MVC Capital: Second “Dutch Tender” Launched
On November 22, 2017, MVC Capital (MVC) announced the launch of its second “Dutch Tender”. Here are the key details; analysis of the potential impact on the BDC’s common shares outstanding and the BDC Reporter’s views on whether the buy-back will successfully end the feud with disaffected shareholder Metage Capital. We end with a recap of our own investing approach towards MVC’s common stock and Baby Bonds.
The “Modified Dutch Tender” is essentially a method to undertake a stock buy-back at the best possible price.
MVC is offering any shareholder interested in participating the opportunity to tender their shares in a process that ends December 21, 2017.
The price at which the shares will be repurchased ranges between $10.40 and $11.00.
The process is described in the press release:
Based on the number of shares tendered and the prices specified by the tendering stockholders, MVC will determine the lowest per-share price that will enable it to acquire up to $25 million of its common stock. All shares accepted in the Tender Offer will be purchased at the same price even if tendered at a lower price.
The Tender Offer is not contingent upon any minimum number of shares being tendered.
The number of shares to be repurchased will vary depending on which final price is fixed:
If the Tender Offer is fully subscribed, MVC will purchase between 2,403,846 shares and 2,272,727 shares, or between 11.4% and 10.8%, respectively, of MVC’s outstanding shares of its common stock.
The proceeds for the stock repurchase will come from the $100mn plus of cash sitting on the balance sheet.
Virtually all the cash was generated from the sale of MVC’s largest investment earlier in 2017.
This is the second “Modified Dutch Tender” in which the BDC has been involved in 2017. See our article from July 21, 2017.
The last tender was fully subscribed, and this may be repeated this time around.
However, one of the major subscribers last time was an insider with a big position in the stock. We don’t know if demand for selling out remains as strong.
MVC’s stock price, which recently reached a 52 Week High of $10.88 has dropped back to $10.69, roughly the half way mark of the tender.
The BDC Reporter analyzed the likely impact of the tender – if successfully implemented on the number of shares outstanding and on the BDC’s dividend liability in an article back on October 23, 2017.
Here are two of the key pro-forma results of the two tenders:
Along with shares bought back earlier in the year as part of a “Modified Dutch Auction” MVC could see its share count of June 30, 2017 drop from 22.56mn to below 17.00mn.
These two buy-backs will save the BDC – which recently boosted its distribution modestly – up to $3.5mn annually in shareholder pay-outs.
Furthermore, the book value of MVC is likely to increase as a result of the Modified Dutch Auction given that shares are being retired at a discount.
Ironically, the central dispute that activist shareholder Metage Capital has with MVC , its Board and Investment Advisor is that the stock price trades at a discount to the BDC’s book value.
At the recent highest stock price, MVC was still at a 19% discount to July 2017’s book value of $13.38.
The full result will be reflected in the quarter end January 2018.
Unless MVC’s stock price jumps up some more, the chances are that the divergence between what MVC is worth on a GAAP basis and in the market will grow even wider.
That might cause Metage Capital – who only lost out by a slim margin in the most recent shareholder vote – has not gone away.
In a press release on November 9, 2017 Metage Capital was very explicit about its intentions if MVC does not bring the stock price within a 10% range of book value:
The Board should be aware that independent shareholders do not support MVC’s current strategy. Metage continues to believe that the Company’s approach is unlikely to be successful in addressing the discount between MVC’s net asset value and share price. We recommend that the Board consults with major shareholders to ensure that the company’s approach reflects shareholder wishes and takes further steps as required. If the discount is not reduced below 10%, or if MVC fails to achieve an acceptable return on capital, it is our current intention to put forward a new shareholder proposal at next year’s AGM.
We should start by saying that we previously wondered aloud whether MVC would persevere with its second Modified Dutch Tender after “winning” the shareholder vote on the Metage Capital proposal.
Mark that down to our own skepticism about these “activist” issues.
Obviously, MVC is going ahead with the promised action.
