California Pizza Kitchen: International Expansion Underway

Mea Culpa. We’ve not written about California Pizza Kitchen (CPK) – one of the more prominent casualties of the pandemic – in some time. The restaurant chain filed for bankruptcy back in 2020 with hundreds of millions of dollars of debt on the books, including $60mn from 8 BDCs. Then a great deal of the debt was converted to equity (which resulted in realized losses) and equity was granted to the lenders in compensation. More recently the company rid itself of its $177mn in post-bankruptcy debt.

This left, since IIIQ 2021, three BDCs with exposure to the rejigged CPK – all in the form of equity stakes. The BDCs involved are Great Elm (GECC); Capital Southwest (CSWC) and Monroe Capital (MRCC), with total exposure at cost of $15.6mn. The equity was received in the IVQ 2020 and has fluctuated in value every quarter since, along with the chain’s business prospects.

These equity valuations peaked in IIIQ 2021 when the three positions were valued at $13.3mn, a (15%) discount to the average cost. In the most recent IVQ 2021, the valuation dropped slightly, probably due to concerns about omicron or perhaps reflecting recent metrics. Nonetheless, the well regarded management of CPK have an aggressive expansion plan in place and just announced two international franchise agreements, and plans to open 7 restaurants overseas by year end 2022.

We can’t be sure, but there’s a good chance CPK’s equity could increase in value as a result of these and other actions, and the improving Covid situation. If so, the BDCs left with an equity stake might be able to recoup their initial pre-bankruptcy investment in full, or even better. GECC has the most to (re)gain, with a current value of $4.7mn; followed by MRCC with $3.7mn and CSWC at $2.3mn. We’ll be looking out for the latest values when BDC earnings season returns in late March/early April 2022.

Battery Solutions: Company Sold

Back in the day, Battery Solutions was an underperforming portfolio company of Alcentra, a BDC since acquired by Crescent Capital (CCAP). At its worst point, Alcentra/CCAP had nearly $5mn invested at cost in subordinated debt and preferred, the latter discounted by (78%). Even as recently as the IIIQ 2021, the preferred and debt were both discounted and rated CCR 3.

However, in the IVQ 2021 CCAP valued the preferred at a premium of 43% all of a sudden and the debt outstanding almost at par. We now know why: Battery Solutions has been sold to Retriev Technologies, according to the Lancaster Gazette. Terms were not disclosed, but we get the impression CCAP has booked itself a realized gain in the IQ 2021 of about $1.5mn above the $5.5mn invested at cost as of the IVQ 2021.

That’s a positive outcome for the Crescent organization, and for an investment that was first booked by the late Alcentra way back in 2014 and has suffered through plenty of ups and downs. We’ll be interested to see if CCAP is in any way involved in Retriev’s financing package or whether the investment is truly off the books. IQ 2022 results should tell the story.

Footprint Acquisition LLC: IIIQ 2021 Update

Footprint Acquisition LLC (doing business as Footprint Retail Services) was founded in 1990 and “performs best-in-class sales, merchandising, installation, logistics and remodel services in retail stores across the United States”. That does not sound like a business that would perform well under current conditions, with so many retailers impacted by the pandemic. We’re guessing that’s why the only BDC with exposure – PhenixFIN (PFX) – placed its preferred investment in the company on non accrual from the IVQ 2020 and discounted the $4.0mn in exposure by 50%.

As of September 30, 2021, Footprint remains non performing, but the value has increased to $3.0mn, and the trend is improving. Besides the ($1mn) unrealized loss in value, PFX is missing out on $0.350mn in annual income from the preferred position, which yields 8.75%.

The public record and PFX’s filings are very short on information, but the improving valuation gives us some comfort. For the moment, though, Footprint is rated CCR 5. However, we’re hopeful that when IVQ 2021 results are published, we may see an increase in valuation. Or even – though unlikely – a return to performing status, even if in PIK form.

Prairie Provident Resources: Renews Debt Facilities

In a press release on December 29, 2021 Canadian oil & gas outfit Prairie Provident Resources announced a one year renewal of its secured revolver and of subordinated notes owed. Furthermore, the agreement between the company and its borrowers requires all subordinated interest payments to be paid in kind. As a result, Prairie Provident will have a modest amount of borrowing capacity under its revolver and more time to turn around the ailing business. The company is publicly traded but it’s stock trades at just $0.07 Canadian per share.

