Current Price – $2.81
Merger Consideration – $3.55+
Upside – 25%+
Expiration date – TBD
MDLY / MCC / Sierra merger saga is ongoing already for more than a year. Materially amended merger agreement was signed at the end of July'19. Recent developments indicate that we might be nearing the finish line. The key risk has been eliminated by the amended merger terms. A settlement with the activist make the transaction more likely. The spread stands at 25% for hedged trade and 34%+ for the unhedged trade with cash portion accounting for more than the current MDLY share price.
Management was targeting Q4'19 to close the transaction, but probably this will be delayed till Q1'20. Meetings to vote on the amended merger agreement are expected to be announced shortly.
Market likely gave up on this transaction after more than a year of delays, proxy fights, conflicted management and etc. This should explain at least part of the spread. Complicated transaction structure coupled with tiny market caps (c. $100m) accounts for a further portion of the spread.
Most importantly, the amended merger terms have eliminated the key risk - MCC shareholder approval is no longer required for MDLY to merge with Sierra. So now all will depend on whether Sierra Income (unlisted BDC) unitholders approve the transaction. And I think they will mostly due to liquidity advantages of the public market listing and internalization of the asset manager. All the proxy fights during 2018/2019 were on the MCC side, so it is a bit hard to guess what is Sierra shareholders' opinion towards this merger.
Previous merger agreement
The initial situation with previous merger terms was posted on SSI back in Aug'18 and I refer to this write-up for background. In a nutshell, MDLY (management company, 82% owned by insiders) intended (and still does) to merge with two BDCs it operates - listed MCC and unlisted Sierra Income - with Sierra as a sole surviving entity. Merger terms were very favorable for MDLY and insiders. MCC activist shareholders revolted and with the settlement received two seats on the board and special committee as well as extracted additional merger consideration for MCC shareholders to be paid directly by insiders.
The main reason for delays were MCC proxy fights. Now with MDLY/Sierra merger not conditioned on MCC shareholder approval, the process is likely to proceed more smoothly.
- Jun 4th - During the annual meeting MCC shareholders re-elect two incumbent directors against advice of ISS and Glass Lewis. Another activist NexPoint had suggested competing slate of directors, but got voted down (15.6m shares against 21.7m shares). Nexpoint argued that incumbents won only because of votes of insiders and their affiliates.
- Jul 29th - amended merger agreement signed, terms outlined below. "Go Shop" period starts to find better proposal for MCC.
- Sep 9th - 13G with 9.3% MCC ownership filed by Glacier Point Advisors.
- Oct 14th - "Go Shop" ends with no superior proposal to the amended merger agreement.
- Nov 11th - 13G with 14.2% MCC ownership filed by Fortress Investment Group.
- Nov 19th - Court Approval of the settlement between MCC and FrontFour - court approval was one of the conditions to close the merger. Following this approval I am expecting announcements on shareholder meetings shortly.
MDLY/Sierra merger not conditioned on MCC/Sierra merger
Wording of the previous merger agreement:
The MDLY Merger is directly related to and contingent upon the merger of Medley Capital Corporation (“MCC”) with and into Sierra, with Sierra as the surviving company in such merger (the “MCC Merger”)
Contrasting this wording in the current agreement:
Pursuant to terms of the Amended MCC Merger Agreement, the consummation of the MCC Merger is conditioned upon the satisfaction or waiver of each of the conditions to closing under the Amended MDLY Merger Agreement and the consummation of the MDLY Merger. However, pursuant to the terms of the Amended MDLY Merger Agreement, the consummation of the MDLY Merger is not conditioned upon the consummation of the MCC Merger. If the MDLY Merger is consummated and the MCC Merger is not consummated, the investment portfolios of Sierra and MCC would not be combined and Sierra would continue with Merger Sub, the surviving company in the MDLY Merger, as its wholly owned registered investment adviser.
Amended merger agreement
The terms of the new agreement are somewhat more favorable for MCC/Sierra shareholders compared to the previous one, the main difference being $47m settlement fund that will be paid out to MCC shareholders from the pockets of management. The structure is quite complicated:
- MCC shareholders will receive 0.68 shares of Sierra for each share of MCC. Additionally, shareholders unaffiliated with MDLY will get additional distributions from the Settlement Fund consisting of $17m in cash and $30m in Sierra common stock (valued at NAV, which is $6/share). Per my calculation this works out to 0.79 Sierra shares and $0.37 cash for each MCC share.
- MDLY shareholders other than LLC unit owners (i.e. insiders) will get 0.2668 shares of Sierra and $2.96 cash for each share.
- MDLY Management will receive 0.2072 shares of Sierra and $2.66 in cash for each unit. Part of this will be contributed to MCC shareholder settlement fund noted above.
- Sierra Income shareholders will continue to own the units they currently do, but the company will be listed.
The simpliest way to look at merger consideration per MDLY share is by applying apply discount to Sierra Income NAV ($6 share as of Sep'19). Even assuming 50% discount to NAV (where MCC trades currently due to lack of scale and profitability), consideration per MDLY share works out to $3.76 or 34% upside to current prices. I believe 50% discount to NAV is very conservative estimate on where the merged MDLY/Sierra Income would trade, so the actual realized upside is probably higher than that.
For the hedged trade and assuming merger closes between all three companies, using current MCC price ($2.1/share) I arrive at the implied price of the merged company of $2.19/share. This in turn translates into consideration of $3.55 for each MDLY share, or 25% spread.
Risk of shareholder approvals
This merger is still a cash out by MDLY management as they will pocket $54m in total (or $70m if MCC/Sierra merger fails) and maintain only limited ownership of the merged company (vs 82% economic interest in MDLY currently). However, I think the likelihood of transaction closing has increased for both full merger as well as only MDLY/Sierra merger.
MDLY approval is a done deal due to voting control by management. I expect Sierra Income shareholders to be in favor of the merger as that is the only short term prospect to get shares listed and trade-able on the exchange. Whether small dilution and material cash payout (equivalent to 14% of NAV) to get the asset manager internalized is worth these advantages remains a question mark. Recent developments with MCC and lack of superior proposal serve as an indication that better terms might be hard to extract for Sierra shareholders. On the MCC side the likelihood of approval has improved due to:
- Settlement signed with FrontFour who will vote their shares for the merger.
- Two incumbent directors reelected in MCC meeting received a total of 13.5m of unaffiliated votes (vs 15.6m shares that were voted for other nominees). I assume that at least that many votes will be cast in favor of the merger.
- "Go Shop" period ended with no superior offers. So it does not seem like there are any other options are on the table.
- MCC is currently trading at 54% discount to NAV and administrative costs consume all investment income. In contrast larger scale Sierra Income generates healthy investment income after management fees. Thus the discount will likely be narrower for the larger scale company after merger with Sierra and with internalization of the asset manager.
- NexPoint has not raised any further issues after the annual meeting. Although these might resurface again following shareholder meeting announcements.
- Two new large holders accumulated a combined 23% position in MCC after the amended merger terms were announced. Both filed 13G instead of 13D. I take these new positions as a sign that they will be in favor of the merger.