Description

CMFN

Joining the chorus of “cheap” BDCs that have been written up recently – I am pitching CMFN, which hasn’t been mentioned much. I think it has several interesting characteristics outside of just being valued on a cheap price to book multiple.

• 1)   Unlike other BDCs, virtually the entire portfolio is easily marked (very limited black box risk)
• 2)   The company had important positive news post the last 10Q, which was discussed on the call but unlikely to have been properly factored in by investors since the 6/30 Q did not reflect the new info
• 3)     Not a likely December tax-loss candidate (barely down on the year)
• 4)     A large discount to book without the usual management / fee structure hair that typically comes with that discount

With a 13% yield, I view as reasonably likely that the fund can trade at 90% of  live NAV (which I estimate at ~$13.50).  So without assuming a bounce in the credit markets, this is a base case 30%+ ROR opportunity over a year with very limited downside risk.

Management Team:

CMFN is the BDC affiliate of Cyrus Capital, a long standing distressed investor that spun from Och Ziff in the late 1990s. The CEO and CIOs are Michael Mauer and Christopher Jansen, whose backgrounds are below. The BDC obviously leverages Cyrus Capital’s team for its investment decisions.

Michael Mauer formerly worked for Icahn Capital where he was a Senior Managing Director and a member of the investment team. In addition, he was in charge of the firm’s Marketing and Investor Relations. Prior to that, Mr. Mauer spent over eight years at Citigroup, where he was a Managing Director.  During that time he led several businesses including roles as the Global Co-Head of Leverage Finance and Global Co-Head of Fixed Income Currency and Commodity Distribution. From 1988 to 2001, Mr. Mauer held several positions at JPMorgan including Head of North American Investment Grade and Leverage Loan Syndicate, Sales and Trading businesses.  Mr. Mauer began his career in 1982 at Price Waterhouse & Co. where he was a Senior Accountant and a C.P.A.  Mr. Mauer received a B.S. from the University of Scranton and an M.B.A. from Columbia University.

Christopher Jansen formerly was a founding Managing Partner and Senior Portfolio Manager for Stanfield Capital Partners from its formation in 1998 through the sale of the Company in 2010. His responsibilities included investment oversight and administration of the investment process and the implementation of portfolio management procedures of the Company’s sub-investment grade/leveraged loan businesses. In addition, as a member of the firm’s Management Committee, Mr. Jansen was involved in planning the strategic direction of the firm. Prior to founding Stanfield, Mr. Jansen was Managing Director and Portfolio Manager at Chancellor Senior Secured Management from 1990 to 1998. From 1983 to 1990, Mr. Jansen held various positions at Manufacturers Hanover Trust Company, served as Vice President in the Bank’s Acquisition Finance Group and LBO Management Group.  Mr. Jansen received a B.A. from Rutgers College and an M.M. from the Kellogg School of Management at Northwestern University

As far as management pedigree goes, they are a step above the average BDC. Additionally, not only does Cyrus own a majority interest in CMFN, but management has purchased shares in the open market on a personal basis multiple times post-earnings when prices were above today’s levels.

Fee Structure:

We have entered into an investment advisory agreement (the “Investment Advisory Agreement”) with CM Investment Partners, as our investment adviser, pursuant to which we pay the Adviser a management fee equal to 1.75% of our gross assets, payable in arrears on a quarterly basis. In addition, pursuant to the Investment Advisory Agreement, we pay the Adviser an Incentive Fee equal to 20.0% of pre-incentive fee net investment income, subject to an annualized hurdle rate of 8.0% with a “catch up” fee for returns between the 8.0% hurdle and 10.0% as well as 20.0% of net capital gains. From February 11, 2014 (the completion of our initial public offering) to December 31, 2014, the Adviser agreed to waive its fees (base management and incentive fee), without recourse against or reimbursement by us, to the extent required in order for us to earn a quarterly net investment income to support a minimum dividend payment on shares of common stock outstanding on the relevant dividend payment dates of 9.0% (to be paid on a quarterly basis). For the periods from January 1, 2015 to December 31, 2015 and from January 1, 2016 to December 31, 2016, the Adviser has agreed to waive its incentive fees, without recourse against or reimbursement by us, to the extent required in order for the Company to earn a quarterly net investment income to support minimum dividend payments on shares of common stock outstanding on the relevant dividend payment dates of 9.25% and 9.375%, respectively (to be paid on a quarterly basis).