However, we still question whether the BDC will be able to turn from being a loss making operation even after engineering the sale of its largest investment (which still remains largely on the books as an equity and debt investment).
The chart below – taken from MVC’s latest 10-Q as of July 2017 – illustrates the challenge.
For each of the last last 4 quarters MVC’s Net Investment Income (called Net Operating Income/Loss here) has been in deficit.
Furthermore, if we leave out the waivers by the Investment Advisor (which can be rescinded at any time) and the PIK income on some of the more questionable investments in portfolio – which may never be collected- the deficit is even higher than the reported numbers.
The recent refinancing of the BDC’s Baby Bond (MVCB making way for MVCD) will save some interest expense down the road but will result in higher expenses in the short run due to the costs involved and the acceleration of previously amortizing expenses of launching MVCB and the fact that both issues will be outstanding for awhile.
Otherwise, though, MVC has not yet taken any action that we are aware of to tackle its greatly inadequate Investment Income (called Operating Income above- a holdover from the BDC’s origins as an equity oriented fund owning rather than lending to companies).
With $300mn of capital at July 31, 2017 investors should ultimately expect – once MVC completes its long promised conversion to being principally a BDC lender – to generate $24mn-$30mn of Net Investment Income annually.
Even with $75mn of undeployed cash sitting on the balance sheet after the second tender is completed, that seems like an implausible feat.
We remain unaware of any material new loans booked by MVC since the summer, when it’s windfall was received.
Furthermore, the BDC – whose credit record is mixed at best – is targeting the most controversial and higher risk type of loan investment: second lien and mezzanine debt.
This is still a highly competitive and risky segment of the lending market.
We wonder if MVC has the origination capability to identify, sort through and book the large number of quality deals that would be required to move the Investment Income needle.
We also wonder what will happen to the risk profile of the portfolio – and whether MVC will be able to arrange Revolver financing against these type of assets.
If MVC is not able to make the conversion to BDC lender and generate a consistent profit, chances are investors will mark the stock down in the quarters ahead, once the drama around the stock buy-backs has abated.
Then the BDC will be right back where this started: with a stock price substantially below book.
What will be different is that the big cash balance will have melted down.
Almost certainly that will set the stage for another round of “activism” by Metage Capital.
From our point of view, if MVC cannot make the conversion to being a BDC lender and generate an appropriate ROE of 8%-10%, Metage Capital and investors might be better off just asking the Investment Advisor to sell or liquidate the portfolio, rather than engage in the complicated scheme that the dissident shareholder suggested.
For good or ill, the MVC Capital storyline is going to take several more quarters at the very least to play out.
We have no position in MVC.
However, the BDC has been on our Special Situations Watch List for many months.
As an investor, we missed our opportunity to buy into the stock when the U.S. Gas subsidiary was sold off.
Back in May, MVC jumped from $8.74 to $9.80 in the twinkling of an eye on the development.
Since then the stock price has moved up another dollar or so per share thanks to the buy-backs and the debt refinance, as this chart shows.
However, barring progress on the fundamental strategic issues discussed above, we project that the stock price is unlikely to move much higher.
If that should happen, we may remove MVC from the Watch List.
(We may well be wrong as we’ve missed the recent increases. We’ll report back when the next financials come out).
Of course, given our doubts about the BDC’s business model and investment execution MVC is not even a prospect on our Long Term Income Watch List.
We have a position in two of our “safe income” portfolios in the BDC’s about-to-be-repaid Baby Bond with the ticker MVCB.
We acquired MVCB back in May 2017 at $25.60 per share on the premise that MVC was not likely to redeem the Unsecured Notes in the short term, and might not even in the medium term.
We were right about the former, but not about the latter.
However, as we calculated at the time, the high yield and the passage of time will leave us with a profitable Total Return over the life of the investment.
To date, we have not decided whether to proceed with an investment with MVCD, trading at $25.41 and yielding 6.1%.
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