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Ares Capital-American Capital Merger: First Look

BDCs:
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Ares Capital (ARCC) has filed preliminary Registration documents regarding the pending merger/acquisition of American Capital (ACAS).

Spelled out for shareholders is how the acquisition will work, the projected value and rationale for the parties involved and voting instructions for a decision date in mid-December 2016, and a final closing in January 2017.

The Form N-14 Registration Statement is several hundred pages long, but includes the standard Q&A for shareholders that covers most of the key issues on pages 3-26.

The BDC Activist undertook a quick fly-by of the document, noting various interesting items on the way:

  • The record date for entitling  Ares shareholders to vote is being set at October 17. See page 125.
  • For history buffs, the whole official chronology of the proposed merger between the two BDC giants is detailed in pages 132-155.

OPINIONATED

Anyone interested in how some of the biggest investment banks in the country value BDCs, from page 168 there are detailed summaries of reports by Goldman Sachs, Credit Suisse and Wells Fargo.

However, BDC shareholders hoping for an insight into these transactions frtom some of the brightest financial minds in the country might be disappointed. Those financial opinions-which the Boards of the respective companies purportedly rely upon to approve the proposed transactions and which are a third party view of what value is being created-are full of exclusions, time limitations and other forms of avoiding commitment. This is standard in the world of mergers and acquisitions, but still bears noting.  The huge fees notwithstanding, shareholders will have to make up their own minds from the evidence at hand.

GOLDMAN MAKES NO COMMITMENT

Here are a few examples taken from the Goldman Sachs opinion from May about the fairness of the transaction from an American Capital  shareholder’s standpoint:

Goldman Sachs expressed no opinion as to any adjustment to the Mortgage Manager consideration, which is subject to adjustment pursuant to the merger agreement.

Goldman Sachs also expressed no opinion as to the ACAM merger, which will occur concurrently with the closing of the merger.

 Goldman Sachs’ opinion does not address the underlying business decision of American Capital to engage in the Transactions or the relative merits of such Transactions as compared to any strategic alternatives that may be available to American Capital.

..nor as to the fairness of the amount or nature of any compensation to be paid or payable to any of the officers, directors or employees of American Capital, or class of such persons, in connection with the Transactions…

And so on and on.

Essentially the Goldman opinion is mostly a desktop valuation of American Capital compared to other larger sized BDCs.

HERE’S THE BILL

For the record, here is what ACAS (and its shareholders) paid for this “opinion”:

The American Capital board of directors selected Goldman Sachs as its financial advisor because it is an internationally recognized investment banking firm that has substantial experience in transactions similar to those contemplated by the merger agreement. Pursuant to a letter agreement dated November 23, 2015, American Capital engaged Goldman Sachs to act as its financial advisor in connection with the contemplated transactions. Pursuant to the terms of this engagement letter, American Capital paid to Goldman Sachs $3.0 million prior to the announcement of the Transactions and agreed to pay Goldman Sachs a transaction fee that was estimated, based on the information available as of the date of announcement, to be approximately $13.7 million, all of which is payable upon the completion of the merger. In addition, American Capital will pay a discretionary fee of $2.0 million to Goldman Sachs upon the completion of the merger. In addition, American Capital has agreed to reimburse Goldman Sachs for certain of its reasonable expenses, including reasonable attorneys’ fees and disbursements, and to indemnify Goldman Sachs and related persons against various liabilities, including certain liabilities under the federal securities laws.

THE MORE, THE MERRIER

American Capital also engaged Credit Suisse to provide a similar opinion under the following terms:

American Capital paid to Credit Suisse $3.0 million prior to the announcement of the Transactions and agreed to pay Credit Suisse a transaction fee that was estimated, based on the information available as of the date of the announcement, to be approximately $13.7 million, all of which is payable upon the completion of the merger. In addition, American Capital will pay a discretionary fee of $2.0 million to Credit Suisse upon the completion of the merger. In addition, American Capital has agreed to reimburse Credit Suisse for its expenses, including fees and expenses of legal counsel, and to indemnify Credit Suisse and certain related parties for certain liabilities and other items arising out of or related to Credit Suisse’s engagement.