Not to be unkind, this is another classic case of kicking the can down the road, presumably on the hope that higher oil prices may rescue the business. We’ve read the latest quarterly results, and are not very optimistic that the business can ultimately be saved, but we’re not oil & gas experts.

The only BDC with exposure – and also not expecting much – is Goldman Sachs BDC (GSBD). Since 2016 (!), the BDC has had $9.2mn invested in the company’s equity. The fair market value of its position has been negligible for years, making this one of those “zombie” investments that generate no income, has little hope for recovery but takes up space in the BDC’s portfolio company list. At its nadir in the IQ 2020, GSBD valued its investment at $38,000. Since then, though, the value has increased – as of September 2021 – to $244,000. That’s 6x higher but still means the position has been discounted (97%)…

At the moment the position is immaterial to GSBD but – given that anything can happen – that could change for the better down that can laden road. We’re tracking what happens to the publicly traded stock and will report back if and when a significant valuation increase occurs. Or a final write-off. Prairie Provident is rated CCR 4 in our 5 point rating system.

Casper Sleep: Company To Be Sold

Casper Sleep is a mixed e-commerce and brick and mortar retailer of “sleep products” – i.e. mattresses. Through the dint of good marketing, the company gained a celebrity following and became a growth story in a highly competitive, non glamorous corner of retail. In February 2020, the company went public but already the bloom was off the rose as the final price was half the initial target. Since then, matters have gotten worse as the company has been burning through cash to fuel its growth, and its stock price has dropped sharply. A few days ago, though, the Board agreed to a take-private buyout offer by Durational Management, whose offer is supported by debt from KKR Credit and Callodine Commercial Finance. $30mn in bridge finance is being made immediately available and has been agreed to by the existing lenders.

Right in the middle of all this is publicly-traded BDC TriplePoint Venture Growth (TPVG), a subordinated lender and investor in Casper since 2017. (Wells Fargo administers a secured, asset based revolver, senior to TPVG). As of the IIIQ 2021, the venture-debt BDC had invested $32.0mn to the company, mostly in the form of two subordinated term loans due in 2022 and 2023. The debt is valued at par. Also, the BDC has invested $1.2mn of preferred and equity, which has been almost completely written down. (By the way, Casper in its official filings says TriplePoint has invested $50mn. The discrepancy might be a related TriplePoint fund being also involved).

We imagine that upon hearing of the buy-out offer TPVG sighed in relief. In recent months, Casper’s liquidity has greatly tightened and management has taken a hacksaw to costs to survive. Lenders have had to waive defaults while a solution was found by the stakeholders. In any case, both Wells Fargo and TPVG quickly agreed to the $30mn of additional “bridge financing” involved.

Based on what we’ve heard, TPVG is likely to get out of this sticky situation with nary a credit scratch, with even its equity stake valued a little higher than just before the LBO announcement. However, the transaction has not yet been consummated, so neither TPVG, nor the BDC Credit Reporter, can count its chickens as yet.

For the moment, we’re rating the company CCR 3, where the likelihood of full repayment is greater than of loss. That could change in a New York minute should something go wrong. We are tagging this company as Trending for obvious reasons. We will provide an update whenever a material new development occurs. We expect the company – even in the best of circumstances – will remain on TPVG’s books through the end of 2021.

Sequential Brands: IIIQ 2021 Update

We’ve now written about Sequential brands twelve times ! Most of the time we’ve focused on FS KKR Capital’s (FSK) substantial exposure to the now bankrupt business. However, we’ve mentioned Apollo Investment (AINV_ which has also been a long time lender, but only in the second lien debt and for a much smaller amount than FSK. With the IIIQ 2021 AINV results, though, we see that the second lien debt was placed on non accrual. That was expected given the Chapter 11 filing.

What we didn’t know till AINV reported is that the BDC and FSK had advanced another $6.5mn and $133mn respectively to Sequential recently but with a maturity at the end of 2022 and in a first lien position. This is DIP financing presumably. That debt is valued at par and the discount on the second lien has been reduced to only (8%). Furthermore – and also both reassuring and expected since we heard the sale of Sequential was turning out well – FSK values its own exposure at or above par – even its non performing loan.

