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OHA Investment Corporation: What Is The End Game ?

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We track every Business Development Company out there, but we do spend more time with some than others. We’ve been an irregular visitor of late to OHA Investment Corporation (OHAI), a micro BDC with macro problems. One of the oldest BDCs around, with an initial specialization in the energy field, the Company’s management contract was essentially acquired from the then-manager NGP Capital by Oak Hill Advisors, a $3 billion under management asset manager back in September 2014. At the time, we and everyone else, had high hopes the new investment advisor would be able to staunch the bleeding at the BDC, whose NAV was on a downward slide and was contending with multiple troubled investments. Hope may spring eternal but after a few weeks both Mr Market and ourselves recognized that there was no quick fix in sight at the newly renamed BDC, and that the stated goal of the new investment advisor to steer the business away from energy and into more traditional areas was a pipe dream because of the oil price slide and the multi-layered troubles with many of the “legacy” investments in the portfolio. We took our medicine, sold our position and looked elsewhere.

YOU CAN’T GO HOME AGAIN

As we continue to add the Watch List investments of every Business Development Company into our much-mentioned BDC Credit Reporter Master List we’ve begun to re-acquaint ourselves with OHAI.  We read the Conference Call transcript this morning, and are rummaging through the 10-K. We knew the news would not be good as we’ve seen the Company replace its CEO in recent months, report quarter after quarter of lower Net Asset Value and slash the dividend. The stock price has dropped in half too. When we looked even closer, we came to the conclusion that the situation is even worse than we imagined, and might get worser (to coin a word).

LITANY LIST

At year end 2015, the Company’s Realized and Unrealized Losses in combination are now more than half the equity capital at par, which is a huge amount to have lost. Unfortunately, there’s no end in sight whatever happens to energy prices (but a higher price couldn’t hurt) as so many of the remaining “legacy” portfolio companies are involved in different distressed situations. The cavalry in the form of higher prices may eventually arrive, but it will likely be too late for most of the energy players still on OHAI’s books. Judging from comments made on the Conference Call-and we’re just reading between the lines-there are further write-downs to come.

NOWHERE TO HIDE

Even the non-energy investments that the Company embarked on before and after the new investment advisor came on board are not immune from the weaker credit conditions. The Company has had a few successes, but several portfolio investments have been modestly written down in the last quarter. Not surprisingly, when the Company re-directed any excess capital to non-energy investments there was a preponderance of subordinated debt and second lien loans booked in an effort to support earnings. Furthermore, the new loans were booked at the top of a frothy loan market.

The Company is fully leveraged, with no additional liquidity available. There are just 17 investments in portfolio with a fair market value of $174mn. 4 of the key loans are in the energy field, and their ultimate outcome is in flux and so very hard to sell or even quantify their true value. Moreover, those 4 investments account for 40% of OHAI’s value. (All the energy investments taken together account for 41% of assets).

END GAME

The very legitimate question that has to be asked is what is OHAI’s end-game ? With no liquidity to grow the portfolio, and a long, hard slog ahead on many key investments that could result in further (and possibly) complete write-offs; no prospect of any equity capital raise with the stock trading vastly below NAV and (even now) the possibility that the dividend could drop further, OHAI has effectively become a “zombie”.  Or, to characterize another way, the Company is (almost literally) half a distressed debt fund and half a small, disparate portfolio of higher risk loans. The advisor cannot make the transition to to a “normal” state because of the overhang of the energy investments. Thus, a “zombie”.

WHAT TO DO ? WHAT TO DO ?

The Investment Advisor appears to be out of ideas. We note that they are charging the full Incentive Management fee of $1.0 in 2015, 25% of the total compensation to the External Manager, notwithstanding the huge drop in Net Asset Value during the last year from $7.48 to $5.49 and that halving of the stock price. Sometimes an External Manager will waive a portion of its Incentive Fee to maintain good relations with shell shocked investors. Not in this case. However, the External Manager or its parent is committing itself to purchase $1mn of the Company’s stock, to add to the 816,041 shares already owned. The vagueness of the promised purchase and its minuteness only underscores the lukewarm relationship between the Company and its managers after so many reverses. We can’t help feeling the External Manager is keeping a running count of how much they’ve lost in purchasing OHAI’s stock at a premium to today’s price (in order to evidence their commitment) and the fees that they’ve received. To date, we calculate that they’re still ahead, but may be in no mood to sacrifice further on what appears like a losing cause.

QUESTION POSED

The “Where Do We Go From Here” question was actually explicitly raised-in a most polite way- on the last Conference Call by Jeff Larson of Claragh Mountain Investments, an investment group. We quote from the transcript:

I will compliment you in the job you guys do in terms of disclosure and transparency and you’ve done with the portfolio so far. But you fought against some incredibly difficult market conditions and with the stock trading at about a 45% discount to net asset value, it’s almost impossible to grow the asset size of the company beyond the existing assets size and any growth through investment income. So at what point do you consider more dramatic steps than buying back 1.5% of the market cap for the company and maybe trying to find a possibility to combine with a more efficient entity or to just liquidate the portfolio in general and generate a 70 plus percent gain for the shareholders?

The CEO’s answer underscores the dilemma which the Company is in, neither able to go forward or back:

Well, look, obviously as we talked about on this call there’s a lot of uncertainty in many respects, many different views in terms of our two legacy assets Castex and ATP [two of the energy loans discussed above-BDC Reporter]. And I think in my view it’s just as difficult — it will be very difficult for anybody to get their arms around those given some of the certainties in energy and oil prices. We will obviously consider any alternative that we think would make sense for the company and the shareholders but at this point we think continue on the path that we’ve been executing on and working to maximize value of those assets, is what we’re doing for now.

