wolfhounds (29.30)

Under, over, and through the radar - MVC Capital

June 07, 2008 – Comments (1) | RELATED TICKERS: MVC , ALD , CSE

Or - how shareholders learned to love getting screwed by management.

On paper (filed documents, that is) this closed end management company looks well managed and produces fantastic results. The company makes investments in privately held smaller companies and debt, anywhere in the world. They have been successful at selling those investments for substantial profits. Since 2004, assets under management have tripled. And after posting a operating loss in fiscal 07 (get to that in a minute), fiscal 08 turned around nicely. But then comes 2nd qtr earnings posted yesterday and it becomes evident to me why the stock deserves to be down 25% in the last year, and the stock is selling at a 10% discount to NAV.

Management proudly proclaimed GAAP net income of $507,000 compared to a loss of $2.2m yoy.  Operating income BEFORE incentive comp accrual was $4.2m, pocketing 88% of net income. The disclosure stated that  certain events would trigger the actual payment, but management has full discretion to control those events. In addition to the hefty incentive awards, the company pays up meaty management fees. In percentages, the numbers look like this:

        '07                '08                                                       

       .54                 .41                                             incentive comp as % of oper expenses

       .723               .763                                            inc comp/mgt fee as % of oper expenes

       1.04               .565                                            inc comp/mgt fee as % of  net income

That's correct, in fiscal 07 MVC had a oprating loss of $4,136 in the year they accrued incentive comp on a deal to sell their Latvian auto dealership for about $80m. Incentive compensation is based on an estimated market value, and is computed on all assets under management and/or realized gains. In a complex formula, it is equal to the lesser of 20% of net income, or the sum of 20% of net capital gains less unrealized depreciation. I must be an idiot for reading that deep into the annual report (pages 10, 85 & 86). How hard is it to trigger gains in a year that other holdings have depreciated on paper.

But it gets better. The tables above include the effect on net income of both incentive comp and management fees. As of fiscal year ended 10/31/06, all MVC employess became employees of TTG Advisors, so that MVC no longer has direct employees. TTG charges a base management fee (bet you guessed that) of 3.25% of assets under management, and TTG can pass back to MVC certain operating costs it bears in connection with specific services. The list is half a page and I'm too lazy to write it.

This company's strategy for making good investments is not the subject here. It's probably why it's a HG pick and rated as a 5 star pick in CAPS. I beg to disagree. this is one of the greatest examples of the legal fleecing of shareholders I've ever seen.