Hercules: Seeing past unicorns

The Palo Alto, California-based BDC’s portfolio had an effective yield of 14.9% in Q2.

Robust merger and acquisition activity will provide consistent investment opportunities in the venture debt space, executives at Hercules Capital said on Thursday’s second-quarter earnings call, but a growing scepticism of “unicorn” valuations will likely stall venture-backed initial public offerings. 

Overall IPO activity of venture-backed private companies “remains stagnant” and “not anywhere near where they should be”, said Manuel Henriquez, the business development company’s founder and chief executive officer. He cited only 25 VC-backed IPOs in the first half of this year and 38 such IPOs that entered the market in all of 2016, referring to data from Dow Jones Venture Source.

Henriquez said a market-wide scepticism has grown surrounding the valuations of private companies backed by venture capital and debt firms like Hercules, particularly aimed at IPOs of firms with valuations in excess of $1 billion, or “unicorns”.

This doubt in part stems from Snap and Blue Apron shares trading well below their debut prices this year, he said. The two companies’ lacklustre post-IPO performance may have a “chilling effect on companies to delay offerings in [the] foreseeable future”.

However, non-IPO venture capital activity remains strong in general, with a total of $33 billion financing 2,200 new companies over the first half of 2017, according to Dow Jones.  

Overall, private firms backed by venture capital showed a “nice steady pace” of overall M&A activity in the second quarter, Henriquez said, with 142 firms acquired totalling $19 billion. Some 305 transactions totalling $45 billion completed so far this year.

More of Hercules’ portfolio companies paid off loans earlier than it had anticipated, executives noted. The BDC realised $166 million in early repayments on its loans in the second quarter, nearly $100 million more than the firm had previously expected. The firm is optimistic, however, that early repayments will return to a normal range of $75 million-$100 million for each of the next two quarters.

Even with these repayments, the BDC was able to grow its portfolio to $1.59 billion in assets under management as of 30 June, which is up from $1.46 billion in AUM as of 31 December, earnings results showed. Accordingly, the firm plans to aggressively deploy capital in the second half of the year, primarily targeting floating-rate and first lien senior secured loans.

The Hercules portfolio posted an effective yield of 14.9 percent over the last quarter, compared to 13.4 percent first quarter, and 14.4 percent the last quarter of 2016. The BDC reported a total net investment income of $25.3 million, or $0.31 per share, by the end of second quarter, compared to $23.35 million, or $0.32 per share, as of 30 June, 2016.

The firm’s net asset value was $9.87 for the second quarter, compared to $9.76 NAV at the end of the first quarter and $9.66 NAV as of the second quarter of 2016.