The TCW Group has made a bid to manage Hercules Capital after the target asked its shareholders to consider becoming a business development company led by Hercules’ chief executive Manuel Henriquez.
TCW said on Wednesday it had submitted a proposal at the weekend to Hercules’ independent board members to become its external investment advisor.
The Los Angeles-based alternative asset manager said its offer would create $125.9 million of “aggregate value transfer” from Hercules to its shareholders when comparing its proposal to Hercules’. This would be the result of a lower base management fee; a cap on the firm’s operating expenses; and TCW’s offer to purchase Hercules’ intellectual property, databases and other related assets for $10 million.
In a letter published alongside the statement disclosing the offer, TCW requested the Hercules board respond by close of business on Tuesday.
Hercules’ board’s counsel replied that the firm’s independent directors would “take the … proposal seriously and will evaluate it and respond … in a timely manner”, according to the statement.
Jess Ravich, TCW’s group managing director and head of alternative products, said in the statement: “We made a good faith request to the Hercules independent board members to delay the special meeting scheduled in June so they could engage with us in substantive discussions and thoroughly evaluate our proposal…
“We still welcome the opportunity to engage with the Hercules board, but their failure to provide any time frame for a meaningful response left us with no choice but to file preliminary proxy materials, as we otherwise would not have sufficient time to make our case to the Hercules stockholders ahead of the special meeting.”
Henriquez and a Hercules spokesman did not return a request for comment. A TCW spokeswoman could not be reached for comment.
Hercules asked its shareholders on 3 May to transition from an internally managed BDC to an externally BDC overseen by Hamilton Advisers, managed by Henriquez. That arrangement would require Hercules to pay management fees and incentive fees to Hamilton.
TCW maintains in its letter that the economics of its deal are “clearly superior” to those offered by Hercules’ proposal. TCW proposed a fixed-rate management fee of 1.75 percent on gross assets, minus cash and cash equivalents.
The Hercules-proposed management fee is a sliding scale based on the firm’s gross assets, according to Hercules’ proxy. It starts with a 2 percent fee on gross assets below $1.65 billion down to 1.25 percent when that figure reaches $2.35 billion. The firm’s total assets, excluding cash and cash equivalents, as of 31 March stood at $1.49 billion.
Based on Q1 figures reported by Hercules, TCW estimates that Hercules’ plan would result in $7 million more in annual fees. This would equal a “value transfer” of $72.9 million after accounting for the firm’s 9.6 percent dividend yield.
TCW has suggested an annual floating-rate hurdle rate of at least 7 percent, calculated at LIBOR, with a 2 percent floor, plus 5 percent. Because of its variable nature, Hercules would need to achieve higher returns on its pre-incentive fee net investment income before the manager would receive its incentive fee. Hercules proposed a hurdle rate of 7 percent.
TCW has proposed a flat incentive fee rate of 17.5 percent. There would be a fee of 17.5 percent on capital gains. Additionally, capital losses would be subtracted from pre-incentive fee net investment income in future periods where there were capital gains.
Additionally, TCW said it would invest at least 50 percent of the incentive fees into the company’s common stock. If the stock was trading above its net asset value per share, TCW would purchase newly issued equity. If it were below, TCW would buy shares on the open market. TCW also said it would purchase $15 million of Hercules stock on “day one”.
For its part, Hercules proposes an incentive fee also based on a sliding scale with its pre-incentive fee net investment income. It would start with a 5 percent fee for a return between 7 percent and 8 percent to 30 percent fee if a return of 10 percent is achieved. The company would also receive a 20 percent fee on capital gains.
‘CONFLICT OF INTERESTS’
Ravich, who wrote TCW’s letter, asserted Henriquez has a conflict of interests because he owns the majority of the proposed advisor, Hamilton Advisers. Ravich has asked Henriquez not be notified of TCW’s offer and that he be excluded from any ensuing negotiations.
TCW would also cap operating expenses at 1 percent of net assets attributable to Hercules’ shares. According to Hercules, its 2016 pro forma operating expenses were 1.36 percent. TCW maintains the 1 percent cap would have saved $2.6 million last year and, based on the 9.36 percent dividend yield, would have resulted in a “value transfer” of $10.1 million.