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 26, 2015
Mr. Richard W. Neu
MCG Capital Corporation
1001 19th Street North, 10th Floor
Arlington, VA 22209
Dear Mr. Neu and the Board of Directors of MCG Capital Corporation:
I am a large shareholder of both MCG Capital and HC2 Holdings, Inc. I own 731,000 shares of MCG Capital, or 2.0% of the outstanding shares, and 1,804,000 shares of HC2 Holdings, Inc., or 7.1% of the outstanding shares.
I once again 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 cents, or 11.5%, higher than the $4.75 Pennant Park proposal. I also want to reiterate that I plan to vote “No” for the Pennant Park proposal, even if no deal with HC2 can be reached.
The purpose of this letter is to outline an alternative strategy that will provide the best possible outcome for MCG shareholders. Since my June 10th letter, HC2 has twice updated their unsolicited offer. HC2 is now offering to pay not only the $7 million breakup fee owed to Pennant Park, but also more than $13 million in additional costs in cash if a deal cannot be closed with the company. Given that MCG Capital cannot shop this deal subject to the terms of the Pennant Park-MCG Capital merger agreement, MCG will not be able to finalize an agreement with HC2 until you declare that offer superior to the existing Pennant Park transaction.
The management of MCG Capital should declare HC2’s offer superior and move forward to finalize negotiations. If the HC2 offer does not close for any reason, the company has many other options available that make it a far superior offer to the Pennant proposal. Accretive Capital has proposed an alternative transaction in which they would manage the assets of MCG at a cost of 75 basis points per year, and under their proposal, the company could use up to $233 million in capital loss carryforwards against future gains in the investment portfolio. I think there is an even better strategy.
MCG Capital should immediately move forward with HC2. If that deal cannot be closed, then MCG Capital should invest 100% of their cash assets into the Vanguard Admiral S&P 500 Index fund, which has an annual management fee of 5 basis points.
A publicly traded MCG Capital, invested entirely in the Vanguard S&P 500 index fund with more than $233 million in capital loss carryforwards, would likely trade at a premium to NAV and would offer MCG Capital shareholders an investment option far superior to the Pennant Park transaction. The company would also have outstanding liquidity, because this investment could easily be sold with 24 hours notice to Vanguard. No such liquidity is available with a portfolio of floating rate business development loans. The Vanguard S&P 500 Index is preferable to the Pennant transaction even without the carryforwards. The potential to use some or all of the carryforwards make it that much more compelling.
Assuming a 30% combined effective tax rate, the $233 million in capital loss carryforwards could be worth a nominal $70 million, before discounting that amount back with a net present value adjustment. Assuming a 50% net present discount, those carryforwards could produce up to $1 per share in additional value to MCG Capital shareholders over the next 4-5 years. This is a viable and excellent strategy. It is low cost and prudent, and it provides an extremely attractive alternative to the MCG Capital transaction with Pennant Park. We would also have the ability to buyback shares in this publicly traded entity, if for some unlikely reason, the shares traded at a discount to NAV. The company can also place ownership restrictions moving forward if necessary to protect our loss carryforwards. A completely liquid investment in the S&P 500 is far more attractive than owning 46% of a floating rate business development loan portfolio. The proposal by HC2 offers an 8.215% yield, an 11.5% premium to the Pennant proposal, and meaningful upside via the conversion option in the preferred security being offered.
The Board of MCG Capital is concerned that HC2 won’t close on the transaction. I suggest the Board can move forward without 100% certainty with HC2. This is because an even better alternative than the Pennant Park deal is readily and immediately available in the event HC2 cannot close. As an owner of 2% of the outstanding shares of MCG, I ask that you consider this strategy as outlined.
While MCG Capital was created to provide income to its shareholders, the Board should not move forward with an inferior offer in an attempt to provide dividends to shareholders. The HC2 offer provides both income and capital appreciation, and the Vanguard S&P 500 alternative provides outstanding tax sheltered investment opportunities. The Pennant Park transaction is a far distant third choice. MCG Capital should take HC2’s $20.5 million and work toward closing a transaction with Mr. Falcone. If you can’t close with HC2, an outstanding alternative is available to the MCG shareholders. I trust you will give this your full consideration.
GP, LF Partners