Thursday, May 13, 2021

Medley Management: Reorg BDC Manager, Better Offer Coming?

[This is marginal idea day, I have a few of these small positions I've started but don't really have the conviction to make them more than that, but others might find them interesting and in the interest pushing out some content, here we go]

Medley Management (MDLY) is an asset manager of private-credit or middle-market leveraged loan vehicles, it was previously the external manager of PhenixFin (PFX), a business development company ("BDC") that was formerly known as Medley Capital (MCC) prior to BDC's board terminating Medley's management agreement at year end 2020.  The loss of the MCC management agreement, alongside years of underperformance, dinged Medley's assets under management to the point the company's operating subsidiary filed bankruptcy protection on 3/7/21.  Today the company has about $1B in AUM, split between their non-traded BDC, Sierra Income Corporation ("SIC"), and some other separately managed accounts or private funds.

A little history, Medley Management was 5-6 years ago a semi-popular way to play the "permanent capital" trend, traditional asset managers were facing the same headwinds they do today with outflows and competition from cheaper indexed alternatives, however permanent capital managers were popular since they managed closed end funds like BDCs or REITs.  The closed end nature and generally punitive termination clauses in external management agreements make them highly valuable.  Medley took this valuable revenue stream, IPO'd it, took on leverage in the form of baby bonds (bonds that trade on exchanges, typically $25 par value like preferred stock) and paid a handsome dividend.  These baby bonds trade under the symbols MDLX and MDLQ, as part of the proposed bankruptcy plan, the baby bonds will be converted into MDLY common stock.  But prior to the current troubles, Medley had been underperforming for years, MCC had been trading a persistent discount to book value and was unable to issue shares.  In 2018, they came up with a plan to do a three-way merger that would combine MDLY, MCC and SIC together to form one large internally managed BDC (similar in nature to the ill-fated NSAM/NRF/CLNY merger), but that merger was challenged by shareholders from the get-go as a non-arms length transaction designed to prop up MDLY and enrich insiders, the merger was ultimately scrapped during the worst of the pandemic.

With that out of the way, here's where the story gets a bit more complicated, MDLY technically represents shares of Medley Management which is just a holding company that in turn owned a portion of the operating subsidiary partnership, "Medley LLC", Medley LLC is the now bankrupt entity that is the asset manager, where the majority of the employees technically work, etc., and most importantly, where the baby bonds were issued.  The remaining portion of Medley LLC was owned by two twin brothers, Brook and Seth Taube who were until recently co-CEOs together, they had the option to convert their units in Medley LLC for MDLY shares, normally you would never do this for tax reasons, but once it was clear that Medley LLC was in trouble and formally filing for bankruptcy, the Taubes converted their units in Medley LLC for shares in MDLY to maintain control of the company.  Their reason for this transaction was a fear that a change of control through bankruptcy would trigger clauses that would allow clients out of their management contracts.

Prior to the unit conversion, MDLY had 670k shares outstanding (after a reverse split), after the Taubes Medley LLC unit conversion the company has just over 3 million shares outstanding.  As part of the restructuring plan, MDLY will be issuing new shares to both classes of baby bonds and to Strategic Advisors, who were a minority investor in the entity that manages Sierra Income.  In 2018, MDLY bought out Strategic using seller financing, MDLY defaulted on the Strategic note in early February 2021, same time the company failed to pay interest on their baby bonds.  Here's what the plan contemplates for both sets of creditors:
Notes Claims. On the Effective Date, each holder of an Allowed Notes Claim shall receive: (i) if such holder votes to accept the Plan, 0.600 shares of newly-issued Class A Common Stock of MDLY for each $25 principal amount of 7.25% senior notes due 2024 (“2024 Notes”) and/or 6.875% senior notes due 2026 (“2026 Notes”) held by such holder; (ii) if such holder does not take any action and does not vote on the Plan, 0.450 shares of newly-issued Class A Common Stock of MDLY for each $25 principal amount of 2024 Notes and/or 2026 Notes held by such holder; or (iii) if such holder elects to Opt-Out of the Third Party Release contained in Article VIII of the Plan and/or votes to reject the Plan, the lesser of (x) 0.134 shares of newly-issued Class A Common Stock of MDLY for each $25 principal amount of 2024 Notes and/or 2026 Notes held by such holder or (y) a pro rata share of the Rejecting Noteholder Pool.

