Current Price – $5.05
Merger Consideration – $6.08
Upside – 20%
Expiration Date – TBD
Medley Management entered into agreement to merge with two BDCs it operates – listed MCC and unlisted Sierra Income – officially aiming to become a larger internally managed BDC expecting that this will result in lower discount to NAV.
Merger consideration is $3.44 in cash, 0.3836 Sierra Income shares and $0.65 in special dividends. Additionally, MDLY shareholders will receive $0.2 in regular dividends. While Sierra Income is currently not listed, trade can be hedged through MCC, as each share of MCC will be converted into 0.8050 of Sierra (plenty of cheap borrow available). At current MCC prices this implies merger consideration of $6.08 per MDLY share – 20% upside.
While management’s motives might seem noble at a first glance, in reality this transaction is pure management cash out at the expense of Sierra and MCC shareholders. Management will receive c. 2/3 of MDLY merger consideration or $70m cash bonanza + insignificant equity in Sierra. While at the same time MCC and Sierra Income will be stuck in a new entity trading at a large discount to NAV.
Merger is subject to majority approvals at all three entities. MDLY approval is given due to management’s control, whereas voting outcome at MCC and Sierra is far more questionable (management owns only 15% of MCC and only 1% of Sierra). Like most of BDCs these are mostly owned by retail investors who might have limited understanding of merger implications and be convinced to vote in favor by their brokers (who convinced them to invest in these vehicles in the first place). Additionally, Sierra shareholders might be eager to see their investment getting listed.
Both BDCs have destroyed value and trade at huge discounts to NAV – MCC at 41% discount and Sierra at 37% discount (which are almost the largest in BDC space). Dividends at both entities have declined.
Sierra was/is regularly running tenders and buying back shares at NAV (which continued to widen the discount for the remaining shares). These tenders are always oversubscribed by the factor of 5x-10x, which kind of shows investor eagerness for liquidity, but it is not clear whether investors will be as eager for the liquidity at 40% discount to NAV. There were also plenty of investors pilling into this BDC at significantly higher prices to where Sierra is expected to trade ($4.7/share) if the merger closes.
The key question is whether management will succeed in fooling MCC and Sierra shareholders (with the help of retail brokers) into accepting the merger which is so obviously skewed towards benefiting only MDLY owners.
The risk is that the deal gets voted down (35% downside) or is renegotiated (guessing 20% downside to break-even).