After the close on May 30, 2017 MVC Capital (MVC) announced a drastic switch in its complex plan, discussed on the BDC Reporter on May 17, 2017 to merge U.S. Gas & Electric, Inc. with Equus Total Return, a dormant BDC which MVC controls.  Here are the initial details analyzed by the BDC Reporter within two hours of the release:

SURPRISE !

Apparently, a buyer has stepped up for U.S. Gas & Electric (USGE) who is prepared to pay more than what the parties would have received under the prior multi-step plan and in a very short period and without the time absorbing “financing contingency” involved in so many deals. The buyer is Crius Energy Trust, also a public company trading on the Toronto Stock Exchange, which bills itself as “one of the largest independent energy retailers in the United States, providing electricity, natural gas and solar energy products to more than one million residential and commercial customers”. Crius Energy Trust has the ticker KWH (clever !) and traded down on the news.

CASH AND PAPER

On paper, Crius is paying a decent amount for USGE: $172.5mn, as well as the repayment of all debt and all transaction costs. However, as the press release shows, only about 50% of consideration is in the form of cash to the electric company’s shareholders or $95mn. The rest is in the form of $47.5mn in Crius Notes due in 2025 bearing interest at 9.5%, and which may be called before maturity. Then there’s $30mn in Crius Trust Units , with a value of $30mn, and which are currently yielding 7.5%. Importantly to MVC, the lock-up period for these Trust Units will be a relatively modest 6 months.

SOME ARE MORE EQUAL THAN OTHERS

MVC’s own benefit from the sale of USGE sums up to $128mn, which consists of its pro-rata share of the consideration being offered, plus two Notes and “deferred consulting fees” being repaid. That’s 28% better than the valuation of USGE on MVC’s books as of January 31, 2017. Curiously, the new deal is not compared with the not-so-old deal of a couple of weeks ago.

EXPEDITED

The chances of this transaction going through appear high, given the absence of a need to arrange financing. (You could argue USGE is providing half the capital itself given the willingness to accept second lien notes and Trust Units).

PAYMENT IN STAGES

For MVC shareholders this will be the gift that keeps on giving in that a portion of the proceeds will be received upon closing; the Trust Units might be sold after 6 months or years down the road and we have no idea if there will be any lock-up for the second lien Notes. However, even if the new debt and Trust Units being added to MVC’s investment portfolio do not immediately turn to cash, the BDC will be gaining a substantial amount of additional, and predictable, income from Crius.  Our back of the envelope calculation suggests MVC will add nearly $6,000,000 in investment income, even before any calculation is made for the re-investment of the equity cash proceeds, repaid notes and consultancy fees. For a BDC which has been attempting to make the transition from an equity orientation to an income orientation, this must feel to management as the right step forward, especially as that income might begin to flow in as early as July.

LEFT AT THE ALTAR

No word, though, on what happens to Equus Total Return, and its non-MVC shareholders, just weeks after being told a merger with USGE, under MVC’s umbrella, was about to occur. Here is a link to an article from Seeking Alpha by Thomas Hughes who has been following the microscopic BDC for some time and who’s headline on April 27, 2017 was “Well, It’s About Time”.  Apparently, MVC has un-rung the bell and all Equus gets is a $2.5mn termination fee. (Some of that indirectly inures to MVC which appears to be the Big Winner in this deal). The BDC Reporter assumes we’ll be hearing of some new scheme for EQS down the road. Being realistic, there may be some lawsuits involved, given the last minute change of heart, which we’ll keep an eye open for.

CONCLUSION

It’s too early to say definitively that this is a plus for MVC shareholders. The BDC Reporter will have to spend more time on the Crius Energy Trust publicly available financials, as well as review the prior transaction to compare and contrast. However, judging by the lateness of the hour; the statements by MVC’s CEO in the press release and a first look at the numbers, we get the impression this will be one in the Win column for a BDC that’s had many reverses of late. The stock price, as this chart shows, has dropped nearly 50% in the last few years. Even the news of the prior spin-off of USGE into Equus failed to excite investors, judging from this 1 month stock chart. At the open on Wednesday, we’ll be curious to see what the reception to the Crius deal is like.

Next week I’ll write Part II of The Big Picture: The Biggest Threat To The BDC Sector.