A few minutes ago Fifth Street Asset Management (FSAM) announced its intention to explore a sale of the controversial asset manager, using Morgan Stanley as its go-to investment banker. Apparently, this was not the first time FSAM put itself on the block (a fact that may come as a surprise to some shareholders of Leonard Tannenbaum’s publicly traded vehicle). FSAM had been shopped last year, but terms were not agreed with any buyers. The news item about this “developing story” is that “the process is in an early stage” and no deal may be forthcoming. Readers should be aware that FSAM is the entity up for sale, and not the two public Business Development Companies which the asset manager runs: Fifth Street Finance (FSC) and Fifth Street Senior Floating Rate (FSFR). Yet what happens at FSAM could dramatically change the future of both those BDCs. Should FSAM be bought out by a new asset manager, the knock on effect at the BDCs is that there will undoubtedly be huge changes in strategy (stop making bad loans will be the first goal); personnel (a BDC has no employees and relies on its Investment Advisor); returns on capital (which have been abysmal in recent years); reputation (FSAM is one of the most excoriated investment shops out there) and ability to raise new equity capital (basically on hold). We wouldn’t be surprised to see an ambitious and patient new owner seek to merge the two BDCs; offer up concessions on fees to placate depressed shareholders and potentially completely re-position the business. (Ares Capital: are you listening ?).
The BDC Reporter’s first reaction -and we reserve the right to change our minds- is that this was a genius move by FSAM and Mr Tannenbaum after a series of bad decisions. Most importantly, we believe this is a plus for FSC and FSFR shareholders. By ejecting himself from FSAM (albeit with a huge payday), Mr Tannenbaum creates an opportunity for a bigger, more experienced and well regarded credit manager to step in and inherit a ready made public BDC platform, with all that already raised permanent equity capital and ongoing income streams. That also provides a way for FSC and FSFR to be “worked out” of their current credit difficulties, and returned to the status of “normal” BDCs by a group with the staff and experience to do just that. When Patrick Dalton joined FSAM as the new CEO of both entities, he drew up a game plan for turning around the two BDCs which included the need to hire key personnel at every level of the organization. Rather than start from scratch a new experienced asset manager will have the personnel to get going right away, and the necessary credibility in the market. We don’t doubt that there are numerous troubled loans on the books of both BDCs. The BDC Reporter has looked at both portfolios in a granular way and come away unimpressed. Here’s a link to our review of FSFR on February 20th 2017, and a link to an in-depth look at FSC’s challenges on February 10th. However, we believe that within a relatively brief period the problems in the portfolios can be identified and fixed without any catastrophic challenge to the survival of the BDCs. Mr Tannenbaum, FSAM’s shareholders, as well as the two BDCs involved are lucky that the markets for leveraged finance assets are in a golden period here.
Of course, as usual the devil will be in the details and in the multitude of conflicts of interest between Mr Tannenbaum, FSAM’s shareholders, the BDC shareholders, the lenders involved at all 3 entities and the would-be Buyer. However if FSAM (Tannenbaum) is not too greedy (he’s presumably been suitably humbled by the hiring and removal of a CEO within a 3 month period) a deal is likely to happen and the logjam created by prior disastrous decisions (raising unnecessarily capital below NAV; booking assets at a break-neck pace to boost the IPO; raising non-accretive debt, etc) may get broken to everyone’s benefit. This exit stage right by FSAM and Mr Tannenbaum may prove to be the beginning of a new act for FSC and FSFR’s shareholders, but only after a slew of investment banking fees, loan write-offs and hard feelings.
DISCLOSURE: On two minutes reflection, and before we wrote this post, we did speculatively purchase stock in both FSC and FSFR (FSAM was already going through the roof) in our personal account and for another portfolio we manage. We are typically long term investors, and would not normally invest in either FSC and FSFR (we refer you back to FSAM and what has come before), but the potential exit of Mr Tannenbaum has changed the narrative, which might make these two BDCs either good “short term plays”, or more appropriate “long term holds”, depending on how this plays out. We already own Fifth Street’s Baby Bonds in our Fund, whose stock price has remained unfazed by this news.