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THE BDC ACTIVIST: First Look At The Fifth Street Senior Floating Rate Proxy

|Includes: Oaktree Strategic Income Corporation (OCSI)

We are considering launching a periodic newsletter in defense of the rights of BDC common shareholders, and which would illuminate the conflicts of interest between managers and shareholders. Our tentative title would be The BDC Activist.

This is just a quick look at the battle lines being drawn between Fifth Street Asset Management, which serves as the Investment Adviser to Fifth Street Senior Floating Rate Corp (FSFR), and the folks at activist investor Ironsides Partners. The battle itself will be waged at the upcoming shareholders meeting.

THE ARMIES GATHER + SKIRMISH

Early salvos have lobbed by both sides in the form of press releases and draft proxy materials, dating back to December 2015. All the filings can be found on the FSFR website. The struggle itself began back on December 18th, 2015 when Ironsides wrote to the Company announcing its intention to name two directors to the Board, and ask shareholders to banish Fifth Street Asset Management as the Investment Adviser AND (in a strange twist) suggest "if the proposal to terminate the Investment Advisory Agreement is successful, advising the Company's Board of Directors that none of FSM or any of its principals or other affiliates should be engaged to manage or advise any of the assets of the Company in any capacity".

NO THANK-YOU FROM THE INCUMBENT

As you'd expect, the Board of FSFR has told shareholders that they are against seeing FSAM fired and banished forever more, and don't like the idea of having two Ironsides appointed directors rather than their own selection, one of whom is none other than the CEO of the external manager. That was neatly spelled out in a proxy filing early in January, but is being revised.

DRESS REHEARSAL

Ironsides,too, have begun to tell their side of the story in a filing dated January 14, 2016. Then the Board revised its Proxy (which we just read very quickly). Eventually we will get the final Proxy materials with all the boxes filled in (much juicy and critical information is currently omitted) as well as numerous press releases and presentations by both sides, then a vote and a decision.

LET'S STICK TO THE ISSUES

We won't opine on any of the issues till all the facts are at hand. However, for anyone interested in the debate about whether BDC companies are run for the benefit of their shareholders or their managers (or some reasonable place in-between) this a real life example. Ironsides is bringing up many of the shortcomings we listed in response to a reader in an earlier post about Apollo Investment. (Read down to the answer given to Captain 997).

Here is the list where FSFR is concerned:

1. The level of the management fees when compared to shareholders returns.

Here is a quote from Ironsides that sums up their beef on this issue:

"While the Company's stockholders have suffered a substantial decline in the value of their investment, FSM has earned substantial fees. According to the Company's public filings, through September 30, 2015, FSM has been paid $16.4 million in cumulative base, administrative and incentive fees since the IPO. This amount should be compared to the negative 35.6% cumulative return experienced by stockholders during the same period. In absolute terms, the $16.4 million in fees should be compared with the $112.2 million loss that stockholders have experienced since the IPO. This is based on the market value of the Company's Common Stock on January 12, 2016, the last day prior to the date of this document, and the $52.9 million in dividends paid by the Company since its IPO, compared with the $394.4 million in capital raised by the Company in its initial public offering in July 2014 and follow on public offering in August 2014."

2. Ironsides,too, is no fan of the Incentive Fee structure:

"we believe that the incentive fee structure for FSM misaligns the interests of FSM and the Company's stockholders. Under this structure, FSM is paid an incentive fee on net investment income and not on total return. As a result, FSM has earned incentive fees even as net asset value has declined".

3. The use of a staggered Board (with 2 Directors elected every year out of 7).

"Because the Company's Board is staggered, only two of the Company's seven directors will be elected at the Annual Meeting, so that stockholders will only be able to replace two of the current directors. We nonetheless believe that it is important to bring stockholder-selected and elected directors onto the Board, whose election we believe will send a strong message to the remainder of the Board and to management that the Company's performance has been unacceptable and must change. We also believe that, while our Nominees, if elected, will not control the Board, they will be strong advocates in the boardroom for stockholder interests, and the platform that we advocate...."

4. The issuance of stock below Net Asset Value to benefit the manager, but dilutive to shareholders.

"This decline [in NAV] in part is attributable to the Board's decision to issue in August 2014 6.67 million new shares at a price of $12.91 per share, when NAV was $15.13, a discount to NAV of almost 15%, from which the Company has not recovered".

We doubt that's all about how FSFR is structured that Ironsides objects to, but directly or indirectly their complains coincide with most of the 7 ways BDCs are run in a "shareholder unfriendly" way listed in my comments to Captain 997. (We are working on a stand-alone compleat list of ways that BDC managers have taken advantage of their pole position in the public companies they manage to squeeze out a disproportionate share of profits and avoid shareholder oversight or input).

We will return to the merits of this "shareholder revolt" by Ironsides once all the facts are in. We will also be very interested to see if big chequebook shareholder activism as practised by Ironsides will win the day, and what the real benefits to all those other shareholders will be. Look for an article on Seeking Alpha or at the BDC Reporter.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.