All this suggests that both FSK and AINV will extract themselves from the slow moving train wreck that has been Sequential Brands with nary a scratch. We rate the company CCR 5 because of the bankruptcy but do not expect any material loss for anyone at the end of the day. (The only exception remains $2.8mn of equity invested back in the day by FSK, which continues to have a value of zero). Sequential is rated as Trending given that the final settlement of the transaction could result in substantial changes in holdings and proceeds received. That may occur in the IVQ 2021 or IQ 2022 results of FSK and AINV.

Maxus Carbon: IIIQ 2021 Update

We last updated what was happening at Maxus Carbon (aka Carbonfree Chemicals SPE) after Apollo Investment’s (AINV) IQ 2021 results. At the time, the BDC – which controls the alternative energy company – was promising better times ahead for this long standing investment that has fared poorly over the years.

We were in a “show me” frame of mind after seeing the debt at the company converted to equity and the $78mn invested at cost written down to a FMV of $25.4mn. Thankfully, matters do seem to have improved. As of the IIIQ 2021, Maxus Carbon’s FMV has increased to $45.2mn, or $19.8mn. (The cost is $78.2mn). For two quarters in a row the investment has been valued higher, suggesting more improvement might be in sight.

We even received a brief update about the business – in the broadest terms – on the most recent AINV CC:

…”our investment in carbon-free consists of an investment in the company’s proprietary carbon capture technologies and an investment in the company’s chemical plant. Carbon free is benefiting from strong interest in carbon capture, utilization and storage as part of broader ESG trends. We believe carbon-free is a leader in this space as evidenced by partnerships announced during the quarter, which demonstrate market acceptance for its technology

AINV Conference Call 11/4/2021

This is a closely-held investment and AINV does not offer much in the way of details and the public record is spotty. Nonetheless, there are reasons to be optimistic that AINV – one day – might find a way to dispose of this non-income producing investment. Even if sold at the latest FMV, the proceeds re-invested at 8.0% would generate a material $35mn plus in annual income.

We are retaining a CCR 4 rating on the company, but added the investment to the Trending list as AINV may increase the FMV in the IVQ 2021.

Kadmon Holdings: Company Sold

Kadmon Holdings is a publicly traded biopharmaceutical company (ticker: KDMN) that has just been sold to Sanofi, a much larger biopharmaceutical concern with a global footprint and 100,000 employees. The equity holders of Kadmon are receiving $9.50 a share or $1.9bn in total.

We believe this is good news for the only BDC with exposure to Kadmon: PennantPark Investment (PNNT). The company has been on PNNT’s books in some form since 2010. Of late, though, the BDC only had a small equity stake with a cost of $2.3mn in 252,014 shares. The FMV as of June 2021 was $1.0mn. Now that’s worth $2.4mn, a $1.4mn increase and cash proceeds that can be rolled from a non-income producing to a yielding status.

We had Kadmon rated as underperforming since 2016 (!) with a CCR 3 rating but Non Material giving the sub-$2.0mn valuation. We’ve upgraded the investment to CCR 1 because of the sale and added to the Trending list. That’s because the BDC should book a final realized gain in IVQ 2021 and a higher value than the latest number we have as of June 2021. A small, but satisfying gain for PNNT given that KDMN’s stock price was as low as $3.36 in the last 52 weeks.

Sequential Brands: Auction Cancelled

Bankrupt Sequential Brands was going to hold an auction for its multi-brand assets, but ended up cancelling. Some of the company’s brands – like Jessica Simpson which was sold back to the celebrity herself for $65mn – were disposed of previously. The principal transaction, though, was a $330mn bid by Galaxy Capital Partners, a portfolio of Gainline Capital Partners – a PE group. Earlier this year, Galaxy bought Apex Global Brands including, Hi-Tec, Magnum and Tony Hawk and has licensing deals with top brands such as Justice, London Fog and many others.

