OHA Investment Corp (OHAI) – Merger Arbitrage – 11% Upside

Current price: $1.30

Merger Consideration: $1.45

Upside: 11%

Expiration Date: 12th Dec 2019

Proxy

 

Merger between two failed BDCs that trade at large discounts to their NAV. OHAI shareholders are set to receive $1.45/share in cash and stock - 11% spread to current price. Cheap borrow is available for hedging, but eventual payout is still exposed to NAV fluctuations, potentially to the positive side. The merger was announced 3 months ago. Shareholder approval is pending - meeting is set for the 12th of December. Downside to unaffected price is 18%.

 

Transaction Details

OHA Investment ($26m market cap and 29% discount to NAV) is getting acquired by Portman Ridge Finance ($84m market cap and 37% discount to NAV).

If merger is consummated OHAI shareholders will receive:

  • $8m (or $0.4/share) minimum in cash - portion paid in cash might be higher as PTMN dilution from new share issuance cannot exceed 19.9%.
  • Remaining portion (after deducting the above $8m) of OHAI NAV to be paid in PTMN stock valued on NAV basis. While this sounds somewhat confusing, it is simply receiving the same 'amount' of net asset value just in different stock. At current NAVs ($1.83/share for OHAI and $3.55/share for PTMN) this results in 0.403 PTMN shares for each OHAI share. Final exchange ration will depend on NAV of both companies at the time of closure.
  • Additional cash consideration of $3m (or $0.15/share) paid by PTMN's external manager and not the acquirer. This is important as there might be different tax treatment for this part of consideration (although company expects it will be treated as standard merger consideration).
  • This results in per share consideration of $0.545 in cash and $0.905 in PTMN shares. Or $1.45 in total.

 

Shareholder Approval and Proposed Buyback

This merger is the result of strategic review that has been ongoing for 1.5 years since Nov 2017. Even ignoring management quality, with portfolio of only $80m OHAI clearly lacks scale with almost all of the investment income consumed by management fees and other admin expenses. As long as it trades at a wide discount to NAV, the company has no chances to raise additional funds and increase its portfolio. And in the absence of merger the company would simply continue to bleed out NAV.

In management's own words:

When we took over management of OHAI almost 5 years ago, we intended to increase its scale and diversify the portfolio away from the energy focus of prior management. Unfortunately, the immediate and severe downturn of energy prices never allowed us to pursue that strategy for the benefit of shareholders in a meaningful way.

While we are proud of the consistent success of new investments made under OHA leadership, these gains have only cushioned the substantial losses. As both the investment adviser and a shareholder of the company, we are surely disappointed by the magnitude of write-downs in the legacy investment portfolio, and we became mindful of the expense burden relative to a subscale investment portfolio.

This prompted our board to explore a variety of options that could provide more scale to OHAI.

It has taken OHAI management 1.5 years to find this merger opportunity and probably there are not many other options in sight. Proxy indicates that a number of parties have shown initial interest in some kind of transaction with OHAI, but eventually all except one dropped out of the race. OHAI has traded at an even wider discount (50%-60%, probably due to legacy asset write downs) before the strategic review, so shareholders have high incentives to approve this transaction in order to avoid returning to the previous discount profile.

OHAI discount

Also I think it is quite rare for BDC management to relinquish control voluntarily. One of the analysts put it really well:

Congratulations on the transaction, and kudos to the OHAI Board for taking -- making the right decision for shareholders as opposed to holding out and milking the company for fees. It's very laudable and not done enough in this industry.

There are a number of other reasons outlined in the presentation (and this joint conference call) why the merger makes sense for both companies - larger scale, spread of admin fees over larger base, NII accretive, cheaper financing and etc. All of these look good on paper but it is not clear if there will be any real value add as the resulting combined asset portfolio will still be sub-scale.

However, one point is particularly attractive. PTMN has proposed to initiate buyback of $10m if the shares of the merged company trades below 75% of NAV. This is almost 10% of the combined market cap and PTMN currently trades at 67% of NAV - so if the discount stays at current levels, buyback should be initiated right after the merger. I think this commitment by management to return further funds to shareholders should incentify shareholders to approve the proposed transaction.

