Description

Triangle Capital (TCAP) is a Business Development Company that had its IPO in February of this year. I won’t go into the description of a BDC since there have been some excellent in depth write ups of other BDC’s on VIC such as AINV, ARCC, and NGPC, among others.

The company started four years ago with a $21.25 million investment from three founders and 35 limited partners. TCAP raised approximately 65 million in its IPO and including its SBA loans has 215 million dollars under management. At the end of the second quarter the NAV was $13.75 and the cash per share was $6.71.

 I believe that the continuing sub prime mortgage issues and overall nervousness in the financial markets give companies like TCAP an opportunity to capitalize on providing funding to quality companies. With potentially less competition from banks, private equity, and private BDC’s it only makes sense that TCAP should see better investment opportunities with better pricing.

While all BDC’s have their own niche or strategy, TCAP offers these unique characteristics:

Because their market cap is only 90mm they can specialize in smaller deals where there is less competition. TCAP can avoid getting involved in auction situations and can build its business more on personal relationships. There are tens of thousands of lower middle market companies in the U.S. with revenues of between 10mm and 100mm in revenues. The vast majority of these companies are privately held with significant financing needs. The relationships that TCAP builds with clients will be helpful as the sources in the leveraged loan market becomes more scarce and brings people back to TCAP for possible additional financing needs.

TCAP has a different strategy than some BDC’s. They are higher risk than others based on a higher percentage of subordinated debt. At the end of the 2^nd quarter, TCAP had a current weighted average debt yield of 14.2%. According to TCAP, BDC’s in general have some type of write off on 8-10% of their investments. If 9 out of 10 investments work out then TCAP would like to have an equity upside on their deals. Currently in 21 out of their 23 portfolio companies they have taken some sort of minority stake in the company. The credit quality of TCAP appears to be excellent with no loans on non- accrual basis. At the end of the 2^nd quarter, TCAP’s weighted average yield on debt was more than 14%.

The other difference between TCAP and most other BDC’s is that TCAP has an SBIC license from the SBA. As of June 20, 2007 TCAP had issued 35.8 million dollars of debentures guaranteed by the SBA. These debentures had a weighted average interest rate of 5.82%. The SBIC license gives TCAP low cost fixed rate funding for 10 years. With 45 million in cash and 50 million in available SBA debt, TCAP has ample liquidity to fund attractive deals. Besides the fact that it would cost TCAP an additional 200-300 basis points on borrowed money without the SBA loans, the term for repayment would be much shorter than the 10 year term.

While it is typical for many BDC’s to have an external management agreement, TCAP is managed internally. TCAP feels this aligns their interests closer to shareholders. TCAP feels that once the proceeds from the IPO are invested, the efficiency of their model will be more apparent. There has also been some insider buying recently.

TCAP is currently trading at a discount to its NAV and a significant discount to the broader group. The dividend yield is going to be the primary driver in the stock price. TCAP raised its dividend from .15 in the first quarter to .26 for the second quarter. I expect the dividend to continually increase as TCAP invests its IPO proceeds and SBA money. If TCAP can deploy its capital over the next four quarters at roughly 9 million a quarter, then it is reasonable to expect a total dividend over the next four quarters of $1.30.

Given their short public history and higher concentration of mezzanine debt and equity, I can understand a discount to other BDC’s that have good track records. I believe that it is reasonable for TCAP to sell at 1.1 times book in 12 months. Someone that bought shares in TCAP today, collected the estimated dividend over the next four quarters, and watched the shares trade up to 1.1 x  a conservative future estimated NAV of $14 would make a 25% return from the current market price.  The downside risk at the current price with the next four quarters of dividends equaling a yield of over 9% seems reasonable to me in looking at other alternatives out there today.

Risks:

TCAP’s highly illiquid loans and investments to private companies with a higher concentration of mezzanine debt could negatively affect results in a more challenging economic environment.

Catalyst