This transaction is being financed with $55mn in cash and the assumption of debt. That debt is held – amongst others – by the two BDC lenders involved – FS KKR Capital (FSK) and Apollo Investment (AINV) to the tune of at least $231mn. As far as we can understand, Galaxy will be the new borrower and FSK – and to a much lesser degree – AINV, will also hold an equity stake in the business.

How all this gets reflected in the two BDCs schedule of investments is impossible to tell in advance. We’d guess that the $3.0mn in equity FSK invested in Sequential might be written off. AINV’s debt was valued at a discount of (12%) as of June 30, 2021 and might result in a haircut but total exposure at cost was only $12.6mn, so any impact will be minimal.

The most intriguing question is how FSK – with $216mn invested at cost in debt treats that investment. We expect no loss will be recognized but some portion of the debt may be converted into equity in Galaxy. Also unknown is whether the new facility will be priced as attractively as the advance to Sequential: LIBOR + 875%. When we get those sort of details we’ll be able to tell what the impact on FSK’s investment income – seemingly running at $24mn per annum before the bankruptcy – will look like. There’s some financial sleight of hand going on here, but the bottom line is that FSK – and seemingly AINV – are undertaking a mixture of a debt refinancing and debt for equity swap.

Sequential remains rated CCR 5 until the bankruptcy judge approves the many moving parts of this transaction and Galaxy gains control. We’ll report back when we hear more from the BDC lenders involved.

C2 Educational Systems: IIQ 2021 Update

C2 Educational Systems is a K-12 test preparation company. As you might expect, with schools closed and face-to-face tutoring banned in many places, the company did not fare well during the pandemic. In fact, we just learned from the public record that the company received a $10.0mn PPP loan to tide matters over. (Also disclosed is that the company employs around 500). We hear from the corporate website that “We’re Back In Person”, which must be good news both for the company and its students.

The only BDC with exposure is Saratoga Investment (SAR), which has been a lender since 2017. For years, the investment was valued at par. However, during the pandemic – and as recently as the quarter ended November 2020 – SAR wrote down its first lien $16mn loan by a fifth. In the quarter ended February 2021, the term debt that was due 5/31/2021 was extended to 5/31/2023, and the pricing increased by 2% to LIBOR + 8.50%, presumably reflecting additional risk. In the most recent quarter ended May 2021, total debt increased by $2.5mn and SAR invested half a million dollars in preferred stock. The discount on the debt has been reduced – but remains in underperforming territory at (13%).

All the above suggests that C2 has needed substantial financial support, but is pulling through. Interest – which amounts to 10.0% in absolute terms – is current and the preferred is valued at a (very) slight premium. We have rated the company CCR 3 since the second calendar quarter of 2020. If the debt investment ultimately returns to par, SAR could see a $2.5mn increase in asset value, plus whatever the preferred becomes worth.

We are adding C2 to our Trending List because the next time the BDC reports earnings – for the quarter ended August 2021 – we may see a material improvement in valuation. However, the recent upsurge in Covid cases could delay this turn around. Given the size of this investment to SAR , this is a company worth tracking regularly for both good and bad news.

GK Holdings: Company Acquired

As we reported all the way back in October 2020 , Global Knowledge or GK Holdings has been acquired by a special purpose acquisition company (“SPAC”) , which itself is going public on June 14, 2021. The new company is being called Skillsoft Corp, under the ticker SKIL. Skillsoft – of course – is a leading training company, which was also gobbled up by the new public entity, which has put its name on the new public business.

Where the BDC lenders to GK Holdings are concerned, this must be good news. According to Advantage Data, there are nominally 6 lenders to the company, with a total cost of $31.1mn. However, these include Harvest Capital and Portman Ridge (PTMN). The former has just been acquired by the latter, so there are only 5 BDCs involved. (Then there’s non-traded Audax Credit whose exposure to the company is carried under the name Global Knowledge Training LLC, albeit the amount advanced at cost is minimal at $0.9mn).

The FMV of all this BDC exposure at March 31, 2021 was $20.9mn. The roughly ($10mn) discounted was from both first lien and second lien debt held, all of which was on non accrual at March 31, 2021. Unless we are very mistaken, all that debt should be repaid in full with the IPO of Skillsoft and the unrealized loss reversed. All the BDCs involved – led by Goldman Sachs BDC (GSBD); non traded Sierra Income and Stellus Capital (SCM) – should be able to record material unrealized gains and re-deploy the proceeds into new investments.

