Current Price: $9.05
Offer Price: $10.30
Expected Closing: Q2 2021
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.
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.
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):
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.