Strategic Claim. The holder of the Allowed Strategic Claim shall receive: (i) 218,182 shares of newly-issued Class A Common Stock of MDLY; (ii) $350,000 in Cash on the Effective Date or as soon as practicable thereafter; and (iii) a secured promissory note, the form of which will be negotiated between the parties prior to the Confirmation Hearing, which provides for 10 consecutive quarterly payments of $225,000 in Cash, commencing on the last Business Day of the first full calendar quarter following the Effective Date.

The baby bonds are getting the short end of it here, clearly the equity is impaired at Medley LLC, but due to the structure of MDLY, management was able to remove themselves from the bankrupt entity and then now is forcing mostly retail investors to approve the plan or get less if they forget (which seems like fair amount would) or straight out reject the plan.  The SEC seems to agree, the SEC has an open investigation into MDLY, they recently had this to say in a court dock filing:

B. The Debtor’s Bankruptcy Case and Restructuring Plan

8. On March 7, 2021, Medley filed a voluntary petition for relief under chapter 11 of the Bankruptcy Code in the Bankruptcy Court for the District of Delaware (the “Court”). That same day, Medley filed the Plan which would exchange the debt owed to holders of the Notes for equity in MDLY.  The noteholders are among the Debtor’s most senior class of debt, as the Debtor has scheduled no secured or priority claims. Under the Plan, holders of the Notes are estimated to receive a recovery between 5% and 22.4%, depending on whether the noteholders vote in favor of the Plan. But because the recovery hinges on the market value of MDLY stock, noteholders could receive much less under the Plan. The Debtor has scheduled only $7.7 million in general unsecured claims, all but approximately $86,039 of which relate to one creditor. These claims are also impaired.

 9. The Plan gives equity special treatment. Specifically, the Plan treats the Debtor’s equity interests as unimpaired and contemplates that unitholders—i.e., MDLY—will continue to own the reorganized Debtor. According to the Debtor’s CFO, equity interests remain unimpaired under the Plan in order to avert “material adverse consequences.” See Allorto Decl. [Docket No. 5], at 12. Specifically, “[t]he Plan is designed to avoid a change of control event through the Chapter 11 Case and limit the potential for client defections.”  

10. It is clear from the first-day declaration and testimony at the Section 341 Meeting of Creditors that at no time prior to the petition date did the Debtor consider any strategic alternative that would have impaired the pre-IPO owners’ interests in the Debtor.

And then in a footnote, SEC hinted that a new revised plan might be coming, presumably one that would give the baby bonds more of the reorganized entity:

1 The SEC staff has informed the Debtor that the Plan is fatally flawed in a number of respects. In response, the Debtor has represented that the objectionable provisions of the Plan, including provisions violating the absolute priority rule, will be addressed in a forthcoming amendment, that the current hearing date will be adjourned, and that the SEC will have an opportunity to review and object to any amended disclosure statement. Although the Debtor has informed the SEC staff that the structure of the Debtor’s Plan may change, as of the date hereof, an amended plan and disclosure statement have not been filed, and the Debtor has not agreed to further extend the date on which the SEC must object to the retention applications. As such, the SEC has no choice but to file its objection based on the currently-filed Plan. The SEC reserves the right to amend this objection if and when such an amended plan and disclosure statement are filed. 

