Current Price: $9.05
Offer Price: $10.30
Upside: 14%
Expected Closing: Q2 2021
Proxy and presentation
This idea was shared by Dan.
This is a merger of two business development companies (BDCs). On the 23rd of December, nano-cap Harvest Capital Credit Corporation agreed to get acquired by its larger peer Portman Ridge Finance. Consideration stands at 100% of HCAP NAV in PTMN shares (valued at PTMN NAV) and cash + $0.36/share in cash directly to HCAP shareholders from PTMN’s external manager Sierra Crest. There is a condition, which states that in case PTMN has to issue more than 19.9% of its shares, the remaining part of the consideration (100% of HCAP NAV) will get paid in cash. At the moment we have:
- HCAP NAV – $11.07/share or $66.7m. Share price – $9.05/share. Share count is 5.968m shares.
- PTMN NAV – $2.92/share or $219.5m. Share price – $2.43/share. 75.17m shares are outstanding.
At current prices, the consideration would be – $6.09/share in PTMN shares + $3.85/share in PTMN cash + $0.36/share in cash from Sierra Crest. This sums up to $10.30/share offering 14% potential upside in a month. As the discount to NAV for both of the companies is similar, the whole upside here results from the cash portion of the consideration (valued at HCAP’s NAV) and the additional cash from Siera Crest.
The transaction needs approval from a majority of PTMN and HCAP shareholders. Meeting date is set for the 7th of June. Closing is expected in Q2 2021.
Overall, the transaction seems likely to close. Some part of the spread can be explained by a bit confusing structure of the consideration, which on a quick glance seems like NAV to NAV exchange leaving no potential upside. Another part could be related to a visually large downside (36%) to pre-annoucnement price. However, as explained below, HCAP, and the whole BDC sector has materially recovered since merger announcement, so I expect downside to be much more modest in case the merger falls apart. Worth noting, that buyer’s credibility and similar transactions closed recently add confidence in favourable outcome for this deal as well.
Positive aspects of this special situation
- HCAP’s founder and chairman agreed to support the merger with his 32% stake. This significantly increases the chance of meeting the shareholder approval requirement.
- The buyer, or at least its external manager, seems credible. Sierra Crest is a subsidiary of BC Partners, investment manager with $23bn AUM in private equity companies. Sierra became PTMN’s investment manager in April 2019. Since then, the company continues to implement consolidation strategy and looking to increase scale. PTMN has already completed two similar acquisitions with identical consideration structures (PTMN shares, cash and cash from Sierra or BC Partners) – OHAI in Dec’19 (valued at around $37m) and Garrison Capital in October 2020 ($78m).
- Financing shouldn’t be an issue. Cash part of the consideration currently amounts to $23m, while as of the recent Q1, PTMN had over $30m of available cash.
- Strategic rationale seems sound and portfolios of both company’s are quite similar. The main goal of PTMN is to increase scale – together with operational synergies management expects to improve its “ability to speak for larger deals”. Operational benefits have been well summarized by PTMN CEO:
We continue to execute on our strategy of targeting consolidation opportunities that become earnings accretive for shareholders of both PTMN and the acquired company. We have been proactive in identifying specific opportunities where our Company can benefit from greater scale and immediate cost synergies. In past transactions we have successfully benefitted from achieving greater scale, which allows PTMN to both increase position sizes while simultaneously reducing the impact of public company reporting and other expenses. We believe the combined company will benefit from having lower financing costs, a lower blended fee structure, a reduction in public company costs per share and an increased trading liquidity in the equity.
Risks
I would expect shareholder approval to pass easily on both sides – this leaves 2 remaining caveats:
- Merger termination. Downside to pre-announcement price stands at 36%, however, is very likely to be smaller as the company, and whole BDC sector, is now in a much better position than at the time of the merger announcement in Dec’20. Since thhen HCAP’s NAV has increased by 15%, while the share price of BDC ETF (BIZD) has increased by 19%. Moreover, the company managed to repay a large part of its credit facility, while the remainign $10m payment is secured by its restricted cash. Credit facility ($45m) is maturing in Oct’21 and previously posed a threat to HCAP shareholders. Additionally, HCAP’s discount to NAV is below the historical levels or the peer group (see chart below), which also adds some protection on the downside.
- Potential deterioration of HCAP’s NAV, which would make direct negative adjustments to the consideration. However, this I don’t think this poses a big threat, given a short amount of remaining time and historically stable HCAP’s NAV.
HCAP
The company is an externally managed BDC, which targets North American companies with revenues between $10m – $100m, and EBITDA at least of $1.5m per year. As of March’21, HCAP’s portfolio consisted of 20 companies with fair value of investments at $77m. Portfolio’s composition: 76.4% – senior secured debt, 13.0% – junior secured debt and 10.6% – equity and equity-like investments.
Apparently HCAP is not a very well managed BDC. A substantial amount of its assets are now marked as investment rating 3 (performing below expectations, but no loss of principal is expected) or 4 (“substantially below expectations and whose risks have increased substantially since the original investment”).
However, in comparison to mid’20 (COVID peak), the assets have recovered quite substantially and moved up on the investment rating ladder. No assets are currently market at level 5, where a loss of principal is expected.
For comparison, asset quality as of June 2020:
Asset quality as of Dec’19:
Historical NAV growth and P/NAV data (source):
PTMN
Fair value of investments stands at $473m. Portfolio composition: 68% – senior secured loans, 14% – junior secured loans, 12% – joint ventures, 3% – CLO fund securities, 3% – equity securities.
