricing downward
o Resetting effective LIBOR to debt portfolio would give 100bps benefit to their NII
§ This will be 10c accretive to NII a year from now
· Excess liquidity
o TSLX has a 0.96x debt to equity ratio currently
o Their target range is 0.9x to 1.25x
o The Middle of the target range equals ~$0.15 of NII accretion
VALUATION
We believe that TSLX has the potential to return 50% to shareholders over the next 12 months in an upside case. In a downside case, assuming the economy does not improve, we believe that TSLX has ample coverage of its dividend, and material principal loss of minimal given the nature of the portfolio and TSLX’s historical track record.
· Upside Case:
o Net Asset Value
§ Assumption: 75% of negative marks taken in Q1 reverse
§ Output: $16.50 in NAV per share
o Earnings
§ Assumption:
· $1.92 mid-point of guidance for 2020E
· Add:
o $0.10 for latent NIM expansion
o $0.15 future income from excess liquidity
§ Output: $2.18 per share in EPS 2021E
o Valuation
§ Assumption:
· 10% div yield on $2.18 of upside EPS
§ Output:
· ~$22 share price (versus $16 currently)
· Equates to 1.3x NAV per share
o This is lower than where the company has traded historically
· Add in NTM dividend of $1.65
· Total potential value of ~$24 per share…
o ~50% upside from current levels
· Downside Case:
o Core Earnings > Div
§ Guided in Q4 to full year 2020 ROE of 11% to 12%
§ Guided in Q4 to full year 2020 NII per Share of $1.84 to $2.01
o Guidance in Q1 of “lower end” of that range
§ ~$1.85 per share
§ This $1.85 still covers the dividend of $1.64
o We believe that risk of principal loss is minimal given
§ the first lien position of TSLX (97% first lien)
§ the low loan to value ratios (34% LTV)
§ the historical track record of TSLX
o Limited risk of dilution from equity raise
§ Has never raised equity below book value
§ “we have always put our capital before our [managements] interests, and will continue to operate in that way”
Disclaimer
The author of this posting and related persons or entities ("Author") currently holds a long position in the securities mentioned above. The Author makes no representation that it will continue to hold positions in these securities. The Author is likely to buy or sell long or short securities of this issuer and makes no representation or undertaking that Author will inform Value Investors Club, the reader or anyone else prior to or after making such transactions. While the Author has tried to present facts it believes are accurate, the Author makes no representation as to the accuracy or completeness of any information contained in this note. The views expressed in this note are the only the opinion of the Author. The reader agrees not to invest based on this note and to perform his or her own due diligence and research before taking a position in securities of this issuer. Reader agrees to hold Author harmless and hereby waives any causes of action against Author related to the above note.
I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.
Catalyst
see write-up