On Advice

As it works to pull off a merger, FS Investments admits shortcomings

Management makes unusual public statements about weaknesses at company's funds

Nov 20, 2018 @ 2:54 pm

By Bruce Kelly

In a highly unusual move for an investment company, FS Investments is currently performing a "mea culpa" for investors and financial advisers.

Any expression of weakness or regret in the kill or be killed world of the asset management and brokerage industries will be regarded as red meat for the competition. Looking to undermine and sow doubt about a rival, competitors will twist such statements and turn them from acknowledgments of specific problems at a company to expressions of weakness and folly.

First off, FS Investments is a business development company and alternative investments behemoth. The brainchild of Michael Forman, its CEO and chairman, and a group of partners, the Philadelphia-based firm manages $24 billion across 12 funds, half of which are high yield. Many were sold by brokers as nontraded vehicles with high commissions.

In a recent call with analysts and in a meeting with advisers, FS Investments' senior management publicly acknowledged its various shortcomings, including: the eroding valuation of its flagship fund, the publicly traded FS Investment Corp., managing underperforming credits in that fund, which is currently working on a merger with another listed BDC; and investors' and advisers' potential confusion around calculating total returns of its BDCs.

Formerly Franklin Square Capital Partners, FS Investments' BDCs are essentially banks, raising capital from investors and making loans to private companies to qualify as a BDC. BDCs typically are closed-end companies that invest primarily in debt and equity of private companies. Yields can be attractive because of the BDCs' exposure to high credit risks amplified by leverage.

As executives are publicly noting, the net asset value — NAV — and share price of FS Investment Corp. are both eroding.

Sold from 2009 to 2012 for a base price of $10 per share, FS Investment Corp. (FSIC) started trading two years later at $10.21.

Time has not been kind to the company ever since. On Monday afternoon, FSIC shares closed at $6.15, a decrease of 38.5% from its 2009 offering price. The company is also cleaning up FSIC's portfolio, which is feeling a drag from about 10 positions it is currently working through.

Meanwhile, FSIC is seeking shareholder approval to merge with another listed BDC, Corporate Capital Trust (CCT).

CCT launched as a nontraded BDC in 2011 for $10 per share. After a reverse stock split, CCT listed a year ago, hit a high of $19 per share and on Monday finished the day at $14.03 per share, a decline of 26.2% from its high.

Under the terms of the agreement, CCT shareholders will receive a number of FSIC shares with a NAV equal to the NAV of the CCT shares they hold, as determined shortly before closing. The NAV for both BDCs is higher than their market values, but both also have recently seen declines in net asset values.

Merging two companies with declining market prices and NAVs is undoubtedly a tough task.

FS Investments and brokerage executives are quick to note that investors in FSIC and other of the company's BDCs, many of which paid 7% commissions to advisers, have made money over the lifetime of the investment because of the high distribution — think dividend — the company pays.

Last year, FS Investments said it would no longer work with longtime sub-advisers to its BDC funds, GSO Blackstone. Instead, it was partnering with KKR Credit Advisors, the adviser to CCT. At the time, Mr. Forman sounded sanguine about the prospects of completing a roll up of a handful of FS Investments' branded BDCs, after the merger with CCT was completed. The goal was to make FSIC a publicly traded behemoth, with $18 billion in assets.

In a conference call with analysts on Nov. 8, Mr. Forman sounded less confident about a roll up with the other FS Invesmtents' branded BDCs than last December when the change in sub-advisers and plans to merge FSIC and CCT were first announced.

"Given recent trading performance of both FSIC and CCT, we do not believe current conditions support such a consolidation, and even when these conditions improve, let me be clear by saying that consolidation with these non-traded BDCs with our listed BDC will need to be accretive to FSIC shareholders, position the publicly traded vehicle for success and be in the best interest of all shareholders," Mr. Forman said.

"In summary, while we were disappointed with the company's recent performance, we accept responsibility for these challenges that are focused on managing the underperforming credits, executing upon the FSIC-CCT merger, underwriting high quality new originations and explore all options for the non-traded funds to determine the best outcome for all our shareholders."

That same morning Brian Boulerice, managing director for business development at FS Investments, told a roomful of financial advisers and industry onlookers that the firm was working to improve.

Speaking in Austin, Texas at the annual meeting of Commonwealth Financial Network, Mr. Boulerice mentioned FSIC's share price lagging its NAV, but focused mostly on FS Investments creating a new reporting tool for advisers that would show clients the total return of a BDC. The new tool includes the fund's distributions and is likely to show a positive total return for investors in various FS Investments' BDCs.

Right now, many investors typically see a return of an FS Investments' BDC based on cost basis analysis on their client statement, potentially creating difficult conversations for advisers with clients. Such statements do not include distributions and potentially can be negative.

"We haven't been easy to work with," Mr. Boulerice said in his presentation. He later added: "We're going to spend a lot of time and money to make sure we are easier to do business with."

FS Investments takes pride in being transparent and candid with advisers and investors, Mr. Forman said in an email. Over the past couple of years, the firm has expanded its roster of alternative investments and is no longer as focused on BDCs.

"When there are dips in our performance, we hold ourselves accountable and explain and implement our plans for improvement," he wrote. "Our focus now with the BDC complex we manage with KKR is to improve performance, complete the merger of CCT into FSIC, and then create a path to liquidity for our non-traded funds."

Such candor is refreshing from a company as large as FS Investments. Mr. Forman and his team should be commended for such an attitude, even if competitors try to take advantage of such statements. The question, however, remains as to the future of the FSIC-CCT merger. Will the merger be completed and will it be a success?

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