While there are many publicly traded BDCs available for investors to choose from, there are only a handful that focus on lending to venture capital and late-stage growth companies. One of the largest of those and arguably one of the best is Hercules Capital (HTGC). Others include TriplePoint Venture Growth (TPVG) and Trinity Capital (TRIN), a relatively new entrant to the publicly traded BDC field. The newest of the group is Runway Growth Finance Corp (NASDAQ:RWAY), the subject of this article.
Who is Runway Growth Finance?
According to the company website, Runway offers financing to late stage and growth companies seeking alternative lending options.
Runway Growth Finance Corp. is a growing specialty finance company focused on providing flexible capital solutions to late-stage and growth companies seeking an alternative to raising equity. Our mission is to support passionate entrepreneurs in building innovative businesses. The company lends capital to companies looking to fund growth with minimal dilution – in turn, Runway Growth Finance seeks to produce favorable risk-adjusted returns for its shareholders.
Runway was founded in 2015 by David Spreng, a venture capitalist who is currently on a medical leave of absence. The company went public in October 2021. The company portfolio has a total value of just over $1B comprised of $978 million in term loans as of 12/31/23 with more than 99% senior secured first lien investments. The company has total committed capital of $2.5B across 77 companies since inception.
Q4 2023 Results
RWAY reported Q4 2023 earnings yesterday, March 7, and investors were not pleased with the results, sending shares crashing -14% as I write this on March 8. In my opinion, this represents a buying opportunity for RWAY investors as the market punished the stock for reporting a bad quarter that might be primarily because of a big drop in NAV from $14.08 at the end of Q3 to $13.50 at the end of Q4. A large component of that NAV decline was due to a one-time write-off that led to a realized loss of $17M in Q4 from the company’s debt investment in Pivot3, according to comments on the earnings call from CFO and Acting President/COO Tom Raterman.
The decline in NAV is primarily a result of an unrealized loss of $7.7 million on our CareCloud preferred stock holdings, which we are electing to hold as we see an opportunity for equity upside in the future as well as the realized loss of $17 million on our debt investment in Pivot3. $6.4 million of which was reflected as an unrealized loss in our Q3 2023 financial statements.
While 2023 was not a great year for venture capital funding, the bank failures that took place in March with Silicon Valley Bank and Signature Bank, followed by First Republic Bank in May caused further hesitancy for lenders to offer financing to growth stage companies in particular. This slide from the RWAY Q4 investor presentation graphically illustrates how the slowdown in venture capital deals really hit the brakes in 2023 after climbing higher over the previous ten years.
RWAY Q4 presentation
As a result, the focus for Runway turned to credit quality which led to fewer deals getting done in the first half of 2023 especially because the opportunities available did not meet the company’s underwriting criteria. In Q4 the company executed 8 deals representing $154.6 million in funded loans, three of which were new investments.
“In 2023, Runway Growth drove shareholder return while taking a measured approach to portfolio management as we preserved industry-leading credit quality,” said Greg Greifeld, Acting Chief Executive Officer of Runway Growth, and Deputy Chief Investment Officer and Head of Credit of Runway Growth Capital. …
In 2023, our strategy was to allow meaningful repayments to occur, to reduce our leverage and increase our access to dry powder.
Total investment income for Q4 amounted to $39.2 million with NII of $18.3M or $.45 per share. NAV at quarter end was $13.50. Aggregate proceeds of $63.4 million were received in principal repayments during the quarter.
The 2023 fiscal year results included NII of $78.3 million or $1.93 per share.
A first quarter 2024 regular dividend of $.40 was announced along with a first quarter supplemental dividend of $0.07 per share.
As of the end of the quarter there were no loans on non-accrual status, however, subsequent to the quarter end one loan was placed on non-accrual status, which may have also been part of the reason for the negative market reaction to the earnings report. From the press release:
Effective January 1, 2024, the Company placed one loan to Mingle Healthcare Solutions, Inc. on non-accrual status, representing an outstanding principal of $4.3 million at a fair market value of $3.8 million as of December 31, 2023. The loan comprised 0.37% of the total fair value of the Company’s investment portfolio, excluding U.S. Treasury Bills, as of December 31, 2023.
In my opinion, this loan is not a big problem (representing less than 0.5% of the total portfolio value) and is typical of investments in venture stage growth companies, but it could portend future issues with other investments in the portfolio.
