NEWS

On June 5, 2019 NextPoint Advisors (NexPoint) issued a press release following the Medley Capital (MCC) shareholder vote on June 4.

As reported by MCC earlier, shareholders appear to have approved the re-election of two incumbent directors over the candidates supported by NexPoint.

ANALYSIS

The BDC Reporter has annotated the NexPoint press release with analysis and commentary to provide readers with an independent view of the state of play:

“Proxy Contest Sheds Light on Widespread Support for Change at MCC

PR Newswire

DALLAS, June 5, 2019

DALLAS, June 5, 2019 /PRNewswire/ — NexPoint Advisors, L.P. (“NexPoint”), a stockholder of Medley Capital Corporation (“MCC” or the “Company”) (NYSE: MCC), responded to the preliminary results of the Company’s annual meeting of stockholders (the “Annual Meeting”), which concluded yesterday. The preliminary vote count from the Annual Meeting apparently indicates that stockholders voted to re-elect incumbent directors Seth Taube and Arthur Ainsberg to the MCC board, despite the Delaware Court opinion and contrary to the recommendations of ISS and Glass Lewis.

BDCR Notes: The BDC Reporter wrote an article about the ISS- Glass Lewis recommendation on May 24, 2019.  For the full list of articles written about Medley, click here. 

However, MCC stakeholders should be aware that Medley Management itself dictated these preliminary results—had affiliate Medley Seed Funding shares echo voted, as they have committed to the Securities and Exchange Commission that they will do with respect to the merger, then NexPoint’s nominees would prevail.

BDCR Notes: NexPoint is suggesting that the shares in MCC controlled by the Taubes (but funded by third party investors) through an entity called Medley Seed Funding (which we’ve written extensively about all the way back to 2016) were voted in favor of the incumbents. Apparently – as we’ve heard before but not seen any supporting documentation – the SEC had required/requested that those shares (which are held at MDLY) should be voted in accordance with whatever side had the majority of votes from non-affiliated shareholders. The press release suggests that, on this occasion, MDLY/Taubes did not vote in that manner, either because not required to or in violation of an agreement. We cannot tell. 

The only significant non-insider support for MCC’s nominees was from a single individual adviser and a Medley joint venture partner.

BDCR Notes: We will await final results to dig out the name of the adviser. The JV partner is Great American Life Insurance Company (“GALIC), which has invested $12.5mn in the JV. 

Other than these groups, which were apparently willing to discount the Delaware opinion and proxy advisory firm recommendations, the support NexPoint received from the shareholders was resounding and included some of the most recognized names in the industry. 

BDCR Notes: NexPoint’s text is short on names and figures. 

Absent these groups and insiders, we understand that the incumbents received minimal support, representing less than 5% of outstanding shares.

BDCR Notes: On the face that appears – if true – like a surprisingly small number. However, in the absence of those pesky facts, we will defer judgment.

“Regardless of the ultimate outcome of the election, we believe we have been overwhelmingly successful in our objective of bringing these important issues to light and championing the fiduciary interests of stockholders,”  said Thomas Surgent, a partner and legal and compliance officer at NexPoint. “We believe we have energized not only the shareholder base, but also the BDC industry as a whole.”

BDCR Notes: We agree that NexPoint has gone the extra mile compared with other would-be suitors for MCC who’ve mostly been pushed away by the existing management and Board and walked away, sometimes leaving with a parting plaintive press release but little more. As for energizing the shareholder base that remains to be seen. The proof of the pudding will be in how shareholders vote on any merger vote that gets presented to them. While we’d like to believe that the arguments made by NexPoint in canvassing for director appointments and for the investment advisory contract have “energized..the BDC industry as a whole”, that’s not the case.

Despite multiple embarrassing revelations about the behavior and performance of the incumbents – including those brought to the fore by the lawsuit in the Delaware Chancery Court by FrontFour – the attempt to merge MCC with its two sister companies has continued apace. We are now many months in and the main lesson to date is that a determined incumbent has a huge advantage in steering matters to their advantage – and against the interests of shareholders. There appears to be no recourse to regulators and an appeal to the courts requires substantial resources and can only address narrow legalistic manners, as seen in how the Delaware Chancery lawsuit has played out. The whole situation has been a black mark on BDC corporate governance and a reminder – if one was needed – that the best interests of the shareholders rank low in priority.

NexPoint hopes that those developments help ensure the MCC board conducts a fair “go-shop” process, and looks forward to participating fully.

BDCR Notes: This must what “a wing and a prayer” looks like. Based on what we’ve heard, MCC’s management continues to actively pursue the three-way merger, albeit with improved terms for MCC shareholders  requested by FrontFour at the expense of Sierra Income, but not of Medley Management. 

What we don’t know is where negotiations stand between Front Four and MCC and between MCC/MDLY and Sierra Income. All the deadlines set out in the latest MCC 10-Q for FrontFour and MCC to agree a settlement have passed. Nor have we heard whether Sierra Income’s Board has agreed to the revised terms, or are about to.

Yet, in the interim, much has occurred that would seem to reduce the value of MCC. Most notably, total assets have decreased sharply due to the sudden repayment of all the BDC’s SBIC debentures. Besides reducing total assets, that has drained cash from the BDC: dropping from $73mn to $20mn after the SBIC debentures were repaid. 

