Business Overview and History
Great Elm Capital Corp (NASDAQ:GECC) is a business development company that seeks to generate both current income and capital appreciation through debt and income-generating equity investments, including investments in specialty finance businesses. Over the past few years, the company has undergone a significant transformation, repositioning itself to navigate the evolving market landscape and deliver sustainable returns for its shareholders.
Great Elm Capital Corp was formed in April 2016 as a Maryland corporation and elected to be regulated as a business development company (BDC) under the Investment Company Act. The company's investment objective is to generate both current income and capital appreciation through a diversified portfolio of debt and equity investments, with a focus on middle-market companies and specialty finance businesses.
In November 2016, GECC began accruing fees for investment management services provided by its external investment manager, Great Elm Capital Management (GECM). The investment management agreement with GECM consists of a base management fee and an incentive fee.
Over the following years, GECC faced some challenges. In 2022, the company had to take steps to reduce its exposure to non-cash generating investments and portfolio concentration. This was a difficult period, but Great Elm Group, the parent company of GECM, provided significant support by waiving previously accrued incentive fees and providing equity capital.
After making progress cleaning up the portfolio in 2022, GECC saw an upturn in its performance over 2023 and 2024. The company was able to rotate into higher-quality credit, grow its asset base, and increase scale. This led to GECC doubling its market capitalization from around $60 million to over $120 million over this two-year period. The company also returned $2.95 per share to shareholders in cash distributions and generated over $2.90 of net investment income per share, outearning its distributions.
In March 2022, Matt Kaplan took over as CEO, and the company embarked on a three-phase strategy to clean up and reposition the business, upgrade the portfolio, and optimize its operations for growth. This strategic shift has been instrumental in strengthening GECC's financial performance and positioning it for long-term success.
GECC's investment portfolio has also undergone a transformation, with the company steadily increasing its exposure to secured debt investments, particularly first lien loans, which now comprise 71% of its corporate portfolio, up from 67% in the prior year. This focus on higher-quality, income-generating assets has been a key driver of the company's improved financial performance.
Financial Highlights and Liquidity
As of December 31, 2024, GECC's net assets stood at $136 million, or $11.79 per share, compared to $98.74 million, or $12.99 per share, at the end of 2023. The company's asset coverage ratio, a key measure of financial leverage, was 169.7% as of the end of 2024, well above the regulatory minimum of 150%.
GECC's total debt outstanding as of December 31, 2024, was approximately $195 million, with its $25 million revolving credit facility remaining undrawn. The company's cash and money market securities totaled approximately $8.45 million at the end of the year.
In the fourth quarter of 2024, GECC's net investment income (NII) was $2.1 million, or $0.20 per share, compared to $4.1 million, or $0.39 per share, in the previous quarter. The decline in NII was primarily driven by the uneven cadence of cash flows from the company's CLO joint venture, as well as the impact of recent equity raises and debt refinancing activities.
For the full year 2024, GECC reported total investment income of $39.32 million, with interest income of $31.54 million, dividend income of $6.92 million, and other income of $0.86 million. The company's annual net income for 2024 was $3.55 million, while annual operating cash flow and free cash flow were both -$82.67 million.
The company's debt-to-equity ratio stood at 1.39 as of December 31, 2024, reflecting its leveraged position. The weighted average yield of GECC's investment portfolio was 12.37% at the end of 2024, demonstrating the company's ability to generate attractive returns on its investments.
Despite the short-term volatility in its earnings, GECC remains well-positioned to cover its increased quarterly dividend of $0.37 per share for the first quarter of 2025, which represents a 12.6% annualized yield based on the company's December 31, 2024, net asset value.
Strategic Initiatives and Growth Opportunities
A key strategic initiative for GECC has been the formation of a joint venture to invest in collateralized loan obligations (CLOs) and related warehouse facilities. This distinctive CLO joint venture structure has allowed the company to increase its exposure to a diversified portfolio of broadly syndicated first lien loans, which GECC believes can provide enhanced economics and steady cash flows over time.
As of December 31, 2024, GECC had deployed approximately $40 million through the CLO joint venture, which the company expects will become an increasingly significant source of income as the platform continues to grow. While the initial cash flow distribution patterns from the CLO investments have been uneven, GECC is confident that this strategy will dampen over time as the company adds more CLO investments and continues to leverage its scale. The company is targeting high teens to 20% returns on its CLO joint venture investments over time.
In addition to its CLO joint venture, GECC has also been actively raising equity capital to support its growth initiatives. In 2024, the company raised nearly $50 million of equity at net asset value, substantially increasing its operating scale. The company has also filed a $500 million shelf registration, which will provide greater financial flexibility and reduce the cost of future debt issuances.
Business Segments
GECC operates in three key business segments:
1. Investment Management Segment: This is GECC's core business, focusing on generating current income and capital appreciation through debt and income-generating equity investments. As of December 31, 2024, the investment portfolio consisted of $324.26 million in total investments, excluding short-term investments. The portfolio was diversified across various industries, with the largest exposures being in specialty finance (13.31% of total investments), structured finance (12.36%), and technology (9.19%).
2. Specialty Finance Segment: In September 2023, GECC contributed investments in certain specialty finance assets to its subsidiary, Great Elm Specialty Finance, LLC (GESF). GESF provides various financing options to middle-market borrowers, including receivables factoring, asset-based and asset-backed lending, lender finance, and equipment financing. As of December 31, 2024, GESF had total assets of $49.22 million and generated $6.48 million in gross revenues for the year. GECC owns approximately 87.5% of GESF following a strategic investment by a third party.
3. Structured Finance Segment: Through its 71.25%-owned joint venture, CLO Formation JV, LLC, GECC invests in collateralized loan obligation (CLO) securities and related warehouse facilities. As of December 31, 2024, the fair value of GECC's investment in the CLO JV was $40.09 million, representing 12.36% of the total investment portfolio.
Risks and Challenges
As with any investment, GECC is subject to various risks and challenges that could impact its financial performance and shareholder returns. These include:
1. Credit risk: The company's portfolio of debt investments, including those held by its specialty finance subsidiaries, is subject to credit risk, where borrowers may default on their obligations.
2. Interest rate risk: Changes in market interest rates could adversely affect the value of GECC's debt investments and its cost of capital.
3. Liquidity risk: The illiquid nature of some of GECC's investments could make it difficult to sell positions in a timely manner, particularly during periods of market volatility.
4. Regulatory risk: As a BDC, GECC is subject to various regulatory requirements that could limit its operational flexibility and access to capital.
5. Concentration risk: GECC's portfolio is relatively concentrated, with a significant portion of its investments in the specialty finance industry, which could expose the company to sector-specific risks.
Outlook and Conclusion
Despite the challenges faced in the fourth quarter of 2024, GECC remains well-positioned for growth and long-term success. The company's strategic initiatives, including the expansion of its CLO joint venture and its successful equity raises, have significantly strengthened its platform and increased its scale.
Looking ahead, GECC is confident in its ability to cover its increased quarterly dividend of $0.37 per share in the first quarter of 2025 and continues to see opportunities to grow its portfolio and generate attractive risk-adjusted returns for its shareholders. The company expects its second quarter 2025 income to exceed the first quarter 2025 income, based on the expected timing of certain items.
GECC's focus on high-quality, income-generating assets and its diversified investment strategy position it well to navigate the evolving market environment and deliver sustainable value over the long term. The company believes that the lumpiness in its earnings from equity raises and CLO investments will dampen over time as it continues to grow and scale its platform, providing a more stable and predictable income stream for investors.