Redeployment Into First Lien Secured Loans Will Support Stronger Income And Returns

Catalysts

About Great Elm Capital

Great Elm Capital is a business development company that focuses on secured, income-generating credit investments and specialty finance solutions.

What are the underlying business or industry changes driving this perspective?

• Redeployment of over $25 million of cash on hand, alongside more than $20 million expected from harvesting nonyielding equity positions like CW Opportunity 2, into first lien senior secured loans should expand interest earning assets and support a rebound in net investment income and earnings.
• Growing access to private credit opportunities with equity upside, as demonstrated by the Nice Pak and CoreWeave related investments and a current pipeline deal targeting a teens type return with warrants, can enhance risk adjusted yields and drive long term NAV per share growth and higher total returns.
• Structural scaling of Great Elm Specialty Finance, including the upsized back leverage facility and a robust deal pipeline at Great Elm Commercial Finance, positions the platform to grow its loan book and fee income, supporting higher recurring revenue and operating leverage.
• Refinancing higher cost debt, doubling the revolver while lowering its rate, and normalizing interest expense after the September overlap period should reduce the company wide cost of capital and improve net interest margins as newly originated loans season.
• Deliberate portfolio de risking through increased diversification, lower average position sizes, and a greater focus on first lien secured exposure in sectors viewed as less exposed to AI disruption, tariffs, and nonprime consumer credit should stabilize credit losses and support more consistent earnings and dividend coverage.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming Great Elm Capital's revenue will grow by 10.2% annually over the next 3 years.
• Analysts assume that profit margins will increase from -17.1% today to 181.2% in 3 years time.
• Analysts expect earnings to reach $112.9 million (and earnings per share of $8.26) by about December 2028, up from $-8.0 million today.
• In order for the above numbers to justify the price target of the analysts, the company would need to trade at a PE ratio of 2.1x on those 2028 earnings, up from -13.9x today. This future PE is lower than the current PE for the US Capital Markets industry at 25.0x.
• Analysts expect the number of shares outstanding to grow by 7.0% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 12.5%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• The bankruptcy of First Brands, which had over a 5% portfolio allocation and reduced NAV per share from $12.10 to $10.01, highlights concentration risk and the potential for future credit losses if underwriting does not keep pace with long-term credit cycle normalization and tighter financial conditions. This would pressure net margins and earnings growth.
• Nonaccrual positions in First Brands, Del Monte and Maverick Gaming, along with the lumpy nature of CLO JV and insurance-related distributions, suggest that income is partially dependent on cyclical and event driven credit markets. A prolonged period of weaker credit performance or lower distributions could constrain revenue visibility and depress net investment income and earnings.
• The strategy to rotate more than $20 million of nonyielding equity, including CoreWeave related exposure, into income generating assets depends on continued strength in private credit markets and attractive deal flow. If competition compresses spreads or macro conditions weaken, reinvestment opportunities may deliver lower than expected yields, limiting revenue growth and net margin expansion.
• Scaling Great Elm Specialty Finance and Great Elm Commercial Finance with expanded back leverage and a robust pipeline increases reliance on secured lending to middle market borrowers. In a downturn or structurally slower growth environment for those borrowers, credit losses or slower loan growth could erode fee and interest income and weigh on long term earnings.
• Issuing equity to raise capital at or near NAV has increased share count and created short term cash drag. If long term market valuations for business development companies compress or capital markets become less receptive, GECC may face constraints on equity funding that limit portfolio growth and operating leverage, thereby capping future revenue and earnings per share.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The analysts have a consensus price target of $9.5 for Great Elm Capital based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be $62.3 million, earnings will come to $112.9 million, and it would be trading on a PE ratio of 2.1x, assuming you use a discount rate of 12.5%.
  
• Given the current share price of $7.88, the analyst price target of $9.5 is 17.1% higher.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.