Hercules: Strong Gains in Venture Capital?

10/26/2015 7:00 am EST

Focus: STOCKS

Tim Plaehn

Investment Research Analyst, Investors Alley

Business development companies (BDCs) operate under special tax rules that allow them to not pay corporate income taxes, explains Tim Plaehn, editor of The Dividend Hunter.

To qualify as a BDC, a company must be in the business of providing financing for small to medium-sized corporations.

Hercules Technology Growth Capital (HTGC) is one of the oldest BDCs, founded in 2003 and public since 2005.

What sets it apart from its peers is its client focus. Hercules works with venture capital and private equity firms to provide funding for companies that are pre-IPO or being groomed for merger or acquisition.

HTGC makes only senior debt loans with maturities of three to three and a half years. About 90% of Hercules' assets are loan with 10% as equity positions that can pay off very well when a client goes public or is acquired.

The loans made by HTGC carry an average core yield of 13% to 14%. The typical loan has a 10.5% coupon rate and the core yield is bumped up by commitment and origination fees.

The company's relationships with over 500 venture capital type firms has allowed HTGC to steadily grow its book of business and also steadily increase its annual dividend.

Since 2010, the annual dividend has increased from $0.80 per share to $1.24 paid in 2014.

In 2014, the company had over $500 million (50% of the total portfolio) of loans repaid, often with equity kicker profits and early termination fees.

Due to the pull-ahead of these profits, the dividend rate has been level for five consecutive quarters and may not start growing again until the asset portfolio reloads

At the same time, the share price has declined, allowing us to buy in at a near 9% yield.

My expectation for HTGC is that the dividend rate may stay level into 2016 and then we will see a return to regular dividend growth.

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