Equus II EQS
September 12, 2005 - 8:14am EST by
2005 2006
Price: 8.70 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 64 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV (in $M): 0 TEV/EBIT

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Equus II (EQS), a closed end fund with a miserable record, has a portfolio of 14 private company holdings and 2 limited partnership interests in other venture funds. With 7.38 million shares outstanding, EQS trades about 25% below its $11.40/sh NAV (6/30). At that date 30% of NAV was net cash (~$3.40/sh). A recent sale of one holding should add $1/sh to NAV, bringing the discount to 30%, and the announced plan to sell the largest portfolio company by year-end could bring $3.50/sh in cash at its current carrying value (recently revised). So 90% of market price is or will soon be cash. The remaining portfolio companies are carried well below cost. In spite of management’s decade long indifference, the discount on EQS may narrow, at least for a while.

The history of business development companies, closed end funds formed under amendments to the 1940 Investment Company Act, permitted to invest in privately held companies to which they supply management assistance, is generally a sorry tale. Designed as a way for retail investors to own shares in venture capital/private equity vehicles, these closed end funds are rife with conflicts of interest. Managers take large fees, control portfolio valuation, and play, via stock options, buybacks and tenders, with shares trading at discounts (see CREN, MCAPS, BBDC, MVC, etc.) Occasionally, however, the opportunity presents itself to take advantage of the price dynamics of one of these closed end vehicles.

The poster child for shareholder suffering may be Equus II (EQS) which has traded at a NAV discount ranging from 20% to 40% while losing value for years. Management seems to spend much of its time seeking exemptive orders from the SEC, permitting it to recompute management fees, block shareholder liquidation resolutions, etc. Meanwhile their prosaic portfolio (pet food, turf grass, wooden pallets, glass recyclers, etc) has been a loser. NAV has decreased substantially.

One hope for a better outcome, or at least narrowing of the discount, was Karpus Investments, a closed end fund activist and agitator, which became EQS’s largest shareholder over the past couple of years. However, although Karpus was able to force its representative onto the board of directors, the firm has been unable to topple the apple cart.

In June, beleaguered by Karpus, shareholder resolutions, etc., EQS announced a plan to appoint a new manager, Moore Clayton Capital Advisors. Casual reading revealed that Moore Clayton would be employing much of the old management in a new subsidiary. Moore Clayton describes itself as an international private equity firm, headquartered in London. In conjunction with this management change, Moore Clayton would purchase or arrange for purchase 27.5% of EQS’s shares in 90 days (by early October). This, assuredly, it seemed, would narrow the discount.

It later turned out, however, that the purchase would include 869,900 in the money (barely) management stock options. The effect of this was to reduce NAV by nearly 50 cents! As Sam Douglass, EQS’ CEO, baldly put it after an article by Dow Jones, the purpose of Moore Clayton’s purchase was “not to provide an immediate return to all of the fund’s stockholders.” A last minute proxy amendment confirmed this.

Subsequently, Moore Clayton has also bought 241,305 shares @ 9.49 from a shareholder, probably the City of London Investment Management Co. This leaves 917,195 shares to go. Presumably getting rid of Karpus (514,738 shares) is priority #1. Thus far, Karpus has not filed an amended 13D, so the negotiation continues. How much progress has been made in purchasing the remaining shares is uncertain, but with less than four weeks remaining to complete the 27.5% purchase, there may be a little pressure. It wouldn’t take much for the stock to appreciate 25%.

In addition, EQS, for reasons best known to itself, has not announced the sale of Doane Pet Care, in which it holds a 5% equity interest. Doane is carried at zero on EQS’s balance sheet, and the sale a couple of weeks ago to the Ontario’s Teacher’s Pension Fund was for $840 million in cash. Doane debt was $690 million, so a conservative estimate would add $1/sh of NAV to EQS $11.40/sh NAV as of June 30. Finally, EQS, which had $25 million of net cash on 6/30, expects to sell its largest (by far) holding, Champion Windows by year end, currently valued at $26 million. Putting this together gives cash at year end of nearly $8/sh. Champion, based in Houston, cannot have lost value in the midst of rebuilding plans for the Gulf Coast.


Announcement of Doane Pet Care sale
Completion of 27.5% purchase
Sale of Champion Windows bringing total cash near current market value
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