BlackRock TCP Capital Corp. (NASDAQ:TCPC) Q1 2024 Earnings Call Transcript

BlackRock TCP Capital Corp. (NASDAQ:TCPC) Q1 2024 Earnings Call Transcript May 1, 2024

BlackRock TCP Capital Corp. reports earnings inline with expectations. Reported EPS is $0.45 EPS, expectations were $0.45. TCPC isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Ladies and gentlemen, good afternoon. Welcome everyone to BlackRock TCP Capital Corp.’s First Quarter 2024 Earnings Conference Call. Today’s conference call is being recorded for replay purposes. During the presentation all participants will be in a listen-only mode. A question-and-answer session will follow the company’s formal remarks. [Operator Instructions] And now I would like to turn the call over to Katie McGlynn, Director of the BlackRock TCP Capital Corp. Investor Relations Team. Katie, please proceed.

Katie McGlynn: Thank you, Emily. Before we begin, I’ll note that this conference call may contain forward-looking statements based on the estimates and assumptions of management at the time of such statements and are not guarantees of future performance. Forward-looking statements involve risks and uncertainties and actual results could differ materially from those projected. Any forward-looking statements made on this call are made as of today and are subject to change without notice. Additionally, certain information discussed and presented may have been derived from third-party sources and has not been independently verified. Accordingly, we make no representation or warranty with respect to such information. Earlier today we issued our earnings release for the first quarter ended March 31, 2024.

We also posted a supplemental earnings presentation to our website at www.tcpcapital.com. To view the slide presentation, which we will refer to on today’s call, please click on the Investor Relations link and select Events and Presentations. These documents should be reviewed in conjunction with the company’s Form 10-Q, which was filed with the SEC earlier today. I will now turn the call over to our Chairman and CEO, Raj Vig.

Raj Vig: Thanks, Katie, and thank you for joining us for TCPC’s Q1 2024 earnings call, which is also officially the first earnings call for TCPC as a combined entity post our successful combination with our former affiliate BDC, BlackRock Capital Investment Corp. or BCIC. Today I am joined by our President, Phill Tseng; and our CFO, Erik Cuellar. We are also joined today by Michaela Murray, who will be taking over the Investor Relations role from Katie McGlynn, who is leading the firm to pursue other opportunities. I’d like to officially welcome Michaela to the show. As a reminder, Katie has been a valued member of the TCPC team and private debt platform since 2018. She was instrumental in structuring and closing the recent merger.

She’s been a great partner and friend, and will be sorely missed. We, of course, wish her well in her future endeavors. For today, I will begin with a few comments on the successful completion of our merger with BCIC. I’ll then provide an overview of our first quarter results. Phill will follow with an overview of the investment environment and our portfolio and investment activity, and Erik will then review our financial results, as well as our capital and liquidity in greater detail. Finally, I will wrap up with a few comments on the opportunities we see ahead before taking your questions. As I mentioned earlier, during the first quarter, on March 18th, we closed our affiliate merger with BCIC. As a reminder, since BlackRock’s acquisition of TCPC’s platform in 2018, the investment activities of both TCPC and BCIC were managed by one team under their current leadership.

The merger simply formalized the combination of these two materially overlapping portfolios and delivers meaningful value for our shareholders through the greater scale and targeted operating efficiency. This includes a lower overall fee structure for the larger combined entity, the likelihood of more efficient access to capital and income accretion for the company and ultimately for our shareholders. From this point forward, we will be discussing financial results for the entity on a combined basis. Now, let’s begin with a review of the highlights of our first quarter results. I am pleased to report that for the first quarter of 2024, TCPC delivered adjusted net income of $0.45 per share, an increase from $0.44 per share in the prior quarter.

Our run rate NII remains among the highest in TCPC’s history as a public company and our annualized net investment income return on equity for the quarter was 14.7%, and NII continues to benefit from relatively higher base rates and spreads. During the first quarter, our NAV declined 6.4%, primarily due to net unrealized losses on portfolio companies previously assessed, including our investments in two Amazon aggregators, Thrasio and Razor, along with our investment in Edmentum. The write-downs in the first quarter are mostly the result of circumstances specific to a handful of companies, and as we have stated before, we do not believe these situations are any indication of broader credit challenges in our portfolio. The majority of our portfolio companies continue to report revenue and margin expansion, with many generating sustained performance improvements.

