Reasons why CD1, CD2, CD3 holders should vote NO
Summary: On 5 Oct, E&P proposed to merge the self-liquidating funds CD1, CD2, CD3 with the unlisted CD4 into a single, unlisted permanent fund with no cash distributions, pooled outcomes (not specific to the fund investor's bought) and max 5% of units per 6 months able to be sold (starting Dec 2023). On 14 Oct, they rushed out a major update: CD1/2/3 investors were furious at suddenly being trapped and the update promises to prioritise withdrawals before new investments.
However, the many significant reasons for shareholders in CD1/2/3 to vote against the merger remain, with the hasty application of lipstick to the pig fooling no-one who has looked at this proposal closely.
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| Look closely or your feet will get burnt! |
Details:
The reasons include:
1. CD4's lack of an exit is E&P's balls up, nothing to do with CD1/2/3
The proposal is booby-trapped for CD1/2/3 shareholders by the totally separate need by E&P to provide an exit mechanism for the unlisted CD4 where you can only currently sell by organising a private arrangement! This major failing of E&P has nothing to do with CD1/2/3 shareholders and CD4 is a much larger fund at an early stage which will override the specific outcomes for CD1/2/3 - which is what their investors chose to be invested in. (CD4 has net assets of $280m. CD1/2/3 total is $320m)
2. CD4 elephant ready to stampede to exit and trample CD1/2/3 keepers
CD4 investors have been trapped for awhile and with an ongoing U.S. bear market there will be a rush to the door for a substantial chunk of that $280m at anything close to NAV. Any exit mechanism (buyback or withdrawals) that provides equal access to CD4 investors will simply dilute it's usefulness and value for CD1/2/3 shareholders. For example, the 6 month merged-fund buyback will trade at considerably lower prices and the biggest proportion of withdrawals will also go to CD4.
3. Self-liquidating at NTA ain't broke, so don't fix (touch) it!
CD1/2 are in wind-down phase with no new investments and CD3 is close behind. The private equity managers have been selling the mature businesses and returning capital and according to the current fund structure/terms E&P ultimately has no choice but to return it to investors via distributions or buybacks. You can see that CD1 has returned $1.17 since Mar 2020. CD2 has returned $0.89 since Mar 2020. CD3 has returned $1.14 since Feb 2021. The return of capital has been proceeding well, not stalling. Conversely, CD4 only recently finished calling capital and apparently has an "indefinite life of 10 years or more". The self-liquidating at NTA feature of the CD1/2/3 funds is their best quality. Investors then get to choose whether, when and where to re-invest in private equity and how much. Obviously, E&P don't want to lose $320m on which to charge fees. Could this possibly be the reason they are proposing to create a perpetual fund with no cash distributions and a narrow, years-long exit strictly policed by their rules and conditions?!
4. Stop playing hide the cucumber and return the cash stash!
Look-through cash (including cash soon to be returned via the PE managers) levels for CD1/2/3 are at least 20-30%. Virtually all of this cash must be returned to investors soon in the current self-liquidating structure. Yet, E&P has failed to disclose (let alone return!) these significant cash holdings while it beavered away on its secret merger proposal that eliminates cash distributions and creates a perpetual fee-generating fund. Instead of providing a transparent assessment of capital return/exit it claims in the Memorandum - Section 3.3 Reasons to Vote in Favour: " the timing of future capital returns is unknown and there may be a tail of investments which take longer to be sold." This is clearly false given the significant recent cash distributions and current levels in CD1/2/3 that have to be returned in the near term if the merger is voted down.
In fact, Section 5.7 states: "If the Proposal is not implemented, the Responsible Entity is likely to use the distributions received to fund capital management initiatives (such as an on-market buyback, to fund working capital requirements, meet future capital calls to the respective LPs (if applicable) and potentially pay distributions for Fund I, Fund II and Fund III." Predictably, E&P are muddying the water here with references to the cash being used for "working capital" or "future capital calls". For CD1/2 all cash has to be returned. CD3 is mostly in wind-down and only a small fraction of net assets are subject to reinvestment.
