Talking Deal Prices: Potential BDC mergers stalled, energy swoon may hit IRRs

When it comes to consolidation among public Business Development Companies, it’s not just about price.

One would think at least a couple of closed deals would have been chalked up by now given sustained weak stock levels of several names in the public BDC space. But while the class seems ripe for consolidation, no deals have made it to the altar yet.

Hurdles standing in the way include fights over shareholder activism and resistance from management groups against a backdrop of market volatility and loan portfolios beaten up by exposure to the energy sector. It’s also harder to sell when you think your company is undervalued at current levels.

American Capital Ltd publicly announced in January it would work with Goldman Sachs and Credit Suisse to solicit merger offers. Ares Capital Corp is said to be a lead suitor for a deal, which may actually happen. Ares bought Allied Capital during the financial crisis in 2009, so it has at least one big BDC acquisition under its belt.

Meanwhile, American Capital has climbed from a 2016 low of $12.30 a share in February to well over $14 a share at press time, a sign that investors feel better about its prospects. Elliott Management, an activist shareholder of American Capital, has been pushing for a change at the company.

Two other possible mergers have been much messier.

TPG Speciality Lending, the BDC arm of TPG Capital, is offering 90 percent of the net asset value of TICC Capital Corp’s loan portfolio for an all-stock acquisition. It’s also hoping to get a shareholder OK for a change in TICC Capital’s board, along with a switch in the manager of TICC Capital, at the BDC’s upcoming annual meeting, which has yet to be scheduled.

TICC Capital executives have been resistant to TPG. They backed a proposal to sell the management unit of the BDC to Benefit Street Partners, the credit investment unit of Providence Equity Partners. But that deal failed to win shareholder approval last year.

Basically, the deal by TPG to buy TICC Capital has degenerated into a proxy fight. Stay tuned.

Finally, there’s Fifth Street, the finance company founded by Leonard Tannenbaum. It’s probably the most complex because it has three publicly traded entities: A bigger BDC, Fifth Street Finance Corp, a smaller BDC, Fifth Street Floating Rate Corp, and the external manager, Fifth Street Asset Management Inc.

Just last month, activist shareholder RiverNorth Capital Management effectively ended its agitation at Fifth Street Finance Corp that began when it bought 6 percent of its shares and pushed for a new external manager. RiverNorth said it agreed to sell its stake to Tannenbaum and an affiliate of Fifth Street Asset Management for $6.25 a share, a premium of 32 percent over its share price at the time. At last check, Fifth Street Asset Management traded at $3.28 a share as optimism faded around RiverNorth’s activism.

Meanwhile, another activist shareholder, Ironsides Partners, has bought up more than 6 percent of Fifth Street Senior Floating Rate Corp to push for change there. A shareholder vote is set for April 7 on Ironsides’ bid to put two board members on the BDC.

Looking at the ups and downs of these BDCs, it all resembles an opera at times, one observer said. A simple, friendly buyout at a premium to the current share price would be nice to see, but don’t count on it.

Energy swoon may threaten IRRs

When Avista Capital sat down with Buyouts in 2014 to talk about the strong performance of its vintage 2008 fund, Avista Capital Partners II, energy services company Hi-Crush got a few positive mentions as helping drive the fund’s IRR of 19.2 percent.

Hi-Crush, a producer of sand used for fracking, was showing a 20.7x return for Avista as of June 30, 2014, at a time when oil and gas companies couldn’t get enough raw materials for their operations. Avista had taken the company public in 2012 at $17 per unit and by the summer of 2014, it traded in the $60 range.

Fast forward to March 2016 and Hi-Crush trades at $4.81 a share. Avista remains the majority holder of Hi-Crush Proppants LLC, which owns about 37 percent of Hi-Crush’s publicly traded shares, according to a recent filing.

There’s no question the lower valuation of Hi-Crush will have some kind of impact on the performance marks for Avista Capital II, although the fund may have other strong performers to take up the slack.

To be sure, even if Hi-Crush’s stock price goes to zero, which is unlikely, it has already delivered a huge return over Avista’s initial cost of $61 million via gross proceeds of $591 million from the company’s IPO and three follow-on offerings of public units. But it’s not likely that Hi-Crush will still produce a 20.7x return for Avista.

As the carnage from lower oil and natural gas prices continues, funds that hold companies exposed to the depressed energy sector may see IRR performance numbers impact their funds. The ranks of top-quartile funds may reshuffle as it all plays out.

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