NEWS

On August 13, 2019 Alcentra Capital (ABDC) and Crescent Capital BDC (“Crescent Capital”) announced “a definitive merger agreement under which Crescent BDC will acquire Alcentra Capital”.

The proposed merger – if approved – will result in non-traded Crescent Capital to apply for a public listing on NASDAQ and trade under the ticker CCAP.

The Form 8-K describing the highlights of the transaction is attached.

ANALYSIS

What We’re Going To Do

The BDC Reporter will seek to review and analyze the key provisions of the proposed merger agreement from the perspective of ABDC shareholders.

Furthermore, we will provide a brief history and analysis of the acquirer – Crescent Capital – from its inception in 2015 till the present day.

Finally, we will estimate the pro-forma outline of the new enlarged Crescent Capital post-merger and the likely dividend and credit outlook based upon a first review of the latest quarterly filings.

Acquisition Terms

Crescent Capital proposes to pay ABDC shareholders a combination of cash and stock in the non-traded BDC.

The cash will consist of two payments but will aggregate $3.1784 per share.

Every share of ABDC stock will also receive 0.4041 share in Crescent Capital common stock.

As the 8-K shows, that means 12.9mn shares of ABDC stock receiving 5.2mn shares of Crescent Capital.

According to the parties:

The total cash and stock consideration to be received at closing is currently estimated to be approximately $141.9 million after taking into account certain post-closing adjustments, or approximately $11.02 per share, representing 1.0x Alcentra Capital’s net asset value per share as of June 30, 2019, and 1.36x the closing price of Alcentra Capital’s common stock on August 12, 2019.

Following the transaction, Crescent BDC stockholders and Alcentra Capital stockholders are expected to own approximately 81% and 19%, respectively, of the combined company, which will remain externally managed by Crescent Cap Advisors.

Wait, There’s More

That’s only the starting point.

Then Crescent Capital will become a Maryland Corporation – the preferred status of most BDCS where corporate governance is concerned – and become a listed company on the NASDAQ.

As part of the going public process, the charter of the BDC will:

generally restrict all Crescent BDC stockholders (other than those Company stockholders receiving Crescent BDC shares in connection with the Mergers) from trading their respective shares for at least six months following the closing of the transaction, subject to a modified lock-up schedule thereafter (lock-up restrictions on 50% of the affected Crescent BDC stockholders’ shares will lapse after nine months, and lock-up restrictions on the remaining shares will lapse after 12 months)

All the existing directors and officers of Crescent Capital will remain unchanged after the merger/conversion.

There does not seem to be any provision for ABDC managers or directors to have any continuing role.

No Mas

ABDC has agreed to cease the sales effort begun several months ago, as part of its agreement with Crescent Capital until all approvals are received and the merger consummated.

However – as is standard in these situations – the Board of ABDC is allowed to countenance unsolicited better offers from third parties.

Should that so-called “Superior Proposal” be accepted ABDC will owe Crescent Capital  “a $4,281,720 termination fee”.

Sweeteners

The 8-K also indicates that following the merger, Crescent Capital will undertake several material “shareholder friendly” changes to its compensation terms.

These include the following:

(1) reduce the base management fee from 1.50% to 1.25%, (2) waive a portion of the base management fee for the six quarters following the First Merger so that only 0.75% will be charged for such time period, (3) waive the income-based portion of the incentive fee for the six quarters following the First Merger and (4) increase the hurdle rate under the income-based portion of the incentive fee from 1.50% to 1.75% per quarter (or from 6.00% to 7.00% annualized).

Ranking

The BDC Reporter tracks all the various public BDC fee permutations.

The proposed 1.25% Management Fee would place the new BDC in the upper quartile of its peers, behind groups such as Goldman Sachs BDC (GSBD); THL Credit (TCRD), Pennant Park Floating (PFLT) and Solar Senior Capital (SUNS).

However, the temporary 6 quarter waiver will result in Crescent Capital having – for a time – the lowest base management fee in the 46 company universe (soon to become 45 with the merger of OHA Investment into Portman Ridge) we track.

Furthermore, the proposed 17.5% Incentive Fee equals the lowest percentages charged in the public BDC space.

The waiver of the Incentive Fee for 6 quarters will make the new public BDC the most competitive in pricing terms of all 46 players.

