|Shares Out. (in M):||25||P/E||9||7|
|Market Cap (in $M):||325||P/FCF||9||0|
|Net Debt (in $M):||140||EBIT||0||0|
Sign up for free guest access to view investment idea with a 45 days delay.
Price Target: $18.00 (45%, including dividend); Downside Risk: $11.50; U:D of 3 to 1
TriplePoint Venture Growth is a high quality lending franchise with a leading position in a small, but attractive market niche. A recent large equity issuance has put pressure on the shares, but we view the issuance as one of several key events over the past year that set the stage for TPVG to structurally improve its ROE to 15%+. This will enable it to raise its (double-digit) cash dividend and highlight its status as the cheapest of the quality BDCs at under 7x pro forma earnings.
What is venture lending?
Venture lending is the business of lending money to startup companies. Due to the nature of startups (no assets, negative cash flows), there is little competition from banks and other traditional lenders. Because startups are small, new and VC-sponsored, most venture loans are sourced through relationships with VC sponsors.
What are the economics of a venture loan?
Venture loans are structured differently from traditional loans. While a typical middle market loan has a five year term and an average duration of 3.5-4 years, a typical venture loan has half that duration, and it is not uncommon for a loan to be paid back in less than one year. TPVG’s venture loans typically have LIBOR-linked cash coupons that range from 6-12%.
Venture loans will often have delayed draw features, whereby the lender commits to provide the agreed upon loan at a set future date, contingent upon the company’s achievement of certain KPIs. The lender collects a fee upfront for making the commitment. Significant additional economics are built into the principal payback in the form of “end-of-term” (EOT) payments that range from 5-10% of the principal. From the lender’s point-of-view, EOT payments ensure that they are able to get an adequate return from a loan that gets called soon after issuance; from the borrower’s point of view, this helps to back-end a bit of the cost for the cash-burning startup. The cash coupon, commitment fees, EOT payments, and other fees combine to generate an attractive mid-teens return – TPVG’s weighted-average yield on their loan portfolio over the past three years has been just under 16%. This compares to the HYG/JNK yielding a bit over 5% and the middle market loan portfolios of quality BDCs yielding 9-12%.
Finally, the venture lender will also usually get some slice of equity or warrants in the startup. The way TPVG does it, equity is a small part of the deal, but there are some venture lenders that view the equity co-invest as the main form of consideration. TPVG has gotten cashed out on their equity in some high profile startups over the past few years: Dollar Shave Club was acquired by Unilever; jet.com was acquired by WalMart; PillPack and ring.com were both recently acquired by Amazon.
What are the economics of the BDC (how do the loan economics flow-through to shareholders)?
The fee structure at TPVG is 1.75% base & 20% incentive over an 8% ROE hurdle. We wrote in detail in our ARCC writeup about BDC fees & flow-through economics, but the basic outline is:
[gross asset yields] – [base management fee] – [other expenses] = [net asset yield]
[net asset yield] levered [leverage ratio] @ [cost of debt, adjusted for WC] = [pre-incentive ROE]
[pre-incentive ROE] x [1 – incentive fee] = [NII ROE to the shareholder]
Historically, most of the key variables above have conspired to lower the flow-through of TPVG’s high asset-level yields to the ROE experienced by the shareholder. A key leg of our investment thesis is that changes have taken place (see catalysts, below) that will structurally improve those variables to the benefit of shareholders. These variables are:
These changes should structurally raise the ROE by ~300bps to 15%, which implies an earnings multiple under 7x.
How can one responsibly underwrite a loan with no hard assets & negative cash flows?
Different lenders take different approaches, but below are some of the key pillars in TPVG’s lending strategy/philosophy:
Who does TPVG compete with? What are barriers to entry?
Competition in venture lending is driven by relationships and speed/reliability of capital. The VC world is fairly closed and secretive, and many entrants without the right relationships or structure have failed (e.g., FSC, ARCC). VCs, for their part, are willing to sacrifice a bit of yield to work with partners that they trust – even 16% debt can be accretive if one is underwriting to gross equity IRRs over 30%! Other barriers to entry include: complexity (the loans are hard to underwrite, structure, and monitor), regulation (hard for banks to lend to startups with no hard assets or cash flow), and scalability (with a sub-$5bn TAM, bigger lenders only have so much incentive to penetrate this niche). Finally, the low duration and small scale of these loans means compressed MOIs and lower absolute-dollars-of-profit-per-loan, relative to more mainstream middle market lending. Readers may find it worthwhile to read ARCC’s discussion on their decision to exit the space in Q3 2017.
There are a number of venture lenders in the market. Some are small, private funds; some focus on early stage companies; some view venture debt primarily as a mechanism to access the VC warrants and equity co-invests. Apart from TPVG, there are two sizable public venture lenders: SVB (Silicon Valley Bank) and HTGC (Hercules BDC). SVB is a strong competitor that leverages its many other banking products (e.g., cash management, mortgages for principals) to solidify its relationships with entrepreneurs and sponsors. However, as a regulated bank, there are limits to how flexible and responsive it can be.
