Description

Medley Management (MDLY) is trading at ~10x current earnings with an 8% dividend, despite having a very stable business model and the potential for significant growth. The company is a credit-focused asset manager with 2/3 of its AUM in permanent capital vehicles, providing a stable and predictable stream of earnings.  Since Medley’s IPO last September the stock has tanked and is rather illiquid, trading less than $1 million/day.  Right around the time of the IPO the publicly traded BDC that MDLY manages, Medley Capital Corp (MCC), saw a drop in its valuation below book value which has postponed AUM growth in that vehicle, which represents 43% of MDLY’s overall AUM.  I believe the busted IPO, illiquidity, and drop in MCC have created an opportunity to buy an asset manager at a very cheap price that is still likely to grow AUM through other vehicles in the short-term and retains the call option from future AUM growth in MCC in the longer-term. 

Company Background

Medley is an asset manager focused on private market direct lending.  The company manages assets in several types of vehicles and has seen overall AUM grow rapidly in recent years: 

Perhaps more significantly, Medley has raised most of its capital in recent years in BDC’s, and these permanent capital vehicles now represent 65% of total AUM (up from 0% in 2010).  In the first half of 2014 these vehicles accounted for over 77% of MDLY’s revenue. For a detailed discussion of BDC’s and the asset managers who look after them, I’d suggest UCB1868’s write-up of FSAM from last December. 

Sierra Income Corp (SIC)

While MCC is unlikely to raise more capital in the short term due to its valuation, I believe the current valuation of MDLY is not pricing in the likely AUM growth at Sierra Income Corp.  SIC is a public, non-traded BDC that is distributed through a large number of broker deals and RIAs.  It is similar to MCC in that it is a permanent capital vehicle, but different in that new sales can continue to occur since the valuation issue present at MCC does not exist at SIC.  The vehicle has been growing rapidly and management has expressed confidence that it will continue to grow:

Assets in Sierra are quite lucrative for MDLY, as it charges a 1.75% management fee on gross assets in that vehicle (“gross assets” includes additional assets bought from using leverage), in addition to two types of incentive fees – 20% of any quarterly income beyond 1.75%, and 20% of any realized gains after that. 

MCC

MCC is a BDC listed in early 2011 that focuses on floating rate, senior secured credit.  When the stock is above book value the company regularly raises new capital, which is obviously great for MDLY.  In the table below I show MCC’s total return (book value growth plus cumulative dividends) versus a number of peers, which is slightly above average since its launch.  Despite that MCC trades at the low end of the valuation spectrum and pays the highest dividend yield of the group.  Price/book for BDC’s is typically quite volatile, but most have averaged a premium to book in recent years so there is a decent chance that at some point MCC will be back above book value and raising new capital.  Notably the company just announced a $30 mm share buyback program a few weeks ago which should help to close the gap.  Buying back shares at a discount is the right move for MCC shareholders and hopefully the right “long term greedy” move for MDLY as well. 

Risks

·         Sierra Income fees/structure – like most products sold through brokers and RIAs, this can be loaded with very high upfront sales charges and other fees.  This isn’t unusual and hasn’t slowed their sales to date (incentives for sales teams can work, after all), but combined with some of the language in the prospectus (“You should not expect to be able to sell your shares regardless of how we perform.”) this isn’t the most warm and fuzzy investment product out there, and all of the fees will dampen the net returns clients receive.  Prospectus is here: http://apps.scdistributors.com/DownloadRequest.aspx?id=SIFullProspectus

·         Lawsuits/prior track record – the managers of Medley previously ran a hedge fund that ran into liquidity problems during the crisis and a former investor sued them for putting assets from the hedge fund into MCC instead of returning them cash: (http://www.forbes.com/sites/nathanvardi/2012/03/19/investor-in-1-4-billion-hedge-fund-firm-run-by-twin-brothers-sues-to-get-money-back/).  While this clearly looks bad, other public documents show that the returns of the vehicle were actually pretty good, despite the liquidity issues (see slide 15 here: http://www.sjretirement.com/Uploads/FED/Item%202%20-%20Direct%20Lending%20Investments.pdf) and it hasn’t stopped them from raising a significant amount of net assets in recent years

·         Vehicles are permanent, contracts are not – while the BDC’s offer huge advantages to MDLY (namely, no risk of redemptions) and in my opinion should warrant a premium asset manager multiple, it’s not guaranteed that Medley will manage them forever.  Technically the board has to approve MDLY as the manager annually.  I view this as a low probability risk, but one that could increase if MDLY does a terrible job managing the assets

Summary

At the current valuation MDLY offers decent returns even if the company doesn’t raise additional capital – paying 10x earnings and receiving an 8% dividend for a company that is managing the majority of its assets in permanent capital vehicles seems reasonable to me.  On top of that I expect continued growth in Sierra Income, potential growth from the private funds/SMA side of the business, and likely growth of MCC over time as well.   While the exact timing of growth at MCC is impossible to predict, the recently announced buybacks are a positive sign and I believe the odds are high that at some point in the next three years MCC will trade above book value and raise more equity.  I believe the market has over reacted to the busted IPO and postponement of AUM growth at MCC, and that MDLY is an attractive long at current levels.    

Catalyst

-Continued dividends

-Growth at SIC

-Eventual growth at MCC