The change in the hurdle rate – which is permanent – will also be a positive for ongoing shareholders in CCAP.

Buying Stock

In what is becoming a standard feature in recent BDC mergers and acquisitions, the buyer will be providing mechanisms to support the stock after the merger is completed:

Additionally, Crescent BDC will implement a stock repurchase program for a period of twelve months following the closing of the transaction via open-market share repurchases in an aggregate amount of up to $20 million, less any amounts provided under any repurchase program for Crescent BDC stock that is entered into by affiliates of Crescent BDC or Crescent Cap Advisors, subject to certain regulatory restrictions (including Rule 10b-18 under the Securities Exchange Act of 1934).

Projected Pay-Out

Going forward, the dividend of CCAP will be $0.41 a quarter ($1.64).

ABDC has been paying $0.18.

The .041 a share of CCAP stock will result in an equivalent distribution of $0.17 a quarter, not including the impact of the cash received.

Pro-Forma Portfolio

At June 2019, Crescent Capital had $626mn of investment assets at fair market value, and $267mn in borrowings. See the 10-Q.

ABDC’s portfolio was valued at $220mn.

The combined portfolio will, thus, be $846mn.

Furthermore, CCAP – but not ABDC – have a joint venture arrangement to which the non-traded BDC has committed  $40mn.

Investment assets in the JV amounts to $272mn.

ABDC has $80mn in debt – including $54mn in unsecured InterNotes – and CCAP $267mn in two secured facilities.

As of the IIQ 2019, CCAP was earning – albeit on different economics – $0.47 per share on a Net Investment Income basis.

(Crescent Capital has been in business since mid-2015 and has been growing by leaps and bounds as its shareholders have constantly added capital).

Strategy

The BDC’s strategy is not dissimilar to the one ABDC espoused after getting into credit difficulties with a second lien heavy portfolio.

Crescent Capital’s business is heavily weighted towards first lien and “unitranche” lending to sponsor-backed middle market companies.

By BDC standards, that’s a lower risk credit approach; similar to the one adopted by Golub Capital (GBDC).

The portfolio yield on debt investments at cost was most recently 8.6% and the portfolio consisted of 91 companies.

ABDC’s yield was 10.7%, and the number of companies 29, but the BDC had been targeting sub-10% yields in recent investments.

The enlarged BDC will have 120 portfolio companies initially.

Performance Issues

By the BDC Reporter’s count ABDC had 8 under-performing companies and – after a quick review – Crescent Capital seems to have 5, for a total of 13.

(These numbers don’t include the JV).

These numbers suggest CCAP will have roughly 90% of its portfolio in “performing” status and 10% “under-performing” to various degrees.

ABDC has one company on non-accrual as did  Crescent Capital (representing 1% of FMV).

From The 10-Q

Combining the internal valuations of the two entities, the value of “under-performing assets” at FMV will be $102mn, or 12.0% of the total portfolio.

ABDC, with $50mn will be the biggest contributor proportionately to the under-performing category, and Crescent Capital has $52mn.

(All data extracted from the most recent 10-Q of both entities).

The new advisor will have some turnaround work to perform on ABDC’s principal under-performing companies, but with only 3 material exposures left, the ongoing impact on the much larger balance sheet should be minimal.

Crescent Capital itself seems to have only one major credit trouble spot, but our view may change as we delve more into the portfolio.

SBCAA

To our knowledge, Crescent Capital has not yet adopted the looser leverage standards allowed by the Small Business Credit Availability Act (SBCAA).

However, we would be very surprised if such a move did not occur promptly after the merger.

As a result we expect both total assets and total debt to increase substantially after the merger is completed.

That will push the BDC into the mid-sized territory, with total portfolio assets north of $1.0bn.

According to the buyer’s own calculation, CCAP will be the 15th largest publicly traded, externally managed BDC.

VIEWS

As Projected

The BDC Reporter had been expecting some sort of M&A activity ever since ABDC postponed its annual shareholder meeting ; hired financial advisers and began “exploring strategic options”.

We discussed the issue at length on April 4, 2019.