COMING UP: TROUBLE

However a Day Of Reckoning may be coming sooner rather than later. The Company’s $72mn Revolver is coming up for renewal. The loan was 100% drawn at year end, but has subsequently been reduced to $67.5mn (plus accrued but unpaid interest) just two days ago.  Whether stated or not the Company is in a race to renegotiate or replace the Revolver, which expires in just two months. The 10-K-in that dispassionate, Keep Calm And Carry On language that filings are composed of, hints at what might happen if the Company is not successful in getting a lender to remain with/or join the listing ship:

However, if we do not have a new investment facility in place prior to that date, or if we are unable to extend our existing Investment Facility, we will consider a number of actions in order to increase our liquidity to levels sufficient to meet our debt obligations under the existing Investment Facility and any other anticipated needs for the 12 months ended December 31, 2016. These actions include: refinancing our debt obligations with other lenders, disposing of certain portfolio investments, and reducing other controllable cash outflows.

We believe we are able to take such actions in a manner that would enable us to meet our debt obligations and other cash needs through December 31,2016. However, failure to successfully execute our liquidity plans or otherwise address our liquidity needs may have a material adverse effect on our business and financial position, and may materially affect our ability to continue as a going concern.
WE TAKE A HARD LOOK WITH OUR BANKER’S HAT ON
Of course, just raising the “Going Concern” issue is a red flag. Certainly management spent very little time on the Conference Call discussing what might be happening about its Revolver. No analyst asked a question (just two investment groups who seem to specialize in distressed special situations). We thought we’d take a look with the dispassionate eye of a former banker, and assess the chances of that refinancing occurring. Yes, there are $174mn in total investment assets at fair market value and “only” $72mn (we’re assuming a maxed out state) to re-finance. Moreover, OHAI is willing to pay up for the debt involved. The current average rate is 4.7% and OHAI would presumably pay even more to get a deal done.
WEAK COLLATERAL
Unfortunately,though, any lender is likely to balk at making much of any advance against the  different energy-related portfolio companies, many of whose investments have been written down to zero. Those which still have a value-aggregating $71mn-are in a state of flux given conditions in the market. Many are not paying interest in cash but in PIK, which most lenders consider effectively equity-like and advance little or nothing against. Then there are the lawsuits flying in a couple of other situations.
STRONGER COLLATERAL
We’d expect any lender to look much more to the non-energy investments for security. Unfortunately, OHAI has only $103mn of those type of assets on its books. After deducting out its sole CLO investments (not usually counted as useful collateral by lenders) and equity stakes, the borrowable base of assets is closer to $95mn. Given the small size of the pool and the second lien or subordinated nature of many of these loans, not to mention their illiquid nature, a careful lender might only advance 35% against such collateral, or 50% at most. That would mean OHAI would have a non-energy borrowing base-using the 50% advance rate-of only $47.5mn.  Just to get enough borrowing capacity to get to the magic $72mn a bank would have to be willing to advance 35% against those questionable energy assets. We wish management well, but this will not be an easy task, especially in the more conservative lending marketplace for both energy and non-energy credits.
SHRINKAGE
Of course (and it’s one of the beauties of the BDC model) OHAI does have options. They could sell off some or all their performing non-energy assets to repay the existing lender if another does not come forward. Unfortunately, that would greatly shrink the portfolio, and leave the Company with about $100mn in assets, more than two-thirds in energy. (Not to rub salt in the wound, but to sell off those assets in a hurry they might have to be further discounted, resulting in an even lower Net Asset Value). Essentially the Company would become a distressed play on a small pool of energy loans, with a few non-energy credits thrown in to generate some cash income. For shareholders that would mean a very uncertain future and (presumably) much lower income and distributions, albeit without any lender to worry about. For the External Manager, fees would be nearly 50% lower, just over $2mn a year. That’s a pittance for an asset management group of this size. Retaining the External Manager’s interest in such a situation has to be in question, especially as they have no avowed experise in the energy field.
BLEAK HOUSE
At this stage, we do not see any happy ending to this story, unless a prodigious turnaround can be achieved in the value of a few of the key energy assets. Standing still is impossible given the need to refinance the debt, and it’s implausible to believe an unsecured debt or convertible offering can save the day at this stage. Investors-including the External Manager-are unlikely to welcome a Rights Offering with so much uncertainty about both the current energy portfolio and the ability to build a more traditional portfolio.
STATE OF PLAY
We suppose most of the current investors in OHAI are distressed investment players like the ones on the recent Conference Call. They may be assuming that if the Company does get forced to liquidate itself, the remaining value will result in a gain on whatever they’ve bought their shares for. Currently Mr Market appears to believe the equity value of OHAI is $67mn ($3.25 x 20.616 million shares).  In our minds that’s still bullish. Let’s assume the non-energy portfolio is sold or liquidated at 95% of current value. That would bring in $98mn and allow the pay-off of the loan at $72mn, leaving $26mn in cash. The remaining energy assets would need to be sold for $41mn, compared with a current FMV of $71mn. Normally we’d say that was a more than sufficient discount but given the nature of this “portfolio” and the macro-market conditions, that might yet not be enough. Add to that the uncertainty about what the External Manager might really do (they may just try to hang on, with all the attendant costs and prospects of ever lower values) and we just don’t see enough upside for any investor not deeply knowledgeable about the “real value” of the key energy assets to risk themselves in these waters. The stock has traded as low as $2.51 a share, and could be back there before long. Or lower. Even if there is any profit to be made from buying OHAI at a discount, the upside must necessarily be minimal at this point. We’ve given up advising investors what to do, but we’re staying away.
DISCLOSURES
We have no position in OHAI. We would short if that were possible in this thinly traded name, but it’s not.
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