Apologies for the recent string of relatively small and/or illiquid ideas, here is another one from the trash bin: Medley Capital (MCC) is an orphaned BDC that will likely be sold in the next several months. The story begins in August 2018, when MCC's external manager, Medley Management (MDLY), orchestrated a three way merger that would combine the manager with its two BDCs, publicly traded MCC and non-traded Sierra Income. That deal met a lot of resistance from shareholders as it appeared to be a non-arms length way to bailout the overleveraged MDLY at the expense of the BDC shareholders while ensuring underperforming management continued on top. The deal was in limbo until May of this year, almost a full 2 years after the merger announcement, when the deal was finally put out of its misery and terminated. I'm skipping a lot of drama in those two years including a proxy fight with the team from NexPoint, but following the termination, MCC continues to retained advisers to pursue strategic alternatives and recently announced that MDLY's management agreement would be allowed to expire at year-end and that MCC will internalize management.
After a 1-for-20 reverse split earlier this year, MCC is trading for ~$26.50 ($71MM market cap) with a 6/30 NAV of $54.83 (MCC's fiscal year end is 9/30, the 10-K should be coming out shortly), meaning MCC is trading at roughly a 50% discount to NAV. For reference, despite the pandemic, the average BDC trades for 86% of NAV today.
For the uninitiated, BDC is an acronym for business development companies, which typical function as non-bank lenders to leveraged middle market (sub $50MM in EBITDA) companies, often providing financing for private equity buyouts or M&A transactions. Following the financial crisis, banks can no longer provide these loans on reasonable terms, so non-bank lenders like BDCs of CLOs have filled much of the void. These loans are all below investment grade and the leverage ratios of the underlying companies is typically 5-7x EBITDA, they can be a bit scummy and certainly shouldn't be pitched as safe dividend payers to retail investors. There are some 45+ publicly traded BDCs (like REITs, there are also non-traded ones like Sierra Income that are sold through the investment advisor channel), most of them are externally managed, often by household names (at least to anyone reading this) like Ares, KKR, Oaktree, Apollo, BlackRock and others that can essentially use the BDC as a lender for their own PE activity. If that wasn't enough, they charge hedge fund style fees to the BDC. These management fee streams are highly valuable as a BDC is technically a closed end fund and the capital inside it is essentially permanent. So the average BDC trades for 86% of NAV, roughly 10 of the 45 trade above NAV which allows the BDC to issue additional equity, anyone below NAV is generally restricted from issuing shares but they can still grow assets through M&A which has been fairly active in the bottom of the sector.
Given this dynamic of external managers wanting to grow fees and now that MDLY will be out of the way (MCC no longer has to serve two masters in a transaction), the orphaned BDC should make for an easy M&A target, especially considering the wide discount to NAV. The buyer and MCC can essentially split the discount somehow and both come away happy. Following the sale of their broadly syndicated loan (larger borrowers, more liquid loans) JV to Golub and paying off one of their two baby bonds, MCC is clearly too subscale (maybe the 40th largest BDC of the 45 by assets) to be internally managed and if the plan was a true go-it-alone strategy, they likely would have refinanced the baby bond versus pay it with cash on the balance sheet. The new CEO is an activist in MCC, David Lorber of FrontFour Capital, he's also headed up the Special Committee, from the internalization press release they've hired a credit person on what seems like a temporary basis to oversee the remaining portfolio, all sort of signals to me that this is once again for sale.
Of course, everyone has seen the deal, it was shopped previously and the conflicted board (MDLY management on the MCC board) turned down other offers during the go-shop period in order to continue to push the MDLY-MCC-Sierra deal that would have preserved MDLY's management team. However, now that MDLY is largely out of the way, debt markets are flush with capital (low rates is great for private debt, everyone will be reaching for yield), we're looking at a potential reopening and economic recovery, I'm guessing at least one of those suitors will come back and make a deal for MCC.
- I haven't discussed the portfolio, obviously given the turmoil this company has been through in the last two years as you'd expect, the portfolio is a bit of an unclear mess of assets. It is more heavy on equities than most peer BDCs, including 764,040 shares of AVTR which is up ~66% since 6/30 or $8MM in NAV ($3ish per share). On the downside, the JV they did sell to Golub is about -$7MM in the other direction. The S&P/LSTA Leveraged Loan Index is now trading about 95 cents on the dollar, up significantly from the lows in March and April, and for reference, on 6/30 it was trading at 89. Even the junkiest of loans, rated CCC, are today trading at 86. We'll see in a few days where the 9/30 NAV is struck, but I don't think it should be materially below where it was on 6/30, but I'm not a credit analyst and only spent a little time thumbing through their holdings.
- This situation reminds me a little bit of RESI, a broken deal, external management being pushed aside and no reasonable path to becoming an internally managed company for the long term. That one ended very successfully with a quick deal that was then revised upwards after a competing offer came to light (I unfortunately was out by the time of the revised deal).
- BDCs are no longer included in most indices, MCC doesn't pay a dividend, there really isn't a natural investor base for this and I think that partially explains how its languished here and really doesn't have a future outside of a deal.
Disclosure: I own shares of MCC