Medley Capital: Insider Buying Plan Upsized

Readers of the BDC News Of The Day will know about the almost daily purchases of Medley Capital ‘s (MCC) shares by Medley Seed Funding I, LLC (“Seed Funding”). Our latest report was an update on June 12th that brought a recap of the buying up to June 7th to 5,312,029 shares, or well over $30mn. Readers who’ve checked out the links we’ve provided to even earlier articles will be aware this buying, which seems to be purchases by Medley Management’s (MDLY) founders and controlling shareholders brook and Seth Taube but is not, is part of a complex scheme between the Medley organization and Fortress Capital and some of its investors. We detailed how the scheme works back in a long post on February 3, 2017. We strongly suggest anyone who is a shareholder in MCC (which is is being invested in ) or MDLY (which is -partly – doing the investing) should review the February 2017 exposition. However, we’ve been noting the unusually high insider purchases that have resulted from the scheme back from September 2016. The initial agreement was penned in June 2016.

The BDC Reporter has been wondering how long this buying would go on for. We now know that Seed Funding – like the Energizer battery before – will “keep on going and going”. The parties to the June 2016 agreement have just agreed to a major expansion of the buying program at the first year anniversary. Here are the details, which continue to be revealed in disclosures but without any press releases by any of the parties involved.

BIGGER AND LONGER

According to a June 12th, 2017 filing , Medley LLC, a subsidiary of MDLY amended its Master Investment Agreement with DB MED INVESTOR I,LCC and DB MEDINVESTOR II, LLC (the caps are theirs). The latter organizations are vehicles affiliated with Fortress. The key changes were : i) to extend the life of the special purpose vehicle which is buying the stock to ten years from seven. ii) to increase the amounts involved to $53.8mn.

The 8-K filing is relatively brief and here is a full copy, for the avoidance of any doubts:

On June 6, 2017, Medley LLC (“Medley”) entered into an amendment to its Master Investment Agreement (the “Agreement”) with DB MED INVESTOR I LLC and DB MED INVESTOR II LLC (the “Investors”). The Agreement, as amended, provides that, among other things, the parties have committed to increase their investment up to approximately $53.8 million in new and existing Medley managed funds (the ‘‘Joint Venture’’) to support growth of the platform. In addition, the Agreement extends the Joint Venture from 7 years to a 10 year term from the Closing Date (as defined in the Agreement). Medley has committed to contribute up to approximately $13.8 million, and an interest in STRF Advisors LLC, the investment advisor to Sierra Total Return Fund, in exchange for common equity interests in the Joint Venture which provides for 85% of the profits of the Joint Venture after the preferred distribution. The Investors have committed to invest up to $40 million in exchange for preferred equity interests in the Joint Venture. On account of the preferred equity interests, the Investors will receive an 8% preferred distribution, 15% of the Joint Venture’s profits, and all of the profits from the contributed interest in STRF Advisors LLC. Medley has the option, subject to certain conditions, to cause the Joint Venture to redeem the Investors’ interest in exchange for repayment of the outstanding investment amount at the time of redemption, plus certain other considerations. The Investors have the right, after ten years, to redeem their interests in the Joint Venture. The Agreement does not contain any mark-to-market provisions which would force liquidation of any assets. Total contributions to the Joint Venture amounted to $27.5 million through March 31, 2017.

WE ANNOTATE. THAT’S WHAT YOU PAY THE BIG BUCKS FOR.

The main take-aways (besides the fact that the endless purchasing of MCC’s stock is likely to continue so BDC News Of The Day will limit its updates to a monthly recap for those of you keeping score at home) is that the MDLY will grow its ownership in its public BDC even further. The amounts may go so far as to double from the current level. How MDLY shareholders – who have very little say in such things given the controlling interest in the management company by Seth and Brook Taube – feel about that is unknown. One of the stated reasons for the creation of the Master Investment Agreement is that MCC’s stock is under-valued. That may be debatable. Nonetheless, MDLY shareholders will be owning a bigger share of MCC, but in the second tier of a two tier structure where the Fortress Investors receive an 8% Preferred Return.