So a better outcome might be coming thanks to the SEC pushing back, but even if the current plan remains in place, the baby bonds look interesting, both on their own and relative to where the common stock trades.  These are all fairly illiquid securities, but as I write this, the two baby bonds (MDLX and MDLQ) trade for approximately $2.30, MDLY trades for $5.70, at a rate of 0.60 MDLY per baby bond that's $3.41 of "value", 46% upside to where the bonds trade.  MDLY is extremely volatile and seems subject to the occasional pump and dump, so maybe the bonds are reflecting the true value and MDLY is just a meme stock trading sardine.

Some back of the envelope math, ignoring the $9.5MM investment in SIC and other cash/assets on MDLY's balance sheet, I get an enterprise value of approximately $23MM through the baby bonds for an asset manager with $1.2B in AUM, a lot of which is paying upwards of 1.75% in base fees.

Seems kind of cheap?  Proforma normalized earnings is probably something like $1MM per quarter.  Now of course you have the Taubes still in control of this thing and assets to continue to flee, but loan mutual funds have seen huge inflows recently in anticipation of higher rates, defaults are at lows, I could see this market making a recovery and potentially benefiting even the marginal players like Medley.

Risk/Other Thoughts: 

  • Please do your own work on this one, the MDLY shares are highly volatile and appear to occasionally caught up in pump and dumps or "meme stonk" trading patterns.
  • The bankruptcy process is uncertain, the plan still needs to be approved by the courts, a lot could go sideways and I'm not a reorg expert by any stretch.
  • Sierra Income Corporation makes up a majority of their assets and the Investment Advisory agreement between SIC and Medley needs to be renewed each year, Sierra can terminate the agreement at any time.  SIC does file with the SEC, in their latest proxy they detailed the events leading up to renewing Medley's contract for another year despite the bankruptcy proceedings, noting that the reorganization would be good for Medley and SIC.  I would also note that none of the independent directors of SIC own any material amount of stock, are paid handsomely in cash, and likely don't want to interrupt that gravy train, but as with MCC, SIC could decide to terminate the agreement and then Medley would be in serious trouble.
  • Medley recently disclosed in an amended 10-K filing that a client representing 18% of their AUM terminated their investment agreement with Medley, the funds will take a couple years to leave the firm (middle market loans are illiquid, they'll runoff in 2-3 years), but again, shows this is a melting ice cube business.
  • I'm bullish on private-credit going forward, say what you will about the Fed's actions but the result is to push people out on the risk spectrum, especially fixed income or yield oriented investors.  To meet desired total returns, the fixed income portion of a typical portfolio is going to have to be riskier than it has in the past.  If the Taubes come to the realization that their name or the Medley name is tarnished, I imagine they'll have a few interested parties in buying them out, or a recut of the Sierra Income internalization transaction could be back on the table again.
Links:
Disclosure: I own shares of MDLQ (and PFX too)

25 comments:

  1. http://www.kccllc.net/medley/document/2110526210513000000000002

    Sorry, my post was almost instantly stale, MDLY pulled the reorganization plan formally, no new plan as of yet.

    ReplyDelete
  2. Have you ever looked at $PIOE, a soon-to-be uplisted pink sheet meta- alternative asset manager? Lots of carry forward NOL's, they're rolling up new alt managers with stock, strong insider alignment.

    ReplyDelete
    Replies
    1. Only briefly, I should re-visit, thanks.

      Delete
  3. https://www.sec.gov/Archives/edgar/data/0001611110/000121390021026130/ea140836-8k_medleymanagement.htm

    And a Wells Notice, maybe I should have left this one in the draft folder

    ReplyDelete
    Replies
    1. Funny; I looked at this today. Have always viewed the Taubes as being just barely short of criminal, but maybe even that was optimistic. I was briefly happy about the Wells notice, but then realized the problem is that anything they're involved in is near-uninvestable, and if they're gone the assets might follow. I'm still tempted by the baby bonds, but as distressed notes of tiny low-asset entities go, am more excited by AFHBL, the notes of AFHIF. If you net out potentially-disposed-of liabilities, forgiven PPP loans, their for-sale HQ, add in some optimism and ignore the going-concern warning, they may be money good, and they're due in under a year. R/r much better back at $6.75, tho.

