BDC Preview: Week Of February 4 – February 8, 2019Premium Free
Here is our preview of the most important developments likely to occur in the BDC sector in the coming week. After a January that was notable mostly for what was happening to BDC prices rather than anything else, the week ahead promises to be jam packed with “hard news”; the ongoing Medley drama and the continuing question mark about how the rally will fare entering into Week 7. The BDC Reporter does not expect to get much sleep.
Medley Mergers: For the first time in weeks, our arbitrary prioritization of what is likely to matter most in the BDC sector will not be led by “the markets”. Not that watching the tape will not be important as the BDC rally grows ever longer in the tooth. However, that other long simmering subject: the attempted merger of Medley Capital (MCC) and Medley Management (MDLY) into non-traded Sierra Income which is to be followed by the internalization of the management arrangement and a public issuance, has reached a boiling point. The BDC Reporter has written two articles over the week-end alone – and more than half a dozen in total – about the twists and turns in this poorly received merger proposal. First, there was opposition from several major MCC shareholders, most notably FrontFour Capital (FrontFour). Then a major proxy advisory firm chimed in with what now seems – as we’ve heard both from the proponents of the merger and its opponents – contradictory views about the merits of the transaction. Over the week-end, the plot thickened when a would-be new manager (NextPoint) offered itself as investment advisor to the shareholders of MCC and Sierra, but not MDLY. In fact, NexPoint’s principal strategy is to dump MDLY out of any arrangement, which leaves a bigger pie for the shareholders of the other two entities to share. That’s how we left matters when we went to bed Sunday night and after much hypothesizing to our readers about the possible impact on the stock price of MCC and MDLY and on the value of Sierra.
We wake to a new press release from FrontFour, quoting another proxy advisory service to support its rebellious view. This time the advisor is Glass Lewis. FrontFour, in a press release, claims Glass Lewis “has recommended that Medley Capital shareholders vote AGAINST the proposed combination of Medley Capital, Sierra Income Corporation and Medley Management Inc”. FrontFour, the most vocal of the merger’s critics, also commented on the NexPoint proposal in favorable terms, calling upon the MCC-Sierra decision makers to engage in negotiations with them. FrontFour used the opportunity – not unreasonably – to bash the corporate governance process of the MCC and Sierra Income Boards regarding the NexPoint offer. We quote:
“We are extremely disappointed that the Special Committee sat on NexPoint’s initial overture for so long, especially after we have been stating for weeks that management’s deal is specifically tailored to benefit MDLY shareholders and the Taubes and that there are superior alternatives for Medley Capital shareholders. It is shocking that the Special Committee didn’t even have the courtesy to acknowledge NexPoint’s initial overture until after it was forced to go public and calls into question whether there are undisclosed inquiries or proposals from third parties or other material information regarding this related party transaction that is being withheld from shareholders. What else is Medley Capital hiding?”
Covering all its bases, FrontFour wants MCC-Sierra to consider the NexPoint offer a “superior proposal” as envisaged in the merger agreement; engage in negotiations with the would-be investment advisor while also putting MCC up for a wider sale to maximize shareholder value received. Oh, and FrontFour wants shareholders – should the merger vote proceed any way – to just say no thank-you. That’s because time is running out, given that the vote of the three Medley entities involved is coming up at the end of the week and nobody really knows what the insiders – common to all 3 entities – are going to do.
We’ve been crystal balling this subject all week-end in our Premium articles and we don’t have room here for further prognostications. However, we can say with considerable confidence that this multiple front battle for the future of MCC, Sierra and MDLY has more chapters in store. Just as important for investors, the uncertainties that we’ve highlighted will cause market prices to fluctuate as everyone seeks to predict the outcome in a manner not dissimilar to the run-up to the Super Bowl. However, this contest may not end on February 8 when the vote is held but could continue for months to come or could move to the courts.
Earnings Season: Apparently the BDC Reporter has problems reading a calendar. Last week we called out the beginning of BDC earnings season as yet another major event to look out for. Of course, we were off by a week ! However, we can repeat with full confidence that this week will keep the BDC Reporter – and many investors – busy with, at least, 10 earnings releases. Have a look at the BDC Earnings Calendar in our Tools section for who will be coming up to the plate. Every quarterly snapshot is important, as investors learn 90% of what they know about their BDC investments during these quarterly reveals. Looking down the list, though – and given this is a preview – the most interesting reports are likely to come from Gladstone Investment (GAIN); Apollo Investment (AINV), Oaktree Specialty Lending (OCSL) and PennantPark Investment (PNNT). As is almost always the case, the importance lies in what we learn about credit developments at all these firms. The last 3 BDCs mentioned are all on the BDC Reporter’s Turnaround List (there are 11 names in all). These are BDCs who’ve faced multiple credit setbacks and are deliberately seeking to make things right by a process of restructuring; sales; write-offs and regular prayer. The 3 names we mention have all made progress in the last several quarters in “turning around” their portfolios, but it’s a process that is not dissimilar to turning around an oil tanker on the high seas. Appropriately enough for AINV and PNNT what is happening – or otherwise – to their energy investments – booked during a more optimistic time and regretted ever since – will be important to discover. We don’t necessarily expect any huge news, but you never know. The trend in energy investment values has been these BDCs friend of late, but none of that is written in stone.
OCSL – by contrast – is still grappling with multiple credit problems across several industries inherited more than a year ago from Fifth Street Finance. The new Oaktree manager has sought to claim victory in prior earnings releases, but our review of the portfolio has suggested several intractable problems remain. Even a brand name distressed investor like Oaktree Capital cannot wave a magic wand and “clean up” a portfolio filled with as many problematic credits as this one. We count 12 under-performing companies in the OCSL portfolio, including its Senior Loan JV, in which the BDC has roughly 15% of its capital invested. The odds are Oaktree will eventually get the job done, but we take nothing for granted. Nor does the market apparently. Look at the 1 year price chart and you’ll see that OCSL has moved virtually nowhere over the period. “Trust but verify” seems to be the mantra investors have adopted, and with good reason:
Finally, GAIN is in a category by itself. The lower middle market focused debt and equity focused BDC has recorded several impressive investment gains in recent years as portfolio investments have been sold for a profit. Moreover, GAIN will be reporting several new successes that occurred during and after the last calendar quarter. Even then, GAIN’s portfolio is still studded with several investments that could result in large capital gains in the future. However, the BDC and its investors will have to take the rough with the smooth. The BDC has a 32 company portfolio of which no less than 12 are under-performing to varying degrees (one third are already on non accrual). We expect management this quarter will emphasize the positive and de-emphasize the negative when results come out, but we’ll be looking at the entire picture with an eye on the longer term outlook.
Leveraging Up: As we indicated last week, we’ll be keeping close tabs on what we hear from reporting BDCs about their approach to bulking up their balance sheets thanks to the new leverage rules allowed by the Small Business Credit Availability Act (“SBCAA”). As our Premium subscribers know from our BDC Fixed Income Market Recap article this week, the public unsecured debt market may be reviving after a moribund few weeks. Saratoga Investment (SAR) has already tapped investors for $20mn and Pennant Park Investment (PNNT) has $250mn in unsecured debt that is getting repaid in March that will need replacing in some way. However, the list of other BDC debt supplicants is much longer and includes GAIN, its sister BDC Gladstone Capital (GLAD), KCAP Financial (KCAP) – already in the news for other reasons – and many more.Already a Member? Log In
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