That said, I again want to provide commentary on a few of the names that contributed to the portfolio mark-outs. Thrasio and Razor both operate in the Amazon aggregator space, and as we have discussed on previous calls, the aggregators are consolidated of small- to medium-sized brands that sell through Amazon’s market-leading third-party platform. This sector was initially impacted by COVID-related supply chain issues and then by slowing growth in online consumer spending as supply chain issues alleviated, resulting in excess inventories and over-leveraged balance sheets. Given the persistent operating and liquidity challenge that resulted, Thrasio, one of the largest standalone aggregators, opted for a balance sheet restructuring via a Chapter 11 filing in February 2024, which we supported given the net benefits from that process.

Although a fair bit of work remains ahead of us, we expect ultimately Thrasio to emerge with a lower and more manageable debt structure, as well as a leaner and more efficient operating profile. This should allow the company to remain a leader in the sector and to focus on a return to profitability post-emergence in what we continue to believe is a long-term and viable and attractive industry. By contrast, Razor Group opted to address challenges via consolidation and acquired Perch in March, solidifying the combined entity’s position as a global leader in the space. Similar to Thrasio’s standalone restructuring effort, we expect the strategic combination to drive a more efficient operating structure than either company could have achieved in the near-term standalone.

We also believe that further consolidation and cost optimization are likely to continue in this space, and ultimately there will be fewer, larger scale and better capitalized vendors serving it. We will continue to update you on the progress of each of these as we are able to. Next, I’ll discuss Edmentum, an online learning provider which, as we noted last quarter, is navigating a reversion to a more normalized, but still positive demand environment. Demand for its tools and services spiked during the pandemic, but that has since corrected following the successful return to in-person attendance in many schools. Relative to pre-pandemic levels, digital education and remote learning services continue to grow in popularity and prominence, and Edmentum remains well-positioned in an industry with positive secular trends.

As a reminder, our current investment in Edmentum is a residual equity position after we receive full repayment on our loan to the company. As a longstanding player in the direct lending space, our team has experienced lending across market cycles and has developed unique expertise and a proven track record of success working through challenging credit situations. We are leveraging this expertise, believe we have the right things in place, and are proactively working with management teams, equity owners and other lenders to improve performance and achieve positive outcomes for our investments. Most importantly, outside of these situations, the credit quality of our portfolio remains strong. As of March 31, 2024, our internal risk rating was relatively unchanged from December 31, 2023, and reflects the fact that the majority of our portfolio companies are substantially in line or ahead of base case expectations.

Our Board of Directors declared a second quarter dividend of $0.34 per share, which implies 132% NII coverage based on our first quarter adjusted NII. The second quarter dividend is payable on June 28th to shareholders of record of June 14. We have always taken a disciplined approach to our dividends with an emphasis on stability and strong coverage for more recurring net investment income. Throughout TCPC’s 12-year history, we have consistently covered our dividends for recurring net investment income and have also paid several special dividends, including in the most recent quarters. Now I will turn it over to Phill to discuss our investment activity and portfolio.

Phill Tseng: Thanks Raj. I’ll start with providing an update on our portfolio and highlights from our investment activity during the first quarter and then provide a few comments on the investment environment. In the first quarter of 2024, we invested $20 million primarily in senior secured loans. Deployments in the quarter included loans to four new and three existing portfolio companies. Consistent with our strategy, our emphasis remains on companies with established business models and proven core customer bases that make them more resilient across economic cycles. In reviewing new opportunities, we emphasize transactions where we are positioned as a lender of influence, where we have a direct relationship with the borrower and the ability to leverage our more than two decades of experience in negotiating yield terms and conditions that we believe provide meaningful downside protection.

We believe this has been a key driver of our low realized loss rates over our history. We also see emerging opportunity on the horizon as pent-up M&A transactions come to market. As the bid-ask spread and valuations for higher quality assets narrow, we expect market participants who have been sitting on the sidelines to be more active. Actual interest rate cuts should help to catalyze a pickup in M&A due to the lower debt service costs for respective borrowers and based on our conversations with market participants, we’re optimistic about activity in the near- to intermediate-term. In this environment, our industry specialization continues to be an advantage as it provides two key benefits for us. First, it enhances our ability to assess and effectively mitigate risk in our underwriting when we negotiate terms and credit documentation.

