On February 5, 2019 Medley Capital (“MCC”), Medley Management (“MDLY) and Sierra Income issued a joint press release.
The press release indicated that each entities special shareholder meeting – scheduled for February 8, 2019 – would be adjourned till early March.
The special shareholder meetings are being held to vote on the merger of the three entities.
The adjournment is necessary because in the recent U.S. government shutdown “key branches of the U.S. Government were unable to process, review and/or approve documentation required to close the mergers”.
The press release indicated the three entities would continue to solicit the votes of shareholders and stated that “Shareholders who have already voted “FOR” the proposed mergers do not need to recast their votes”.
Finally, the press release provided voting instructions:
Shareholders of each of MCC, Sierra and Medley can vote “FOR” the respective mergers by authorizing their proxy by telephone or through the Internet or by filling out, signing and dating the voting instruction form and returning it in the postage-paid envelope previously provided. If Sierra or MCC shareholders have any questions, or need assistance with the voting of their shares, please contact the companies’ proxy solicitor, Alliance Advisors, at 1-855-643-7309, Monday through Friday between 9 a.m. and 10 p.m. and Saturday through Sunday between 10 a.m. and 6 p.m. Eastern Time. If MDLY shareholders have any questions, or need assistance with the voting of their shares, please contact their proxy solicitor, Innisfree M&A Incorporated, at 1-888-750-5834.
The BDC Reporter was surprised by the long delay between the government shutdown, which began 35 days before its temporary end on January 25, 2019, and the adjournment.
Why the Medley organizations waited until 3 days before the shareholder vote to adjourn the meeting for something that was well known for weeks before is unclear.
Exactly which branches or departments of the U.S. Government are involved in the “process,review” and approval is not given.
We have suggested in prior articles that the approval of the Small Business Administration (“SBA”) might be problematic, but is not related to the government shutdown.
The SBA may decide not to allow any SBIC license held by MCC to be transferred to the merged, Sierra Income entity.
As of September 30, 2018 MCC’s subsidiary SBIC LP had $75.0 million in regulatory capital and had $135.0 million in SBA Debentures outstanding that mature between March 2024 and September 2025.
SBIC debentures constitute one third of MCC’s total borrowings and the SBIC subsidiary contains one-third of the BDC’s aggregate investment assets.
Approval by the SBA of the transfer of the license to Sierra Income – which has no SBIC license of its own – is a pre-condition of the proposed merger.
No mention was made in the press release of the NexPoint offer to serve as the Investment Advisor to a combined Sierra Income-MCC (but explicitly not MDLY).
As discussed on these pages, NexPoint made the proposal back on January 24, 2019 and again on January 31, 2019.
In a response on February 2, 2019 MCC and Sierra said the following:
The MCC Special Committee and the Sierra Special Committee and the respective Boards of MCC and Sierra, adhering to a rigorous review process – consistent with their fiduciary duties and in consultation with their respective independent legal and financial advisors – will carefully review the letter and respond to NexPoint as appropriate.
Four days later, no response has been received.
In the interim, two shareholder advisory firms have recommended an AGAINST vote on the proposed merger.
This included Institutional Shareholder Services (“ISS”) which had previously recommended a FOR vote.
Glass Lewis, according to dissident shareholder FrontFour Capital, is also advising shareholders to vote AGAINST.
The press release by Glass Lewis suggests an AGAINST vote should “send a mandate to the board to conduct a wider sale process.”
Both FrontFour and Glass Lewis – in separate analyses – have expressed doubt as to whether the Boards of the BDCs involved have “failed to seek out and evaluate other strategic alternatives”.
We’re Not Done Here
In that regard, MDLY issued a supplement to its disclosures on February 5, 2019 in response to requests by FrontFour, as explained in the preamble:
The information provided below was requested by FrontFour Capital Group LLC and FrontFour Master Fund Ltd. (collectively, “FrontFour”) in a letter, dated January 30, 2019, from FrontFour’s counsel to the Board of Directors of MCC. Sierra, MCC and MDLY do not believe any of the information that was requested in the letter from FrontFour’s counsel is material or required to be disclosed. However, in the interest of transparency and in an ef ort to avoid unnecessary and meritless litigation regarding the sufficiency of the disclosure in the Definitive Proxy Statement, MDLY has provided the requested information as set forth herein.
There are 3 parts to the disclosures. The first is a history of expressions of interest received for MDLY in 2017.
In total, MDLY received eighteen non-binding indications of interest from twelve parties, including indications of interest for MDLY and for its assets. According to the various bidders, these indications of interest included the following metrics: (I) a purchase price per share ranging from $5.00 to $9.00, (II) a premium over the then-market price of MDLY Class A Common Stock ranging from 25% to 47%, (III) an equity value ranging from $147 million to $280 million, and (iv) an enterprise value ranging from $250 million to $450 million.
The MDLY filing also admitted:
However, the two indications of interest from Bidder 1 and Bidder 2 submitted in July 2017 were preliminary in nature and no final proposals were submitted. Of the ten parties who submitted preliminary indications of interest in November and December of 2017, only one (Bidder X) submitted an indication of interest in the second round of that process. Moreover, as discussed below, negotiations with Bidder X did not result in an actionable transaction, and a number of issues remained unresolved when negotiations terminated. As a result, because each of the proposals submitted were nonbinding, included various conditions and carve-outs, involved different forms of consideration (some of which was contingent), and in all but one case did not move to the point where documentation was discussed or deal terms negotiated, we believe it is impracticable and speculative to assign a particular value to any of the proposals…
Yet, a few paragraphs earlier in the same document MDLY does compare the indications of interest to its own merger offer:
The consideration contemplated by the non-binding indications of interest compares to the Class A MDLY merger consideration in the contemplated transaction of $6.80 per share with a mix of 40% stock and 60% cash (dollar equivalent based on the pro forma Combined Company’s net asset value per share of $7.06 as of September 30, 2018)
The second item in the MDLY disclosure is greater detail about the projections of future revenues by all three entities involved in the proposed merger.
