29th May 2020
The Board of Directors of VPC Specialty Lending Investments Plc
6th Floor 65 Gresham Street,
Staude Capital Limited
Dear members of the Board
As mentioned in our earlier letter (available here), the investment personnel at Staude Capital Limited act as the portfolio management team¹ for the Global Value Fund, an investment company that has been an investor in VPC Specialty Lending Investments Plc (VSL, ‘the Company’) since 2017.
We note the recent publication of the Company’s annual report, which includes a unanimous recommendation by the Board that shareholders vote in favour of a continuation vote that must be held at this year’s Annual General Meeting.
Given the poor market rating that the shares of the Company have attracted for some time – a situation that was entrenched well before the challenges that COVID-19 has brought – we find the arguments that the Board have provided for recommending continuation wholly unsatisfactory. The Board has failed to acknowledge the chief issue that the Company’s shareholders currently face. Namely, a structural discount problem inherent at VSL which substantially impairs shareholders’ total returns.
In arriving at its recommendation, the Board appears satisfied to rely on a series of pitifully unambitious ‘active measures’. The Board claims these measures have been designed to achieve a ‘marked reduction’ in the Company’s discount and to align the Company’s NAV performance to future continuation votes.
In this letter we set out our analysis of each of these measures in turn, an analysis that we are confident the vast majority of the Company’s independent shareholders will broadly agree with. But in summary, it appears that our Board believes an acceptable outcome for its shareholders includes NAV returns that are nearly half those promised at IPO. It also believes that the discount problem will have been solved if, in three years’ time, the discount to NAV is anything less than 15%. This is a level that the shares were already trading at three months ago and a situation that the Board has described as disappointing in the last two annual reports.
Considering the dismal lack of ambition that our Board seems to hold for shareholders’ capital, and the inherent weaknesses in the arguments that it has put forward, we have decided to publish this as a public letter to the directors of VSL. There are a number of reasonable questions that the Board’s tepid set of proposals invite, and the Board should be willing to answer these publicly. Again, we are confident that a majority of the Company’s independent shareholders will want to hear answers to these questions too.
We ask that the Board reassesses its current position and brings forward a new set of proposals for shareholders to vote on. Proposals that include reasonable return targets for the Company and which have a genuine prospect of solving the Company’s longer-term structural discount problem.
If the Board fails to bring forward different proposals, we will have no alternative but to vote against continuation and will feel compelled to publicly advocate for this outcome. This will be despite us having a favourable view of the manager and its investment strategy.
We have continued to engage with a wide number of VSL’s shareholders since the Board published these proposals. We have yet to speak to an investor who believes that the targets that Mr Ingram, Mr Peggam, Mr Katzenellenbogen and Ms Passey have set for shareholder capital are reasonable objectives. It is our belief that if the continuation vote is held based on the proposals the Board has announced to date, it will fail without the support of the shares controlled by the manager. It may well even fail while relying on this shareholding.
Needless to say, if the continuation vote were to be passed only with the support of shares controlled by the investment manager, no properly functioning UK investment trust Board should consider this an acceptable outcome. Moreover, in our view, such an outcome could hardly be a proud moment for the advisors that have been engaged to lead the Company through this process. Would such an outcome really be an acceptable practice to be promoting in the UK investment trust industry?
Our comments on the Board’s ‘active measures’
Measure 1: a continuation vote in 2021 if the one-year NAV return is below zero
It is deeply concerning that the Board finds it acceptable to only offer another continuation vote (not an exit) if the Company generates a negative return over the coming year. This target is not just underwhelming, it is entirely inconsistent with the arguments the Board set out in making its case for recommending continuation. Specifically, the Board stated:
- ‘The Investment Manager believes that the market for new investment opportunities in its sector is the most promising since the Company launched in 2015’
- ‘The Investment Manager believes that the Company’s pricing power on new deals has increased significantly since the onset of the COVID-19 crisis’
- ‘In reaching its recommendation for continuation, the Board considered … the prospect of the Investment Manager being able to continue to deliver good returns to shareholders in terms of both yield and NAV accretion in the next few years’.
What concerns us most about this proposal is not the distressing lack of ambition that the Board has. Rather, that if the manager can succeed in simply not losing money in the most exciting investment environment it has enjoyed since IPO, shareholders will not be afforded another continuation vote until 2025, five years from now.
Measure 2: a 100% exit opportunity following the 2023 AGM if the three-year NAV return is less than 18%
We find it inconceivable that our Board believes a three-year 18% NAV return is an acceptable target to set for the manager. On an annualised basis this equates to only 5.6% per annum, a figure that is less than what has been achieved since inception and 44% below the return target that the Company set out at IPO, being 10% per annum.
