PCF’s Rights Offer, Tender Offer, Or Both? What’s Going On Here?

PCF: Rights Providing, Tender Provide, or Each?

Quite a few our members have talked about the Excessive Yield Securities Fund (NYSE:PCF)’s current Rights Providing announcement, giving shareholders the fitting to purchase further inventory at a below-market value. Though PCF has not been in our mannequin portfolios, I are inclined to regulate it because it’s managed by BullDog Investments, the activist group (much like SABA) that manages the Particular Alternatives Fund (SPE), which we personal and has finished so nicely.

PCF’s Rights Providing caught my consideration as a result of rights choices are usually not a lot what you anticipate to see when activists are circling a fund with a excessive low cost, or already operating one, like PCF, with its excessive present low cost, just lately 14.7%. Extra typically in these conditions, we are inclined to see tender presents, the place the fund presents shareholders the fitting to “tender” (i.e. promote) a few of their shares to the fund, often at a higher-than-market value. The aim of a young supply is often to shrink the fund’s low cost, as described right here. A rights providing is the alternative of a young supply, and is often supposed to increase the scale of the fund by promoting further shares to present shareholders at a below-market value. That’s unlikely to have the impact of decreasing an present market low cost.

Listed here are the important particulars about PCF’s rights providing, lifted and edited a bit from the prospectus linked up above:

“The Rights are non-transferable, is probably not bought or bought, and won’t be listed for buying and selling on any alternate. The Rights will expire with out residual worth on the Expiration Date (August ninth, however may very well be prolonged). The Subscription Worth per share would be the GREATER of

97% of the typical market value per Share for the three buying and selling days ending on the Expiration Date, i.e. a 3% low cost from the market value; and 85% of the Internet Asset Worth (NAV) per Share on the Expiration Date; i.e. a 15% low cost from NAV”

At the moment PCF shares promote at about $6.55, which is nearly a 15% low cost from the NAV of $7.70.

The #1 pricing choice, 97% of the market value, could be 97% of $6.55, or $6.35. That will be a reduction of 17.5% from the NAV of $7.70.

Meaning if the deal had been finished right now, choice #2, which is a reduction of “solely” 15%, would apply and the shareholders exercising their rights would be capable to purchase at 85% of the fund’s NAV, which right now could be $6.55, the identical as the present market value. That primarily implies that if costs and reductions stay the identical from now till the rights train date (August 9 or later if prolonged), then shopping for by exercising the rights would supply just about no further worth in comparison with simply shopping for PCF shares out there.

After I first learn PCF’s rights providing phrases, I scratched my head a bit (fairly a bit, really) making an attempt to know them, which is usually the case with the pricing system of rights choices. However just a few issues grew to become clear. The 15% low cost stage seems to be a flooring on what the rights providing value would ever be, in that if the low cost grows even larger than it at present is (it is already virtually 15%) then pricing choice #2 would kick in and restrict the value to a 15% low cost. So there isn’t a level in exercising the rights should you suppose the low cost may get even larger and also you hope to achieve from that.

However suppose the value of the fund begins to extend and the low cost shrinks. At some cross-over level, a smaller low cost to NAV would imply that 97% of the market value would equal and ultimately exceed a market value that was discounted 15% to NAV. What would that smaller low cost to NAV be, that 97% of it will equal a 15% low cost to NAV? If we will calculate that cross-over level, the place the 2 pricing choices had been equal, then we might have a fuller image of the pricing prospects, and know the purpose at which smaller reductions would set off the #1 choice, the place the value could be 97% of the market value.

Let’s attempt some fundamental highschool algebra.

First, we’ll be aware that the market value of a fund is 100% minus the proportion low cost, instances the NAV So Possibility 2, the market value represented by a 15% low cost from NAV (i.e. 85% of NAV) we are going to name: 0.85 X NAV Possibility 1, is a value of 97% of the market value. We need to discover the proportion low cost that ends in the crossover level, the place a market value multiplied by 97% would equal the identical value as that we simply labeled “.85 X NAV”; i.e. the proportion low cost (Name it “D”) that ends in the Possibility 1 value being the identical as the value that will apply if Possibility 2 (the 15% low cost) had been triggered So placing all of it collectively, our algebraic system for fixing for the unknown low cost “D”, is:

.85 X NAV = .97 X (1 – D) X NAV

Fixing for “D”, first we divide each side by “NAV”, leaving us with

.85 = .97 X (1 – D)

Then we divide each side by .97, leaving us with

.85/.97 = 1 – D

.876 = 1 – D

Add “D” to every aspect of the equation:

D + .876 = 1

Subtract .876 from either side of the equation, and we see that

D = 1 – .876

Or, in different phrases: D = .124, which we might specific as a reduction of 12.4%

What does this imply? With the 2 pricing choices, you’re at all times assured a minimum of a 3% low cost off the market value.

As we simply demonstrated, as soon as the market value reaches a reduction of 12.4% off of NAV, then the “Possibility 1” low cost of three% off the market value brings the market value right down to the equal of the “Possibility 2” most 15% low cost from NAV.

It’s clear that with the Rights Providing’s pricing system choices 1 and a pair of, there isn’t a technique to receive a value decrease than a 15% low cost from NAV. In fact, the value might conceivably go up greater; and the one low cost you’re assured is a 3% low cost off the market value, not off the NAV.