And second, it expands our deal sourcing capabilities with sponsors and non-sponsors who value our industry experience, which lends itself to more reliable execution for borrowers. Follow-on investment in existing companies continue to be an important source of opportunity for us. About half of the capital we deployed in the last 12 months was to existing companies. One of the recent investments made during the first quarter was an investment in PMA Asset Management. PMA is a leading money market asset manager serving local government, K through 12 education and other public sector entities. The company provides its public sector clients with a comprehensive suite of investment advisory, fund administration and capital markets advisory services.

BlackRock provided capital to support a sponsor’s acquisition of PMA. We believe this investment offers an attractive risk-adjusted return and provides a unique opportunity to invest in a scaled money market asset manager that has a vividly consistent payment growth over its history. New investments in the first quarter were offset by dispositions and payoffs of $24 million. As part of our ongoing portfolio management, we closely monitor and directly engage with our existing portfolio companies, proactively assessing both current and projected performance relative to our original underlying assumptions. In the limited situations where performance is below our expectations, we’re engaged with the management teams and the owners to proactively drive performance improvement and ensure our capital remains well-protected.

Managing situations where capital may be at risk is a top priority for our team and we believe our 20-plus years of experience in managing portfolios through cycles is a significant competitive advantage for TCPC. We are pleased to report that the majority of our portfolio companies continue to deliver revenue growth and margin expansion as they successfully navigate the higher rate environment, lingering inflation and general uncertainty in the economy. We believe this reflects the durability of companies in the middle market, as well as our ability to pick the right industries and the right companies and to structure transactions that are good for our borrowers and for our investors. Now, I’ll turn to our portfolio. As a reminder, these figures relate to our consolidated portfolio following a merger with BCIC.

At quarter end, our portfolio had a fair market value of approximately $2.1 billion. 91% of our investments were senior secure debt spread across a wide range of industries, providing portfolio diversity and minimizing concentration risk. At quarter end, our diversified portfolio consists of investments in 157 companies and our average portfolio company investment was $13.5 million. As the chart on Slide 7 of the presentation illustrates, our recurring income is distributed broadly across our portfolio. It is not reliant on income from any one company. In fact, more than 75% of our portfolio companies each contribute less than 1% to our recurring income. 80% of the portfolio are first-lien, providing significant downside protection and 97% of our debt investments are floating rate.

The overall effective yield in our debt portfolio is 14.1%, reflecting the benefit of higher base rates and wider spread on new investments. Investments in new portfolio companies during the quarter had a weighted average effective yield of 14.7%, exceeding the 14% weighted average effective yield on exited positions. To-date, we have had no prepayment income for this second quarter. In looking forward, we believe we’re well positioned to continue to deliver attractive returns given that our team has one of the longest track records in direct lending of any of the publicly traded BDCs. Irrespective of when the Fed rate cuts commence, we believe we will be in a slower growth and an elevated rate environment for the foreseeable future and could see a range of macroeconomic scenarios.

But in periods like this, we believe our experience and our deep industry knowledge provide us advantages that result in strong results throughout various market cycles. The market environment that persisted over the past year is changing. For a large part of 2023, we saw wider spreads, we saw more conservative leverage profiles and generally stronger structural protection. However, for much of this year so far, we’ve seen a broader repricing and we expect it to continue. This means managers have to work harder to identify deals with favorable economics and favorable structures. As we noted last quarter, there’s been an increased bifurcation of the direct lending market which continues to persist today. Many have observed more borrower-friendly trends, such as tightening pricing and covenant-like deal structures.

These are especially prevalent in the upper middle market or large cap direct lending market, given the robust return of banks to that segment. However, in the core middle market, where we focus, there’s been less impact by this trend. We continue to benefit from lower leverage overall and the presence of maintenance covenants and fewer even documents, all of which leads to generally tighter documentation practices. We continue to see a durable yield premium for our transaction flow relative to the broadly syndicated market. Now, I’ll turn it over to Erik to walk through our financial results, as well as our capital and liquidity positioning.