Cash and liquidity at quarter end included $281 million with another $278 million available in borrowing capacity. During the quarter a secondary offering was completed with 3.7 million common shares owned by Oaktree sold in November. Oaktree has been a partner with Runway since 2016 and despite selling shares in the offering they continue to own a significant number of shares, in fact as much as 40% of outstanding shares as of 12/31/23 according to Yahoo Finance.
Yahoo Finance
Acting CEO Greg Greifeld summarized the Q4 results with an optimistic tone for 2024:
Our team continues to see a robust pipeline of opportunities. Despite the challenging market and deal activity, our pipeline of qualified, actionable deals grew relative to 2022. This demonstrates our increased discipline and tighter credit box. In the first quarter of this year, which tends to be our slowest seasonally, we have issued multiple term sheets with new borrowers. 2024 is already off to a fast start between our newly formed joint venture with Cadma and transaction activity.
New Joint Venture Announced
On March 7 Runway announced the formation of a new joint venture with Cadma Capital Partners. From the press release:
“… the Company has established a joint venture (“JV”) with Cadma Capital Partners (“Cadma”), a credit financing platform for the venture and growth ecosystem that is an affiliate of Apollo Global Management. Cadma provides asset-backed financing to venture and growth lenders, high-growth companies, and financial sponsors.”
The newly formed joint venture, Runway-Cadma I LLC, will be an equal partnership between Runway and Cadma. The joint venture, with financing capacity of up to $200 million, will focus on financing private and sponsor-backed late- and growth-stage companies.
According to one comment on the RWAY news of this new JV, this new source of income should result in a higher yielding return than the regular portfolio loans. On the earnings call, in response to a question CFO Tom Raterman explained how the JV will be funded:
In terms of the amount that we’re putting in, initially, we’re each putting in $35 million in equity and then we’ve arranged financing to take it up potentially to $200 million or even more. So that’s the initial cap structure that we’re thinking about. And in terms of the focus, it’s really largely what we’re doing. We view this as an opportunity, particularly in a situation where we can’t, won’t go to the equity markets as an opportunity to continue for us to stay in the market with those late stage companies where the deals tend to be larger, diversify the portfolio through that JV, through our interest in the JV and add a new earnings stream.
Risks and Competition
Other BDCs that also lend to venture stage and growth companies like HTGC, TPVG, and TRIN have reported mixed results for Q4 and FY23. While HTGC reported record net income for Q4 and FY23 the net debt investments decreased from Q3 to Q4. The results were very good overall, and the market pushed up the HTGC stock price after earnings.
TPVG, on the other hand, had a less than stellar report on March 6 with a loss of NAV, realized losses of $50M, and an increase in non-cash/PIK income. The price of TPVG also tanked on March 7 after earnings.
TRIN had a better report than TPVG or RWAY but perhaps not quite as good as HTGC. The report for TRIN on March 6 included a 15% YOY increase in NII, a slight increase in NAV (from $13.17 to $13.19), and record gross total investment commitments of $340.7 million.
Seeking Alpha
Comparing the total returns over the past 6 months it becomes clear that HTGC and TRIN have been performing well while TPVG and RWAY are struggling.
With Jerome Powell warning Congress that there will be more bank failures, perhaps the market for venture stage BDCs is becoming more cautious in general. Also, the latest jobs report has calmed investor fears that rate cuts may be off the table. But if interest rates do get cut in June that could also have a negative impact on the future earnings potential for the floating rate loans that RWAY holds.
Summary
There are several aspects of the Q4 earnings report, news of a new JV with committed capital, and concerns over non-performing loans that are all possible reasons for the huge drop in price of RWAY stock today. Add to that the potential for rate cuts to eat into the company’s future earnings potential and the reaction is somewhat understandable, however, I feel that the market reaction was overdone and offers an opportunity for income investors to buy shares of a well-run BDC that still pays a substantial dividend.
The following slide from the Q4 presentation shows the key portfolio metrics that investors need to consider before dismissing the BDC as a bad investment.
RWAY Q4 presentation
With a Q4 investment yield of 16.9% and a robust, diverse source of investment income, RWAY is well positioned to support a continued high yield dividend that is currently about 14% annually based on the latest quarterly base dividend of $0.40 (presuming no additional supplemental dividends will be paid). As a RIC the company is required to pay out at least 90% of taxable income each year. With quarterly NII of $.045 in Q4 the base dividend is still well covered. The outlook for 2024 is quite positive with a strong balance sheet, plenty of available liquidity and the prospect for additional high yield revenues from the new JV on the horizon.
I rate RWAY a Strong Buy at the current market price of about $11.50 per share as I write this on Friday March 8. Please do your own research and do not invest without understanding the risks involved.
Read the full article here
