Golub Capital BDC, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 4/5

Golub Capital BDC, Inc. is a business development company that primarily invests in U.S. middle-market companies through senior secured and junior debt, and some equity positions, seeking current income and capital appreciation.

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.

Business Overview: GBDC operates as a business development company (BDC), providing debt and equity financing to U.S. middle-market companies. Its main goal is to generate current income and some capital appreciation. The company has a diverse portfolio that includes senior secured loans, second lien loans, subordinated loans, and equity investments. It serves as a funding partner to companies with revenues typically between $50 million and $1 billion annually. The majority of their portfolio holdings are within the United States.

GBDC offers various financing solutions, including first and second lien loans, senior secured debt, and some mezzanine debt, which all have different characteristics and risks profiles. Senior secured loans are senior in claim and offer security as well as a lower risk but are also lower yielding. Whereas mezzanine debt is more speculative and has higher risk while being higher yielding.

Revenue Distribution: GBDC’s revenue is primarily derived from interest income on its debt investments and dividends from equity investments. The precise allocation of revenue across different types of holdings has varied over time based on investment strategies.

Interest Income - This includes interest on loans made by GBDC to its portfolio companies.
Fee Income - Income from transaction, loan origination, and prepayment fees.
Dividend Income - Includes profits that came from GBDC’s equity ownership in some companies

The company’s most recent financial reporting shows investment income at the top which it considers more important and also notes other items, like non-recurring items, into their net income figures, but those items are less important for the company’s economic performance.

Industry Trends: The BDC industry is heavily impacted by interest rates, as interest-earning instruments such as loans is their main source of revenue. In periods of high-interest rate environments, these companies have the ability to generate higher income, as their revenue increases with a higher-base lending rate. In times when rates decrease, the inverse is true. Thus the interest rates in the economy play a huge role in the performance of this business. The BDC industry also faced a lot of regulation in recent times which is expected to improve governance and safety of capital allocation.

Competitive Landscape: The BDC landscape is crowded, with several BDCs competing for deals. Therefore it is very important that a company distinguishes itself from others for a competitive advantage. It can be a combination of multiple factors like access to capital, sector specialization, deal selection process, long-term relationships with companies they provide funding for, etc. GBDC is one of the largest players, so it is considered a well-established company with a track record. Despite that, smaller competitors may still get deals by cutting prices and offering lower interest rates, so the industry can get competitive at times.

What Makes GBDC Different? GBDC has shown a focus on the core middle-market, lending to industries across different sectors in the economy. It claims its success on relationship building and a good understanding of complex businesses. Although management claims their underwriting process to be a strong one, the fact that there are many other players that provide similar services, might suggest it’s not that big of an advantage.

Financial Analysis:

GBDC’s last quarterly earnings call was on November 7th, where they stated that interest rates have been a large benefit to their core income. They’ve also stated that they have maintained a strong balance sheet and are disciplined on how they manage their capital.

Reorganized Financial Statements: GBDC does not fully disclose data about profitability by the type of loan, though it claims it is a main focus of their operations. We will focus primarily on the total assets and loans since the revenue source is mainly based on the interest generated from the loans and its ability to pay.

Invested Capital: A quick glance at their investments shows that GBDC has a large mix of different types of debt. Senior secured debt, other loans and credit instruments, as well as equity.
NOI (Net Operating Income): For the sake of simplicity, let’s assume that the company is fully financed with equity. Therefore, all the interest and non-interest operating expenses will equal net operating income. We do this mainly because of the lack of disclosure of cost of capital on an individual loan basis.
Free Cash Flow: Since we assumed the company is fully financed by equity and we are taking out the non-operating part, free cash flow will equal the net operating income-minus the capital expenditures(investments in their loans, etc.). Given there was no further investment in their portfolio, the free cash flow would actually be their earnings.

Balance Sheet Health: GBDC’s balance sheet is quite strong, but it should be mentioned that any leverage they use in their operations can be a source of risk. Also, BDCs, by definition, are prone to heavy leverage which may impact solvency and credit ratings when the market deteriorates or default rates go up.

Debt-to-Equity: GBDC is funded by a mix of debt and equity, where the debt is a lever that enhances their returns but might also affect their resilience in periods of economic downturns. The Debt-to-Equity has been in decline, and while we are not given specific figures for each period, we will look into that with their liabilities.
Debt & Equity: The total Liabilities of the company were $5.2 billion, and the Shareholder Equity stood at 1.3 Billion. Therefore the debt to equity ratio is about 4x. We would prefer this to be lower, around 2-3x. But their target capital structure is a 1 to 1.5x leverage, so they aren’t that overleveraged.
Liquidity: GBDC’s liquidity is in a good position. The level of cash and cash equivalents have been consistent, and their total assets are more than liabilities. This is a good sign.

Overall, the company is well capitalized, and we rate its Balance Sheet Health at a 4/5. Although leverage does exist and should be considered a risk, the company is in a good position with debt mostly to secure loans and equity to capitalize on it.

Moat Rating: 2 / 5 While GBDC operates in a field that is profitable, it struggles to develop a significant moat. It is difficult for these types of companies to have substantial moats due to the lack of uniqueness of their product and service.

GBDC is well established and has been operating for a while, but this doesn’t create a competitive advantage, since competitors can easily step into the industry and compete for market share.
The distribution networks and other tangible assets are easily replicated and the switching cost is generally low.
The only factor that may provide a slight edge in their business is the management and their ability to procure good returns from their debt, as well as the proprietary analytics.

Risks to the Moat & Business Resilience:

Interest Rate Changes: A rapid increase or decrease in interest rates will affect the company’s revenue and hence profitability by changing the returns on the company’s interest-based holdings.
Credit Cycle: GBDC is highly exposed to credit and default cycles. Economic stress might lead to defaults on their debt, which would cause the company to see their income and value of capital decrease rapidly.
Liquidity Risk: There are a lot of private credit and private debt positions, which are extremely illiquid. Hence, if a crisis happens, it is difficult for the company to liquidate assets quickly.
Competition: Many companies operate in the BDC space. Those companies can compete with GBDC for investment deals which would reduce the margins and could cause GBDC to lose its position.
Management Decisions: Errors in judgment by the management, as well as the ability to identify and pick profitable lending opportunities, can negatively impact the overall performance of the company.

GBDC has shown a consistent history of performance and revenue. They also have been prudent in their capital structure and portfolio management, which would indicate that the business has some degree of resilience. We believe that the business can survive major economic downturns, but the performance might suffer.

Understandability: 3 / 5 The business model is fairly easy to understand, as it is based on interest income from debt and some equity appreciation. However, to understand the underlying risks and the company’s true profitability, the investor will have to dig deep into the footnotes and analyze financial data, including ROIC for example. They also operate in a very complex industry structure that is impacted by interest rates, and various economic and competitive cycles, making it complicated to forecast future performance with a high degree of accuracy. Because of the level of financial jargon and the intricacies of the financial instruments, it requires a bit of understanding to be fully digested.