Looking for some income from technology? Join the club – we’ve all heard about how tightfisted tech firms are with their payouts. With the tech sector propelling the market upward in 2020, it sure would be nice to earn a few bucks in income along the way.
Enter Horizon Technology Finance (HRZN), a Business Development Company, or BDC, which makes secured debt and venture lending investments to venture capital backed companies in the technology, life science, healthcare information and services, and cleantech industries.
As we’ve noted in some of our recent articles about other BDCs, this group has taken it on the chin this year. However, a few of them, like HRZN, have held up better than most.
While HRZN still trails the S&P 500 in 2020 and over the past year, it’s up 9.7% over the past quarter, and has greatly outperformed the Wells Fargo Business Development Company ETN, BDCS:
Management declared and maintained the regular $.10 monthly payouts for September – November. Management has declared monthly distributions of $0.10 per share for 48 consecutive months.
HRZN’s trailing 12-month coverage factor is a strong 1.22X, based upon NII/share of $1.52. HRZN’s monthly payouts have been well covered by Net Investment Income, vs. a combo of NII and capital gains, as with some other BDC’s.
“The distribution level reflects our outlook for the balance of 2020 and our spillover income at June 30. We have now covered our distributions with NII for the past 2.5 years.” (Q2 2020 call)
Given the rapid downward trajectory of the US economy in the COVID-19 era, investors are wary of the financial health of BDCs’ holdings of little-known, privately held companies, with little public data available about them.
HRZN use a multi-tier rating system for grading its holdings’ performance, as do many BDCs. The top tier 4 represents the highest credit quality rating and 3 is the rating for a standard level of risk. Tier 2 represents an increased level of risk and, while no loss is currently anticipated by management for a 2-rated loan, there’s potential for future loss of principal. A rating of 1 represents deteriorating credit quality and high degree of risk of loss of principal.
As of June 30, 2020, there were two debt investments with an internal credit rating of 1, with a cost of $13.5 million and a fair value of $7.1 million, vs. a cost of $5.8 million and a fair value of $2.3 million, as of 3/31/20, and a cost of $5.7 million and a fair value of $2.0 million as of 12/31/19.
So, the lowest tier trend was up in Q2 ’20, but the $7.1M amount represented just 2.1% of HRZN’s total debt investments’ fair value.
The other tiers showed a healthy progression in Q2 vs. Q1 2020, with the next lowest tier, tier 2 decreasing from $56M to $48M, and tier 3 improving by 14%, to $265M, while top tier 1 fair value increased by ~41%, to $23.5M.
As of 6/30/20, the two top tiers were ~84% of HRZN’s debt investments at fair value, up from 81% at 3/31/20:
HRZN funded six new loans to four new life science portfolio companies and to existing life science portfolio companies in Q2 2020, totaling $40M, and consolidated $15M in loans from its former joint venture onto its balance sheet, which resulted in HRZN’s ninth straight quarter of portfolio growth. The yield for the new loans was 11.1%.
Management continued to focus on the life sciences market during the pandemic, where it sees better investment opportunities.
The Q2 2020 fundings were: A $10 million venture loan to Sarah Bell, a developer of an FDA approved rapid response device to diagnose seizures.
A $10 million venture loan to Magnolia Medical Technologies, a developer of an FDA-approved blood culture collection device.
A $10 million venture loan to Provivi, which is developing cost-effective natural crop protection products.
A $5 million venture loan to Emalex Bioscience, which focuses on treating central nervous system and fluency disorders. They also funded an additional $5M to Kate Farms, one of HRZN’s existing healthcare portfolio companies.
HRZN also had $30M in prepayment activity in the quarter, a healthy sign in a tough environment. Its debt portfolio yield for the quarter was 16.9%.
“We closed a $100 million in new loan commitments and approvals. And ended the quarter with a committed and approved backlog of $101 million, compared to $44 million at the end of the first quarter of 2020. The increase in our committed backlog mostly resulted from new life science commitments with typical milestone driven and/or tranche funding patterns. A pipeline of new opportunities as of today is $520 million.” (Q2 call)
Earnings for Q1-2 2020 were strong, with total investment income up 26%, and net investment income, NII, up 33%. HRZN had $2.66M in realized gains, vs. a -$3.45M loss in Q1-2 2019.
NII/Share was flat, but that was quite an achievement, as the share count increased by ~33%. Ditto for NAV/Share which was $11.64 as of 6/30/20, on a much higher share count vs. $11.60 as of 6/30/19. NAV/share rose $0.16 from March 31, 2020.
Net investment income for Q2 2020 was $0.40/share, vs. $0.26/share in Q1 2020 and $0.37/share for Q2 2019.
For Q2 2020, net increase in net assets resulting from operations was $7.9 million, or $0.47/share, vs. $4.5 million, or $0.34/share, in Q2 2019.
At $12.00, HRZN is selling at a 3% premium to its 6/30/20 NAV/share of $11.64
It sold at a premium to book value for most of 2019 and in early 2020, but, like most other assets, hit its biggest discount in the March 2020 lows. It returned to a premium price/book valuation in late July/early AUgust, following its strong Q2 2020 earnings report.
HRZN’s Price/NII per share looks cheaper than industry averages, while its attractive 10% yield is a bit below the industry very high average of ~11%, which illustrates how much yield the market demands of the BDC industry:
HRZN’s ROA, ROE, and EBIT margin all look much better than the averages, while its debt leverage is a bit lower, at .92, which is lower than management’s target leverage ratio of 1.2 to 1.
HRZN further strengthened and diversified its balance sheet by amending its credit facilities with New York Life Insurance and KeyBank, and ended the quarter with more than $200 million of capacity to support its portfolio companies and to selectively make new investments.
As of June 30, 2020, the company had $60.0 million in available liquidity, consisting of $37.3 million in cash and money market funds, and $22.7 million in funds available under existing credit facility commitments.
There was $45 million in outstanding principal balance under the $125 million revolving credit facility. This Key Facility allows for an increase in the total loan commitment up to an aggregate commitment of $150 million.
In June 2020, Horizon amended its $100 million senior secured debt facility with a large U.S.-based insurance company to extend the investment period to June 2022, pursuant to which Horizon may borrow up to $100 million under the terms of the secured notes. The investment period will be followed by a five-year amortization period. The stated final payment date was extended to June 2027, subject to any extension of the investment period. The interest rate on the notes issued under the facility is based on the three-year USD mid-market swap rate plus a margin of between 3.55% and 5.15% with an interest rate floor, determined by the rating of such notes at the time of issuance. As of June 30, 2020, there were $13.3 million in advances made at an interest rate of 4.60%. (source – HRZN site)
Horizon Funding Trust 2019-1, a wholly-owned subsidiary of Horizon, previously issued $100.0 million of 2027 Asset-Backed Notes, at a fixed interest rate of 4.21%, which are rated A+ by Morningstar Credit Ratings, LLC, and backed by $160.0 million of secured loans from HRZN.
There’s a lot to like about HRZN – its attractive, well-covered monthly distributions, its earnings growth, and the fact that its portfolio is holding up well in this tough environment, so much so that management already has declared a steady monthly payout for the next three months.
Given the uncertainty of the pandemic, and its effect on the economy, and the upcoming US elections, we rate HRZN a speculative buy.
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