Honeycomb Investment Trust (HIT) has announced that it has made a proposal to Pollen Street Secured Lending (PSSL) regarding a possible merger between the two. Under the terms of the proposal, PSSL shareholders would receive new ordinary shares in HIT on a NAV for NAV basis. The company says that a further announcement will be made in due course but the key takeaways, so far, are as follows:
- The board of HIT believes that there is an opportunity for shareholder value creation from the combination of HIT and PSSL to create the leading listed investment trust dedicated to providing finance to the specialty finance market.
- The HIT board considers that the combination of PSSL and HIT would be in the best long-term interests of both companies and their respective shareholders.
- HIT has consulted with certain of its largest shareholders who have indicated they are, in principle, supportive of the Possible Merger. These investors also hold shares representing, in aggregate, 30.7% of the PSSL total number of outstanding.
- Based on HIT’s and PSSL’s unaudited NAV per share (post recent share buybacks) of 1,016.4p and 948.8p at 30 June 2020 respectively, PSSL shareholders would be entitled to receive 0.9335 new HIT ordinary shares in exchange for each PSSL ordinary share.
- PSSL shareholders would also be entitled to receive the dividends, if any, declared by PSSL in respect of the three month period to 30 June 2020 and the three month period to 30 September 2020, provided that the aggregate of the dividends for each such period does not exceed 12.0 pence per PSSL ordinary share and is covered by income for the period.
- The terms would not be adjusted for any dividends declared by HIT in respect of both the three month periods to 30 June 2020 and 30 September 2020, provided that the aggregate of the dividends for each such period does not exceed 20.0 pence per HIT ordinary share. PSSL shareholders would not be entitled to receive these dividends.
- The Possible Merger would result in PSSL shareholders owning approximately 65.3 per cent of the Enlarged Group on a fully diluted basis.
- Subject to consultation with shareholders, HIT is considering alternative structures including either a partial cash alternative, subject to certain limits, or a share buyback programme post completion of a transaction.
Rationale for a combination of HIT and PSSL
HIT believes the creation of the leading UK specialty finance investment trust has a number of benefits for both PSSL and HIT shareholders. It has listed these as follows:
- Scale: The Enlarged Group would have combined investment assets of approximately £1.5bn enabling it to continue to capitalise on attractive investment opportunities, while ensuring a stable NAV return to shareholders.
- Diversity: The Enlarged Group would have a more diversified portfolio, better positioning it for changing economic cycles.
- Liquidity: The Enlarged Group will seek confirmation from the Financial Conduct Authority and London Stock Exchange that it is eligible for a transfer to the premium segment of the main market of the London Stock Exchange. HIT’s enhanced scale is expected to support inclusion in the FTSE 250 Index following any transfer to the premium segment, resulting in a broader and deeper potential investor base for both entities. The Enlarged Group is expected to enjoy an elevated market profile including increased analyst coverage, which should enhance the liquidity of the Enlarged Group’s shares in the secondary market.
- Synergies: The combination is expected to lead to a reduction in operating costs for the Enlarged Group given potential de-duplication benefits. In addition, HIT has agreed with Pollen Street Capital Limited (“PSC”), its investment manager, that in the event a formal offer on the terms of the Possible Merger was made and was successful, the fee arrangement in the existing investment management agreement between HIT and PSC would be reduced to reflect the increased scale of the Enlarged Group. The exact terms of the reduced fees would form part of any announcement of a firm intention to make an offer for PSSL, if such an announcement were to be made.
- Financial impacts: Given the potential benefit from a reduction in investment manager fees and other cost savings, the combination is expected to result in compelling value creation for both sets of shareholders, with enhanced overall shareholder dividend potential relative to their respective standalone dividend prospects.
- Active discount management policy: Given the impact of recent market volatility on the share prices of both HIT and PSSL, HIT believes the proposal provides an opportunity for both sets of shareholders to realise NAV over time in more normalised markets.
- Following the combination, HIT would seek to operate an active discount management policy as well as proactively seeking to manage any investor specific liquidity demands. This would include, inter alia, periodic return of capital to shareholders via the use of selective share buybacks and/or tender offers as well as potential strategic placements with new investors. HIT has already implemented such measures effectively as highlighted most recently by the share buyback announced on 2 June 2020.
- The pro forma borrowings of the Enlarged Group will leave sufficient headroom relative to the current leverage targets of HIT and PSSL.
- Positioning: Both PSSL and HIT, managed by entities affiliated with PSC, have a long track record of consistent credit performance and dividends. In particular, the prudent approach over the course of the COVID-19 related macroeconomic downturn has preserved capital and the manager expects increased investment opportunities in the coming months. The Enlarged Group will have the scale and resources to take full advantage of any improvement in the market environment.
[QD comment: In many respects, this makes sense for shareholders of both funds. The merger should provide for a larger more liquid vehicle and, with one set of fixed costs spread over a larger asset base, shareholders should, all things being equal, benefit from a lower ongoing charges ratio. These proposals are no great surprise as it doesn’t really make sense for the fund manager to be running two separate vehicles, that are this similar, with the additional costs this implies. We’ve long thought that this was only a matter of time.]