SEATTLE--(BUSINESS WIRE)--The following letter was sent today to the Board of Directors of MCG Capital:
Attn: Charles Frischer
4404 52nd Avenue, NE
Seattle, WA 98105
June 10, 2015
Mr. Richard W. Neu
MCG Capital Corporation
1001 19th Street North, 10th Floor
Arlington, VA 22209
Dear Mr. Neu and members of the Board of Directors of MCG Capital Corporation:
I am a large shareholder of both MCG Capital and HC2 Holdings, Inc. I own 500,000 shares of MCG Capital, or 1.3% of the outstanding shares, and 1,804,000 shares of HC2 Holdings, Inc., or 7.1% of the outstanding shares.
I urge you to immediately declare the $5.30 stock and cash offer presented by HC2 superior to the offer from Pennant Park. This will force Pennant to either meet the HC2 terms or have MCG Capital move forward with the HC2 offer. The $5.30 offer presented by HC2 is $0.55 (11.5%) higher than the $4.75 Pennant Park proposal. In addition, the option to take either HC2 common stock or HC2 preferred shares provides MCG Capital shareholders with two excellent choices. The preferred share option provides MCG Capital shareholders with both an 8.125% yield on their investment and excellent optionality for significant upside, as HC2, under the leadership of Phil Falcone, continues to rapidly increase its intrinsic value. Given the strong demand for preferred shares in this low-interest-rate environment, I believe that these preferred shares will immediately trade at a premium to par and would be the likely choice of most MCG Capital shareholders. Based on the terms presented in HC2’s most recent letter, I would easily choose the preferred shares, and I am prepared to be a long-term holder of these shares. These shares would provide both a great source of income and significant upside potential as HC2 continues to create shareholder value.
I have reviewed the objections that management and your legal/financial advisors have raised regarding the proposal from HC2. I believe that many of these objections can be overcome if you actively engage in negotiating with HC2. Unfortunately, I also believe that some of these objections have been raised for the sole purpose of not doing a deal with HC2, regardless of terms and conditions. It appears to me that both Morgan Stanley and Wachtell Lipton are trying hard to kill the HC2 superior offer, versus working hard to deliver more value to MCG Capital shareholders by pursuing a superior offer from HC2.
In reviewing MCG Capital’s latest slide deck, which tries to outline the company’s reasons for not accepting the superior offer from HC2, you raise a number of objections, which I would like to address.
- Failure to Close Due to Regulatory Issues. The HC2 offer is 11.5% higher than the PFLT transaction. I am willing to lose 2 months of 8% income from PFLT to get 11.5% more from the HC2 transaction. Two months annualized is only 1.3% of lost income. That is a small price to pay to get 11.5% more proceeds and the potential for meaningfully higher capital appreciation due to the conversion option on the preferred shares. Since Phil Falcone took control of HC2, the shares have increased in value from $4.00 to $11.00. While past performance does not guarantee future success, Mr. Falcone has demonstrated a strong ability to drive significant shareholder value. The preferred shares give investors the ability to earn an 8.125% yield and the opportunity for considerably more upside if HC2 management can continue to deliver excellent returns. The management team at MCG Capital must review both the downside and upside of a potential deal with HC2. This point on the slide deck clearly ignores the significant positives of doing a transaction with HC2.
- Failure to Obtain HC2 Shareholder Approval. While I can only speak for myself, I can publicly state that based on the terms outlined in the most recent HC2 letter, I would vote 100% of my HC2 shares in favor of this transaction. While I have not polled other HC2 shareholders, I am extremely confident that the vast majority of the HC2 shareholders would likewise vote in favor of this transaction.
Failure to Obtain MCG Shareholder Approval. MCG Capital’s
management team has shown an unexplained reluctance to negotiate with
HC2 and to declare the HC2 bid superior to the existing Pennant Park
bid. MCG Capital management team’s lack of engagement with HC2 is not
conducive to getting shareholders the best offer. The team at MCG has
been unwilling to reach out to HC2 to obtain clarification on simple
matters such as the payment of the break-up fee. At times it seems
personal interests may be taking priority over getting the very best
deal for MCG shareholders.
In light of this behavior on behalf of MCG Capital management and Pennant’s inferior offer, I believe that Pennant Park’s proposed transaction will likely be voted down by MCG Capital shareholders. For my part, I plan to vote 100% of my 500,000 shares against the existing Pennant Park proposal. The proposal from Pennant Park essentially pays the MCG Capital shareholders $4.75 in stock for $4.75 in mostly cash assets. I am not afraid of losing a deal with virtually no premium to our NAV. Therefore, the easy decision for me is to vote no in the event the Pennant Park deal is put to shareholders. MCG Capital can do better, and the deal proposed by HC2 is far superior to the current proposal.
- Termination Due to HC2 Covenant Breach. In my opinion, the HC2 transaction has no termination risk under this section because HC2 is not about to break any of their loan covenants during the next 2 to 3 months. This is just another attempt to throw meaningless obstacles in the way of a superior transaction. HC2 will be adding a meaningful amount of cash to their balance sheet if his deal is approved. Why would HC2 lenders even conceptually declare a covenant breach prior to such a positive transaction? This is simply not going to happen and therefore is not a credible risk to a transaction with HC2.
- Termination Due to HC2 Stock Price Drop of 30% or More. Once again, MCG Capital appears to have taken a most draconian approach to the HC2 proposal. While any stock drop is possible, a 30% stock drop is unlikely, especially since HC2 would be taking over a company with more than $145 million in mostly cash assets. MCG Capital also has significant risks if Pennant Park shares drop. Once again, MCG Capital is viewing the HC2 transaction only from a worst-case scenario. If HC2 stock goes up more than 20%, the MCG Capital shareholders would earn additional proceeds from this transaction. No mention of such potential upside is described in the most recent MCG Capital slide deck.
- Operating Covenants. MCG Capital should not limit HC2 from entry into new lines of business or acquisitions prior to closing. HC2 has executed on a number of important acquisitions by moving decisively and quickly. This has allowed HC2 to add valuable businesses such as Schuff and Global Marine before other competitors could place a competing bid. Limiting Mr. Falcone’s ability to do a potentially excellent acquisition during the 2 or 3 months between approval of a deal and the close would hurt both existing HC2 and future HC2 shareholders from the MCG Capital transaction.
Overall, the management of MCG Capital has a fiduciary responsibility to run a smart and fair process in the sale of this company. The HC2 proposal is excellent, and the company should notify Pennant Park of the receipt of a superior proposal. MCG Capital management may think that because I am a large HC2 shareholder, my views are subjective. That would be unfair. Phil Falcone has done a great job creating shareholder value at both HRG and HC2. He will have the ability to continue that value creation with the funds obtained from an acquisition of MCG Capital. The preferred share structure gives MCG Capital investors the opportunity to benefit from a high yield instrument and provides for significant upside potential. The terms and conditions proposed by HC2 are both superior to the Pennant Park deal and undeniably fair to MCG Capital shareholders. I ask that you immediately enter into serious negotiations with HC2 and move forward to closing.
GP, LF Partners