I came up with different numbers. PTMN will issue new shares not to exceed 19.9% of current shares. I think they will issue 14.96 million new shares based on last share count. Last PTMN NAV per share was $2.92/share per last 10Q. Based on those numbers, I believe Stock based consideration will be valued at (14.96X $2.92 =$43.68 million consideration).
HCAP last NAV was $66.67 million. Cash to be received will be ($66.67 million NAV – $43.68 million stock “value” of PTMN = $19.08 million)
PTMN last share price was $2.32. Given 14.96 million new shares, stock consideration is worth only $34.71 million to HCAP shareholders.
Total consideration by my calculation is $19.08 million cash plus stock worth $34.71 million at Friday’s closing price = $53.79 million.
Current market cap of HCAP is $56 million.
Not sure I did this correctly, but I don’t see any premium in the deal at today’s prices.
I think you subtracted a few numbers wrong ($66.67 million NAV – $43.68 million stock “value” of PTMN = $22.99 million, not $19.08 million).
This also excludes the $0.36/share consideration from Sierra Crest, which is worth another $2.14 million. Using your numbers, I get $34.71 million stock consideration + $22.99 million cash consideration + $2.14 million Sierra Crest consideration = $59.84 million total consideration, or $10.02 per share.
Looking over my post, I realize that the share price of PTMN is about 5% lower than when this was posted. But even using a stock price of $2.43 for PTMN, total consideration for HCAP using my estimate was $9.24.share.
One can also elect to receive cash for the 19.9% of PTMN shares issued (subject to proration).
I am thinking whether this option may be valuable and actionable .
The exchange ratio for the cash option will be determined by average VWAP of PTMN in the 10 business days leading up to the Determination Date (which is 2 business days before the Closing Date).
I assume the Closing Date is several days after the special meeting, and therefore the Determination Date is also around June 7, and the average VWAP will be based on the 10 day from May 25 to June 7.
Interactive Brokers’ deadline for election is 1 pm on May 27. So we can make the decision based on price information for (at most) the first three days of of the 10 day window .
It looks like the best decision is to stick with the default option of accepting PTMN stock, while fully hedging the PTMN exposure until the deal closes, as three days of info is still too little information to act upon.
The only exception will be if PTMN price falls off the cliff on next Wednesday morning, and in that case one may want to elect to receive cash and close the PTMN hedge.
Looks like there is an option to receive a 100% cash consideration instead of PTMN shares + cash. The cash consideration in lieu of PTMN shares is calculated as the VWAP of PTMN in the 10 trading days preceding the close of the deal.
Anyone considering going this route?
I don’t think you’re correct on the cash option. The cash portion will be prorated by the aggregate cash consideration cap, which equals to HCAP NAV – 19.9% of PTMN shares x PTMN NAV. You can find the explanation and illustrations on pages 75-77 of the proxy statement. Basically, the maximum amount of cash you can receive at the moment is $22.983m (aggregate cash consideration), or $3.85/share. The remaining amount will still be PTMN shares.
The total consideration now stands at $10.10 which will be composed of $5.89/share in PTMN shares, $3.85/share in cash and $0.36/share in additional cash. This consideration will be received if every shareholder chooses the cash option. If some do not make the choice the default option is to receive PTMN shares, meaning that more cash will be left for those who chose the cash option. The cash option is far more beneficial as basically all of the upside comes from the cash portion of the consideration only.
By the way, today is the last day to acquire shares in order to be able to choose the cash consideration option.
If we choose the cash option, we still have to decide how much to hedge, and how we unwind the hedge:
(1) The cash value (in lieu of PTMN stocks) will be determined by VWAP of PTMN, so we do have to hedge against PTMN until end of the 10-day VWAP calculation window, when “cash” finally becomes 100% cash.
(2) In principal, we want to unwind 10% of our hedge every passing day over the 10-day window, if we expect to receive all consideration in cash. If we expect to be pro-rated, we will keep some hedges on even after the window.
(3) Depending on the final result of proration (cash vs stock), we may have under- or over-hedged.
I guess it’s this complexity and uncertainty that has kept the spread wide.
I read the proxy again. I think the upside coming from “cash portion” will benefit both cash option and share option equally.
Although the Total Stock Consideration is calculated based on PTMN NAV, everyone (electing cash or not) will receive the same Per Share Cash Price (as defined in the proxy).
Those who receive shares will receive PTMN shares “equal to the number of shares of PTMN Common Stock with a value equal to the Per Share Cash Price based on the PTMN Per Share Price”.
In short, they are actually not doing an NAV-for-NAV exchange, and will receive more PTMN shares to compensate for PTMN’s NAV discount.
Looks like the numbers are in:
VWAP of PTMN shares for the cash election appears to be $2.38
Cash election: $7.43 PTMN Cash + 0.74 PTMN shares + $0.36 Sierra Crest = $9.59 total consideration
Share election: 3.86 PTMN shares + $0.36 Sierra Crest = $9.74 total consideration
https://www.portmanridge.com/news-releases/news-release-details/portman-ridge-finance-corporation-completes-merger-harvest
Return ended up lower than expected due to HCAP NAV deterioration – dropped from $11.07/share (at the time of write-up) to around $10.37 (6% decrease). Not sure why did it fall so much in such a short timeframe. PTMN NAV and share price remained unchanged, so as HCAP NAV dropped, share consideration (election) value increased above cash election. Anyways, the idea still resulted in a pretty solid 6% (cash election) gain in 3 weeks.