Medley Management (MDLY) – Merger Arbitrage – 20% Upside

Current Price – $5.05

Merger Consideration – $6.08

Upside – 20%

Expiration Date – TBD

SEC Filling

 

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).

 

20 COMMENTS

  1. dt

    The spread on MDLY/MCC arbitrage has narrowed from 20% to 3% and I am closing out the position. Gain of 17% in 3 months.

    The transaction is expected to close in Q1 2019 and the risks to closing it remain exactly the same – the largest one being that Sierra Income unit holders will oppose the deal (albeit so far no objections have been voiced publicly).

    If the announced Q3 dividend payments are taken into account then the spread increases to 6% (not part of the initial write-up, where I only counted Q2 dividend, which was paid in Sep). There is also a chance that there will also be another quarterly dividend before the merger closes. This would increase current spread to 9%. From the conference call:

    Casey Alexander

    Thank you. These comments are greatly appreciated. One other question. We also appreciate that, when the merger was announced it was stated that the dividend policy would remain in place through the close of the deal and we did see that, the third quarter dividend of $0.20 was announced and should go ex-dividend in a couple of months. If the closing of the merger extends into late Q1, would it be your anticipation that MDLY would likely take another dividend based upon fourth quarter.

    Brook Taube

    That’s a good question, Casey. I don’t want to jump the gun on forward dividends. But I would reiterate and we’ve publicly said it in a press release and disclosing the proxy that the intention of, all of the parties was to keep their dividend policies in place between announcing and closing.

    https://seekingalpha.com/article/4222208-medley-managements-mdly-ceo-brook-taube-q3-2018-results-earnings-call-transcript?part=single

  2. over2u

    Spread widens again to c.16% on no relevant news, so may offer an opportunity to re-enter.

  3. dt

    Roumell Asset Management opposes the transaction:

    The market’s response is effectively a fairness opinion on the proposed transaction, and in our view, makes clear that MCC shareholders are not being equitably treated in the deal.

    Another reason we oppose the proposed combination is our belief that, given MDLY’s performance in managing MCC, the MCC board should have fired MDLY by now.

    In our opinion, MCC’s board effectively threw its shareholders under the bus, while saving MDLY’s public shareholders and private unitholders, by proposing to combine a subpar asset manager with the currently separate and predominantly first-lien asset portfolio of MCC.

    https://www.prnewswire.com/news-releases/roumell-asset-management-intends-to-vote-against-the-proposed-transaction-among-sierra-income-corporation-medley-capital-and-medley-management-300759025.html

    1. dt

      Indeed – so many activist investors started objecting this deal over the last couple of months.

      Strange that in this case proxy firms ISS and Glass Lewis are in disagreement whether this is good/bad deal for MCC shareholders.

      I think that after vocal opposition the chances of MCC and Sierra shareholders approving the transaction are quite slim. But one never knows – these BDC are often owned by rather indifferent shareholders who care only about the currently high dividend yield.

  4. na

    2 “Independent” Directors at MCC resign leaving 2 remaining “Independent” directors.

    On March 18, 2019, the Company notified the New York Stock Exchange (the “NYSE”) that, following the resignations of Mr. Mack and Mr. Lerdal, the Company had only two independent directors and audit committee members. On March 19, 2019, the Company received a notice from the NYSE that, due to the resignations of Mr. Mack and Mr. Lerdal from the Board, the Company no longer satisfies (1) the requirement that listed companies have a majority of independent directors as set forth in Section 303A.01 of the NYSE Listing Company Manual and (2) the requirement that the audit committee of a listed company to have a minimum of three members as set forth in Section 303A.07 of the NYSE Listing Company Manual. On March 20, 2019, the Company filed with the NYSE a written affirmation to notify the NYSE of the deficiencies described above.

    The Company’s Nominating and Corporate Governance Committee is searching to identify qualified candidates to replace Mr. Mack and Mr. Lerdal as directors of the Board, members of the Audit Committee of the Board, and members of other committees of the Board. The Company intends to fill the vacancies created by the resignations of Mr. Mack and Mr. Lerdal in conformity with Sections 303A.01 and 303A.07 of the NYSE Listing Company Manual and regain compliance as soon as practicable.

    https://www.sec.gov/Archives/edgar/data/1490349/000121390019004569/f8k031819_medleycap.htm

  5. dt

    Settlement reached between Medley Capital and FrontFour:
    – Permission for MCC to undertake ‘go shop’ process;
    – Appointment of two FrontFour directors in MCC board, including chair of the special committee;
    – Settlement fund in case MCC/Sierra merger is still consummated in the amount of $47m

    When it comes so settlement fund, I do not fully understand whether this is additional consideration to be paid on top of what was stipulated in the merger agreement or whether this is something else. The press release is very unclear regarding this. Any thoughts?