All the above is based on surmise rather than an explicit acknowledgment by any of the BDCs involved, so we’ll wait till the IIQ 2021 results come out before changing the credit rating from CCR 5 – non performing – to CCR 6, or “repaid”. (The exception to that statement is GSBD, which went on the record months ago about its expectation of not incurring any loss on GK Holdings thanks to the SPAC deal, and is the principal basis for our optimism in this regard for all the lenders involved). However, we’re certainly adding the company to our Trending list as we expect both value and income to drastically change in the IIQ 2021 results.

I 45 SLF LLC: IQ 2021 Update

We’ve written once before about this joint venture, which invests in large cap borrower syndicated loans, between Main Street Capital (MAIN) and Capital Southwest (CSWC). That was back in the beginning of the pandemic as the nature of the investments, the leverage being used and lower LIBOR were all conspiring to drive down I-45’s value. This caused the two BDC partners to ante up additional capital. At its worst – in the IQ 2021 – the discount applied was (42%).

Since then the situation has greatly improved. Some of the extra capital advanced has been returned; troubled credits have improved in value and the discount on the JV – whose total cost is now $91mn – has been reduced to (21%). This is what CSWC’s management said about the status of the JV on May 26, 2021:

 “The I-45 portfolio also continued to show improvement during the quarter as our investment in the I-45 joint venture appreciated by $1.5 million. Leverage at the I-45 fund level is now 1.27 debt-to-equity at fair value. The increase in leverage at I-45 was mainly driven by an equity distribution to the JV partners during the quarter, which represented most of the capital contributed to the JV during the hike of the COVID-related market disruptions. … As of the end of the quarter, 95% of the I-45 portfolio is invested in first lien senior secured debt with diversity among industries and an average hold size of 2.8% of the portfolioIn March 2021, we amended our I-45 credit facility, lowering our cost of capital to LIBOR plus 215 basis points and extending the maturity of the facility to 2026“.

We are retaining the CCR 4 rating on the company, the above notwithstanding, as we still expect a material realized loss will be recognized when I-45 is ultimately wound up. Last time round we projected that hypothetical loss – still years away – could amount to ($15mn-$20mn). We stand by that estimate, but at the moment the unrealized loss is ($19.4mn), 4/5ths of which will inure to CSWC.

We have the JV on our Trending list because we expect a material – albeit not very large – value increase in the IIQ 2021. That’s because large cap borrower loans are in great demand – the JV has 36 companies in its portfolio – and their value has probably increased since March 31, 2021. Overall, though, this is not an investment that causes us much concern under existing market conditions.

Golden Bear 2016-R: Update

Apollo Investment (AINV) has been invested in Golden Bear 2016-R since IVQ 2016, and the investment has been underperforming – by our standards – since IQ 2018. However, we’ve refrained from writing about Golden Bear before because we were – and remain – somewhat unclear what the investment consists of. We know Golden Bear is some sort of securitization – presumably the equity portion – and that AINV is a 100% owner. We also know that the BDC booked $1.2mn of dividend income from that source in the IQ 2021, which is consistent with the payout in the last three years. What we don’t know is what assets Golden Bear is securitizing, and why AINV has reduced by a third the value of the $16.8mn invested at cost in the vehicle.

We have rated Golden Bear CCR 4 because it seems unlikely the BDC will recoup its capital invested. The latest valuation is slightly better than the prior quarter, and improved on the worst discount of 45% reached in the IIIQ 2020.

We’ll continue to provide occasional updates, but neither the amount of FMV nor the income involved is of great importance to AINV.

Paper Source: Sold To Elliott Management

Last time we wrote about Paper Source Inc., the stationery retailer was bankrupt and Mid Cap Financial – an affiliate of Apollo Global Group – was preparing to acquire the company in a “stalking horse bid”. This would have made Apollo Investment (AINV) – a lender and investor to the company – a part owner (and also likely a lender) to the post-bankruptcy business. AINV as of March 31, 2021 had $16.4mn in debt at cost to Paper Source (its equity stake had no dollars attached) and a value of $13.4mn. For some reason, AINV carried the debt as performing, notwithstanding the bankruptcy.

