A Boost In M&A And Capital Markets Activity Will Drive Portfolio Expansion

Key Takeaways

• Favorable originations market, M&A activity, and capital markets drive portfolio growth and revenue increase for Hercules Capital.
  
• RIA-managed fund expansion and leveraged strategies support earnings, while risk management initiatives safeguard asset quality.
  
• Yield reductions and venture capital shifts could pressure margins, with rate floor limitations and financing challenges impacting income and growth potential.

Catalysts

A business development company.

• Hercules Capital is well-positioned to benefit from a more favorable originations market in 2025 due to its high liquidity and low GAAP leverage, which should positively impact revenue growth.
  
• The anticipated increase in M&A and capital markets activity, with more support for technology-oriented businesses, is expected to drive portfolio growth, enhancing both revenue and potentially net investment income.
  
• Continued expansion of their RIA-managed private credit funds could increase recurring fee income, thereby positively affecting earnings.
  
• The planned increase in leverage throughout 2025 aims to offset yield compression, which should support earnings growth and maintain dividend coverage.
  
• Initiatives to manage first lien exposure and enhance credit quality can optimize net margins by mitigating risks and maintaining asset quality.

Hercules Capital Future Earnings and Revenue Growth

Assumptions

• Analysts are assuming Hercules Capital's revenue will grow by 6.4% annually over the next 3 years.
• Analysts assume that profit margins will increase from 52.7% today to 57.8% in 3 years time.
• Analysts expect earnings to reach $344.2 million (and earnings per share of $1.94) by about March 2028, up from $260.1 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 16.5x on those 2028 earnings, up from 12.2x today. This future PE is lower than the current PE for the US Capital Markets industry at 21.0x.
• Analysts expect the number of shares outstanding to grow by 6.99% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 8.53%, as per the Simply Wall St company report.

Hercules Capital Future Earnings Per Share Growth

Risks

• The decline in core yields from 13.3% in Q3 to 12.9% in Q4 due to base rate reductions and spread compression on new originations could pressure net margins if continued yield contraction isn't offset by additional leverage or other income increases.
  
• Approximately 50% of the portfolio loans have reached their contractual floor on rates, meaning that potential further rate reductions will not provide benefits and could impact net investment income.
  
• There were net realized losses of $33.5 million during Q4, with significant impacts from unrealized losses in previous periods crystallizing, which could continue to affect overall earnings if not managed.
  
• The increasing difficulty for some venture-backed companies to secure new financing at previous valuations could strain those borrowers’ cash flows, potentially leading to credit losses that impact net margins or revenues.
  
• A shift in venture capital trends with investors focusing more on valuations rather than capital deployment could result in slower growth or more stringent funding conditions, which may dampen future revenue streams from investment activities.

Valuation

• The analysts have a consensus price target of $21.278 for Hercules Capital 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 $25.0, and the most bearish reporting a price target of just $16.0.
  
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2028, revenues will be $595.2 million, earnings will come to $344.2 million, and it would be trading on a PE ratio of 16.5x, assuming you use a discount rate of 8.5%.
  
• Given the current share price of $18.6, the analyst price target of $21.28 is 12.6% 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.