A new public Business Development Company (“BDC”) has arrived on the credit fund scene: the clumsily named TCG BDC (ticker: CGBD), sponsored by Carlyle Global Credit, which itself is an affiliate of the Carlyle Group, one of the largest asset managers out there. CGBD announced its initial public offering on June 5, 2017 and closed the sale of 9,000,000 shares two weeks later on June 19th . With the addition of CGBD, the BDC Reporter’s universe of publicly-traded BDCs that we cover daily increases to 46. The new player – based on the market capitalization table on the handy Closed-End Fund Advisors BDC Universe data page – will begin as the seventh largest public BDC vehicle, with a book value just under $1.2bn. (Don’t look for CGBD on the CEF Advisors table yet. The BDC is to new to yet figure in). To introduce readers to the new BDC on the block, we have reviewed the Prospectus in some detail. There is a great deal to cover, so the BDC Reporter will be breaking this primer on Carlyle’s public BDC into several parts. In Part I we’ll begin with History/Formation, and move on to Strategy. In latter articles we’ll look at Compensation, Corporate Governance, Credit Risk and Financial Performance. As we hope to show by going carefully through each category is that an in-depth exploration will ultimately contribute to an investor’s assessment of the risks and returns to be expected from Number 46. First, though, we have to become better acquainted with the CGBD story:
The BDC was formed back in February 2012 as a Maryland corporation and structured “as an externally managed, non-diversified closed-end investment company. Only in May 2013 was the election to be regulated as a BDC undertaken and investment operations launched. The initial name of the fund was Carlyle GMS Finance. (The unfortunate name change, in preparation for the IPO, to TCG BDC occurred a few months ago). The Prospectus is coy about who were the original investors in the BDC, and who will still represent the bulk of shares outstanding going forward, and all the terms of the advisory contract between them and the external Investment Adviser – Carlyle GMS Investment Management LLC. Some of those terms are being drastically changed following the public offering. However, we do know that investors have been subject to repeated capital calls as the BDC has grown in size since May 2013. We also know that from the outset the BDC was focused on building up a portfolio principally consisting of senior loans in so-called “middle market companies” with EBITDA between $10mn and $100mn, and typically sponsor-backed by drawing on the origination resources of the Carlyle Private Credit platform , which the Prospectus says “is Carlyle’s direct lending business unit that operates within the broader Carlyle Global Credit Platform”. See below for more on CGB’s strategy.
In early 2015, though, the BDC partnered up with Madison Capital ” a leading middle market senior lender with approximately $8bn of AUM”, and well known to most everyone in leveraged finance. This allowed the two firms to offer borrowers a “full unitranche lending solution”, with Madison Capital providing the first lien/first out position and CGBD in first lien/last out. Furthermore, in 2016 CGBD partnered up again – and committed a great amount of capital – to a 50/50 Joint Venture with a Canadian pension fund (which the Prospectus does not name but calls “large”) entitled the Credit Fund. Like so many other JVs in the BDC space, the off balance sheet vehicle invests in very similar loans as the rest of its business but in a 2:1 leverage structure.
Just a few weeks ago, the BDC also acquired/merged with another Carlyle-controlled entity called NF Investment Corporation in a cash and stock transaction which only closed in June. The acquisition added $267mn in portfolio assets, spread across 75 portfolio companies. Again, the Prospectus is short on details about NF Investment Corporation or the genesis of the transaction (which required an investor capital call to be consummated) but the fund appears to have been managed by the Carlyle principals in charge of CGBD’s Investment Adviser.
At March 31, 2017, as page 63 of the Prospectus shows for readers who want to follow the transformation, the BDC had 41,708,155 shares and NAV of $763.3mn, or $18.30 a share. However, the capital calls pushed up NAV to $953mn. Following the sale of 9mn shares to the public the “as-adjusted NAV” was estimated at $1,113mn, and that’s before the underwriters over-allotment figures in, and the total share count is up to 60,966,283. Effectively, the IPO shareholders will own 15% of the new public entity and the inscrutable NAV Per Share math comes to $18.25.
The important take-away from this history lesson is that the shape and size of CGBD has changed drastically since the last financial statements in March 2017 when investment assets were just under $1.4bn and net assets were at $763mn. Since then we’ve had the NF Investment merger; the IPO and a barely discussed in the Prospectus surge in net asset purchases on the BDC’s balance sheet. Please see page 12 and Recent Developments. In two months between April 1 and June 2 2017 “we made new investments of approximately $332mn, of which $226.3mn were funded”. However, another $135mn was repaid, most on balance sheet and some in the JV.
