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CM Finance: Result Of Reconvened Shareholder Meeting

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NEWS

On December 22, 2017 CM Finance (CMFN) announced the results of its reconvened Shareholders Meeting, held the prior day. CMFN announced that the only issue still up for a vote was the grant by shareholders of the right to issue shares at a price below NAV, and that the proposal was approved. See the SEC filing attached.

At a prior shareholder meeting the first proposal – the re-election of two Directors-  was approved.

As of September 8, 2017, the record date for the Annual Meeting, 13,689,723 shares of common stock were eligible to be voted. Of the shares eligible to be voted, 10,460,386 shares were voted in person or by proxy in connection with this proposal.

Here is the result.

ANALYSIS

The vote was roughly two to one in favor – even when shares affiliated with the Investment Advisor  are taken into account.

Not addressed by the SEC filing – but mentioned in a prior BDC Reporter article written when CMFN’s 2017 Proxy was first published back on September 1 2017 – was how two major shareholders voted.

The Proxy notes indicate that both groups have signed irrevocable proxies agreeing that their shares – which account for 43% of total shares outstanding – will vote along with the majority.

The two groups are the Cyrus Funds and investment banking firm Stifel.

Together, the two groups own 6mn shares in CMFN. See page 5 of the Proxy.

[These two groups are not only major shareholders in CMFN, but also the source of many of the deals booked  AND hold a substantial equity interest in the BDC’s Investment Advisor: 58% in aggregate.

As far as we can tell, if assets increase thanks to an equity offering and fees grow accordingly, Cyrus and Stifel will benefit from their stake in the Investment Advisor].

The BDC Reporter- whose background is in lending and private equity rather than public company governance – does not understand how the math works here.

If roughly 10.2 shares were voted Yea or Nay (there were 0.255mn abstentions) , and 3.3mn were against the below equity raise and 6mn were held by Cyrus and Stifel – who presumably were in favor of the proposal- that suggests only 1.2mn truly unaffiliated shareholders voted for the proposal.

Yet, the proposal is deemed to have passed.

We will be reaching out to CMFN – which has not yet posted the SEC filing to its website – for clarification.

In the interim, we are offering up what we know and understand.


VIEWS

Surprise

The BDC Reporter was surprised that CMFN even sought to raise fresh capital at a discount given the huge price discount to book and the poor performance in recent years, as discussed in our September 1 article.

We were uncharacteristically blunt and recommended to any shareholder interested in our opinion to vote NO on the proposal.

Clearly – given the repeated attempts to get the proposal approved (there were 3 shareholder meetings and nearly a third of the year has passed since the initial Proxy) – the Investment Advisor has been keen to get the approval to sell stock below NAV.

When the Proxy was first published CMFN’s stock price was at $9.90 and IIIQ 2017 book value was $12.39 a share.

Since then, the discount to book has only grown wider with the stock price dropping as low as $7.70. See Chart.

By The Book 

If ever there seemed to be a time NOT to seek to raise equity at a very dilutive price below book, this seemed a textbook case.

Other under-performing BDCs like Medley Capital (MCC) and Prospect Capital (PSEC) have not even bothered to ask for shareholder approval on this contentious subject.

Moreover – as we noted in the September 1 article – CMFN’s financial situation is not so dire than an equity rescue plan seemed necessary and the Investment Advisor – with a couple of opportunities to make that case – have not done so.

Last quarter 3 new deals were booked and post quarter end another one added to the now 23 company investment portfolio.

Debt to Equity last time we heard was at 0.7x, on the high side but not unusually so.

The Simplest Explanation

So why the repeated efforts to gain authorization to issue more shares at a 30%-40% discount to book ?

The BDC Reporter’s Occam’s Razor deduction: CMFN is seeking to raise fresh equity capital, even if at a discount.

The Reason Why ?

That may account for the stock price drop since September as investors have sussed out that a dilutive offering is coming.

Still, given the number of non-affiliated shareholders who said no to the idea, we imagine that if CMFN goes ahead with a capital raise market reaction might still be negative.