At 1.75% vs. the standard 2% the headline fee is lower. However it also excludes cash, has a catch-up provision, and a three-year look back feature. While not cheap, this is a best in class fee structure for the industry. CMFN also provided a waiver of its fees to get the dividend stable through 2016 (the waiver is no longer needed since the portfolio is ramped).

Portfolio:

The table below provides a listing of all positions, Bloomberg tickers where available, pricing on 6/30 (per the company), and pricing on 9/30 and 11/5 from Bloomberg and dealer runs. The goal is to calculate a “live” NAV. I’ve left the unmarked positions flat to 6/30, except for AAR (which I discuss later), which I’ve taken down 5 pts, and the warrants which I've written to 0. Apologies for the challenged formatting in the table below...

The NAV projection is done as follows:

1. 1)      Take the $ P&L across the positions (either 6/30-9/30 or 6/30-11/5). Divide by the Net Assets on 6/30 ($196,950,849).
2. 2)      Take the % change and apply to it to the $14.41 headline NAV on 6/30.
3. 3)      Subtract out the special dividend that was paid related to capital gains on Virgin Atlantic ($0.43)
4. 4)      Add an accrued dividend (run rate of 11-12 cents per month, so today would be + $0.24)
5. 5)      This gets us to a NAV in the $13.40s for today, and a bit higher for 9/30.

The company may have traded these positions (for better or for worse), so there is no guarantee this number is perfect.

Oil & Gas Exposure and Downside Risk:

The oil and gas exposure comes from two names (now that the scary sounding New Standard Texas was repaid at par, and Crestwood Pipeline sold in the secondary market).

Caelus Energy: This is a large Apollo backed deal loan, I won’t dive into its merits here, but our credit team has a positive view on it.

AAR Intermediate: This is a lightly levered services business originated in the Fall of last year. The CEO has discussed this position several times and I quote the Q1 2015 conference call:

AAR is a Colorado-based oilfield services company. This is a great example of a dislocation in industry that creates opportunity. There are a lot of bad deals out there in oil and gas space generally and a lot of those should never be done. This is an environment that also causes good deals to struggle. AAR is a good investment and a good deal, where we spent months doing diligent meeting customers, multiple site visits. We are very focused on the structure on top of the health of the company. Our loan is less than two times levered on a run rate. It has significant amortization and strong maintenance covenants. As part of our investment, we received warrants in addition to 15.6% yield on our first lien loan to the company that with a 13% coupon. This investment was a result of our strategic relationship with Stifel.

As a metric of margin of safety – you can set both Caelus and AAR to be worth 0 (I don’t think this is realistic), but you will still see a NAV in the 11 handle.

To get the NAV down to today’s price (giving no credit for the dividends earned over the period it takes to get there), you’d have to write all the energy to 0, and then have NAV decline another 9%

SBA License:

The company is working towards an SBA license which would allow it access to extremely attractive financing and added portfolio leverage.

Catalyst:

The company pays an attractive 13.5% dividend yield, so no immediate re-rating is required. However, the following may help

• 1)      Earnings release next week will show a much lower headline energy exposure than before. To the extent the team traded out of Caelus as oil sold off in the summer, that would be more upside
• 2)      Oil prices start to rally
• 3)      Some bid comes back to the BDC space
• 4)      Open market share purchases by management or the company

Question:

Do the high fees make the discount irrelevant?

While the fees are high, the BDC structure here does provide tangible value:

1. 1)      Extremely attractive financing terms with no recourse to the BDC investor
2. 2)      Difficult to access positions
3. 3)      Real distressed expertise (Cyrus’ funds charge comparable fees, and to my understanding are largely closed).
4. 4)      The fees for this entity are structurally better than its peers, but the discount is wider both relative to others today, but also in absolute terms historically

 
What is the variant perception? 

I think most investors haven't done the work on the underlying portfolio (and recent changes) and just view this is an illiquid, very oil and gas sensitive lender. Hence the rally in the Spring and subsequent sell-off in late summer. 

Catalyst

 Catalyst:

The company pays an attractive 13.5% dividend yield, so no immediate re-rating is required. However, the following may help

• 1)      Earnings release next week will show a much lower headline energy exposure than before. To the extent the team traded out of Caelus as oil sold off in the summer, that would be more upside
• 2)      Oil prices start to rally
• 3)      Some bid comes back to the BDC space
• 4)      Open market share purchases by management or the company