Anyway, scrub all the above. In the interim, Elliott Management – owner of Barnes and Noble – has swooped in and acquired Paper Source out of bankruptcy for $91.5mn. Here is a link to a trade publication article on the subject, and an extract which explains the appeal of Paper Source to the buyer:

In a presentation, Elliott described the businesses of Barnes & Noble and Paper Source as “highly complementary, with shared product ranges and a common commitment to excellent customer service.” The investment firm noted that Paper Source will continue to operate independently and keep to its core product offering of greeting cards, stationery,office supplies, gifts and other products. At the same time, Elliott noted that “considerable opportunities exist for mutually beneficial retail partnerships.”  

Although Mid Cap/AINV lost the opportunity to acquire Paper Source – something of a mixed blessing given brick and mortar’s endemic challenges regardless of the pandemic – this is probably good news for the BDC. We get the impression the first lien debt – as well as DIP financing recently provided – will be repaid in full. That should allow AINV to post a several million dollar increase in value from the ultimate proceeds, which should show up in the IIQ 2021 results, or by the third quarter at the latest, as the transaction closes.

We may be jumping the gun, but expect to take Paper Source off our underperformers list. Given the potential increase in value, we are adding the company to our Trending List for the IIQ 2021 given the likely upside to be booked. This was never going to be a major setback for AINV and now looks likely to be a minor success. As has been the case on multiple occasions of late, thanks are due to a frothy financial environment and the fast recovery from the pandemic conditions that initially brought the company low.

Ambrosia Buyer Corp: IQ 2021 Update

We’ve discussed Ambrosia Buyer Corp, which also goes by the name Trimark USA LLC and TMK Hawk Parent Corp on BDC books twice in the past. The first article was on November 26, 2020 when we discussed a major dispute between different lender groups. On February 5, 2021, we confirmed that second lien debt outstanding had been placed on non accrual by Apollo Investment (AINV). However, several other BDC lenders – involved in both the first and second lien debt – had discounted the value of their positions but had not placed the obligations on non performing status. AINV admitted to continuing to receive contractual interest, but applying the proceeds to reducing the cost basis of their investment.

Neither AINV nor the other public BDC with exposure (first lien) New Mountain Finance (NMFC) addressed what is happening at the company on their IQ 2021 conference calls. Last we heard, the dispute between different lender groups was before a judge but we’ve not been able to determine an outcome, if any has occurred. Still, in the IQ 2021 both AINV and NMFC reduced the discount applied to their debt positions. The former’ discount is now (38%) versus (52%) in the prior quarter but remains on non accrual and the cost is still being reduced from interest proceeds. NMFC has reduced its own discount by 10%.

From what we can gather the disputed rescue package has provided the company with much needed liquidity and – presumably – market conditions are improving as lockdowns end and people are eating out again. Moody’s still rates the company Caa2 – or did in January 2021. We’d like to offer more clarity but with the BDC lenders mum, we can only suggest that the company is on the mend and a major financial crisis does not seem likely.

We continue to rate Ambrosia CCR 5, even if NMFC and two other BDCs still have the debt as performing. The company is still Trending, because it’s likely that the valuation will change again – probably for the better – in the IIQ 2021 results when they come out. Moreover, the lawsuit between lenders may get resolved.

ADG, LLC: IVQ 2020 Update

ADG, LLC (dba Great Expressions Dental Centers) is a BDC portfolio company we should have written about ages ago for a number of reasons. First, BDC exposure is Major: $106mn at cost, almost all held by Ares Capital (ARCC), with New Mountain Finance (NMFC) holding a $5.9mn second lien position. Second, the company was underperforming by our standards even before the pandemic and since everyone’s been sheltering in place, has been on non accrual since IQ 2020. Finally, we’re projecting the company is Trending, i.e. likely to materially change in value in early 2021. More on that at the end. Although we’ve not written about ADG, LLC before we’ve been tracking the business in our Company Files and in our daily search for new developments.