Hercules is viewed by most BDC investors as the clear leader in the venture lending space. We agree that it is the leader in size ($1.5bn portfolio), but not in much else. On the face, there is nothing dramatically different between the TPVG & HTGC portfolios: historical loss rates are similar in the 1-2% range; TPVG yields are maybe a point higher; however, we view HTGC’s book as diversified into some lower-quality investments, and that is consistent with what we have heard from others who have looked closely at the space. More importantly, we think TPVG management (Jim & Sajal) are more thoughtful and shareholder-oriented than HTGC (Manuel), a view that was validated when Manuel tried to externalize the HTGC manager without compensation last year. For those so inclined, we think a long TPVG/short HTGC pair is compelling, given that TPVG offers higher quality at a 30% discount (and a positive spread).
The biggest other competitor of note is VC equity – insofar as capital flows into VC funds and compresses target IRRs, it can make sense for startups to use less venture debt. The primary aggressor that concerns us here is Softbank. However, their impact has thus far been low, as they don’t write checks that are small enough to compete with TriplePoint.
What about the credits? What happens when borrowers get into trouble?
TPVG’s net loss rate has been 1.7% in the 4.5 years since its IPO; it’s loss rate prior to the IPO was nil (TriplePoint was underwriting venture debt in private funds since the early 2000s). Peer HTGC – whose public track record extends through the financial crisis – has a similar net loss rate, though it jumped to ~6% in 2009 & 2010, some of which it clawed back in subsequent years. We view these loss rates and profiles as generally in-line with quality BDCs or B/BB credits.
The portfolio itself is impossible to underwrite independently: all loans are direct to private (and fairly secretive) companies. That being said, we have found management willing to speak about specific credits, both on the calls, as well as offline. We walk through the biggest credit issues they have faced:
How do you get comfortable with the structure & governance of this externally-managed BDC?
The fee structure at TPVG is high among BDCs (1.75% base & 20% incentive over an 8% ROE hurdle), but it is not the highest. We find a higher fee level to be appropriate, given the higher cost of venture lending relative to more traditional middle market – smaller loan sizes and higher turnover means more cost-per-dollar of AUM. This observation is supported by the high cost structure at internally-managed peer HTGC. Importantly, the 8% hurdle has a FULL lookback feature with respect to capital losses/markdowns, which is unusually shareholder-friendly within the BDC space, and provided significant benefit to the shareholder in the wake of the losses in Coraid & HouseTrip.
TPVG’s shareprice has traded below NAV for most of its history, but it has not raised equity below NAV. On the occasions where it has raised equity, the manager has eaten some of the deal fees to ensure the raise was not NAV-dilutive. When Goldman Sachs Asset Management (GSAM) did a PIPE with them last year, the TriplePoint principals participated alongside them at a meaningful level. GSAM also “cornerstoned” TPVG’s most recent offering in August, and they own a bit under 10% of the shares.
What is the right valuation for this unusual BDC?
Quality BDCs trade at 9-13x net investment income, and TPVG trades at the low end of that range, on a trailing basis. Thus, we value TPVG at 9x pro forma earnings (NIIps of ~$2.00). One could argue for a higher multiple, given the abnormally high ROEs and greater potential for accretive inorganic growth: 13x forward earnings would imply a $26 price target and a double over the next year, but we doubt the market would ever get that high, given that only one BDC has achieved a P/NAV that high in recent years (MAIN).
This $18 price target represents a 8% current dividend yield, which is within range for quality BDCs (though we would expect them to raise the dividend as the ROE expands). This $18 price target is 1.3x forward NAV, which is high for an externally-managed BDC, but we think the abnormally high ROEs justify it.
In the downside case, we note that TPVG has faced a fairly adverse set of conditions over the past four years (i.e., TriplePoint’s worst two credit losses in the past 15 years; a subscale G&A burden; a high cost of debt & equity capital, etc.), yet it has been able to cover its double-digit dividend and deliver a ~10% annualized total return since the IPO – I wish all my mistakes did that!
We’re nearly five years out from the IPO; what makes this work now?
This is a catalyst-laden investment. Four things happened earlier this year that should structurally improve TPVG’s base ROEs and propel the shares higher:
Taken together, these catalysts: raise TPVG’s profile, quadruple its liquidity, increase its scale & operating leverage, reduce concentration risk, increase the quality & number of deals that it can do, increase the efficiency of its balance sheet, and reduce the volatility of its earnings. Most importantly, these changes enable it to structurally boost its ROE from ~12% to ~15%, which should enable it to increase the dividend and lead to a rerating of the shares.
As noted above, most of the catalysts catalysts required to raise their profitability have materialized. Now they just need to deploy the newly-raised capital and raise the dividend.
|show sort by|
Are you sure you want to close this position TRIPLEPOINT VENTURE GWTH BDC?
By closing position, I’m notifying VIC Members that at today’s market price, I no longer am recommending this position.
Are you sure you want to Flag this idea TRIPLEPOINT VENTURE GWTH BDC for removal?
Flagging an idea indicates that the idea does not meet the standards of the club and you believe it should be removed from the site. Once a threshold has been reached the idea will be removed.
You currently do not have message posting privilages, there are 1 way you can get the privilage.
Apply for or reactivate your full membership
You can apply for full membership by submitting an investment idea of your own. Or if you are in reactivation status, you need to reactivate your full membership.
What is wrong with message, "".