This Members Mailbag includes a brief update on big-dividend BDC Triangle Capital (TCAP) following an inquiry from Blue Harbinger member Bob S.; Bob’s full inquiry is included below, but he’s basically asking about the “strategic alternatives” discussed by management during the quarterly call, and he also notes that TCAP’s “former CEO really screwed up.” This write-up includes our opinion on the future of TCAP.
To keep things concise, this write-up basically lists (and describes) a variety of important considerations about TCAP, followed by our overall opinion and outlook. But first, here is Bob’s full inquiry…
TCAP: What do you think? I have held mine and bought a little more before most recent announcement. If they sell the management co, there is not much future. I have talked to CEO and Board members. Still no idea what they will do. Perhaps package all non accruals and sell them. Don't know what that would accomplish. Former CEO really screwed up. Have you listened to management discussion? It is worthwhile. Best. Bob
Thanks for that Bob, and here is what we think about TCAP…
Overview: We’re NOT selling
TCAP recently reduced its dividend, and the share price has been absolutely horrible. However, we’re not selling. As a Business Development Company (“BDC”), TCAP is basically a portfolio of higher risk loans, and we like to have SOME exposure to that part of the market, especially given the high yield (if you’re an income-focused investor, BDCs can be attractive). We did reduced our exposure to BDCs earlier this year (we sold PSEC before it crashed: see here and here), but we continue to own TCAP.
Worth mentioning, high yield debt has sold off across the market recently, and this is contributing to TCAP’s selloff (BDC’s have also been challenged lately). However, we don’t believe we’re heading into a financial crisis (this would be very bad for TCAP), and we do believe TCAP (and BDC’s in general) have continued growth prospects ahead (TCAP continues to make attractive new loans).
About the Dividend Cut:
We believe TCAP is being proactive with its recent dividend cut, essentially keeping the dividend amount reasonable versus net investment income. Whereas other BDCs make the mistake of keeping dividend higher than NII just to keep shareholders happy in the short-term, TCAP proactively right-sizes the dividend, and this is good for the company’s long-term health. The last time TCAP “right-sized” the dividend, the shares sold off, but then rebounded significantly in the days and weeks after.
Here is how management described the dividend during the call:
The color behind our dividend adjustment, based on continued yield compression, our continued transition into more secure senior oriented securities and on credit underperformance, our board has decided it is in the best interest of the company and our stakeholders to adjust the quarterly dividend to $0.30 per share or $1.20 per share on an annualized basis, a level that is currently supported by our core NII and our investment portfolio composition. Our board believes this dividend level will provide the company with the ability to operate a greater degree of financial flexibility during this period of transition.
TCAP 2.0:
TCAP is basically in the process of transitioning from all very high risk investments to less high risk investments. The company refers to this as TCAP 2.0. It makes sense that TCAP will be experiencing some growing pains during this transition. For example, less risky investments offer lower yields, and this helps explain the dividend cut. However, keep in mind, the higher risk loans on TCAPs balance sheet still have value (including the one they just wrote down), especially considering the overall economy remains strong.
During the call, TCAPs current management basically threw the old CEO under the bus, suggesting the old CEO made loans that were too risky. Current management believes the challenges they are facing now are the result of 2014 and 2015 vintage year loans that were made under less stringent underwriting guidelines of the old CEO. Nonetheless, these loans still have value, TCAP has the financial liquidity to survive despite some troubled assets, and the market and the company's strategies (TCAP 2.0) have attractive room to grow and improve.
Strategic Alternatives
During the quarterly call, TCAP management described a variety of “strategic alternatives” as follows:
…our desire to explore strategic alternatives. Over the past five years, the private credit market in general and the BDC industry in particular have experienced phenomenal growth and in the process solidified an important role in the provision of capital to private companies operating in the US. As with any developing industry which offers ample white space and attractive returns for investors, new entrants, new products, and differentiated business models always emerge. As TCAP undergoes its transition to a more secure off balance sheet lender, targeting the lower middle market, we recognize that there might be a long-term partner within we might align that could accelerate our transition and in the process provide additional value to our shareholders…
...Such options could include for example a potential sale of certain investments, a joint venture or partnership, or a merger or strategic combination. As a result the board has authorized a formal review of strategic alternatives and expects to announce the engagement of an advisor in the near future.
We interpret this as management suggesting that TCAP could get bought by someone (perhaps another BDC). And this makes sense considering TCAP has attractive growth potential right now, and the price is very low right now (acquirers like to “buy low”). In our view, such an acquisition could significantly increase TCAP’s price because the acquirer would likely pay a premium to the current market valuation, and because it would theoretically give TCAP more financial strength.
With regards to selling only some of its assets (perhaps the most distressed assets) seems odd (unless TCAP is forced to because of liquidity risks, but TCAP still has plenty of cash). BDC’s have basically built their businesses taking business that banks have sold (or wouldn't consider in the first place) because it was too risky for the banks. TCAP could theoretically sell some of its riskier assets to another BDC, but they don’t necessarily need to considering they have plenty of liquidity on their balance sheet (and they just freed up more with the dividend cut).
TCAP's Price to Book Value:
For reference, TCAP currently trades at a significant discount to its Net Asset Value ("NAV"). Specifically, TCAP's price to book value is currently 0.7x. For reference, it has traded as high as 2.0x in the last 5 years, and 0.7x is the lowest it has been.
The current low price-to-book value is a result of concern over the recent asset write-downs and dividend cut, but it's also a result of the recent widening in credit spreads for high-yield bonds across the entire market. We believe wider spreads is temporary because the economy remains strong (we're not heading into a recession), and the TCAP specific fear has gone to far. Specifically, TCAP deserved to sell off significantly after its last quarterly announcement, but it has sold off too far considering it now trades at a big discount to its NAV.
Conclusion:
We hate to see the price and dividend of one of our holdings decline. But even more so, we hate to sell something only to watch the shares then rebound after we sold them. We believe the recent price decline has gone too far given TCAP’s book value and future prospects (i.e. TCAP 2.0). We also believe the selloff is partially driven by the broader selloff in high yield.
However, the economy is still strong and improving (this is good for TCAP’s business), and we don’t believe we’re headed into another dramatic financial crisis (this would be very bad for TCAP’s business). We continue to own our shares of TCAP, and we believe given the current price to book value (0.7x) and market opportunities, TCAP has long-term upside (and we like the big dividend, even after the "right-sizing"). Long TCAP.
You can view all of our current holdings here.