5. Who do you trust? (Cui Bono or Cui Boneheads?)
- E&P, who's already spent millions of investor's money on a restructure that is supposedly driven by shareholder's interests but didn't consult any of them? And will waste even more investor funds to try and get its proposal over the line despite seeing the majority of intended votes are against it.
- E&P, whose directors all recommended (as in the best interests of shareholders) the original proposal announced 5 Oct 2022 but have already signed off on major changes by 14 Oct 2022 after hearing the reaction from furious investors in CD1/2/3?
- E&P, whose Memorandum - 3.3 Reasons to Vote in Favour claims: "The Proposal provides Unitholders the opportunity for scale benefits and cost savings" when the reality is that due to the wind-down phase CD1/2 are in and then CD3, CD1 investors currently save on most of their holding costs (no GP fee since June 2022), CD2 will obtain GP fee-free status by Feb 2023 and CD3 by July 2026 (with most of the capital returned long before). The truth is that the total costs for CD1 and CD2 would go up significantly. GP fees would reapply indefinitely for CD1/2, and performance fees which never existed for CD1/2 would now apply. These cost downsides are not disclosed in this section on Reasons to vote in favour.
These are just a few examples out of dozens. In just the first section of the Memorandum <Section 3.3 Reasons to Vote in Favour> I found significant omissions or misleading statements in literally every element of it: See > Reasons to vote in favour of E&P's CD fund merger proposal?
The reality is that such complex funds with their 80pg PDS and 184pg Explanatory Memorandum's ultimately rely on the good faith actions and trustworthiness of the Responsible Entity (currently E&P). Everything significant (like withdrawal capacity and fairness) is conditional and depends on the discretion of E&P.
Fund managers with trustworthy reputations can raise new money in new funds. They don't resort to trying to trap investors who are looking forward to escaping. If you trust E&P, feel free to vote to give them full power to decide if and when you get any funds back and what you're invested in. Every substantial investor I know does not trust E&P and is voting NO.
6. Please sir, I don't want to be Krolled!
It looks like Kroll was seeking entry into the dictionary with its report. Kroll, the supposed independent expert, recommends the merger is in the best interests of CD1/2/3 shareholders but it's report demonstrates it is neither independent nor an expert.
Here is just the tip of the iceberg of flawed advice:
- pg90: " At the completion of the buyback programs, approximately 6.3% and 4.9% of Fund I and II Units had been bought back, respectively. These programs failed to significantly close the gap between the Unit price and NAV per Unit."
<< The buybacks could have bought 10% of units every 12 months and been run continuously, not been quit after only one partial use. Also, when the buybacks were operating more aggressively they did close the discount. >>
- pg 90: "Whilst liquidity is also provided by distributions following the sale of underlying investments, distributions from Funds I and II are expected to decline over time as the Funds are wound down."
- pg98: "The Proposal provides an ability for Unitholders to maintain their investment rather than being forced to liquidate over time, although this may not suit some investors"
<< I know 5th graders who understand investors are best able to manage their exposure themselves by simply buying and selling whatever investment they want out of thousands of options, when they want, and choosing how much. Not by being trapped in a perpetual fund they didn't choose! Kroll did not poll investors in each fund to conclude only some would prefer the existing self-liquidating structure. The truth is that the vast majority of CD1/2/3 shareholders prefer the self-liquidating structure and Kroll has deliberately obscured this. >>
7. Please buy this banana but don't smell it, I promise it's not rotten!
After distributions to date, CD1 investors have only $52m left in net assets. CD2 investors have $108m left. CD3 have $162m left. And 20-30% of that is cash ready to be released! But, in the merger, all are being asked to buy CD4's ~$280m in net assets at full sticker price despite the market ascribing 30-50% discounts on CD1/2/3 asset values and E&P advising that it doesn't want to list CD4 as it's liquidity solution as it would trade at a huge discount!!
And in the original proposal, investors would be giving E&P the right to reinvest into new assets (without the Cordish family onboard) and pay full sticker price plus fees in perpetuity. The Merger Proposal Update aims to salvage the vote with concessions prioritizing withdrawals but if E&P are aware the majority simply want to exit, why cook up a proposal to lock in most of the capital for years? The answer is, as usual, self-interest in perpetual fees.