Here’s the lie of the land: At year-end 2020, ARCC had a small first lien debt position of $7mn, half the size of the quarter before and performing, valued at a (10%) discount to par. The BDC also holds an $89mn second lien debt position due 3/1/2024 that is on non accrual but discounted only (12%). NMFC also holds a second lien debt position – maturing at the end of March 2024 – and discounted (24%). However NMFC’s debt – which may or may not be in the same facility – is not carried as non performing but its 11.0% yield is all Pay-In-Kind. Then there’s $3.0mn in equity held by ARCC (which has a very long standing relationship with the company that predates its current PE owner) , valued at zero. The total FMV for all positions and both BDCs is $89mn. ARCC is forgoing about ($7.5mn) of annual investment income due to the non accrual.

There’s no up to the minute news in the public record but the BDC valuations have been greatly improving in the last three quarters. That suggests the business is turning around. We do know that the whole dentistry sector is on the upswing after some dark months last year when dental chairs were off limits in many states due to Covid-infection fears. Sadly, neither ARCC or NMFC has mentioned ADG on their conference calls. Nonetheless, we’ll go out on a limb and suggest there’s better news ahead. That’s why we have ADG, LLC “Trending”, with the prospect of higher debt or even equity valuations and the possibility the second lien debt might return to performing status.

For the moment ADG, LLC remains rated CCR 5 but we’ll be looking out for ARCC’s disclosure about the company on April 28, 2021 when its IQ 2021 results get published.

American Achievement Corp: Exits Chapter 11

We hear from S&P Global Market Intelligence that “the bankruptcy court overseeing the involuntary bankruptcy petition filed against American Achievement Group Holding Corp. on March 16 has dismissed the case, according to a court order, ending the company’s brief encounter with Chapter 11“. The BDC Credit Reporter had written about the involuntary bankruptcy (which occurred January 14, 2021) back on February 20, 2021. We won’t go back into the whys and wherefores that caused the bankruptcy filing. However, we don’t know the full details of how matters have been patched up except that the parties have agreed to an out-of-court restructuring which will “would leave all creditors unimpaired“. Another $35mn Revolver is contemplated to provide the company with liquidity.

We can’t say when all this will come together but the news seems to be good for the only BDC with exposure: Sixth Street Specialty Lending (TSLX). The BDC had placed its $23.8mn in senior debt to the company on non accrual in the IVQ 2020 and discounted its position by ($2.2mn), or (9%). Presumably the debt will shortly return to accrual status and – we assume – accrued interest will be collected.

The company is rated CCR 5 and remains there for the moment. However we are adding American Achievement to our Trending list because we expect in the IQ or IIQ 2021 for a significant change in status (from non performing to performing) and the resumption of interest income, which amounts to $2.2mn a year, not to mention a rating upgrade. We will circle back when we receive confirmation from TSLX that all is well.

Production Resource Group LLC: IVQ 2020 Update

A reader wrote to ask for an update on Production Resource Group, LLC which we wrote about on May 27, 2020, just after the debt went on non accrual. This is a fair question and reminds us to set up a more formal regular credit follow-up system, especially for larger amounts at risk. In this case the advances by the three BDCs involved were huge – $511mn – as of the IQ 2020.

The current amount outstanding at year-end 2020 from two of the BDCs involved – FS KKR Capital II (FSKR) and Ares Capital (ARCC) – is high but has decreased, as we’ll explain – to $267mn. (No word yet from non-traded TCW Direct Lending VII, which had advanced $30.2mn as of IIIQ 2020).

Apparently – according to FSKR – a “debt for equity ” swap occurred in the fall of 2020:

We have reached a definitive agreement to recapitalize the Production Resource Group balance sheet and bolster liquidity. In exchange for our term loan position we will receive a package of take-back securities that are comprised of a reinstated term loan, preferred equity and common equity. The consensual restructuring transaction provides for a substantially reduced debt and interest burden while maintaining a path for a substantial recovery of our original par balance along with significant upside beyond that.

FSKR CC – 8/11/2020

In the IVQ 2020 this was reflected on the BDCs balance sheets and P&L. ARCC booked a realized loss of ($60mn) and its total exposure at cost dropped from $104mn at cost/$38.4mn at FMV in IIIQ 2020 to $45.6mn/$45.8mn. Exposure consisted of two Term Loans maturing in 2024, but with much lower pricing than before. Our rough estimate is that ARCC’s investment income will have dropped from $9.0mn annually to $3.9mn – a ($5.1mn) loss of income. The BDC also has Class A common stock units with a cost of $4.9mn and an FMV of $5.2mn.

