Great Elm Capital Corp (NASDAQ:GECC) is a diversified business development company (BDC) that has undergone a transformative journey in recent years, strategically positioning itself to capitalize on opportunities within the specialty finance sector. With a focus on generating both current income and capital appreciation, GECC has leveraged its externally managed structure and partnerships to expand its investment platform and deliver attractive risk-adjusted returns to shareholders.
Company Background
Established in 2016, GECC was initially structured as a non-diversified closed-end management investment company. The company elected to be regulated as a BDC under the Investment Company Act of 1940, seeking to generate current income and capital appreciation through debt and income-generating equity investments, including investments in specialty finance businesses. GECC is managed by Great Elm Capital Management, LLC (GECM), a subsidiary of Great Elm Group, Inc. (GEG). The company began accruing fees for GECM’s services under the Investment Management Agreement in November 2016, which includes a base management fee and an incentive fee. In 2022, GECC’s shareholders approved an amendment to the Investment Management Agreement to reset the capital gains incentive fee and mandatory deferral provisions.
Strategic Developments
In 2021, GECC made significant moves to strengthen its financial position by issuing $50 million in 5.88% notes due 2026 and $40 million in 8.75% notes due 2028. The company also entered into a $25 million senior secured revolving credit facility during this period. At the time, GECC’s investment portfolio consisted primarily of first lien loans with no exposure to CLOs. However, the company faced challenges during 2020 and 2021, experiencing net losses due to the economic impacts of the COVID-19 pandemic. Despite these headwinds, GECC remained focused on its strategy of generating current income and capital appreciation through debt and income-generating equity investments.
In September 2023, GECC took a transformative step by contributing investments in certain operating company subsidiaries and other specialty finance assets to its newly formed, formerly wholly-owned subsidiary, Great Elm Specialty Finance, LLC (GESF). Concurrent with this contribution, a strategic investor purchased approximately 12.5% of the equity interests and subordinated indebtedness in GESF. Through its subsidiaries, GESF provides a variety of financing options along a continuum of lending to middle-market borrowers, including receivables factoring, asset-based and asset-backed lending, lender finance, and equipment financing. This strategic move has enabled GECC to generate both revenue and cost synergies across its specialty finance company subsidiaries.
Investment Portfolio
As of September 30, 2024, GECC’s investment portfolio totaled $418.8 million, a significant increase from $241.4 million at the end of 2023. The portfolio’s composition has shifted in recent quarters, with first lien loans and collateralized loan obligations (CLOs) now accounting for 60% of total holdings, up from 44% in the prior year. This strategic shift towards secured, income-generating assets has been a key focus for the company, as it seeks to enhance portfolio quality and maintain a balance between risk and reward.
GECC’s investment portfolio is divided into two primary segments: Specialty Finance and Structured Finance. The Specialty Finance segment, which includes investments in various specialty finance businesses, had a fair value of $43.61 million as of September 30, 2024, representing 13.08% of the total investment portfolio. The Structured Finance segment, which includes GECC’s investment in CLO Formation JV, LLC, had a fair value of $32.89 million, comprising 9.87% of the total portfolio. The remaining 77.05% of the portfolio, valued at $256.78 million, consists of diversified debt and equity investments across various industries.
Financials
GECC’s financial performance in the third quarter of 2024 reflects the successful execution of its growth strategy. The company reported net investment income (NII) of $4.1 million, or $0.39 per share, a notable increase from $3.1 million, or $0.32 per share, in the previous quarter. This growth in NII was primarily driven by the increasing contribution from GECC’s investment in its CLO-focused joint venture, which has become a significant income-generating platform for the company.
For the most recent fiscal year (2023), GECC reported revenue of $30.20 million and net income of $25.33 million. The company’s operating cash flow (OCF) and free cash flow (FCF) for 2023 were both $25.68 million. In the most recent quarter (Q3 2024), GECC’s revenue increased to $11.73 million, representing a year-over-year growth of 26.4%. Net income for Q3 2024 was $4.07 million, up 33.4% year-over-year. However, OCF and FCF for Q3 2024 were negative at -$54.40 million due to higher investment activity in the quarter.
The CLO joint venture, formed in 2024, has been a key strategic initiative for GECC. By deploying approximately $33 million into this platform through the third quarter of 2024, the company has gained exposure to a diverse portfolio of broadly syndicated first lien loans, financed primarily by long-term floating-rate debt. The joint venture’s initial distributions have been strong, with GECC receiving around $3 million in the third quarter on its invested capital. Management believes this innovative structure provides superior financing and enhances the company’s ability to minimize book-tax differences that can arise from directly holding CLO equity.
Liquidity
GECC’s balance sheet and capital structure have also been strengthened in recent quarters. In September 2024, the company issued $36 million of 8.125% unsecured notes due 2029, with the underwriters exercising the full over-allotment option for an additional $5.4 million in October. The proceeds from this offering, combined with available cash, were used to redeem all outstanding 6.75% notes due in January 2025, extending GECC’s debt maturity profile and providing enhanced financial flexibility.
As of September 30, 2024, GECC’s debt-to-equity ratio stood at 1.83x. The company had $30.5 million in cash and cash equivalents, with a $25 million revolving credit facility with City National Bank that remained undrawn. GECC’s current ratio and quick ratio were both 0.30, reflecting the company’s liquidity position.
Portfolio Quality
Despite the ongoing macroeconomic uncertainties and volatility, GECC has demonstrated resilience in its portfolio. As of September 30, 2024, non-accrual positions declined to $1.3 million, or less than 1% of the portfolio’s fair value, from $9.4 million, or approximately 3%, at the end of the previous quarter. This improvement reflects the company’s disciplined approach to credit management and selective deployment of capital.
Future Outlook
Looking ahead, GECC remains focused on executing its long-term growth strategy. The company expects NII to experience some quarterly fluctuations due to the uneven nature of CLO distributions, particularly in the early stages of the joint venture’s life. Specifically, GECC anticipates a step down in NII for Q4 2024 due to these fluctuations. However, as the platform scales and the asset base expands, management anticipates these income variations to normalize over time.
GECC’s Board of Directors has authorized a $0.35 per share cash distribution for Q4 2024, payable on December 31st to stockholders of record as of December 16th. This distribution equates to an 11.6% annualized dividend yield based on the September 30th net asset value. The company believes it is well-positioned to continue increasing its scale and covering its dividend, supported by recent capital raises and the ramp-up of distributions from the CLO-focused joint venture.
Moreover, GECC’s enhanced investment platform, strengthened balance sheet, and diversified portfolio provide a solid foundation for the company to capitalize on opportunities in the specialty finance sector. The successful integration of GESF and the ongoing expansion of the CLO joint venture are expected to be key drivers of GECC’s future growth and performance.
Conclusion
In conclusion, Great Elm Capital Corp (NASDAQ:GECC) has undergone a transformative journey, positioning itself as a diversified BDC with a strategic focus on the specialty finance sector. Through its innovative partnerships, disciplined capital deployment, and commitment to enhancing portfolio quality, GECC is well-positioned to deliver attractive risk-adjusted returns to its shareholders over the long term. The company’s primary focus on the United States market, combined with its lack of major scandals or management issues, provides a stable foundation for continued growth and performance in the specialty finance sector.
Disclaimer: This article is for informational purposes only. It does not constitute financial, legal, or other types of advice. While every effort has been made to ensure the accuracy of the information presented here, the author and the publisher do not make any guarantees about the completeness, reliability, and accuracy of this information.