BlackRock TCP Capital Corp. (TCPC) [NASDAQ:TCPC], a business development company known for its savvy investments in the middle market, recently announced strong Q1 2024 results, boasting a 14.7% annualized net investment income return on equity. However, a closer look at the Q1 2024 earnings call transcript reveals a looming storm: the troubled Amazon aggregator space. TCPC holds significant positions in two prominent aggregators, Thrasio and Razor, both of which have been battered by industry headwinds. While Raj Vig, TCPC’s CEO, assures investors that these are isolated incidents and not indicative of broader credit challenges, the reality might be far more unsettling.

The Amazon aggregator model, once hailed as a revolutionary force, has hit a wall. COVID-related supply chain disruptions, followed by a slump in online spending, have left aggregators grappling with excess inventory and inflated balance sheets. Thrasio, one of the largest standalone players, succumbed to these pressures and filed for Chapter 11 bankruptcy in February 2024. While TCPC supported the restructuring, hoping for a leaner and more profitable Thrasio to emerge, the company's mark on this loan stands at a disconcerting 33.1%, significantly higher than the implied recovery value for senior lenders.

Razor, another major aggregator in TCPC's portfolio, has chosen a different path, acquiring Perch in an attempt to consolidate and achieve greater efficiency. However, this move comes amidst a wave of similar consolidations in the aggregator space, driven by a desperate need for cost optimization. This frenzy raises a crucial question: is the aggregator model fundamentally flawed?

While TCPC projects continued consolidation and the emergence of fewer, larger-scale aggregators, the industry's future remains shrouded in uncertainty. The success of these consolidations hinges on achieving significant cost reductions and aligning operations with the evolving e-commerce landscape. If these efforts fail, TCPC's exposure to the aggregator space, estimated to be close to 7% of their portfolio, could translate into substantial losses, potentially impacting the BDC's impressive track record and jeopardizing its ability to deliver attractive returns to shareholders.

Potential Impact of Aggregator Model Failure on TCPC

Let's assume, for a moment, that the aggregator model is inherently unsustainable, and these consolidations fail to deliver the anticipated results. What would be the potential impact on TCPC?

NAV Erosion: TCPC already marked down its Thrasio loan to 33.1%, implying a significant potential loss. If other aggregator investments experience similar declines, TCPC's NAV could erode further. Considering the estimated 7% exposure to the aggregator space, a substantial markdown could lead to a significant drop in NAV, potentially exceeding the 6.4% decline witnessed in Q1 2024.

Dividend Sustainability: TCPC prides itself on consistently covering its dividends with recurring net investment income. However, if aggregator investments generate lower-than-expected returns or experience losses, TCPC's NII could take a hit, potentially jeopardizing its ability to maintain its current dividend level.

Reputational Risk: TCPC has cultivated a reputation for prudent underwriting and strong risk management. Significant losses in the aggregator space could tarnish this reputation, making it more challenging to attract future investors and access capital on favorable terms.

Effective Yield on Debt Portfolio (TCPC)

The chart below, derived from TCPC earnings call transcripts, shows the effective yield on TCPC's debt portfolio over the past three quarters. The upward trend reflects the benefit of both higher base rates and wider spreads on new investments.

While the Amazon aggregator story is still unfolding, the stakes for TCPC are undeniably high. The company's ability to navigate this turbulent space will be a crucial test of its expertise and resilience.

"Fun Fact: Did you know that the term "Amazon aggregator" was coined in 2020? It was used to describe companies that acquire and consolidate smaller Amazon businesses, leveraging economies of scale to achieve greater profitability. However, the recent turmoil in the aggregator space suggests that scaling up may not be the magic bullet many initially believed it to be."