FSKR’s exposure at cost just before the non-accrual was $381mn – a large amount even for a BDC its size. As of year end 2020 FSKR has $221mn invested between 4 term loans and two preferred stock holdings. We suppose – but cannot confirm – that the ($160mn) difference was booked as a realized loss. Unlike ARCC, FSKR does not call out Production Resources Group in its 10-K, with its ($872mn) of net realized portfolio losses in 2020. FSKR currently values its multiple holdings at a combined $199.7mn.

We have upgraded the restructured company from CCR 5 to CCR 3 – after three quarters of non performance – from IVQ 2020. Given the very little information we have about the new financial structure and the still challenged business of sports broadcasting, the company remains on the BDC Credit Reporter’s underperforming companies list. We’ll update our Company file when we hear from TCW Direct Lending VII and write a new update when all the IQ 2021 results are out.

For both ARCC and FSKR, this has been a material set-back, permanently reducing both income and capital and illustrates the danger of taking very large positions (especially in the case of FSKR, which is half the size of ARCC but took on more than twice the exposure). For ARCC, this was the second largest realized loss of 2020, out of total net realized losses of ($148mn). Nor was being at the senior level in the capital structure much protection against loss. Judging from ARCC’s write-offs, some 60% of capital advanced when things turned sour has been lost. All the BDCs involved will have to hope their equity stakes in the reorganized company provide some eventual offset. Maybe Production Resource Group will be bought by a SPAC ?

FDS Avionics Corp: Company Sold

Increasingly Business Development Companies are “turning around” their own under-performing portfolio companies. This drastically changes the profile of an investment – usually both increasing the capital put at risk and extending the holding period. Furthermore the ultimate prospective return changes as equity stakes taken from a turn-around can range widely in value over time. With that in mind, the BDC Credit Reporter is very interested in chronicling every instance of a BDC seeking to tackle a distressed asset. In this case, Fidus Investment (FDUS) took charge of FDS Avionics in 2014, investing $7.2mn of subordinated debt and equity.

By 2017, the company was in trouble and FDUS booked a ($2.4mn) realized loss and invested another $750,000 “along with certain co-investors and management, giving us a controlling interest”. In 2019 FDUS – on a conference call – explained its approach: “This is an aerospace parts company, it’s primarily electronics. It serves the general aviation, the commercial and the military end markets, so there’s some diversity there. It’s been lumpy historically. And it also was in need of a product refresh whereby customers really wanted to wait for certain new products versus buying some of the legacy products. We continue to believe in, I’d say, the value proposition of the business. And as such, we made a control equity investment probably 20 months ago now.”

Through IVQ 2020, FDUS exposure at cost was $8.4mn in first and second lien debt, preferred and common. At one point FMV had dropped as low as $4.0mn. Now we learn the following: ” On February 12, 2021, we [FDUS] exited our debt and equity investments in FDS Avionics Corp. (dba Flight Display Systems).  Flight Display Systems was acquired and combined with Calculex Inc. and Argon Corporation under a new holding company, Spectra A&D Holdings (“Spectra”). We received payment in full of $5.1 million on our second lien and revolving debt. We sold our preferred and a portion of our common equity investments for a realized gain of approximately $1.0 million. In conjunction with the transaction, we invested $8.0 million in first lien debt and $4.1 million in preferred equity, of which $2.0 million was rolled over from our original common equity investment in Flight Display Systems”.

So FDUS is clawing back $1.0mn of the ($2.7mn) lost in 2017 but has actually increased its exposure by one third. The BDC will be accruing income on the loan (terms not yet revealed) and -possibly – on the preferred (unlikely). For a time consuming investment that was fraught with problems this is a successful interim resolution, but far from the final word. We may be years away from a final tally.

We are upgrading the company – now Spectra A&D Holdings – to CCR 3 from CCR 4 and we will periodically revisit how the new owners are performing.

Accent Food Services LLC: Restructured

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.