Here’s an extract from what we wrote at the time, speculating (not so) wildly about the form of any sale and the price that ABDC shareholders might receive:

Ocwen’s Razor

That leaves a sale – in some form – of ABDC as the most likely alternative and Houlihan Lokey – who did yeoman’s work on Triangle Capital – as an appropriate adviser.

The form of a sale – as noted – will be very important if that’s where this is headed.

Nothing Is Easy

ABDC – like Triangle Capital and Fifth Street Finance and MCG Capital before them – have troubled portfolios which complicates the situation, but does not represent an insurmountable obstacle.

Would a buyer be chosen to just acquire the assets ? Or would a new external manager be brought in who would – like Fifth Street – take over the portfolio in return for the compensation on offer ?

In either case, what sort of discount – if any – would ABDC have to absorb given the never ending credit troubles ?

Add Sweetener ?

How would ABDC shareholders be convinced to go along for the ride if a buyer was found ?

Maybe a one time payment would be made and/or attractive compensation and sponsor investment terms offered.

That’s the route taken by the new manager of KCAP Financial (now PMNT) and the would-be manager of Medley Capital (MCC).

Or, ABDC and this hypothetical buyer might offer nothing at all except association with a bigger, more successful name and the hope of a brighter future than the dark days of recent memory.

That’s the approach Oaktree Capital took when taking over the two Fifth Street BDCs and when KKR replaced GSO Blackstone in what is now FSK.

That last one is what we imagine might be Bank of New York’s favorite outcome.

Pure Speculations

What the ultimate price shareholders might receive – which is different than what the Investment Advisor might gain – is very hard to tell given the many uncertainties at this stage.

All we know is that book value at December 31, 2018 was $11.13.

We surmise that  properly managed in the hands of A N Other BDC that should earn a 8% ROE or $0.89 in terms of Net Investment Income Per Share.

Assuming a 10x multiple – in line with sector averages – that implies a very, very hypothetical value of $8.9 a share, a 17% premium to the closing price.

Nothing was said about the subject on the latest earnings Conference Call, which – with the benefit of hindsight – speaks volumes.

Better Than Expected

We were proved right about the cash payment to shareholders – a now necessary sweetener in BDC M&A it seems.

However, the price ABDC has received – at 1.0x book value – is better than we anticipated.

As we write this, ABDC is trading at $9.20, higher than the $8.90 the BDC Reporter envisaged 6 months ago.

Eye On The Prize

That seems less to do with ABDC’s credit performance – which has not materially improved – but with the ambitions of the well heeled buyer for long term market success.

Even troubled and small sized BDCs like ABDC and recently acquired OHA Investment (OHAI) have an outsized value to their acquirers in the valuable public BDC market, with its above average fees and cachet.

Whether ABDC will trade even higher as the analysts and investors run the numbers and value the stock component of the transaction remains to be seen.

Handicapping 

We will say, though, that the chances of the transaction going through are high.

Chances are low that a competing bid – with all the costs and turmoil that ensue – will emerge.

That’s partly because the offer made by Crescent Capital is above average, both in terms of its immediate benefits to ABDC shareholders and going forward thanks to the fee structure; waivers and buybacks.

Also helping is the diminutive size and troubled portfolio involved at ABDC which makes the BDC relatively unappetizing as a premium acquisition candidate.

Moreover, Crescent Capital could still improve its offer.

The non-traded BDC and its blue chip manager/owner have the resources to defend the deal from most any reasonable offer from left field.

We expect the merger will occur and the new CCAP will trade before year’s end.

That may not grow the total number of BDC players but will increase total public BDC AUM, and bring another well known asset manager into the public fold.

More To Come ?

This is a process in the BDC sector that is far from over.

Even as we speak there are probably multiple groups with billions of dollars in assets under their control planning how to match Crescent Capital’s vault from the shadows of the non-traded BDC world into the public arena.

Or from the even more obscure world of private leveraged lending into the BDC arena, as recently achieved by BC Partners, which has since attracted its own investment by Blackstone. 

For long suffering BDC shareholders in under-performing entities, the ABDC and OHAI transactions should give some hope that there may be a way out by merger or acquisition in the not so distant future.

Just as a teaser – and being very optimistic about the willingness of existing managers to make a deal – we count 9 under-performing BDCs that might be “in play”.

No, we’re not even counting Medley Capital (MCC) or OHAI or ABDC.

More on that in a future article.