Nicholas Marshi
October 07, 2016
Ex-Private Equity Manager turned Hedge Fund Manager

Full Circle Capital: Shareholder Letter to Board

October 7, 2016: The BDC Activist reviews Sims Capital Management's latest letter to Full circle's (FULL) Board, and has a few comments about the possible way forward.
  • October 7, 2016: Two days ago, one of the largest shareholders in Full Circle Capital (FULL) re-iterated opposition to the proposed merger with Great Elm Corporation.
  • Sims Capital Management (“Sims”) wrote to the Board of FULL, following up on prior correspondence in which complaints had been made about many aspects of the deal.
  • The BDC Activist reported on an earlier September 7th  inter-action between Sims and the Board and provided some context in an earlier post.
  • One of Sims key concerns has been the questionable value of the Avanti Communications bonds that MAST Capital is planning to contribute to the merged entity.
  • We have been commenting on the Avanti assets-which will be a major portion of Great Elm’s total portfolio when the dust settles. See here , here and most recently here, when Avanti received the accolade of “riskiest public company in the world”…
  • satellite-in-space
  • Sims’s latest letter to the Board-which has never responded to the best of our knowledge-was all about Avanti. Sims claims the Consent Solicitation we cited in our most recent post did not succeed and “ the Senior Debt is now in default “. [The underline is in the original].
  • The letter helpfully goes on to remind FULL’s directors that MAST Capital proposes to contribute $55mn of Avanti Notes to Great Elm, 61% of their total contribution.
  • The BDC Activist has been pointing out for some time that MAST Capital has a major position in the Avanti Notes AND owns a portion of the equity, setting off obvious conflict of interest alarms bells. At least to us. And Sims.
  • The October 5 letter, though, fills in some of the blanks about who owns what and how much. Apparently-and we’re quoting from what Sims is saying: MAST Capital Management and unaffiliated Solus Alternative Asset Management, hold $385mn of Avanti Notes, 60% of the total. In addition, MAST is also a 10% owner of Avanti’s stock.
  • With Avanti clearly in trouble, creditors and shareholders will have very different interests going forward, as Sims points out.
  • The activist shareholder has a very clear message for the FULL Board: use the Avanti default as an opportunity-in line with the terms of the Merger Agreement-to cancel the transaction and “walk away”.
  • The letter then mentions a couple of other previously discussed conflicts of interest surrounding the transaction including the “consulting agreements” between the current managers  and Great Elm, and the fees received and to be received by Houlihan Lokey while one of its representatives is on the Board of FULL.
  • Sims asks the rhetorical question: “who is looking out for FULL shareholders ?”
  • The answer, according to Sims-and consistent with prior communications-is to duck the merger and proceed with a liquidation of FULL’s assets. Here we quote from the cover letter that accompanied the letter to the Board:
  • SCM [Sims Capital Management]  believes that Fund shareholders will be better served by turning down the Proposed Merger, and then proceeding to liquidate the Fund. (We acknowledge the fact that liquidation will result in the destruction of the value of the Tax Losses, but we have not been successful in getting the Special Committee or the entire Fund Board to address this issue.) SCM does not necessarily believe that liquidation is the best option available to the Fund and its shareholders, but believes that it is far preferable to the Proposed Merger.
  • SCM goes on to put a dollar value to shareholders from the liquidation strategy: SCM believes that [FULL] Fund shareholders should receive a minimum consideration of Fund NAV as of June 30, 2016 ($3.59 per share), plus a pro rata share of the Fund’s net investment income from that date to the date of liquidation. Based upon its recent financial performance, the Fund has been generating positive net investment income.
  • Sign roads going two ways
  • This is where Sims and the BDC Activist part ways. We too have reviewed FULL’s latest financial performance, and it’s a very optimistic investor who will count on getting $3.59 a share (plus Net Investment Income) from selling off the assets. The BDC Credit Reporter spent a few hours dissecting the portfolio a few days ago.
  • Not to re-invent the wheel, we’re going to quote from a response to a reader by the BDC Credit Reporter on Seeking Alpha when we commented on FULL’s recently published 10-K . The reader thought FULL’s portfolio not so bad. We differed and gave the following analysis: “With all due respect, FULL’s portfolio IS very troubled, which is exactly why the Company is in this bind. Some facts: Despite writing off $23mn in assets last year, or nearly 20% of equity capital at par, the remaining portfolio is valued at $81mn, but has a cost of $96mn at June 30, 2016. That’s already $15mn in Unrealized Write-Offs. With aggregate Realized Losses of $33mn so far, if those $14mn get written off as well, Total Realized Losses over the relatively short history of this BDC will be $47mn. That’s nearly 40% of every dollar of capital invested in by shareholders.