    “The Settlement Term Sheet contemplates that the merger agreement for the MCC Merger would be amended to, among other matters, permit MCC to undertake a “go shop” process to solicit superior transactions to the MCC Merger, and to provide that if the MCC Merger is consummated, a settlement fund will be created, consisting of $17 million of cash and $30 million of Sierra common stock, the number of shares of which is to be calculated using the pro forma NAV reported in the future proxy supplement describing the amendments to the MCC merger agreement, for a total of $47 million of settlement consideration, which will be distributed to eligible members of a class of MCC stockholders. ”

    http://www.medleycapitalcorp.com/phoenix.zhtml?c=236906&p=irol-newsArticle&ID=2394610

    1. na

      It reads as though the $47m is an additional consideration. What else do you think it would be?

      1. dt

        As I said, the press release is really vague – why not just amend the merger consideration that MCC shareholders would be receiving? Also not clear who will be making $17m cash portion of the payment? Will it be new Sierra shares issued or existing transferred to the settlement fund?

        Documents released yesterday have some further info, but as least for me it does not make the situation any clearer:

        Settlement Amount. The Settlement Stipulation shall provide that, if the transaction contemplated by the revised MCC Merger Agreement closes, then immediately after the closing, defendants in the FrontFour Action shall cause the contribution of $17 million in cash and $30,000,000 of SIC stock, the number of shares of which is to be calculated using the pro forma NAV reported in the future proxy supplement describing the amendments to the MCC Merger Agreement (the “Settlement Amount”), 1 to a settlement fund (the “Settlement Fund”), which shall be distributed to eligible members of the Class as described below. For the avoidance of doubt, in no event shall MDLY be responsible for the payment of any portion of the Settlement Amount.

        ‘Defendants’ in this case are legacy MCC directors and MCC itself.

        New merger documents have to be released by the 15th of May, so we might have clearer information then. But it seems that MDLY merger is likely to progress on unchanged terms on condition that merger between Sierra and MCC happens, as FrontFour has agreed to vote in line with other MCC directors on the matter.

  6. dt

    Proxy fight is ongoing between NexPoint and MCC management. NexPoint is pushing to replace two incumbent directors at the upcoming shareholder meeting. If successfull, this would mean that NexPoint + FrontFour have a total of 4 directors from the board of 7. ISS and Glass Lewis are in favour of NexPoint.with very vocal arguments on value destruction by current management.

    I think that MDLY/MCC/Sierra merger is now completely dead.

    If proxy fight is successful, an option would be to invest in MCC expecting sale of the company or turnaround in operations (and subsequently improved valuation), as MCC is currently trading at 45% discount to its NAV. However, after a quick look across number of BDCs and comparing EV/Investment Income (not a perfect metric, but should approximate what others might be willing to pay for MCC assets) it does not seem there is much upside. On top of that MCC assets have seen continuous write-downs over the years and investment income has been on sharp decline, so it is very unlikely someone will pay anything close to BV for these.

    NexPoint presentation – https://www.sec.gov/Archives/edgar/data/1490349/000119312519149485/d750086ddfan14a.htm
    MCC response – https://www.sec.gov/Archives/edgar/data/1490349/000121390019009422/defa14a052219_medleycapital.htm
    NexPoint’s analysis of ISS and Glass Lewis Reports – https://www.sec.gov/Archives/edgar/data/1490349/000119312519158476/d731391ddfan14a.htm

    1. na

      Which BDCs did you look at? Can you share your EV / investment income table?

  7. William Chia

    What do you guys see as the natural end game here? MCC trades at such a wide discount but the Taube brothers will either 1) run it to the ground or 2) desperately monetize the management contract. I am not sure if there is anything to play for here. But MCC has bonds that trade in Israel that seem to trade very cheap relative to the US and might be a safer play on the whole situation at a double digit yield

  8. dt

    Shareholders re-elected incumbent directors.

    NexPoint released letter clarifying that non-insider support was minimal:

    “The only significant non-insider support for MCC’s nominees was from a single individual adviser and a Medley joint venture partner. Other than these groups, which were apparently willing to discount the Delaware opinion and proxy advisory firm recommendations, the support NexPoint received from the shareholders was resounding and included some of the most recognized names in the industry.

    Absent these groups and insiders, we understand that the incumbents received minimal support, representing less than 5% of outstanding shares.”

    https://seekingalpha.com/pr/17536084-nexpoint-responds-preliminary-results-medley-capital-corporation-annual-meeting-vote-prepares

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