Four largest OHAI shareholders own 32% of stock and one of the directors additional 4%. I am guessing these larger shareholders would have voiced their concerns already if they intend to reject the merger. As nothing has been heard in 3 months since the announcement, I am assuming these 36% of votes are already in the bag.

 

NAV Volatility

The eventual payout for OHAI shareholders depends not only on PTMN share price (can be hedged by shorting), but also on NAVs at the time of closure.

Proxy indicates development of net asset value for both companies over the last 3 years.

For PTMN:

OHAI

And for OHAI:

OHAI-0

PTMN NAV declines exceeded dividend payouts, whereas OHAI NAV appeared more stable recently. OHAI NAV declines in 2017/2018 drops were driven by large write-downs of legacy assets. If these trends continue for the next quarter, then the eventual exchange ratio will be higher than the currently estimated and consideration received by OHAI shareholders will increase.

OHAI is due to report Q3 NAV on the 12th of November and PTMN Q3 NAV has already been announced at $3.55/share.

 

Risks

  • Shareholders reject the merger - 20% downside in that case;
  • OHAI reports decline in NAV with Q3 results on the 12th of November;
  • OHAI NAV declines more than NAV of PTMN during the time left till merger is consummated (if reverse happens, would be a positive effect).

15 COMMENTS

  1. dt

    OHAI Q3 results are out.

    NAV as of Q3 stands at $1.76/share.

    This reduced the upside from $1.45 to $1.41 (due to reduced merger consideration in PTMN shares). NAV will likely change further till transaction gets finalized (or shareholder meeting), but I would expect NAV of PTMN to decline more than NAV of OHAI, which should affect merger consideration positively.

  2. ActOfWill

    Hi thanks for the idea. What is the worst case tax treatment for the 0.15c consideration coming from the external manager?

    1. dt

      Below is extract from the proxy. If it is not considered part of merger consideration, it will be deemed ordinary income and taxed accordingly (depends on personal circumstances).

      “With respect to the Additional Cash Consideration, there is limited authority addressing the tax consequences of the receipt of merger consideration from a party other than the acquiror and, as a result, the tax consequences of the receipt of the Additional Cash Consideration are not entirely clear. PTMN and Sierra Crest intend to take the position that the Additional Cash Consideration received by a U.S. holder is treated as additional merger consideration. It is possible, however, that the Additional Cash Consideration may be treated as ordinary income and not as cash received in exchange for a such holder’s OHAI Common Stock.”

  3. ryanwalex

    This is one that I have been looking a lot at. I have a bit of a different take though. The $0.40 per share in cash and the exchange for PTMN stock is NAV for NAV. Thus, those should effectively break even. However, the PTMN is trading ~60% of NAV and OHAI is trading at ~70% NAV, so you lose a little bit there. However, the additional $0.15 in cash is where the gain is. The downside to this trade is the price to NAV. If a bunch of special situation investors buy up OHAI to a much higher percentage of NAV to PTMN, then you could potentially lose the $0.15. Additionally there could be some additional selling of PTMN after the merger. At the end of the day they are trading NAV for NAV, but if those NAV’s deviate from each other that could be negative for this trade.

    1. dt

      Your are slightly incorrect:
      – For the cash portion ($0.4/share) one receives 100% of NAV without any discount, so it’s additional profit relative to OHAI trading price.
      – For the stock portion you are right that the difference in discounts results in minor losses on this part of consideration.

      Taken together the two effects above kind of cancel each other out and then as you suggest the whole spread comes from the additional $0.15/share to be paid by the third party.

      Also keep in mind that PTMN discounting might change after merger if the buyback announcement will have any effect on the share price of the combined company.

      1. Zulu Investment Partnership

        Hi, how did you make this tracker? Is it using vba (macros)? Really nice tracker.

        1. cam1830

          Agreed this is a nice looking tracker, can you explain how you made it?

        2. Platitudes

          It’s just a chart. Best way is to trial and error on sheets. Very similar to excel.

  4. riskarber

    from press release today after market:

    each share of OHAI common stock will receive approximately $0.57 in cash and 0.3688 shares of PTMN common stock

  5. dt

    Marking this as closed with 6% return over a month. The result is slightly lower than initially expected due to unfavorable NAV movements.

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