Furthermore, MCC reported IQ 2019 results which showed ($10mn) in Realized Losses, adding to ($53mn in the prior period). Even using the BDC’s own internal rating system showed $170.665mn of investment assets performing below expectations. That’s equal to 28% of investment assets and a whopping 62% of net assets. See page 5 of the auditor’s report in the 10-Q.

Although the BDC has claimed for several years to be turning round the portfolio, 9 under-performing companies with an FMV of $56mn are on non accrual , even after all those realized losses we just mentioned. 

The BDC Reporter undertakes its own credit assessment. At March 2019 we identified 13 under-performing or so-called Watch List companies out of 60.  With the sale of additional assets to repay the SBIC, we may see the number of performing companies left in the portfolio drop from 47. That might cause the percentage of under-performing companies – already at 22% – to increase even more as a share of the portfolio. 

As a result, MCC is very close – as revealed in its 10-Q – to be in default under its unsecured Israeli bonds. For the moment, management seems to be playing for time. A few days ago a conference call was held by phone with many of the Israeli bond holders (whose positions are trading at 85 cents on the dollar). No substantive progress was made but another meeting was set 3 weeks in the future.

We estimate – barring a miraculous recovery in asset values by the end of June – that MCC will report NAV sufficiently low in the IIQ 2019 to trigger an official covenant default under the Israeli bonds. Management must be hoping to convince the Israeli debt holders to delay any action until the merger with Sierra Income occurs, which might right the metrics involved. Given that a merger – even if everything goes swimmingly for the incumbents – must be months away, MCC is likely to be tap dancing around the Israeli debt holders for some time yet.

That said, the concerns that NexPoint previously raised regarding the pitfalls of the go-shop process remain, as none of the structural issues—including the potential for deadlock on the special committee and the narrow definition of “superior proposal” under the merger agreement—have yet to be addressed.

BDCR Notes: The promise of a “go-shop” process, raised by FrontFour, was undercut by the wording of the tentative agreement reached with MCC. At this stage, though, we don’t even know if FrontFour is involved or what the final terms of an understanding between these parties might look like. As stated above, the BDC Reporter believes the likeliest path at the moment is a renewed attempt to get a tripartite shareholder vote, led by the Taubes. 

Finally, NexPoint hopes that the board has taken note of the fact that, especially after removing Medley management’s vote, this vote reflects that there is nowhere near the stockholder support needed to approve the mergers.

BDCR Notes:  This remains to be seen. We don’t believe that either the Board or the insiders believe that to be the case, and will forge on to cause a shareholder vote.

We believe the back-up plan that the Taubes/MCC have in mind should the merger be rejected is to continue to manage MCC – warts and all – as an independent company. That may explain why the stock price of MCC dropped (7%) when the news of the director vote came out. 

About NexPoint Advisors, L.P.  

NexPoint Advisors, L.P. (together with its affiliates “NexPoint”) is an SEC-registered investment adviser to a suite of alternative investment vehicles, including a closed-end fund, a business development company, and an interval fund, among others. An affiliate of Highland Capital Management, L.P., NexPoint is part of a multibillion-dollar investment platform that serves both retail and institutional investors worldwide. NexPoint’s investment capabilities include high-yield credit, real estate, public equities, private equity and special situations, structured credit, and sector- and region-specific verticals built around specialized teams. For more information visit www.nexpointfunds.com.

VIEWS

What’s Next ?

The MCC shareholder vote may have come and gone but innumerable uncertainties remain, many of which we’ve mentioned above.

Last One Out

In addition, we have to wonder what’s happening in the corridors of the Medley organization itself, and how the professionals involved are faring with this unrelenting uncertainty.

Will there be an origination and loan management organization at the end of this, or will the best people be lost to other lenders ?

Waiting And Watching

Next we wonder what’s happening in the boardroom at Sierra Income, watching the incredible shrinking Medley balance sheet and earnings power.

How will the “independent” directors justify to themselves – and their very passive shareholders – the ever bigger bite MCC and MDLY are preparing to take if the 3 way merger moves forward as anticipated ?

Divorce Proceedings

Then there’s the pending lawsuit by MCC’s former SBIC manager Marilyn Adler.

We’ve read the complaint which, if true, is a damning indictment of how the existing managers treated both their senior manager and the BDC.

If this goes to trial we may learn a great deal more about why – in a very rare move – the SBIC essentially pulled its license, requiring MCC to scramble to pay off all debentures.

Refund

Also pending is whether MCC will receive any repayment from its insurance company for litigation costs incurred to date.

The BDC is counting on the monies to improve its deteriorating liquidity position.

This is what was stated in the most recent MCC Conference Call on the subject:

Included in the $10.2 million of professional fees [ in the IQ 2019 earnings] were $8.5 million of expenses related to the Delaware litigation and $1 million of expenses related to the pending merger. The company is seeking reimbursement under its insurance coverage for the $8.5 million of litigation-related expenses and any reimbursements will be netted against the expense.

Question Mark

We will continue to keep track – as best we can – of what’s happening here.

However, the only thing that is clear in all this is that the final disposition of MCC and the other Medley organizations is unknown and unknowable.

We wonder how many more weeks will pass before a sense of clarity emerges and what will be left of MCC at that point.