Plan A

Just in case, CMFN is going to proceed, let us review what the Proxy indicates about a below book capital raise so shareholders and potential investors are prepared:

Pursuant to this provision, the Company is seeking the approval of its common stockholders so that it may, in one or more public or private offerings of its common stock, sell or issue shares of its common stock in an amount up to 25% of the outstanding common stock as of the date when this proposal is approved by the stockholders at an offering price per share that is below its then current NAV, subject to certain conditions discussed below. Under this proposal, there is no limit on the discount at which the Company may sell its shares. If approved, the authorization would be effective for a period expiring on the earlier of the one year anniversary of the date of the Company’s 2017 Annual Meeting of Stockholders and the date of the Company’s 2018 Annual Meeting of Stockholders, which is expected to be held in November 2018. The latest date at which such authorization would expire is November 7, 2018.

Furthermore, the Proxy sets out conditions that would have to be met:

Conditions to Sales Below NAV

If this proposal is approved, the Company will only sell shares of its common stock at a net price below NAV during the specified one year period if the following conditions are met:

filing a new post-effective amendment to an effective registration statement if the cumulative dilution to net asset value per share from offerings under the registration statement exceeds 15%;
both a majority of the Company’s independent directors who have no financial interest (other than ownership of shares of the Company’s common stock) in the sale and a majority of such directors who are not interested persons of the Company have determined that such sale would be in the best interests of the Company and its stockholders;
majority of the Company’s independent directors, in consultation with the underwriter or underwriters of the offering if it is to be underwritten, have determined in good faith, and as of a time immediately prior to the first solicitation by or on behalf of the Company of firm commitments to purchase such securities or immediately prior to the issuance of such securities, that the price at which such securities are to be sold is not less than a price which closely approximates the market value of those securities, less any underwriting commission or discount; and
following such issuance and taking into account any other issuances, not more than 25% of the Company’s then outstanding shares as of the date of stockholder approval will have been issued at a price less than the Company’s then current NAV.

Open Mind

Keeping an open mind – and assuming CMFN does go ahead with a below book capital raise – is that attractive at the current price level ($7.50-$8.00) a share ?

We’ve racked our brain to find an argument in favor of such a course of action.

The BDC points to greater assets, better liquidity and taking advantage of opportunities.

Unconvinced

However, with current earnings already below the distribution ($0.22 versus $0.25 in the IIIQ 2017)  and a good portion of the BDC’s assets invested in second lien debt and with an overweight position in energy loans (despite having been burned in the past by this exposure), we’re having trouble making much of a case.

Along with a number of other public BDCs, there is still some question about CMFN’s business model and its ability to generate a decent Return On Equity for shareholders over the long term.

CMFN has only been public since 2014, but as of September 2017 had incurred nearly ($30mn) in Realized, Unrealized and Distributions In Excess of Income losses on initial capital of $200mn.

A year and a half ago the quarterly distribution was $0.3516, but has since been reduced to $0.25, a nearly 30% drop.

Looking Forward

Looking into 2018, the BDC Reporter’s Dividend Outlook (see the Table on the front page) is for a DECREASE.

Over 5 years, we project a 30% decrease in the distribution from its current level due to the higher risk profile of the portfolio and the track record to date.

If we’re right about the long term, CMFN at the end of 2022 will be paying a quarterly distribution of $0.175 or $0.700 a year, or 50% of the payout in mid 2016.

These projections were made prior to the prospect of a below book 2018 equity raise, which may cause us to reduce our expectations further.

The price may seem a bargain at its current depressed level – which may account for the 4% increase in the price since December 18’s low to $8.05 – but could be roiled by the possible equity raise.


INVESTMENT APPROACH

Common Stock

Given both the short term risks and the long term outlook – with or without an unexpected equity raise – the BDC Reporter’s investment approach is to stay away from any investment in CMFN.

Bottom fishers may get lucky here, with the BDC nominally yielding 12.4%, but the downside is too great for us.

Our New Year’s resolution (we’re a little early) is to be ever more careful (see the latest Market Recap for some of the reasons why) where BDC common stock investments are concerned.

In what might end up being a Bad Year for BDC investments – and for CMFN – “discretion is the better part of valor“. 

At the very least, the fact that CMFN has the 4th highest yield in Closed-End Fund Advisors BDC Table should cause other would-be or existing investors in CMFN to pause and consider. 


DIVIDEND OUTLOOK 

We are maintaining our DECREASE rating for calendar 2018.

The ex-dividend date for the IVQ of 2017 has already passed.

No distribution level has yet been made for the next quarter. We expect the next announcement in February 2018 with the December 2017 results.

We don’t project a specific quarter in which a dividend reduction will occur but continue to believe the chances are high a cut will be coming over the next 4 quarters.

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