Activism is rarely pretty. Time-consuming and expensive, campaigns aren't always successful. But if there were one activist battle that should be a slam dunk, it's the one that's soon to start at Fifth Street Finance Corp. (NASDAQ: FSC).
I can think of few companies in greater need of an activist. Since its IPO in 2008, Fifth Street Finance has generated a negative annualized return, dividends included, according to LongRunData.
Even if we give the company the benefit of the doubt, and say that share price movements aren't representative of a company's true performance, it's difficult to make the case that Fifth Street Finance has been anything but disappointing.
Fifth Street Finance has incinerated its shareholders' capital, posting realized losses in all but one full fiscal year as a public company. (In addition to net realized losses of about $180 million over its corporate history, net unrealized losses tally up to nearly $161 million.)
Its performance mirrors that of pre-financial crisis business-development companies (BDCs) despite the fact it wasn't around to underwrite the frothiest deals of the pre-crisis period.
Like all BDCs, Fifth Street Finance is a jockey play. It's a bet on a management team. And if historical performance is any guide, this management team has consistently generated realized capital losses, destroying capital and future earnings power. Most importantly, because of a problematic fee agreement, Fifth Street Finance's external manager does not feel the pain for poor underwriting decisions.
But you don't have to take it from me. KBW analysts recently wrote in a note to investors that "activist investors have been publicly calling for change, and we believe shareholders should vote to terminate the external management agreement and replace the manager."
Earlier in 2015, on a conference call for TriplePoint Venture Growth, another analyst said, "I wouldn't trust [this] BDC to underwrite a sponsor loan, much less a venture debt deal; I don't think they have the expertise." It's easy to infer from the discussion that he was, in fact, referring to Fifth Street Finance. For the record, sponsor loans are Fifth Street Finance's bread and butter.
Picking a new jockey
In a binding vote, shareholders will have the opportunity to terminate the agreement between Fifth Street Finance and its current manager.
Activist investor RiverNorth has pushed for the change, but it won't be easy. Though RiverNorth has a sizable economic stake, much of it appears to be in the form of derivatives. Thus, the activist controls about 5.9% of the vote when derivative investments are backed out.
Meanwhile, the current CEO of Fifth Street's external manager, Len Tannenbaum, has increased his stake in Fifth Street Finance. He recently purchased more than 2.2 million shares, likely in an attempt to corral voting power and keep the BDC under his management. A recent SEC filing suggests he and affiliated entities control about 8% of shares outstanding.
As for who owns the remaining stake, it's not exactly knowable. Morningstar data suggests institutional owners controlled more than 52% of the company as of the most recent reports, but ownership data is already stale by the time it is reported. It's quite possible that many owners have since sold out.
Fifth Street Finance is worth something. It's probably not worth its recent net asset value of $8.41 per share in a liquidation scenario. But under different management, and with a better fee agreement, I find it difficult to argue the case it's worth less than the $4.60 price at which shares currently trade. Conversely, under the status quo, it's hard to argue its worth much more.