Backside line, with the fund’s shares already promoting at virtually a 15% low cost to NAV, anyone (whether or not a PCF shareholder or not) should purchase all of the shares they need available on the market, with out bothering with the rights providing.

So Why Hassle With A Rights Providing? Effectively, Not So Quick, There’s Extra To The Story!

As we learn the rights providing doc, we discover there’s extra to this story. The tip-off is correct right here, within the part of the Rights Providing doc that discusses the needs of the providing:

“Goal of the Providing

The Board believes that growing the Shareholder base of the Fund might enhance the proportion of Fund Shareholders that actively take part in Shareholder conferences. The Fund’s Shareholder base has turn out to be more and more inactive with respect to participation in Shareholder conferences, culminating within the failure to acquire a quorum to do enterprise on the annual assembly of Fund Shareholders in 2023. The Board believes that, with a view to receive a quorum to do enterprise at any future assembly (particular or annual) of the Fund’s Shareholders, the Fund wants to extend the quantity of lively Shareholders. With out acquiring such a quorum, will probably be just about unattainable for the Shareholders to approve any proposals requiring shareholder approval, together with coming into into the proposed Advisory Settlement and implementing the Funding Modifications.”

Bulldog Investments, the activist group that now controls this fund, apparently has concepts for tips on how to enhance efficiency and enhance the fund’s worth, together with closing the large 15% low cost. However it could possibly’t do it if the shareholders, lots of whom might have purchased their shares previous to Bulldog’s takeover of the fund six years in the past, fail to take part. So the aim of this rights providing is to entice sufficient at present lively and conscious shareholders to purchase extra shares, so there will probably be a possible majority for the actions Bulldog desires to soak up the longer term.

However administration appears to know that the rights providing, in and of itself, is not all that enticing to shareholders, since as we simply demonstrated above, anybody (whether or not a shareholder or not) should purchase into the fund on the open market proper now and get just about nearly as good a deal as doing it via the rights providing. They usually might do it with out all of the uncertainty that comes from a rights providing, the place you have to commit your self earlier and the value will not be recognized till someday after August ninth.

The place’s The Silver Lining?

Fund administration offers the sport away after they say, in a listing of doable dangers and adversarial penalties, that the plan is to do a young supply, as soon as this rights providing is completed. It is fairly uncommon for a fund to do a rights providing to extend shareholdings after which flip round and do a young supply to purchase in shares proper afterwards. However we all know that activist companies love to do tender presents (learn this text and the hyperlinks to it to know why), so my assumption is that the true goal right here is to do a young supply, however they’ll solely do it in the event that they get sufficient new shareholders on board to vote in favor of doing it. Therefore the rights providing to usher in sufficient new shareholders to have adequate votes to approve a young supply that may observe the rights providing.

This is the part that mentions this, sticking it in because the “excellent news” on the finish of a listing of doable Rights Providing negatives:

“The Providing:

Could dilute the mixture NAV of Shares owned by Shareholders who don’t absolutely train their rights and buy further Shares, and such dilution could also be substantial; Could considerably dilute the voting energy of Shareholders who don’t absolutely train their Rights since they’ll personal a smaller proportionate curiosity within the Fund upon completion of the providing. Could enhance the low cost at which the Shares commerce to NAV if the Subscription Worth is lower than the NAV; Could trigger the low cost under NAV at which the Fund’s Shares are at present buying and selling to extend, particularly if Rights holders exercising the Rights try to promote sizable numbers of Shares instantly after such issuance; Nonetheless, this risk could also be mitigated by the Fund’s dedication to conduct the self-tender supply described under.”

That final line says all of it, in my view.

The providing memorandum goes on to say, in one other part:

“As well as, the Board intends to authorize a self-tender supply by the Fund to start after the Particular Assembly which will probably be at a value of a minimum of 98% of NAV for a minimum of (A) 90% of the variety of shares issued within the rights providing if all of the proposals on the Particular Assembly are accredited by the Fund’s shareholders, or (B) 60% of the variety of shares issued within the rights providing if the entire proposals on the Particular assembly are usually not accredited by the Fund’s shareholders.”

Placing these two actions collectively:

PCF’s board desires to do a young supply, at which a few of our shares will probably be repurchased at a 2% low cost to NAV. Meaning if I am going out and purchase PCF shares now on the 14.7% low cost, and this all goes via, I could possibly tender a few of them at a 2% low cost a pair months later. In the meantime, I can accumulate a distribution yield of 11%, at present being absolutely lined by NII and capital positive factors; and declared out via the tip of September. PCF has the identical administration crew that runs Particular Alternatives Fund (SPE), which we personal and has finished nicely; so I imagine PCF is a fairly good funding to carry, given its enticing yield, low cost, and good administration, whereas watching and ready for the eventual tender supply. Worst case, even when the rights providing fails in its mission of attracting sufficient new shareholders to approve the following steps PCF administration desires to take to enhance the fund, it is nonetheless a sexy maintain within the meantime. Since initially publishing this for my Contained in the Earnings Manufacturing unit members about two weeks in the past, I did exit and purchase shares of PCF at its low cost of virtually 15% low cost. The identical alternative nonetheless exists, with its present low cost at 14.7%.