      Also, CPTA is one for your BDC rerating folder. Pretty simple story: deleveraging, new manager will pivot into more yieldy assets. Still subscale, but at around half of NAV even after its big recent runup. Not exactly a quality name.

      Another one I hold a bunch of and which might be of interest is MN. A lot of net cash, AUM slowly moving in the right direction. Meh products and management (they are not terrible but I suspect they may be greedy), but you are paying an EV of under .3% of AUM for a profitable enterprise.

      There you go: the usual endless litany! A pleasure to read the blog, as always.

      Delete
    2. Thanks for the ideas. The other "uninvestable" asset manager I've been looking at, guessing you have too is AAMC. They've got this strange preferred stock that was issued when things were good, zero coupon, intention was the buyback stock with the proceeds, then things obviously went south, the pref is dead and in litigation. They recently settled with one holder, the larger holder is still it litigation, but if they were to settle on similar terms, appears its trading at less than 50% of NAV (AAMC is currently just a handful of mREITs on the balance sheet). No CEO, sort of an outline of strategy to become a hard money lender, but that's really it.

      Delete
    3. CPTA is interesting, thanks, didn't realize they are getting a new manager, the new manager is affiliate of BC Partners which manages PTMN and has been rolling up all the tiny BDCs (currently acquiring HCAP). Seems like a logical step would be to fold CPTA into PTMN as well.

      Delete
    4. Yeah, I'm not really sure why they're not pursuing that vs. keeping it as a separate entity for now, though I guess the option's available down the line.

      Another quick hit: added more RHE-PA today. Pref of a tiny LTC operator that's had Job-like luck and was anyway in a difficult market even pre-Covid. They are highly leveraged but on top of their liabilities and, if you squint and are moderately credulous, cash flow positive.

      All the equity accrues to the prefs, which have been accumulating unpaid dividends for some; liquidation pref + accrued divs are now like $35/share, vs. a price of around $4. Weirdly, the common caught a low-float "Gamestop bid" and has gone up massively this year (co is really tin).

      There is new language in the most recent quarterly re: efforts toward refinancing of obligations, including prefs, and they note that they spent $400K on such efforts this past quarter, vs. $100K in the same quarter last year (this language is new too). Based on this, I am guessing they have advanced toward some solution for the prefs. Since they're trading under 1/8 of liquidation value, it seems like there's a lot of room for additional value to accrue to them even with a bargain-price exchange/other offer.

      Delete
    5. You find all sorts of interesting ideas, a quick look and this does seem interesting. No idea what the common is doing, but through the prefs you can basically create the owned portfolio of triple net leases for like a 13% cap rate? $7.8MM of rent in 2021. CTRE, old spin that is much higher quality obviously doing recent transactions for 8-11% cap rates. But my guess is they'll try a AHT style tender off, offer the preferred shareholders common and just dilute the hell out of the current common stock. Probably still works.

      Delete
    6. One thing that is a bit strange, the preferred stock hasn't nominated board members despite their right to?

      Delete
    7. I think in the pref you're effectively getting the portfolio at a cheapish price and with acceptable prospects for improvement, but that's not the main draw. Have checked in on this occasionally since the days when it traded as Adcare and they were trying to do in LTC what GPT did in industrial, which obviously didn't work, and I don't have that much faith in their ability to prosper, notwithstanding some poor luck and some sketchy now-ex management. But, yeah, the main thing is the pretty-good odds I see to get a well-below-par-but-above-market offer for the prefs to eliminate that overhang, which seems to be in the offing. So I think of it as more of good-odds trade (like CPTA) in a so-so co than anything long-term.