Erik Cuellar: Thank you, Phill. As Raj noted, our net investment income in the first quarter benefited from the increase in base rates over the last 21 months and was $0.45 on an adjusted basis for the quarter. As detailed in the earnings press release, adjusted NII excludes amortization of the purchase accounting discount resulting from the merger with BCIC and is calculated in accordance with GAAP. The full reconciliation of adjusted NII to GAAP NII, as well as other non-GAAP financial metrics is included in the earnings press release and 10-Q. Today, we declared a second quarter dividend of $0.34 per share. We remain committed to paying a sustainable dividend that is fully covered by our net investment income, regardless of the interest rate environment, as we have done consistently over the last 12 years.

Investment income for the first quarter was $0.90 per share. This included recurring cash interest of $0.78, non-recurring interest of $0.02, recurring discount and fee amortization of $0.03 and PIK income of $0.05. PIK income remains in line with the average over our history. Investment income also included $0.02 of dividend income. Operating expenses for the first quarter were $0.35 per share, including $0.21 of interest and other debt expenses. Incentive fees in the quarter totaled $5.8 million or $0.09 per share. Operating expenses for the quarter reflected the impact of the lower management fee rate since the closing of the transaction on March 18th. We expect other synergies and expense savings to materialize over the next few quarters.

Net realized losses for the quarter were $168,000 or less than a penny per share. Net unrealized losses in the first quarter totaled $23 million or $0.37 per share, primarily reflecting unrealized markdowns on previously discussed investments as Raj described earlier. The net increase in assets for the quarter was $5.1 million or $0.08 per share. As of March 31st, we had five portfolio companies on non-accrual, representing 1.7% of the portfolio at fair value and 3.6% at cost. During the quarter, we added two portfolio companies to non-accrual status, including Aventiv, previously known as Securus, as well as Gordon Brothers, a pre-existing non-accrual portfolio company from the acquired BCIC portfolio. Turning to our liquidity, our balance sheet positioning remained solid and our total liquidity increased to $409 million at the end of the quarter, relative to our total investments of $2.1 billion.

This included available leverage of $286 million and cash of $121 million. Unfunded loan commitments to portfolio companies at quarter end equaled 4% of total investments or approximately $91 million, of which only $57 million were revolver commitments. Net leverage excluding SBIC debt for the quarter is 1.08 times, well within our target range of 0.9 times to 1.2 times leverage. Our diverse and flexible leverage program includes three low-cost credit facilities, three unsecured note issuances and an SBA program. Given the modest size of each of our debt issuances, we are not overly reliant on any single source of financing and our debt maturities remain well-laddered. Additionally, we are comfortable with our current mix of secured and unsecured financing and we expect to address the upcoming maturity of our 2024 notes in the near future.

Combined, the weighted average interest rate on our outstanding borrowings, including debt assumed as a result of the merger, increased modestly during the quarter to 5.08%. That average interest rate is up only 217 basis points since March of 2022, while base rates increased more than 500 basis points during this period. This is the result of our lower overall cost of capital. Now, I’ll turn the call back over to Raj.

Raj Vig: Thanks, Erik. Since we took TCPC public in 2012, we have delivered a 10% annualized return on invested assets and an annualized cash return of 9.7% to our shareholders. We are very proud of these results, which include performance during periods when base rates were substantially lower than they are today. We believe this performance remains at the high end of our peer group and speaks to our ability to consistently identify attractive middle market investment opportunities at premium yields and to deliver exceptional returns to our shareholders across market and economic cycles. Following our successful merger with BCIC, we look forward to continuing to deliver financing solutions to our borrowers and to structure transactions that deliver attractive returns to our shareholders. And with that, Operator, please open the call for questions.

See also Top 20 Copper Producing Countries in The World and 40 Perfumes Celebrities Actually Wear (but aren’t paid to).

Q&A Session

Operator: Thank you. [Operator Instructions] Our first question today comes from the line of Robert Dodd with Raymond James. Robert, please go ahead. Your line is open.

Robert Dodd: Good morning. Well, good afternoon, I guess. On the Thrasio, et cetera, the advocates on agribusiness space, I mean, on Thrasio particularly, I mean, the bankruptcy got resolved, I think, after quarter end. And I just want to clarify, I think, in the docs in the discussion was implied recovery below the mark that you currently have it. It carried that. Is that factored in or because you disagree about the valuation of business long-term potentially or is it because it happened after the quarter end that was not fully known at the time you were evaluating some of these positions?

Raj Vig: Robert, I think I got most of that question, but I think the question was, is the bankruptcy after quarter end? Is that correct?

