Hercules Reiterated at Neutral


We have reaffirmed our Neutral recommendation on Hercules Technology Growth Capital, Inc. (HTGC). Our decision is based on the company’s better-than-expected first quarter 2012 results.

Hercules reported first quarter 2012 distributable net operating income (:DNOI) of 26 cents per share, 3 cents ahead of the Zacks Consensus Estimate. This also surpassed the prior quarter DNOI by a penny.

Improved results were primarily driven by a remarkable growth in total investment income coupled with lower operating expenses, enhanced credit quality and adequate liquidity levels. However, significant increases in interest expenses and loan fees were the headwinds.

Hercules is a safe asset for yield-oriented investors. As it is a Regulated Investment Company (RIC), it is bound to distribute majority of its earnings to the shareholders. Besides the regular dividend, the company is expected to declare a special dividend to distribute any remaining earnings within the same year. This kind of a dividend policy is highly valuable for maintaining investors’ confidence in the stock.

The emergence of numerous technology-related companies and their significant reliance on unconventional sources of funding has led to the growth of venture capital markets. Consequently, this has provided companies, like Hercules, with opportunities to earn good returns by offering investment capital to such companies.

Though, Hercules is a relatively young company, its credit performance and investment origination activities reflect a positive trend and are expected to continue in the long term. Moreover, Hercules is well positioned to benefit from the improving M&A scenario, as there could be material appreciation in its warrants position. This will benefit its investment portfolio in addition to the equity and debt issuance in the reported quarter.

We believe that such efforts will help the company to gain substantial market share and enhance its profitability in the long run. The extension of the share buyback program will further enhance investors’ confidence.

Yet, insufficient experience poses as a threat for Hercules as it fails to provide records in support of its investment approach. Concentration risk also seems to thwart its growth prospects.

The persistent low interest rate environment and stringent regulatory requirements are a likely to affect the company’s performance. As a Business Development Company, Hercules is required to invest mainly in domestic companies, which, of late are experiencing financial crisis.

As a result, it fences its access to the capital market. Moreover, most of its peers are not exposed to such specific regulatory requirements, which would restrict them from making optimum utilization of investment opportunities that come along.

As a result, we believe that the risk-reward profile for Hercules is currently balanced, and therefore we reiterate our Neutral recommendation on the stock.

Hercules currently retains a Zacks #3 Rank, which translates into a short-term Hold rating. One of its peers American Capital, Ltd. (ACAS) also retains a Zacks #3 Rank.

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