    Yet, it gets worse: Of the remaining 22 company portfolio (we are not counting an investment repaid subsequent to fiscal year end), of which there are 19 loans and 3 equity only investments,there are 5 borrowers on Non Accrual. Those 5 loans still have a value of $8.3mn at June.

    Sadly, one of those borrowers went on non-accrual as recently as mid July (Luling Lodging). See Note b8 in the 10-K.

    Of the 14 loans still Performing there are other difficulties.The PEAKS-Trust 2009 collateralized Note obligations has to be on anyone’s worry list. The Note is secured by student loan receivables from former graduates of ITT Educational Service s. Very recently ITT filed for bankruptcy (Chapter 7-the bad one) in a very high profile case and many unhappy students are ganging together to refuse to make payments on their student loans, claiming they were defrauded. So no ITT guarantee on the Notes and they have dropped to 71% of par in value at the end of August, from 84% in June. The Company does not expect the value to drop more. Would you be so optimistic ? We are not.

    Then are two loans carried as Performing but which are paying only in Pay In Kind. Selling Source has $4.1mn at Cost and is valued almost at par. However the 17% interest rate is paid only on paper. Likewise with US Shale Solutions (the name alone wants to make us put them on a Watch List) which has two loans with a cost of $3.6mn, but all the interest is PIK or “Non Income Producing” as per the ** in the notes section. Hard to be sanguine on recovery when you see the $4.2mn in equity invested in US Shale marked at zero as of June.

    We are also skeptical of the loans to Pristine Environment, all carried at full value and with a cost of $10.3mn. We’re nervous because the loans bear a very high interest rate. Even the Revolver is at 15% and a Term Loan even higher. In this environment companies don’t pay such huge rates unless there’s something wrong.

    Bottom line, there are only 10 loans on the books without a Non Accrual, or PIK income or an abnormally high rate or something (and that includes a wireless operator in Puerto Rico, which we have on our Watch List). Adding them all up at June Fair Value, these 10 have a value of about $50mn by our count, which is under $2.2 a share, while the Company’s stated book value as per the 10-K is $3.59 a share.

    Given all the above, we have to reaffirm that the BDC Credit Reporter believes the FULL portfolio is in very poor shape, and seems to be getting worse since fiscal year end. .. In fact, we’re wondering if even the current stock price of $2.64 (a 32% discount to book) may seem a little steep when all the chickens come home to roost. We re-iterate that we no position in either FULL or FULLL (the Notes) and all this pessimism comes from a close reading of the publicly available-but very dense-information. Readers should take it in the spirit it is intended: as a heads up”.

  • We don’t disagree with Sims that going ahead with a merger where much of the portfolio contributed is in Notes that appear to be in default and trade at a 22% discount to face value (when we just checked using Advantage Data’s real-time system) and with a team that includes many of the individuals who brought about the implosion of the Company. Plus, Great Elm have not helped themselves by leaving completely unclear how the new merged company makes the transition from the holder of a small portfolio of mostly troubled and illiquid loans and bonds-many of which will require intensive care for months to come-to a “normal” BDC throwing out a steady distribution.
  • Moreover, after reading the recital in the Proxy about the sales process for FULL we have no illusions that there are many buyers with open cheque books lining up to buy its rag tag assortment of assets at anywhere close to book value, especially as credit quality continues to be on the descent in some cases.
  • On paper, liquidation is the best alternative amongst the unpalatable choices available. However, if that should the course that FULL’s Board should suddenly choose in response to Sims entreaties, shareholders should not kid themselves that they will be ending up with $3.59 a share plus profits. We don’t even agree-after an initial review-that the BDC is making any money on a cash basis. With high legal bills (a merger and lawsuits to fight), 5 non accruals, possibly more on the way, much income in PIK form that may never be collected, and the Investment Advisor charging full freight again (after promising to waive much of the compensation), we are not as sanguine as Sims. Let’s not forget that the FULL Notes will need to be paid off, and staff retained at high cost to liquidate the Dirty Dozen of under-performing assets.
  • As we write this the FULL stock price is at $2.70.  If Mr Market knows all, that suggests book value is a pipe dream. Even if the “real” value is somewhere between these two numbers, we would guess that it’s closer to the stock price than the June 30, 2016 book value. Not a pretty picture.
  • Plus, we have to ask this question to Sims : Who’s going to do the liquidation work ? A Full Circle Investment Advisor who fessed up to the Board recently that they needed to get paid again because they didn’t have the resources to continue otherwise (it’s in the Proxy) ? A third party ?
  • full-disclosureDisclosure: We have no position in Full Circle Capital or any of the participants in this transaction.
  • FULL

 

 

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