FrontFour had expressed grave skepticism about the numbers and their use to justify the merger consideration, especially the MDLY revenues.
MDLY broke out its projections for different funds under its management, both existing and planned, between 2018 and 2021.
All the numbers were estimated and none were actual.
While both MCC and Sierra Income’s revenues are expected to be flat or grow very modestly, MDLY’s numbers are expected to boom, judging by the disclosure.
Existing advisory clients revenues are projected to double over the period, from $14.9mn to $29mn.
“New Advisory Clients” are to jump from $0.1mn in 2018 to reach $11.5mn, spread over 4 funds.
No explanatory information is provided as to how any of this growth is to occur and why MDLY has not achieved these results in the past.
In fact, no notes or comments of any kind were supplied.
The third part of the disclosure was to clarify the relationship between MDLY, MCC and Medley Seed Funding I-III and Fortress.
For readers who’ve not been keeping up with the Medley twists and turns, this relates to a JV set up by MDLY with Fortress to purchase the stock of MCC.
The principals of MDLY were given voting authority over the JVs involved, and great deal of MCC stock was purchased even as the price gradually declined in value.
The BDC Reporter has written extensively on the subject for several years, but the subject remained essentially unnoticed
This disclosure repeated prior filings and was summed up as follows:
Specifically, the Joint Venture effectuated the formation of (I) MSF I for the purpose of acquiring common stock of MCC, (II) MSF II for the purpose of acquiring common stock of STRF, and (III) MSF III for the purpose of holding a certain equity interest in STRF Advisors LLC, an affiliate of Medley LLC that will be the sole investment advisor to STRF. Other than the interests described above, there is no loan or other obligations between Medley LLC (or any of its affiliates) and Fortress. Fortress has no recourse against Medley LLC with respect to the Joint Venture or otherwise, other than certain redemption rights relating to each party’s interest in the Joint Venture.
Omitted from the MDLY disclosure – or any disclosure by MCC or Sierra – is any evidence that either entity was “shopped” in the manner of MDLY.
“Something’s Happening Here/What It Ain’t Exactly Clear”
The adjournment is only going to add to the uncertainty surrounding all 3 Medley companies.
Here are the key known unknowns:
Will MCC-Sierra even respond to the NexPoint offer ?
If they do so, will the offer be sufficient – in the estimation of the two Boards – to be considered “superior” and cause the merger to be abandoned ?
Will the Board of MCC start again instead and solicit offers for the BDC alone from any interested party ?
If MCC-Sierra do not respond to NexPoint, will the vote proceed in March as now planned ?
If the SBA does not approve the transfer of the SBIC license will the merger be abandoned or amended ?
Will any other regulatory authority seek to block or amend the internecine agreement ?
If the merger vote proceeds – with or without the SBIC license – will all 3 shareholder groups approve ?
If one or more shareholder groups vote AGAINST, what will happen next ?
No Crystal Ball
Obviously, we don’t know what will happen.
Our best guess is that the Medley insiders will seek to proceed with the merger vote, regardless of what happens to the SBIC license.
This will involve either ignoring or staring down the NexPoint offer and the shareholder complaints.
Clearly – based on the MDLY February 5, 2019 disclosure – the insiders are worried about litigation.
Unfortunately, none of the information in that filing addressed any of the concerns shareholders might have.
In fact, the expansion of the MDLY projections only underscores how unbelievable those numbers are.
MDLY is selling a growth story that would be more appropriate for a software company.
We’d be curious to know how the uncertainty surrounding the future of MDLY is affecting its asset gathering operations.
FOR OR AGAINST
If a merger vote does occur, the unknown is the outcome.
Judging from the latest press release – the initial subject of this article – MCC and Sierra are highly anxious for a FOR vote.
We found the instructions quoted above in the NEWS section potentially misleading to shareholders who may not be following this subject carefully.
The language seems to suggest that shareholders can only vote FOR.
(We have not quite got to that yet).
However, we will leave that to the appropriate regulators.
If this was a sports game, we would say that NexPoint has reduced the Medley insiders early lead, but the home court advantage may still decide that contest.
However, the shareholder vote is another issue.
The delay in the vote will aid those in favor of an AGAINST decision; providing shareholders who’ve already voted a chance to switch from FOR to AGAINST.
Moreover, we expect to hear constantly from the dissident parties (NexPoint, Front Four, various major shareholders) and – maybe – new players.
Yesterday – February 5 – before the vote was potponed the stock of MDLY was going back up and MCC was slightly down.
That suggested investors were swinging somewhat back to believing the merger might push through.
Writing this before the market opens, we’d guess that the price momentum might swing the other way in the hours ahead.
Final Word: Disclosure
Once again, given that we are writing so much on the subject, we seek to confirm that we have no position – short or long – in the stock of any Medley entity.
(We have a long position in MCC’s unsecured debt, which should be fine under any scenario).
Our interest in the subject has more to do with what this drama tells us about BDC’s deeply flawed corporate governance.
In any case, as we hope we’ve shown, the final resolution of this matter is anybody’s guess and we like to think of ourselves as careful long term investors than short term speculators.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: We are long MCC's unsecured debt