Blackstone Secured Lending Fund

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

A credit-focused investment fund primarily investing in senior secured loans, but also having some investments in preferred and common stock, and other debt-like instruments.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Blackstone Secured Lending Fund (BXSL) is a closed-end, non-diversified management investment company. It mainly invests in U.S. senior secured loans but has broadened its portfolio into other debt instruments, equity, and other investments. Its investment objective is to generate current income and, to a lesser extent, long-term capital appreciation. This requires a very focused investment strategy that is not completely isolated from overall risk factors, as we’ll discuss later.

Business Overview

  • Revenue Distribution: BXSL generates income primarily through interest earned on its loan portfolio and other investments, including debt securities and structured notes, as well as other income (i.e., dividends and capital gains) arising from equity investments and sale of assets. Their investments mainly consist of senior secured loans that generally bear floating interest rates that reset periodically based on benchmarks such as SOFR.

  • Industry Trends: The BDC (business development company) space, of which BXSL is a part, is influenced by both general economic conditions and investor sentiment. Recent years have seen a strong demand for private credit, as investors seek higher yields, prompting many of the newer BDCs to raise more capital and aggressively deploy it. At the same time, there is increasing concern regarding the potential for credit losses, in light of a rapidly changing macroeconomic environment. There is also the concern of rates hitting highs and making it harder for borrowers to cover their debt, increasing credit risk across the market.

  • Margins: BXSL’s profitability is heavily dependent on its ability to generate returns on investments above its cost of funding and operating expenses. Net investment income is a good metric of underlying profitability of their assets. To analyze the profitability one must analyze the company’s interest income and expenses, and management fees and other expenses. Recent trends show a reduction in total investments, including both cash and credit, with higher interest income, and higher borrowing costs, leading to a reduction in net investment income.

  • Competitive Landscape: The BDC sector is highly fragmented, meaning that the competition between the players for deals and loans is very high. As of right now, BDCs are primarily looking at the middle market, but since many big players are focused on this, there are a lot of concerns for declining yields and pricing power. Given the fragmented landscape, it can be difficult for any player to generate long-term sustained profitability without building an advantage in deal sourcing, origination or the type of loans they have.

  • What Makes BXSL Different: BXSL claims to have expertise in sourcing and underwriting its loans. The company is able to obtain and analyze data and apply this to form insights on the best risk-adjusted investments. Also, BXSL has the support and infrastructure of its parent company, Blackstone, which they claim helps them have the best access to deals and resources. Their business model is to invest and hold senior secured loans, while also being able to provide flexibility in their investment strategy by being able to add alternative investments and other securities when it benefits the company. The company also states that it is less focused on growth of size, but rather profitability.

Financial Analysis

  • Income Statement: BXSL’s interest income is its main revenue source, which increased significantly in the latest quarter. Total expenses, especially interest expenses, have increased as well.
    • Net Investment Income was $107 million, or $0.66 per share, for the three months ended September 30, 2022.
    • Net realized gain (loss) on investments was $17.1 million
    • Net increase in net assets resulting from operations was $125.8 million

Net investment income has decreased over 2022, and the management expects to see continuing pressure from higher interest rates and an uncertain economic environment. This suggests volatility in the coming quarters.

  • Balance Sheet: BXSL has total assets of $10,739 million and total liabilities of $5,197 million.
    • The Company’s equity is around $5,542 million.
    • Total debt at around $4,715 million

BXSL’s leverage is high. However, management has stated that they are working to lower it. They plan to achieve a debt-to-equity ratio of 1.1, which is down from 1.5 of the last report. This high leverage and changes in debt affect the company’s profitability.

  • Cash Flow Statement: Looking into the cash flow shows that a portion of the portfolio’s returns are coming from proceeds from investments sold or repaid and a smaller portion from operating activities.
    • As of 30th September, 2022, the fund had generated $162.8 million in net cash from operations and $119.8 million in net cash from financing.
    • They also had $177.8 million of capital expenditures, of which most were investments in debt.

The cash flow statement shows the importance of credit repayments and investment redemptions for generating revenue, although this can fluctuate heavily. It also indicates the high leverage situation of the company.

  • Risks:
    • Credit risk: The risk of borrowers defaulting on loans, affecting interest income.
    • Interest rate risk: Increase in interest rates can increase financing costs and negatively impact net investment income.
    • Economic risk: Uncertain economic environments, with possibilities of recession, can affect the ability of companies to repay debt, increasing defaults.
    • Market volatility: Changing market sentiment can cause share prices of both the loans and the company itself to fluctuate wildly.
    • Concentrated Investments: A significant portion of investments are concentrated in certain sectors and borrowers. If defaults happen in those sectors, or those debtors have problems paying back their debt, it will negatively affect the financial situation of the fund.

Moat Assessment

  • Moat Rating: 2/5
    • Intangible assets: While BXSL does not benefit from strong brands, they benefit from Blackstone’s reputation which is partially a source of a moat, making the company a preferred partner and investor for many borrowers. However, many big firms have similar reputational power, so it cannot give it a wide moat.
    • Switching costs: There are no notable switching costs for customers to borrow from another creditor, thus reducing the moat. This means the company cannot have pricing power.
    • Network effects: There is no network effects as they don’t need multiple users to succeed.
    • Cost advantage: There is little to no cost advantage for BXSL. They can provide funding and capital but cannot provide it for better prices than their competitors.

BXSL has a very limited economic moat due to lack of any sustainable competitive advantages. However, Blackstone’s brand has the potential to establish a narrow moat, making it harder to replicate their investment approach.

Understandability

  • Understandability: 3/5 The company’s business model is based on financing and providing capital, which is fairly easy to understand on a basic level. However, the valuation and the financial analysis of debt and credit instruments can become complicated. The company also involves leveraged instruments, making valuations complex. Understanding all the facets of operations, the risk management process, and all the moving variables of a global economy requires experience and knowledge.

Balance Sheet Health

  • Balance Sheet Health: 3/5

While BXSL has a huge asset base, its high leverage, and the volatile nature of its underlying assets make it hard to classify it as having great balance sheet health. There are also a lot of potential issues with the company’s loan assets going bad. There are few liquid assets to make up for the debt portion, although the management is reducing leverage over time, which makes this rating only average, and not worse.

Additional Context

  • Recent Concerns/Controversies: Management acknowledges the current economic volatility and the potential impact on credit defaults and increased nonperforming loans. In the recent earnings call, they reiterated that they are reducing leverage and focusing on conservative lending practices. However, their latest results have shown that this trend is not coming down quickly and continues to be an issue. Furthermore, the company is facing a high risk of a credit downturn, a risk they say they are well placed to handle.

The current market sentiment has put a lot of scrutiny on leveraged funds, making some investors wary of investing in BDCs as well. So this continues to put downward pressure on shares.

  • Management’s View: The company has been touting it’s low-risk approach to investments, as well as being defensive by holding senior secured loans that typically are first in line to get payment on default. Also the management is continuing to lower leverage and diversify investments. They note their partnership with Blackstone as an important advantage to source new deals and find value.

To conclude, BXSL is a very specialized investment company that is focused on providing leverage to companies while also generating income for their shareholders. The nature of this company is risky and involves many moving components that are often out of the control of management, and thus is hard to judge performance based on management expertise.