Robert Dodd: It was resolved after quarter end, right? I mean, it was finalized and what I read was implied value to senior lenders, 20%, which obviously is lower than the current mark that you have that carried out. So is that a disagreement with the valuation, which is fine or is it that it wasn’t factored in yet because it hadn’t been resolved yet?

Raj Vig: Yeah. So let me — I think, let me, I think I get the question. So, Phill and I, our valuation procedures are done through third parties and they will take into account…

Robert Dodd: I am okay.

Raj Vig: And they’ll take into account, the — all the circumstances at the time of the valuation. The bankruptcy process is kind of a different process where the valuations that are being put forth may be more strategic, depending on where you are in the capital structure. So will there be differences? Potentially, yes. Are they — are folks looking at it for the same purpose? Not necessarily. And I guess what I would say is, we have maintained the valuation process and policies that we think are appropriate for the portfolio markings. The value that — the bankruptcy itself was really a collective decision of something that was a more strategic tool to do, some additional financing, clean up the capital structure and other liabilities.

But I will say for any company, and not just Thrasio, but in general where there is a restructuring either in or out of court, you’re just going to see, as you know, Robert, more volatility and maybe variance in marks until the ultimate realization. That probably happens here. That probably happens with the other aggregators. And it has happened with Edmentum where ultimately we’re doing right by the process, giving all the information that’s available, including the filing. But ultimately the realization is cash based and I think in the case of Edmentum, at least, even though the equity is volatile, we’ve taken all our cash and the original debt off at par plus. And here the effort is going to be on maintaining that the rigor on the valuation, but really focusing on the recovery on a real-life basis, which will probably be a couple of years of work and restructuring.

But yes, the valuations may differ. Our folks will take the operating results in hand. I don’t think they’re going to necessarily take the bankruptcy valuation as a face value versus the information we give them around forecasts, projections and things of that sort. Hopefully that answers your question.

Robert Dodd: Yeah.

Phill Tseng: And Robert, I will add…

Robert Dodd: Absolutely.

Phill Tseng: …as it relates…

Robert Dodd: Go ahead.

Phill Tseng: And Robert, as it relates to the 331 mark, this loan actually has had some trading activity even through the bankruptcy process. So it’s quoted and that’s what drove the mark at 331.

Robert Dodd: Got it. Thank you. I understand. There’s a lot of moving parts in there. Then next question, I mean, I think Phill, you said, you expect activity in the market to pick up and I may have written this down wrong, as rates decline. So looking at the curve today and it moves around a lot, right? Rates aren’t really projected to decline materially at money at all this year based on the curve today. Again, that will change next week. So, can you give us any more, I mean, are you expecting the activity level to remain very moderate so long as rates stay here or are there other factors that can drive this?

Phill Tseng: Yeah. That’s a good point. You’re right. The four-year curve is dramatically different than it was, let’s say, a few quarters ago. I think a few quarters ago, folks were expecting rates to kind of stabilize down in the mid-high 3s in about 18 months, but I think we’re now looking at probably closer to mid-4s. So you’re right. Rates are not expected to come down as dramatically. So we are moderating our expectations, because real rate cuts will drive more higher equity valuations and more processes that probably get done. But I think the fact that rates have normalized here, I’m not sure folks are really expecting the rate to increase, given what’s been talked about in the market in the last few weeks.

But we are continuing to hear from market participants, whether they’re investment bankers or private equity sponsors, that there are a lot of processes underway. There are a lot of non-process processes, meaning there are a lot of pre-marketing of deals, trying to do some price discovery on assets, and so that tells us that there’s some momentum underway. The second is we’re continuing to hear from clients out there, institutional investors, that they are continuing to demand distributions coming back from their GPs. So they’re putting more and more pressure in order to give more money for future businesses to get money back. And so what you’re seeing are GPs trying to really test the market. But two, if they’re not selling businesses outright, then they are looking at other ways of distributing capital back to their clients, like dividend recaps, maybe for continuation type vehicles.

Dividend recaps are areas that we’ve, sorry, deal profiles that we’ve funded over the course of the past several quarters for great assets where they have been laggard all the time, we’re happy to continue putting good money after the situation. So I think we’re cautiously optimistic, Robert, but I agree, the yield curve not showing a more dramatic reduction is, it is something that we should be watching closely.