First Lien Lending And Lower Funding Costs Will Support Long Term Earnings Quality

Catalysts

About MidCap Financial Investment

MidCap Financial Investment Corporation provides primarily first lien financing solutions to sponsor backed core middle market companies across diversified industries.

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

• Growing sponsor M&A activity and add on financings in the core middle market should sustain a healthy pipeline of directly originated loans, supporting asset growth and interest income over time.
• MFIC's access to MidCap Financial's large origination platform, extensive data set and long tenured management team enables selective deployment into better risk adjusted credits, which should help stabilize credit costs and support net margins.
• Persistent demand for private direct lending as an alternative to broadly syndicated and high yield markets positions MFIC to maintain high first lien exposure with covenant protection, which should help preserve net asset value and earnings quality.
• Recycling low yielding Merx capital into higher yielding core middle market loans, alongside expected additional Merx paydowns, creates a runway for mix driven yield improvement that can offset base rate headwinds and support net investment income.
• Recent reductions in the cost of debt through the revolver amendment and CLO reset lock in cheaper, long dated financing, which should expand net interest margin and enhance earnings resilience as the portfolio is re deployed.

Assumptions

How have these above catalysts been quantified?

• Analysts are assuming MidCap Financial Investment's revenue will decrease by 4.8% annually over the next 3 years.
• Analysts assume that profit margins will increase from 30.8% today to 52.6% in 3 years time.
• Analysts expect earnings to reach $147.5 million (and earnings per share of $1.59) by about December 2028, up from $100.0 million today. The analysts are largely in agreement about this estimate.
• 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 10.6x on those 2028 earnings, down from 11.4x 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 decline by 0.51% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 9.8%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• A prolonged decline in short term base rates, with SOFR projected to trough around 3%, would pressure MFIC's asset sensitive balance sheet and could materially reduce net investment income and dividend coverage. This could increase the risk of a lower share price if earnings no longer support the current payout and return on equity.
• The recent rise in non accrual investments to 3.1% of the portfolio at fair value, coupled with idiosyncratic credit issues including tariff and consumer sentiment pressures and a bankruptcy at Renovo, may signal mounting credit risk. This could lead to higher realized and unrealized losses, eroding net asset value and depressing GAAP earnings over time.
• Intensifying competition in direct lending, reflected in tightening spreads and original issue discount, alongside a muted M&A environment, could constrain the ability to redeploy Merx repayments and other repayments into equally attractive high yielding assets. This may limit portfolio yield and constrain revenue and net interest margin.
• MFIC's strategy to run at higher leverage around 1.4 times and to rely more heavily on CLO and secured financing increases sensitivity to credit cycles. Any deterioration in middle market credit quality or funding conditions could magnify losses and volatility in net income, potentially driving a de rating in the valuation multiple.

Valuation

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

• The analysts have a consensus price target of $12.91 for MidCap Financial Investment based on their expectations of its future earnings growth, profit margins and other risk factors.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $15.0, and the most bearish reporting a price target of just $11.5.
  
• In order for you to agree with the analysts, you'd need to believe that by 2028, revenues will be $280.5 million, earnings will come to $147.5 million, and it would be trading on a PE ratio of 10.6x, assuming you use a discount rate of 9.8%.
  
• Given the current share price of $12.26, the analyst price target of $12.91 is 5.0% higher. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• 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.