      The board thing is weird. I have seen that once or twice; wish I could recall the circumstances around thos instances. IN one case, the company was more or less begging pref holders to vote someone on, but shareholder interest was so low that eventually the co gave up trying to solicit.

      Delete
  4. For whatever reason, I am more sanguine on AAMC (though I don't own it right now), because I think I understand the path to value--which probably means I'm missing something.

    ReplyDelete
  5. I've been following the Medley situation for a couple months. I always believed their plan of reorg was never going to make it through. What I have been unable to figure out is if the Taubes are gone what stops them from canceling the managment contract at SIC once the baby bonds take over the equity. Chapter 7 seems like the worst possible outcome for the baby bonds, so even though the Taubes should be gone I believe the best outcome is to keep them involved because they basically control the contract at SIC plus 1940 act ownership reasons become questionable. Keeping the Taubes involved actually leads to the best outcome for the bonds.

    ReplyDelete
    Replies
    1. Thanks - I think I agree. Somehow need to thread the needle, presumably the SEC is why the Taubes gave up their CEO roles, need to keep them involved but give the bonds more of the equity, strike that balance to keep everyone happy.

      Delete
    2. I think with the Wells Notices that MDLY is destined for Chapter 7 regardless. They had a big client leave at the end of April, saying they wouldn't meet additional capital calls (which is a huge no-no as an institutional investor). It is also typical for pension funds and other institutional capital to have a redemption clause for when a manager or PM receives a Wells Notice (nobody wants to get sued for having given money to a crook or a potential crook).

      If MDLY gives up more equity to MDLQ/MDLX it'll trigger a change of control which requires Sierra to terminate MDLY. It's possible the Sierra Board retains MDLY again after the auto-termination, but why would the board risk being sued after being given a free pass with a manager that has received a Wells Notice?

      When all is said and done, MDLQ/MDLX will probably recover less than $2, if anything.

      Delete
    3. Good comment, you're probably right. The Wells Notice certainly brought the nuclear option into play where Sierra terminates and its all over.

      Delete
    4. Brooke Taube resigned from the board of Sierra Income. Not sure if there is much to read into it.

      Delete
  6. https://www.sec.gov/Archives/edgar/data/0001611110/000143774921013619/mman20210527_8k.htm

    Sierra Income exploring strategic alternatives, which might include terminating Medley, this is pretty speculative at this point.

    ReplyDelete
  7. AAMC up on volume. Searched, but can't find - did litigation settle?

    ReplyDelete
    Replies
    1. It was written up as a long on a subscription service, little bummed, I haven't bought any but agree that its an interesting situation if you can get lucky and time a preferred litigation settlement.

      Delete
  8. I sold my bonds this morning on the WSB pump, sometimes you get lucky, relatively small profit, but I'll continue to follow the story as its just a fascinating situation.

    ReplyDelete
  9. Aren't there other ways of sweetening the pie for MDLQ without giving control?

    ReplyDelete
    Replies
    1. There probably are but I'm uncertain if this can still be a Chapter 11, might turn into a Chapter 7, that's my main concern. Medley LLC owns some of SIC but that's really about it, and SIC is pursuing strategic alternatives which might lead to them cancelling the management agreement and it doesn't have a termination payment. Not much else left after that. Curious to see what the new plan looks like, not saying I'm staying away, still going to follow it but this WSB pump this morning seemed like a gift.

      Delete
  10. MDC, would also be interested in your thoughts on FVE. Stock is trading around $6.

    ReplyDelete
    Replies
    1. Funny timing, I did sell today. Its very cheap, but I just want to build some liquidity for other ideas and I don't like how management has never really laid out a clear capital allocation policy. They have too much cash, I'm worried they'll do a Portnoy classic where they buy some unrelated business with the excess liquidity, and collect the revenue share. The special sit that attracted me is over, was more than a double, have long term capital gains, just was time to move on for me. But still clearly cheap.

      Delete