When we went to the pro-forma calculation in the Prospectus which typically rolls forward from the latest financial statements and includes all the latest activity we found all the key new data was not included. All this chopping and changing has run ahead of Carlyle and its underwriters ability to tell us what the newest BDC owns and owes. Prospective investors may either need to sharpen their pencils (and make a number of assumptions) or wait till the first public quarterly report to get a snapshot of the new TCG BDC (you see what we mean about the name ?).
As touched on above, the BDC’s stated strategy is to principally provide senior debt financing to sponsor-backed leveraged companies. The BDC Reporter likes to “see what they do, rather than what they say”. Thankfully, there is information available. On page 105 the Prospectus calls out the fund’s “accomplishments” since the commencement of operations and through May 10, 2017: deploying $1.7bn in 118 “funded first lien debt investments” , $274mn in 31 funded second lien, $127mn in “structured finance obligations”, $6.6mn in equity investments and $180mn in the Credit Fund JV. (We assume “structured finance obligations” means CLO investments, which the BDC appears to have mostly sold off in recent periods). This list gives an idea (with the exception of the CLOs) of what CGBD’s investing strategy will be going forward: almost exclusively a lender, with a preponderance of first lien loans ,but with a significant minority of second lien and last out unitranche. Regarding the latter, BDC executives have tried to convince us that the junior portion of unitranche loans is more akin to first lien debt risk than second lien. We are unconvinced and point readers to page 69 of the Prospectus which breaks out yields – the best thermometer for measuring risk- by category of loans. Regular first lien debt at CGBD yields 7.35%, which suggests a relatively low risk profile in leveraged loan terms. Second lien debt yields nearly 3% more, or 10.07%. However, the junior tranche of the unitranche loans is yielding 12.00%. All blended together, the BDC’s aggregate yield is at 8.33%. We’ll have more to say when we address Credit Risk.
We’ve not been able to find any disclosure from the new BDC yet as to the average EBITDA size of the current borrowers. A look down the portfolio list suggests bigger rather than smaller companies, especially as the strategy of Carlyle Credit appears to be taking down a large portion of a financing and divvying up the outstandings amongst different funds – including CGBD – under its effective control. Suggested throughout the Prospectus is that Carlyle’s huge origination network, plus its ability to underwrite for large amounts as well as the relationship with CGBD means the portfolio will be filled with loans identified, negotiated and syndicated out -whether in-house or to third parties- by the Carlyle organization. This appears to be similar to the approach which Golub Capital (GBDC) has successfully operated on. Like GBDC, Carlyle is also aiming for a highly diversified portfolio. At March 2017 (which we now know is a bit out of date) CGBD had 94 investments in 82 companies with portfolio assets of $1,393mn. That’s just under $17mn per company, and relatively “granular”.
Technically the strategy is to be diversified across industries as well. The Prospectus mentions exposure to no less than 30 different sectors. However, the BDC Reporter notes that Healthcare ( one of the segments we worry about portions of) represented 12% of total portfolio assets, which suggests that the reality of where the deals are may be taking precedence over the stated ambitions. However, energy exposure (which the BDC Credit Reporter believes might be due to wallop some BDCs a second time round) is low, as is Retail, Metals & Mining and Software (all sectors that deserve special credit attention).
Carlyle’s strategy is also to build up its Credit Fund JV, which thanks to its high leverage multiple, generates an above average return even if the loans and borrowers i the vehicle are marginally less risky than the on balance sheet portfolio. (In fact, there’s much overlap between the names). A great deal of capital has been committed to the JV by both its partners and more is available to be drawn to allow further expansion. This mimics strategies adopted by that other relatively recent public BDC Goldman Sachs BDC, as well as GBDC and Fifth Street Finance (FSC), amongst others.
CGBD has been active as a BDC since 2013 – neither a very long nor a very short time – but has been in a constant stage of metamorphosis, probably with the IPO goal in mind. Two major partners have been added in Madison Capital and A Large Canadian Pension Fund; a JV vehicle arranged; structured finance obligations jettisoned; a major acquisition just undertaken and a large amount of new loans just booked – all in 4 years. As a result, it’s hard to tell -figuratively and by the numbers – what the real CGBD looks like. The business strategy appears to have been consistently applied since inception, but the material exposure to last out positions in unitranche loans is a relatively new structure which has not been extensively tested by exposure to recession conditions and may or may not justify the 12% yields being achieved. Outside of the relationship with Madison Capital, the rest of CGBD’s business strategy is relatively ordinary, with much of the potential appeal lying in the presumed access to a huge credit origination machine.
Still, there’s much more to review, including a mixed compensation picture; the usual one-sided corporate governance and a close, initial, look at credit quality.