Tucked deep inside a new regulatory filing, Prospect Capital Corporation (NASDAQ:PSEC) shed new light into its plans to spin off assets to shareholders.
Prospect Yield Corp. is the first and largest of the spinoffs. It owns Prospect Capital's CLO equity investments, which were most recently valued at $1.06 billion, or 16% of Prospect Capital's investments on its balance sheet.
A quirk in the spinoff
On Page 9 of Prospect Capital's recent 40-APP filing, the company said it might involve one or many "anchor investors" when it spins off assets to shareholders.
The relationship between the anchor investors and the spinoffs are described as follows (emphasis mine).
In conjunction with the rights offerings, the Company may select an anchor investor or investors that will purchase shares of the applicable NewCo in a private placement. Anchor investors, if any, will pay the same subscription price as the public; however, anchor investors will receive an upfront fee for the applicable rights offering in exchange for their upfront commitment to purchase shares. Further, anchor investors will sign a six-month lock-up agreement restricting them from selling such NewCo's shares. In the event that there are anchor investors, the applicable rights offering may be decreased by the amount of shares of such NewCo the anchor investors commit to purchase.
An example might help explain how this works. Suppose Prospect Capital finds anchor investors who will purchase 50% of Prospect Yield's shares at book value -- $530 million. To induce these anchor investors to participate, suppose Prospect Capital pays them an up-front fee of $79.5 million, or 15% of the purchase price.
This would leave the other 50% of Prospect Yield available to Prospect Capital's existing shareholder base. Those shareholders, however, would pay the full subscription price -- unlike anchor investors, shareholders won't get an up-front fee to buy the stock.
The net effect is that shareholders pay $530 million for 50% of Prospect Yield. The anchor investors pay $450.5 million after fees for the other 50%. In all, assets marked at $1.06 billion are sold for a total price of $980.5 million after fees, a 7.5% discount to book value.
The impact on shareholders
Involving anchor investors has some interesting consequences for Prospect Capital's shareholders.
In my example above, $1.06 billion of assets would leave Prospect Capital. In exchange, Prospect Capital would receive $980.5 million in cash less fees paid to the anchor investor or investors. The rights offering would invariably carry additional expenses that would further reduce Prospect Capital's total haul.
Thus, we can reasonably assume the result will be some book value erosion. Importantly, the spinoffs will not be "NAV neutral," as management previously suggested, if they include significant fees paid to the anchor investors.
I can't help but think that all this wheeling and dealing benefits the management team far more than it does shareholders. The management team gets the benefit of raising hundreds of millions, if not billions, of dollars in new fee-earning assets under management. And it all comes as a direct result of selling assets owned by its shareholders at a discount to book value.
Here's how I think this could play out: Book value per share goes down. Prospect's assets under management go up. The management team wins; shareholders lose. And it all gets obscured by a rights offering and the payment of a fee to anchor investors. What else is new?