This is the third article we’ve written about Accent Food Services, LLC. We started out in September 2020, basing ourselves on what Fidus Investment (FDUS) was willing to tell us about the vending machine company’s troubles. Even then, we were bracing for the worst: “We know too little – even the identity of the first lien lender and its payment status – so we can’t estimate whether Accent will pull out of this valuation dive or not. Given the second lien status, though, a complete write-off is possible.”
Roll forward to the most recent FDUS reporting for IVQ 2020 and we learn that “In Q4, we realized a loss of $36.1 million on Accent Food Services“. That’s 100% of the total cost of the funds FDUS advanced to the company. Just before Accent began to deteriorate – IIIQ 2019 – FDUS had the investment valued at $35mn. The BDC was receiving about $3.5mn in annual investment income before Accent went on non accrual late in 2019. As recently as September 2020, FDUS still valued its debt at $5mn.
Not unreasonably, a BDC analyst asked for a recap of what went wrong at Accent and to his credit, the CEO of FDUS gave a fulsome answer, albeit after the horse has left the barn. We are re-publishing the full discussion from the February 26, 2021 FDUS conference call:
“What I would say, look, Accent was on nonaccrual prior to COVID-19. Having said that, it had a positive outlook and had real market presence. I mean revenues were growing. It just — it needed to clean up its act, which is actually now done, and COVID created the opportunity for the company to do that and get their cost structure in line and whatnot.
But — so the — what happened was the shelter-in-place orders, and in particular, the work-from-home orders greatly impacted the business, right? The most of any company in our portfolio, no question. So our one nonaccrual got hit the hardest.
Secondly, I’ll go — say the senior debt providers and, quite frankly, the equity group were not helpful to put it mildly. And the senior group played loan-to-own ball and — as opposed to work together, which most people do. And so given the status of the company at the second half of the year, which were very different, quite frankly, than the projections we were getting throughout the COVID period, we chose not to double down, and basically, take a controlling stake in the company. We have that opportunity. And it would have required a very large equity investment. And so it’s very unfortunate all around, but that’s how it played out.
And the company has a solid medium-term outlook and a good management team. And so we supported the company with actually a small equity investment in the new restructured company. So that’s the situation. It’s very unfortunate. But we didn’t have — other than owning the company and writing a very big equity check, we didn’t have the cards given the — given COVID. And that’s what happened“.
There’s a lot to unpack there, including the reminder that BDCs like FDUS have the ability to walk away or “double down” (the very language underlining the uncertainty involved). Generally speaking, it’s hard for a second lien lender to control a situation like this one and the large amount already invested might actually have been a deterrent to putting even more money to work. We find it amusing that FDUS invested $2mn in the newly restructured/owned company but – maybe – that will provide some partly offsetting return one day.
Otherwise, though, this was a major loss for the BDC, far and away the biggest write-off taken in a difficult year and a reminder of how vulnerable junior debt capital can be, especially in the lower middle market. (BTW, FDUS also booked multiple realized gains in 2020, leaving the BDC with a net realized loss of just ($1mn) for the year.
In terms of our ratings, we are upgrading Accent Food Services from CCR 5 to CCR 3. Even though the amount FDUS has invested is now small – barely material by our standards – we’ll continue to update the company’s progress to the best of our ability.