Hi YXI friends,

Hercules Capital (HTGC) is a unique player in the BDC space as it focuses on venture capital-backed companies in technology and life sciences. These companies are often riskier, looking for rapid growth rather than steady earnings. But HTGC is definitely doing something right, given investors are lining up to pay a 70% premium over NAV.

Is this premium justified? Today, we’ll dive into HTGC’s latest performance, asset write-downs, capital structure, and how it may do in the upcoming rate-cut cycle.

DISCLAIMER: This newsletter is strictly educational. Any information or analysis in this note is not an offer to sell or the solicitation of an offer to buy any securities. Nothing in this note is intended to be investment advice and nor should it be relied upon to make investment decisions. Any opinions, analyses, or probabilities expressed in this note are those of the author as of the note's date of publication and are subject to change without notice.

1. HTGC’s Market Position

With an Enterprise Value of $4.8 billion, HTGC is the 7th largest BDC, behind MAIN. As a function of its smaller book size, HTGC has “only” 123 companies in its portfolio, with investments fair-valued at $3.57 billion.

The Effective Yield of HTGC’s portfolio is 14.7% including all fees, or 13.7% excluding early-repayments and one-time fees. This is a higher yield on NAV than what we have seen so far from the top 6 BDCs, because of the “riskier” nature of the portfolio companies being VC-backed ventures.

VC-backed companies are “riskier” because the name of the game is aggressive growth to world domination. VCs are less concerned about short-term profitability than a company’s potential to become a “Unicorn” (1-billion-USD valuation) and help investors make 100x their money back via IPO.

There are two notable ways that HTGC is mitigating the credit risks of its investments.

Firstly, HTGC has overtime transitioned away from traditional venture-lending into more institutionally companies, i.e. later-stage, institutionally-backed growth companies. About 80-85% of life sciences investments are in publicly traded companies, whereas 90% of technology investments remain in privately held companies.

Secondly, HTGC mitigates the risk profile of its investments by focusing on Senior Secured Debt. 93% of HTGC’s investments are Senior Secured, and 90% are First-Lien. 97.4% of the debt investments are floating rates.

It should be noted that given many of HTGC’s portfolio companies operate in technology, healthcare, and biotech, 61% of the loans include intellectual property as collateral (such as patents, trademarks, and proprietary technology). The IP may be extremely valuable if the company becomes a revolutionary, world-conquering business, or it could be worth very little in the event of commercial failure.

A small percentage of HTGC’s investments are in warrants and preferred stocks. Warrants are essentially call options bundled with the debt instrument, allowing HTGC to purchase the portfolio company shares at a predetermined price. The hope is for these warrants to play out favourably if the portfolio companies IPO or get acquired.

2. HTGC’s Latest Performance

HTGC’s Q2 performance

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