Current Price: £0.33
Liquidation Value: £0.44
Expiration Date: 2023
This idea was shared by Matt.
This is a liquidation of a small fund in the UK with a timeline of 2-3 years, however, the distributions are likely to be front-loaded. Portfolio assets have already been heavily discounted by new manager and we have added a further 20% discount to arrive at our expected liquidation value of £0.44. Trading volume is very limited. This security is tradeable on IB with ticker SQNX.
KKV Secured Loan Fund was originally established by SQN Capital, an asset manager focused on leasing and structured debt lending to corporates in the US and the UK. The fund was listed on the London Stock Exchange in 2014. A second share class was launched in 2016 (the C shares). The C shares are tied to a separate pool of assets than the ordinary shares (“Ords”). Launching a second share class is a fairly common way for UK listed closed-end funds to raise new capital and to eliminate any concerns over whether the marks of the existing asset pool are reflective of underlying value.
The fund is currently in run-off. A new manager, KKV Investment Management, replaced the original asset manager in mid-2020. Their original intention was to continue the fund as going-concern but as the manager familiarized themselves with the portfolio they realized that (1) it was a lot more complex than they had anticipated; and (2) there were far more credit issues than had been disclosed to them or to investors. KKV re-underwrote all the positions and re-marked the portfolio in June 2020 by writing down the Ords portfolio by 55% and the C portfolio by 32%. The manager is now focused on liquidating the assets through a combination of refinancings and disposals. The fund has made two distributions to shareholders to date and has already returned 50% of the total market cap as of Dec’20. The board and manager have both demonstrated they are focused on a quick return of capital to shareholders and minimizing the run-off costs.
The C shares currently trade at £0.33/share. The C portfolio consists of about 20 loan assets. The most recent NAV update (May’21) shows C portfolio NAV at £0.553/share (64% upside). C share portfolio is generating $1.7-$2m of cash interest quarterly (gradually declining as loans are repaid/sold), which should exceed the admin/liquidation costs. We expect it will generate positive cashflow as the portfolio winds-down. So you have a positive carry portfolio that is trading at a significant discount to management’s base case valuation.
Worth noting that the new manager has reviewed/written down the portfolio in June’20, when the COVID impact and uncertainty were still very high. Therefore, there is a chance that current management’s NAV estimates are already conservative enough. Nonetheless, with liquidations often turning out worse than management’s projections, it seems prudent to apply a further 20% discount on management’s NAV estimate resulting in the expected liquidation value of £0.44 per C class share (33% upside) with potential for a much better outcome if loans are repaid at current carrying values.
As of December’20 report, 35% of the portfolio by carrying value was due to mature in 1 year or sooner. Although the portfolio has some long-dated assets and the liquidation is expected to be completed in a few years, based on what management has done to date (multiple assets have been sold/refinanced since the start of 2021) as well as Brett Miller’s track record we would expect the distributions to be front-loaded.
Brett Miller, an executive director who joined in September 2020, has been involved in a number of other listed closed-end fund liquidations and achieved good results for investors. Brett was involved in the liquidations of Hadrians Wall Secured Investments (a portfolio of direct loans to UK SMEs) and Ranger Direct Lending (a global pool of loans to finance companies), both of which achieved very good outcomes for investors who bought in at substantial discounts to NAV. His style is to sell or otherwise liquidate assets quickly, cut costs to the bare minimum and make frequent distributions to shareholders as the asset base gets converted into cash – in the case of the Ordinary shares (KKVL.L) they have paid out £0.105/share so far this year on a stock that was at £0.175 at the start of January.
The ordinary shares (KKVL.L) also trade at a substantial discount to NAV and provide an interesting arbitrage opportunity. However, I believe that C shares are more attractive and offer a slightly simpler proposition. The outcome in the ordinary shares will be heavily driven by the results achieved in selling off a portfolio of misfunctioning anaerobic digestion plants, where the range of outcomes is pretty wide – it is unclear if making them viable is simply a question of further investment or if there are deeper issues which cannot be solved.
C Share Loan Portfolio
As of Dec’20 KKV balance sheet was comprised of loan portfolios, a substantial cash balance ($18m) and some minor other assets. Following large dividend payouts since the report, it is likely that cash balance has already been depleted and the only asset remaining in the C portfolio is the loan book. Any cash left on the balance sheet or any generated cash interest exceeding admin expenses would add further upside to our liquidation estimate.
The numbering of the C portfolio borrowers below is as per KKV Dec’20 report. For some reason, the company slightly changed the numbering convention from Dec’20 onwards, so the numbers below won’t exactly match with the earlier reports (e.g. Jun’20 annual report).
The most recent May’21 NAV update indicates carrying values being adjusted upwards (already reflected in the £0.553/share figure):
- borrower 47, 48 & 51 (shipping vessels) combined NAV lifted from £10.2m to £13.3m, an uplift of £3.1.
- borrower 54 NAV reduced from £2.7m to £1.9m, a reduction of £0.8.
- borrower 40 refinanced their facility repaying £8.3m vs £7.3m December NAV, an uplift of £1m (these funds were used to pay out dividends).
