Last week, Ares Capital Corporation held its annual investor day conference to speak directly to analysts and investors about its business. These conferences generally stick to a script -- Ares obviously wants to spend its time talking about Ares -- but one analyst used the last few minutes to ask about its opinion of the proxy battle at TICC Capital (NASDAQ: TICC).
I'm glad he asked. Ares executives are probably the best people to ask. After all, Ares Capital completed the largest BDC acquisition ever when it acquired Allied Capital in 2010. Of course, it did so on friendly terms. There certainly weren't three different proxy cards being passed around to count shareholder votes, like we see at TICC today.
Ares acquired Allied in a stock-for-stock deal at a price below Allied's book value. TPG Specialty Lending (TSLX 0.86%) is offering TICC a similar deal, one paid for in stock at a discount to book.
Is this the future for BDCs?
Most BDCs, even Ares, currently trade below net asset value, or book value. A very small minority trade at a premium. It seems natural to assume that the highly valued BDCs could start rolling up the sector in stock-for-stock transactions. Issue stock valued at 1.1 or 1.2 times book to buy up competitors for 0.8 or 0.9 times book. That's a recipe for serious wealth creation for shareholders.
That's the basis for what an analyst asked Kipp deVeer, an Ares partner and co-head of its Direct Lending Group.His answer explains a few of the issues that might put a twist in any acquirer's plans.
One of the issues that we have as we look at consolidation, is folks say, "You guys are an experienced acquirer; we think you're a steady hand; why wouldn't you go in and find a $300 million asset BDC that was trading at 0.7 times book and offer them 0.9?"
No. 1 -- it's a mess, which we're watching right now.
No. 2 -- making 10 points on $300 million of assets is immaterial to our company for the effort that we'd have to put in.
No. 3 -- I think the likelihood of succeeding is mediocre because, even as it relates to TICC, we have a board -- a couple of our board members are in the room today -- when we go to them every quarter and we tell them that NAV is NAV, they believe us, generally. So, if we went to our board and said, "We'd really like to sell our company at 0.9 times book; what do you think about that?" I would hope our board would say, "You're fired; we're going to bring somebody else in to liquidate your portfolio at NAV, because that's what you told us it was worth."
It's a really unusual transaction that we're watching occur...It'll be interesting to see if a more difficult market -- i.e., where folks are actually realizing losses and having problems extending credit facilities -- creates consolidation. You know, we like to buy things cheaply, so things are cheap now, but there's no real path to getting things done, I think is my own personal view, without breaking a lot of china, and I'm not sure we're there yet.
"Breaking a lot of china"
DeVeer explains the challenges of TICC Capital's board of directors really well. On one hand, there are conflicts. TICC is pushing really hard to turn the company over to Benefit Street Partners, which, depending on how you look at it, might not be the best deal for shareholders.
On the other hand, TICC Capital is a healthy company insofar as it isn't facing any big challenges in credit quality or funding its balance sheet. Thus, selling out at a discount to book will obviously raise some question marks. TPG Specialty Lending offered to pay about 0.87 times TICC Capital's last reported book value to acquire the company. (TPG Specialty Lending may have been willing to pay more; we'll never know, since TICC effectively shot down any deal discussions with TPG. Besides, with no other bidders in the ring, I think it's fair to say TPG has no reason to make a better offer.)
I think the major takeaway here is that barring real stress in the industry -- Allied Capital's bondholders were ready to yank their investment in the company before it agreed to sell to Ares -- deals probably won't get done. The incentives are poor. Atop most BDCs are entrenched management teams who make obscene amounts of money clocking in to work every day. Why give up a paycheck unless you're almost certain to lose it anyway?
The decision on what's to come at TICC Capital will have to come by a color-coded vote by its shareholders. But if anyone was expecting that hostile takeover attempts would become the new normal in BDC land, it appears that answer is a resounding "no."