Fifth Street Asset Management: Sale Of SubsidiaryPremium Free
Fifth Street Asset Management (FSAM) is not a BDC, but a publicly traded asset manager. Most importantly FSAM (or a subsidiary) is the Investment Advisor to two BDCs we track: Fifth Street Finance (FSC) and Fifth Street Senior Floating (FSFR). We’ve temporarily added FSAM to our News Of The Day Watch List until the question mark about the future of the asset manager is resolved. Most every reader will know FSAM has admitted being in negotiations to be acquired since a June 30 press release. That followed a June 29 news story by the Wall Street Journal being conveniently “leaked” the news that a negotiation was underway and that Oaktree Capital – a huge asset manager with a finger in many pies -was on the other side of the table. A tentative purchase price was even mentioned, according to “some people”. Since then there’s been radio silence from all the parties and even the WSJ. The BDC Reporter has pointed out along the way that this delay in completing the transaction creates a risk for investors in all 3 Fifth Street related entities, given that the “news” of the deal has already caused huge moves in their respective stock prices. For example, within a couple of days FSAM’s stock price moved up 50%, before slipping back slightly.
Today FSAM made an announcement of a sale, but not the one expected. Here are the details. We’ve added analysis of FSAM’s dire financial standing, drawn from the latest 10-Q and added the BDC Reporter’s view of what MIGHT happen next. We end with a disclosure about our position(s) and the rationales involved for anyone interested.
In a press release on July 7, FSAM reported selling Fifth Street CLO Management LLC (“CLO Management”) , a wholly owned subsidiary, to Newstar Financial, Inc. (NEWS). Net of “associated indebtedness”, FSAM will receive $16mn of proceeds. The press release specified very clearly that the monies will be used to pay down FSAM’s Revolver, when the actual closing occurs in a few weeks. More on that below.
Here is what the press release said about the CLO subsidiary:
FSCM was formed in 2015 to manage Fifth Street’s middle market CLO business. The company currently manages two CLOs, with approximately $726 million of assets under management as of March 31, 2017, backed by middle market loans, and holds certain interests in its sponsored CLOs primarily to comply with regulatory risk retention requirements.
However, like most every other attempt at building out the FSAM franchise, FSCM has not grown very much. The value paid includes FSAM’s investment in the two CLOs that were sponsored. CLO sponsorship is a highly competitive business where even the smaller players have billions and billions of dollars under management in order to be cost effective. This is what Leonard Tannenbaum, CEO of FSAM (and its largest shareholder) said in the press release:
“Over the course of FSAM’s strategic review, it became clear to us that given the market environment and headwinds we faced over the past year and a half, it would be difficult to scale our CLO business,” said Leonard M. Tannenbaum, Chief Executive Officer of FSAM. “We believe that exiting this business line is in the best interest of our shareholders and is an important step as we continue to enhance our liquidity position and streamline operations.”
We looked at the 10-Q for a refresher of what the “associated indebtedness” was where CLO Management was concerned. The 10-Q shows that when the subsidiary was set up in 2015, FSAM borrowed the capital needed to invest in the CLO funds under its management. Here are the details:
On September 28, 2015, CLO Management entered into a Risk Retention Term Loan to provide financing for its purchase up to $17 million of CLO II senior notes at a variable rate based on either LIBOR or a base rate plus an applicable margin. Borrowings under the Risk Retention Term Loan totaled $16,972,565, of which $12,972,565 remains outstanding, and accrue interest at a rate based on the interest rate on the financed notes and the weighted current cost basis which was 4.23% as of March 31, 2017. The Company’s beneficial interests in CLO II in the aggregate amount of $23,260,659 at fair value are pledged as collateral for the Risk Retention Term Loan. The facility matures on September 29, 2027 with certain lenders party thereto from time to time and Natixis, New York Branch, as administrative agent and joint lead arranger, and Bleachers Finance 1 Limited as syndication agent and joint lead arranger. The Risk Retention Term Loan contains customary affirmative and negative covenants for agreements of this type, including financial maintenance requirements, delivery of financial and other information, compliance with laws, further assurances and limitations with respect to indebtedness, liens, fundamental changes, restrictive agreements, dispositions of assets, acquisitions and other investments, conduct of business and transactions with affiliates. As of March 31, 2017 and December 31, 2016, the Company had $12,972,565 of borrowings outstanding under the Risk Retention Term Loan which approximated fair value.
One Of Many
Judging by the comments from Mr Tannenbaum you might get the impression that the sale of FSCM was a one-off because of the problem with adding to the “scale” of the business. However, FSAM has been systematically selling or closing down all its ancillary businesses for several months now. Here is one, which is a family affair, mentioned in the latest 10-Q:
On December 22, 2014, FSM [“Fifth Street Management’] entered into a limited liability company agreement, as majority member, with Leonard Tannenbaum’s brother, as minority member, for the purpose of forming MMKT Exchange LLC (previously IMME LLC), a Delaware limited liability company (“MMKT”). MMKT was a financial technology company that sought to bring increased liquidity and transparency to middle market loans. FSM made a capital contribution of $80,000 for an 80% membership interest in MMKT. In addition, MMKT issued $5,900,000 of MMKT Notes, of which $1,300,000 was held by FSM.On August 8, 2016, MMKT entered into an agreement with its noteholders to settle and cancel the MMKT Notes in exchange for consideration of $2,833,050, of which $634,460 was paid to FSM. As a result of the cancellation, the Company realized a gain of $2,519,049 during the fiscal year ended December 31, 2016. In connection with the settlement and cancellation of the MMKT notes, FSM incurred an expense of $100,000 that was paid to third-party noteholders in exchange for a release of claims against FSM and MMKT. On August 12, 2016, MMKT sold the rights to its platform, including all intellectual property, in exchange for $50,000 and distributed the proceeds to its noteholders, including $11,197 which was distributed to FSM. The Company recognized a gain of $50,000 related to this sale within Other income (expense) in the Consolidated Statements of Operations. On December 30, 2016, MMKT was dissolved and a final distribution of $69,480 was made to the noteholders, including $15,560 which was distributed to FSM.
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