Bare-knuckle tactics used in hostile takeovers seldom make it to the world of private lending to small American firms. Until now.
Highland Capital Management is seeking to oust two directors at Medley Capital Corp., a business development company it holds a small stake in. MCC is controlled by the Taube twins, Seth and Brook, who are trying to merge it with their other companies amid a stark decline in its performance. Highland says the plan is highly flawed.
Highland’s more aggressive steps — which include a proposal to run MCC — may prompt better governance and improve shareholder rights in the BDC industry, where significant growth has drawn concerns about excessive risk taking. Business development companies now manage more than $90 billion. They’ve been able to proliferate because they can generate high income for their mom-and-pop investors by lending money to smaller businesses.
“There has been an uptick in shareholder activism in the BDC space in the last three to four years,” said John Mahon, a partner at Schulte Roth & Zabel LLP. “Highland’s proxy move is a new step in activism in its aggressiveness. If Highland succeeds, that could bring more activism to the BDC world.”
Highland’s battle, undertaken through its NexPoint Advisors LP affiliate, follows efforts by FrontFour Capital Group, a larger shareholder in MCC. Connecticut-based FrontFour in December objected to the Taubes’ proposal to combine MCC with companies they also control, Sierra Income Corp. and Medley Management Inc. which it had outlined in August.
FrontFour’s arguments have included that the merger transfers $120 million away from shareholders, based on MCC’s stock price drop after the deal’s announcement. FrontFour took the matter to the Delaware Chancery Court, which agreed with FrontFour’s claim that the MCC directors, including the Taube brothers, breached their fiduciary duty in approving the merger. The court noted the BDC’s 85% plunge in net investment income since 2014.
“In this case, the timing, structure, initiation and negotiation of the Proposed Transaction were conceived for the purpose of — and did — advance the Taubes’ interest at the expense of the Medley Capital’s other stockholders,” the court said in its decision.
Settlement Reached
MCC and FrontFour reached a settlement in April whereby MCC agreed to amend its transactions to include a go-shop process. That means it has to solicit superior proposals to the merger. Under the settlement accord, two FrontFour employees were appointed to the board to replace John E Mack and Mark Lerdal, who had resigned — after getting a scathing assessment of their behavior by the court. (Mack is not to be confused with the former Morgan Stanley Chairman and Chief Executive Officer John J Mack.)
In response to a Bloomberg News request for comment, Lerdal disputed the court’s depiction of his performance. “I believe I was independent in all regards,” he said.
Highland now aims to take it further. It wants to appoint two directors to the board, resulting in the ouster of Seth Taube and Arthur Ainsberg, and the appointment of Stephen Mongillo and Mark Goglia. It argues that the continued presence of five of the original board members jeopardizes shareholder interests, by risking deadlock. It also makes the acceptance of alternative proposals unlikely, Highland said in a May presentation.
Institutional Shareholder Services and Glass Lewis, two shareholder advisory firms, recommended that investors vote for Highland’s directors, according to a statement from NexPoint on Friday. The Dallas-based money manager isn’t seeking to take over the BDC but wants to manage the vehicle –a role that can earn lucrative fees.
Interest in alternative transactions had already emerged, including from ZAIS Group Holdings, Origami Capital Partners and Marathon Asset Management. Those were considered but ultimately not engaged with, according to the court’s verdict in March. In fact, in one text to Brook Taube’s cellphone, MCC director Lerdal asked if they had to respond to “every f*cksake on the planet.”
Acquiescent Group
BDC shareholders tend to be an acquiescent group mainly of retail investors. While many of the small-business lenders are publicly-traded, regulations capping ownership to 3% made it harder for holders to galvanize for change. Efforts are underway to change that, however, and the SEC sought comments on amending the rule later last year.
Shareholder activism has happened before in the BDC space. In 2015, private equity giant TPG via its BDC successfully helped block the sale of another BDC investment adviser– which NexPoint also objected to. The following year, it sought to fire a manager at a BDC is held shares in– although that plan ultimately failed. TPG’s 2015 scuttle helped alter how BDC M&A has been structured, by lifting shareholder expectations of what they should receive, according to Schulte Roth & Zabel’s Mahon. But investors are getting even more aggressive now.
Thomas Surgent, a partner and chief compliance officer at Highland Capital Management and NexPoint, cited a misalignment of interests and the influence of entrenched insiders on the merger deals.
“Our interests are completely aligned with stockholders, because our goal in this election is simply to ensure that there is an even playing field for all participants in the go-shop process,” he said.
A representative for New York-based Medley Capital declined to comment. FrontFour didn’t immediately respond to request for comment.
If such efforts, including Highland’s proxy bid, lead to a better outcome for Medley shareholders, they may lure more institutional investors to the industry, according to Mitchel Penn, an analyst at Janney Montgomery Scott LLC.
“These situations regarding activism teach and educate the market,” he said. “The BDC space is evolving and investors are becoming more sophisticated.”
Highland asks for votes to be received by June 3 following an annual meeting the next day.
