In an 8-K on July 6, 2017 MVC Capital (MVC) confirmed the previously announced sale of its affiliate U.S. Gas and Electric (USGE) had been completed on July 5. Here are the details, our analysis of the likely impact of the USGE transaction on investment income and earnings over time; the BDC Reporter’s own mixed view of MVC’s prospects and a disclosure about our own exposure:
MVC has received the following :
“gross consideration for its investment in USG&E valued at $128.1 million, including $11.0 million for the repayment of its two outstanding loans from MVC. The fair value of the consideration received by MVC for its equity investment in USG&E is $116.4 million (excluding any illiquidity discount for the securities received) in comparison to the last publicly reported fair value of $89.4 million, as of April 30, 2017. As a result of the gross consideration received, MVC anticipates a realized gain of $115.9 million, excluding all fees and distributions received since its initial investment in 2007. The $116.4 million is comprised of: (i) cash of approximately $50.0 million ; (ii) 9.5% second-lien callable notes due in July 2025 with a face amount of $40.5 million (before certain post-closing and indemnification adjustments, if any) ; and (iii) 3,282,982 Crius trust units ( currently yielding 7.5%) valued at approximately $25.9 million”.
Otherwise, the 8-K was short on further details, referring readers to prior disclosures.
There are numerous moving parts to consider in order to evaluate the impact of the USGE proceeds on MVC’s Investment Income and Net Investment Income going forward.
First, there will be taxes to be paid in installments (given the sale of USGE is essentially being paid out over time).
Seeking Alpha author Richard Lejeune has sought to quantify the special capital gain tax distribution to be paid out to shareholders at $0.91 a share or $21mn.
If true, that will leave MVC with approximately $107mn.
Sources Of Income
As we see above, $26mn will be in Crius “trust units”. These are dividend paying, and should generate about $2.0mn a year for MVC.
With a lock-up period on the units already invested, that’s likely to be a steady source of cash for a couple of quarters at least, unless something untoward happens to Crius.
Then, the $41mn in Second Lien Callable Notes will generate $3.8mn in annual income. We assume MVC will hold on to this debt (or may be obligated to) for the foreseeable future.
Finally, after taxes are paid out (good for shareholders, less good for the balance sheet) there will be $40mn in cash to re-invest, presumably principally into income generating loans. At a 10.0% pro-forma yield that $4mn a year in hypothetical dollars.
In toto, and for a period, MVC should be able to generate – once all the capital has been re-deployed- nearly $10mn a year of investment income.
That’s a very big number for the BDC whose last quarterly earnings report, as discussed by the BDC Reporter on June 9 2017, boasted only $3.9mn of Investment Income (or $15.6mn annualized).
Moreover, when PIK income is deducted and after all expenses (including generous waivers from the Investment Advisor) the net cash loss was ($2.7mn) for the quarter and ($10.8mn) annualized.
The bottom line: the USGE sale is MVC’s chance to get to operating break-even.
The downside is that a quarter of cash Investment Income will be coming from junior investments in Crius.
We’ve pointed out in earlier posts that MVC is an atypical BDC and the Investment Advisor has been making slow progress in becoming a “normal” BDC lender.
The successful sale of USGE is a big step forward in diversifying the portfolio and reducing reliance on USGE from an income point of view.
This was a move that needed to happen.
Last fiscal year, USGE represented one-third of total Investment Income.
In the fiscal year before USGE did not make any distribution to MVC and the BDC’s Investment Income was a third lower.
That’s not a sustainable business model by BDC standards, even though MVC has been dodging and weaving and staying alive longer than most every other BDC.
However, MVC will initially be moving from the fryer to the pan, given the still heavy reliance on Crius, instead of USGE, for its Investment Income.
Question Marks All Over The Place
Moreover, as we illustrated in our June 9 2017 review of MVC’s investment portfolio, many questions remain about the viability of several investments.
By our count, out of 29 portfolio companies (not including USGE) 11 may be worthless or close to and generating no investment income.
Moreover, with the jewel in the crown (USGE) sold, there are precious few equity upsides left in the portfolio to temper the large number of weaker credits.
Overall MVC remains a work-in-progress and still heavily weighted to a few investments and not even consistently at cash break-even of a recurring earnings basis, even after the USGE sale.
Investors may rush in to get the potential capital gain dividend only to find that they can’t get out so easily.
With the USGE transaction already in the rear view mirror, the future valuation of MVC will depend principally on its credit deployment and performance going forward.
And to whatever happens – for good or ill- to Crius Energy Trust in the next few quarters.
By Nicholas Marshi, BDC Reporter