Alternative investment firms are taking advantage of a dislocation in the market to target business development companies as acquisitions, thereby gaining access to a source of retail capital, a possible route to defined contribution plans and a sizable arbitrage.
Mergers and acquisitions of BDCs have just started to crop up in the past 18 months, including PennantPark Floating Rate Capital Ltd.'s acquisition of MCG Capital Corp. in August and private equity firm Oak Hill Advisors LP's November 2014 takeover of NGP Capital Resources Co.
And more BDCs are being urged to sell assets or put the companies up for sale.
“Much of the BDC sector is trading below book value, which makes additional capital raises more difficult,” noted Will Tuttle, partner in the corporate and securities group in the Washington office of law firm Dechert LLP.
That has led business development companies to expand their capital base by acquiring other BDCs, he said, but also has “caused those not in the BDC space to think of ways to gain entry.”
Within the past six months, activist hedge funds also have tried to acquire BDCs, seeking the arbitrage between the stock price and the value of the company's underlying assets.
Private equity firms began launching BDCs five years ago as a way of getting a permanent source of capital. Business development companies are mostly publicly traded closed-end funds that provide debt to small- and middle-market companies and private equity level fees to their owner. Money managers including Ares Management LLC, Tennenbaum Capital Partners LLC, Apollo Global Management LLC, KKR & Co. and BlackRock Inc. all launched BDCs around that time.
BDCs have been “a growing trend and a changing trend ever since the big guys like Apollo” got into the business, said Elliott Wislar, CEO of New York-based Clearbrook Global Advisors LLC, an adviser and consultant for multimanager strategies.
Recent M&A activity around the companies is “part of the move by large asset managers to cover the more alternative asset classes from equity to debt,” said Ken Young, partner in Dechert's Philadelphia office.
“Private equity is an elephant hunting business,” Mr. Young said.
Alternative investment managers are looking to increase their assets under management in part by adding new asset classes.
If an equity investment in a business is too pricey, why not make a debt investment in the company instead, he said.
BDCs might also be a way for private equity investment firms to get their investment options into defined contribution plans, Mr. Young said.
“Defined contribution is where the asset management business is going. Liquid, traded BDCs and other closed-end funds are good ERISA investments,” he said.
Money managers with big defined contribution businesses also are looking at BDCs, Mr. Young added.
At the same time, Congress is considering legislation that could make BDCs a more attractive asset class.
“If the BDC legislation passes, I think it makes the BDC a more attractive asset class for managers and investors (in BDCs), and that could increase the interest in BDC consolidation transactions,” Mr. Young said.