WELLS FARGO TOO

Ares Capital engaged Wells Fargo to provide an opinion from their perspective. Again, the investment banker pointed out that in the preparation of the numbers they relied on ACAS and ARCC’s management’s reassurances “that they are not aware of any facts or circumstances that would make such information inaccurate or misleading”.  Moreover, Wells admits in the filing that they had only a limited data set available:

As the Ares Capital board of directors was aware, Wells Fargo Securities was advised by the management of American Capital that current financial forecasts relating to American Capital taking into account, among other things, the pro forma impact to American Capital of the transactions contemplated by the Mortgage Manager Purchase Agreement, had not been, and would not be, prepared or provided to Wells Fargo Securities for purposes of its opinion.

Plus:

Wells Fargo Securities utilized the Ares Capital Stand-alone Forecasts and the Ares Capital Pro Forma Forecasts, without independent verification, in its analysis.

The compensation for what effectively is a valuation that any graduate student could prepare is as follows:

        As compensation for Wells Fargo Securities’ financial advisory services to Ares Capital in connection with the mergers, Ares Capital has agreed to pay Wells Fargo Securities an aggregate fee based on the fair market value of the Ares Capital consideration to be paid by Ares Capital in the mergers, which fee is currently estimated to be approximately $13 million, $1.0 million of which was payable upon delivery of its opinion and the principal portion of which is contingent upon consummation of the mergers. In addition, Wells Fargo & Company and certain of its affiliates (i) are acting as a lender in connection with the upsizing of Ares Capital’s Revolving Funding Facility, which may facilitate the financing for the mergers, for which services Wells Fargo & Company and its affiliates currently expect to receive an aggregate fee currently estimated to be approximately $6.0 million. Additionally, Wells Fargo Securities is acting as a book-running manager in connection with Ares Capital’s September 2016 debt offering for which services Wells Fargo Securities expects to receive an aggregate fee currently estimated to be approximately $0.9 million. Ares Capital also has agreed to reimburse certain of Wells Fargo Securities’ expenses and to indemnify it and certain related parties against certain liabilities that may arise out of Wells Fargo Securities’ engagement. Additionally, Ares Capital has engaged Wells Fargo Securities, among other investment banks, to arrange a series of investor calls relating to a potential debt offering.

NO RELIANCE

The BDC Activist is just pointing out that the opinions provided by the big investment banks have very little value as true independent valuations given the almost complete absence of any data verification, the omission from consideration of very important issues and the financial arrangements involved, both for the deal and future business. No investor should expect to “hear a discouraging word” or receive much in the way of illumination as to the current or future prospects of Ares Capital once this deal is all tied up.  As usual in these cases, these opinions are principally contracted to ward off potential litigation.

Moving on…

MORE MONEY ISSUES

ACAS shareholders finally learn on page 212 how the principals of the BDC will fare in the merger. We wrote back in January that we surmised-when the die was not yet cast-that the top managers of ACAS were preparing to sell off the Company and cash in their chips. Our conclusion was partly based on the value of those chips.

Much of those suspicions are confirmed on page 213 of the Registration, showing that the top 8 executives at American Capital will be receiving over $180mn from their stock options. Then there are the employment agreements and Golden Parachute arrangements for the Top Five, which aggregate above $50mn (if we’re reading the legalese right), spelled out in the pages that follow. If you include the value of Ira Wagner’s options (he left in 2015 and does not get some of the post-closing goodies) and the options of other ACAS senior officers, the BDC Activist guesses the insiders at ACAS may be receiving over $300mn as a result of ARCC’s acquisition.

TYING IT ALL TOGETHER

Are those payments “fair” ? Of course none of the investment bankers or the Boards of the respective companies will be drawn into THAT subject.

MORE TO COME ?

The BDC Activist will be having a more concerted look at the Registration Statement in the next few days and report back if anything of interest pops up in those hundreds of pages.

 

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