How is this return hurdle consistent with what the manager is telling the Board about the current investment environment? The target the Board has set is also below the returns needed for the Company to cover its 8p per annum dividend target and, in our view, is not at all commensurate with the risks incurred from indirectly lending to sub-prime borrowers.
As a minimum, we believe the Board should explain to its shareholders the reasons why it believes such an underwhelming return objective is an acceptable benchmark.
Measure 3: a 25% exit opportunity following the 2023 AGM if the average discount is greater than 15% in a four-week period to 31 March 2023
This final objective is particularly unsatisfactory. We believe that it is the persistent, structural discount that most investors have been frustrated by, not recent returns. While 15% is an improvement from today’s 27% discount and the 53% discount in April, in the last two annual reports the Board and manager have only referred to the observed mid-teen discounts on the share price as ‘disappointing’. We note 15% is also wider than the 11.1% discount that the shares touched on 21 February 2020 – a level you were keen to highlight in AGM notice. Given the Board is setting a target that is three years into the future, why is anything less than a 15% discount level now an acceptable outcome for our Board?
To make matters worse, we believe the proposal is inherently flawed. How can a four-week measurement period be a plausible window over which to measure whether the Company has achieved a discount level target? What was preventing the Board from using a length of time that at least ensured there was some substance to the information being observed?
Finally, it is plainly underwhelming that our Board seems only to have the confidence to offer a 25% exit if such a tepid discount target has not been achieved. This means that should the wide discount persist, a shareholder who needs to realise part of their investment must sell the remaining 75% at the prevailing unacceptable discount level.
Issues not addressed in your circular
While you offered arguments for why shareholders should vote in favour of continuation, you failed to offer any legitimate reasons why shareholders should not be entitled to realise their own investment in the Company at NAV via an orderly run-off now. The nearest the AGM notice came to this was a poorly explained warning that the timing of a ‘liquidation’ in the current market could be ‘unfavourable’ and which highlighted the 32-month average maturity on the portfolio. To repeat the arguments from our first letter:
- An orderly run-off requires no ‘liquidation’ of investments. Most of the portfolio is self-liquidating. It merely comes down to whether cash flows are reinvested, or whether they are returned to shareholders that opt for run-off.
- Regarding timing, shareholders are clearly able to decide for themselves what is, or is not, in their best interests. Moreover, it is not clear to us why this situation would be different at any future continuation vote. In fact, the current environment makes a faster run-off more likely if platforms trigger credit performance tests that would allow VSL to retire facilities earlier – an event that seems highly likely in the current environment. Added to this, we are already seeing platforms choosing to pre-pay early, as evidenced by the $60m of proceeds VSL received from 1 March to 20 May 2020.
We were also surprised to see no reference to how the Company might manage the inherent conflicts of interest that the manager’s 18% voting stake represents, noting that this is the first meeting since that stake was acquired. This has been cited as a key concern by every shareholder we have spoken to so far. Given the Board has stated that it has now had an opportunity to speak with many of its shareholders, we would be surprised if you were not clearly aware of this. It is our view that any long-term solution to VSL’s discount problem must also include a solution that appropriately manages this issue. Of course, as well as controlling the voting rights of the largest shareholder, the manager also has a voice in the boardroom (Richard Levy) and we note Mr. Levy is once again being put up for election as a non-independent director. We would question whether Mr. Levy’s presence on the Board is now appropriate given SVS Opportunity Fund’s 18% stake in the Company, especially when the manager can always be called to assist with Board meetings without the need for a vote too.
It has been disappointing to learn that the upcoming AGM will be a closed affair and shareholders will not be able to ask their Board questions in real time. We ask that the Board reconsiders this, noting the importance of this AGM given the continuation vote and the large discount to NAV. For a company providing capital to online lending platforms backed by some of San Francisco’s leading venture capital firms, it is entirely unsatisfactory that VSL is unable to even offer a dial-in facility for this meeting, instead conducting its AGM in a service station off the M25. If it is true that ‘it is not the Board’s intention to exclude or discount the views of the Company’s shareholders’ then in the current day and age, this is very easily fixed. The Board will of course be aware that the Company’s largest counterparty, Elevate Credit, hosted its AGM online on 1 May 2020 and shareholders had the opportunity to engage directly with their Board.
We look forward to hearing answers to our questions and would be happy to discuss any of the issues raised in this letter directly with the Board.
Finally, as this has been published as an open letter, we have been encouraged by how many shareholders have made the time to get in touch with us to discuss the challenges VSL is facing since we published our last public letter. We believe all shareholders should have a voice on these important matters and continue to encourage all shareholders, big or small, to reach out to us to discuss the issues we are all facing.
Director, Staude Capital Limited
020 3874 2241
Director, Staude Capital Limited
¹ The investment personnel seconded from Staude Capital Limited act as portfolio manager of the Global Value Fund under the regulatory license of Mirabella Financial Services LLP, which is authorised and regulated by the FCA.