Gladstone Investment: Resilient And More Attractive After Q3 Report (NASDAQ:GAIN)

Back in December last year, I wrote an article on Gladstone Investment (NASDAQ:GAIN) setting a buy even though it has one of the smallest market caps in the BDC. For example, as of now GAIN carries just over $750 million in its AuM figure, which is ~4x below the sector average. This, in turn, implies the following:

• GAIN is exposed to elevated concentration risk
• The investment opportunity landscape is much more narrow for this BDC since it is not able to accommodate large ticket size transactions

With that being said, I still believe that GAIN is a very attractive investment pick that has, in fact, just got more enticing because of the combination of a slight correction in the share price and strong Q3, 2023 results (October – December, 2023 period).

The reason why investors should consider Gladstone Investment in their portfolios is because the portfolio characteristics, sound leverage and strong net investment income generation offset the drawbacks stemming from the size issue.

Synthesis of Q4 results and thesis review

As opposed to many BDCs out there that have registered subpar results at the net investment income level mostly due to decreased AuM base and rising non-accruals, GAIN has managed to deliver improved results relative to the prior quarter.

As the table below indicates, the adjusted net investment income component per share has climbed higher by 8% compared to Q2, 2023 (July – September, 2023 period). This has taken place despite higher number of outstanding shares, and the overall headwinds from depressed investment volumes in the industry.

What is important to underscore is GAIN’s investment during Q3, 2023, where the BDC channeled additional ~ $65 million (~ $39 million of secured second lien debt and ~ $26 million of common equity) to one of its portfolio companies, which was seeking to execute an accretive M&A transaction.

As a result of this investment, GAIN was actually able to maintain its AuM base after factoring in the organic reductions stemming from loan repayments and equity sales.

In this context Gladstone Investment’s small size came in handy, where only one transaction was sufficient to keep the portfolio balance in check. Typically, BDCs carry 100+ of portfolio companies, which provide greater diversification effects than in GAIN’s situation, where the total exposure is distributed only among 25 companies. Yet, again – as we noticed from the above, there are moments where smaller size can turn out to be an advantage.

During the quarter, GAIN exited its investment in one portfolio company that resulted in success fee income of ~ $1.5 million, repayment of ~ $28 million principle (plus accrued interest), and most importantly, a realized gain of $43.5 million.

The realized gain component is a strong testament of GAIN’s ability to create value by applying a strategy, where it provides a combination of debt and equity financing to its portfolio companies. Namely, on top of the net investment income streams, the BDC is able to capture equity-type returns once exits are made.

Moreover, if we look at the dynamics at the capital structure end, it seems that the Management was all about preserving its dry powder and fortress balance sheet that has one of the lowest leverage profiles in the BDC sector.

Even though GAIN had the option to source incremental debt financing to fund the new investment, the Management team opted for sourcing fresh equity via ATM program. During the quarter, GAIN issued new shares at $14.51 per share and raised circa $21 million in net proceeds. These sales were above our then-current estimated NAV per share as well as significantly above the current price. Furthermore, in January 2024, GAIN tapped into the ATM program once again by issuing new shares at $14.53 per share raising ~ $7.7 million in net proceeds. Again, these sales were above our then-current estimated NAV per share and the current stock price level.

So, thanks to these measures in conjunction with a successful realization of the aforementioned exit, GAIN’s leverage profile has strengthened even further.

From this we can imply that GAIN is preparing its balance sheet for the next opportunities over 2024, which are very likely to emerge given the tailwinds in the M&A and capital markets space.

The fact that Rachael Easton – Chief Financial Officer outlined in the recent earnings call that GAIN’s credit facility has been brought back to opportunistic levels clearly signals that the BDC is eager to grow:

So, we were able to increase the facility by bringing in a new bank. We brought in Fifth Third, and we were also able to increase one of the other bank’s commitments as well to get back up to that $200 million amount. And we believe this additional capacity is really important in providing flexibility as we contemplate future pipeline in the deal flow process.

Finally, it is comforting to notice that the debt maturity profile remains well-laddered with first refinancing event happening only in mid-2026.

This is very solid and beneficial for the subsequent financings, where the Management has secured both ample liquidity amount through extremely low leverage and expanded credit facility and locked-in cost of financing that is not imposing any refinancing risk over the next two years.

The bottom line

GAIN remains a resilient investment case with strong balance sheet and improving net investment income levels despite the challenging backdrop at the new investment flow end.

During the recent quarter, Gladstone Investment has taken additional measures to bolster its liquidity profile that will come in extremely handy in accommodating new investments.

For me, GAIN is a clear buy.