SunAmerica Sees the Writing on the Wall

Includes: FGF, FGI
by: Gwailo

wall writingAs Yogi Berra said: "It's hard to make predictions, especially about the future."* But the preliminary results for the self-tender offers at SunAmerica's closed-end funds FGF and FGI have now been announced, and it's clear that the smart money wants to get out.

FGF had offered to repurchase 30% of its shares at 98.5% of asset value, using a pro rata distribution of portfolio securities, rather than cash, as payment. (To accommodate small shareholders, the offer was amended in midstream so as to pay them cash instead of a grab bag of odd lots.) The response was overwhelming: on Friday SunAmerica announced that "approximately 13,811,673", or 67.9% of FGF's 20.3 million shares had been tendered. Since the tender is only for 6.1 million shares, a quick calculation indicates that following the offer, a majority of the remaining shares (about 7.7 million out of 14.2 million) will be those that were tendered, but not accepted.

Before the offer, institutions and CEF activist hedge funds owned most of FGF: third quarter Schedule 13F SEC filings showed 47.2%, and an additional 14.96% was reported in an October 14th Schedule 13D filing by Phil Goldstein's Bulldog Investors.

Since less than half of the tendered shares are being bought back, the institutions and activists now have three alternatives. They could "hit the bid" and sell their remaining shares at market -- but FGF's trading discount to net asset value has widened rapidly since the offer ended, and reached 10.5% at Friday's close. They might wait: FGF has announced an intent to make additional self-tender offers in 2011 and 2012, but these are contingent on having trading discounts average more than 10% in the meantime, and in any case they would only take up 10% (2011) and 5% (2012) of the remaining shares. The third possible course for the institutions and activists would be to use their new-found majority, and push to have FGF liquidate, open-end or merge.

FGF is a "gimmick" fund: SunAmerica subcontracts actual management to "name brand" managers (keeping for itself 40 to 60 basis points in fee markups -- about $1.5 million per year.) Investors who want to use these managers can access them through various open-end mutual funds and avoid the deadweight loss from FGF's trading discount. What's more, FGF's portfolio is made up of liquid, publicly traded large- and mid-cap U.S. "growth" companies. Using a closed-end fund to hold such investments does not add liquidity, but detracts from it. There is no reason for FGF to exist (other than as a source of economic rent for SunAmerica), and its investor-owners would have an immediate 10% gain if it were wound up and dissolved.

What's true for FGF is doubly true for its sibling fund, FGI. Here the institutional ownership is even higher, at 52.2% plus Bulldog's 17.6%. FGI's tender offer was smaller, covering only 25% of the shares, while the portion tendered was even greater, at 75%. This means that only 1/3rd of the tendered shares will be accepted, while two out of every three shares remaining afterwards will represent those that were tendered but not accepted.

That's a lot of big, unhappy investors. FGI, too, saw its trading discount widen when the offer ended, such that anyone selling at Friday's close would have taken a 10% haircut to net asset value. Finally FGI's "large-cap blend" portfolio means that it is even worse than FGF from the standpoint of liquidity. It has less than zero reason to exist.

There are some smart folks at SunAmerica, and the directors of FGF and FGI are no dummies. A few weeks ago they saw the light, and amended the offers accordingly. Now let's hope that they'll read the writing on the wall.

* Some scientists claim it was actually Quantum Nobel Laureate Niels Bohr who said this. Then again, as Yogi Berra said: “I didn’t really say everything I said”.

Disclosure: Author is long FGF