STAY CALM AND CARRY ON ?

The other item we noted is the penultimate line in the 8-K. Apropos of nothing – because the subject was not one of the items amended on June 6 – the disclosure points out the Agreement “does not contain any mark-to-market provisions which would force liquidation of any assets”. This is not so much a disclosure as a reassurance that the downside we’ve been warning our audience about will not occur: the dumping of all these shares by Seed Funding back into the market. Or, in other words, if MCC’s stock price drops sharply, there is no provision that allows Seed Funding or the Fortress investors to require repayment by the sale of their principal asset: the stock of MCC or another Medley fund they might have acquired. That’s all very well and good, but we would point out that there are numerous other provisions in the Master Investment Investment Agreement which could cause a default and the potential share dump back into the market, as we covered in our February 2017 review.

SPELLED OUT

As we suggested then, the risk here is that MCC – at some point in the future – cuts its distribution so much (or suspends entirely like what happened at American Capital, Allied Capital, GSV Investment and MCG Capital and many other BDCs during the Great Recession, and what has just happened at Medallion Financial and is likely to occur at OHA Investment if anyone thinks the BDC Reporter is digging too much into the past for prior examples) that the Fortress investors are no longer receiving their 8% Preferred return. Or any return. Or any number of other covenants such as the Taubes remaining at the helm.

IMPLICATIONS FOR MCC SHAREHOLDERS

In the short term, this unusual buying arrangement is probably positive for MCC and its shareholders. The constant buying supports the stock price. If fundamentals weaken and the stock price drops further, Seed Funding will be eager to dollar cost average down and make their pay-out requirement less onerous and will be buying more under its pre-established purchase scheme. Moreover, the risk of having this all unwind will keep the Taubes and MDLY very focused on maintaining MCC’s distribution at an optimal level. (Paradoxically, what happens to NAV and the stock price may be less important, given that the lower MCC’s stock price goes, the better the deal for new stock purchases).

In the long term, should MCC stumble down the road, the risk is that the stock price could be walloped by the forced sale of all those shares owned by Seed Funding.

More subtly, this arrangement (which also indirectly serves as a sort of “poison pill”) means that its unlikely MDLY or the Taubes will face much opposition from “shareholder activists”, which is another term for other billionaires seeking to gain control on the cheap. Even “normal” shareholder opposition to the Taubes and MDLY’s stewardship of MCC may be muted by both their large shareholding block (funded by MDLY’s shareholders and the 8% yield starved investors brought in by Fortress) and the knowledge that any shake-up might result in a huge number of shares getting sold into the market.

ASK YOURSELF THIS

This is a very clever arrangement (and could possibly get copied by other asset managers with public BDCs – like Fifth Street Asset Management and its two public BDCs). However, whatever short term support to the stock price involved for MCC shareholders, the question still remains whether the BDC’s credit performance – which has been abysmal – can get turned around by the managers of its Investment Advisor who have proven themselves very clever in the capital markets but have much yet to prove where credit underwriting and portfolio construction are concerned. Ironically, this whole arrangement should cause MCC shareholders to focus on the BDC’s fundamentals and outlook.

SUMMARY

Medley LLC, which is owned by MDLY, has extended and doubled the size of its unusual stock buying arrangement between the public management company and Fortress Capital shareholders.
In aggregate, this special purpose vehicle will buy $40mn in Medley Group fund shares, mostly in MCC.
The result is likely to be short term support for MCC’s stock price, and little likelihood of a change in the Investment Advisor, who was almost evicted previously.
In a worst case scenario – should MCC’s performance sharply deteriorate in the next ten years, there is a risk the vehicle could be unwound and all shares purchased dumped into the market.
MCC shareholders – both current and future – are left to evaluate the BDC’s fundamental outlook, which remains in question.

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