More details on individual borrowers:
- Borrower 40 – ROV (drone submarine) operator supporting offshore O&G industry. KKV provided £2mm of new debt in July 2020, with the sponsor contributing £3mm new equity.
- Borrower 41 – Organic waste management business operating in Northern Ireland. Described as well run and is servicing the deb.
- Borrower 43 – A highly structured transaction that is ultimately backed by a portfolio of leases made by a specialist finance company in Mexico. LTV (per the borrower) has gone from 93% in June 2020 to over 100% in 2021. As of June 2020 the loan was still current, but given the high LTV, the jurisdiction and some indications of bad faith on the part of the borrower the manager has written this down to 72c.
- Borrower 42 & 58 – Originally a $13mm investment in a contingent surplus note and a $2mm loan investment into an offshore reinsurance business and its onshore holding company respectively. The business offers multi-year guaranteed annuities (“MYGA”), which is effectively the same as a CD. Effectively, the insurance company raises money by agreeing to pay a long-term annuity and invests in a pool of assets, hoping to earn a spread over the cost of the funding. The loan was made in March 2019, with a 14 year term. In 2020 it breached its capital coverage restriction imposed by the regulator, which halted interest payments on the surplus note and the loan, but was able to cure the breach by December of 2020. Interest payments have not recommenced. The manager has written the asset down to zero. Based on what we know, this seems like a very punitive response. We are aware that 58% of the underlying portfolio is CLO mezzanine debt. CLO mezzanine debt dropped like a stone in H1 last year but has rallied and is largely back to the level it was pre-covid, with no meaningful defaults by the CLOs themselves. Indeed spreads have tightened to a degree that many CLOs are now refinancing their mezz tranches at more attractive levels. A similar structure on the ordinary share portfolio was bought back by the borrower at 60c on the dollar in Q1 and we expect a similar outcome here.
- Borrower 44 – Wholesale lender to small businesses in the UK. The company provides 90% LTV financing on a pool of loans to small businesses in the UK. The borrower is required to remove under-performing assets and replace them with performing assets. While performance was hit by Covid it appears the overall pool has performed well and has been amortizing ahead of schedule since the beginning of 2021, with the facility expected to be repaid in October 2021.
- Borrower 45 – French auto-parts manufacturer. Filed for insolvency in November 2020. Likely to be pretty close to a zero recovery.
- Borrower 46 – Secured loan to buy a new AW169 helicopter in June 2018. It is currently on lease in Germany. Given this is a performing asset and has been amortizing debt (was originally a £6.5mm facility) the relatively high provision reflects what the manager calls “the limitations of German Mortgage/German Security”. In our experience recovery of secured assets in Germany is a reasonably straightforward affair. Based on our analysis the LTV is high c 80-90% on an unleased basis.
- Borrower 47, 48 & 51 – Secured against marine vessels. There are also loans to the same borrower from the ordinary shares. Based on previous management commentary, it appears the loans are secured against various vessels with a parent guarantee. As of the June annual report the vessel value was “significantly” lower than the debt. Although the type of vessels securing the debt are unclear the rally in day rates for virtually every type of vessel should mean that the cashflows and collateral value have materially improved. The manager itself wrote-up the loans in their March 2021 interim NAV calculation from £10.2mm to £13.3mm. We expect that the loans may well be fully covered at this point.
- Borrower 49 – Subordinated loan to a composting facility in North Ireland that is owned by a farmers co-op. The loan financed the construction and the customers are the owners, who are contracted to buy all their compost from the plant.
- Borrower 51 – Waste electrical and electronic recycling facility. Performance was impacted by covid and the borrower and the company agreed a short-term debt holiday. Volumes recovered in June and debt service recommenced alongside catch-up payments.
- Borrower 52 – Regional recycling business in the UK. Appears to be performing well.
- Borrower 53 – Term loan to construction and property development company in Northern Ireland. Collateral is stakes in 7 projects to build and operate 7 schools.
- Borrower 54 – Rental company that supplies portable batteries, with a guarantee from a related-party manufacturer that built the battery units. Growing market (replacement of diesel generators with batteries) and the company should be performing well.
- Borrower 55 – Sale & leaseback of materials handling equipment to a listed US business that uses the equipment in Walmart distribution centers.
- Borrower 56 – Marine services business based in the UAE. While most of the business is O&G-related, gulf producers have been far less impacted than other segments of the O&G market and the company continues to perform.
- Borrower 57 – Secured against a down-payment on 6 Leonardo helicopters. The leasee no longer wants to take delivery of the aircraft and have been deferring delivery. The leasee continues to pay interest on the facility. It seems like a weird situation and the range of outcomes appears to be pretty wide, but the manager commented that they expect to be repaid in the coming year.
- Borrower 59 – Pipe-unblocking company servicing the oil & gas industry. Loan has remained current and is expected to be repaid at maturity in Q4 2022.
- Borrower 60 – Subsea pipe installation and inspection business. Debt is current.
Shareholders are mostly UK institutions (Fundrock, Standard Life Aberdeen, etc). Management does not have material investments in the company.
C portfolio as of June’20: