E&P vultures hide the CD Funds carcass but will it work?

Summary: The AFR recently revealed the latest material information E&P hadn't disclosed to investors: that Pengana Capital has made two bids for the CD Funds and is very keen on consolidating them into its ASX private equity fund PE1. E&P not only rejected the proposals and prevented due diligence, but kept everything secret from investors, perhaps hoping Pengana would give up and no other would-be predators would be aroused. E&P seems to think it owns the funds to run for its own interests; "captive capital" indeed! Investors need to contact their CD Fund Directors to insist that merger proposals are actively encouraged in a competitve and transparent way that reaches the best feasible outcome for shareholders (not E&P). CD Fund investors voted overwhelmingly against the proposals put forward by E&P and the current Directors. Investors will obviously need to keep the pressure on and, ultimately, the current Directors may need to be replaced if not willing to pursue the explicit interests the majority of investors have conveyed.

E&P hope to drain every last drop of fees from the CD Funds

Details:

1. Summary of Pengana Capital offers, E&P response and current status

After the resounding defeat of E&P's merger proposal in Oct 2022, Pengana put forward an original bid for the CD funds in Dec 2022 and then an enhanced offer in Feb 2023: proposing to merge the CD funds with PE1 (Pengana's private equity fund) with CD investors receiving PE1 shares but taking a haircut on the exchange value and also having to wait 18 months to sell the PE1 shares (those selling early wouldn't receive up to 15% of the shares).

E&P rejected the improved offer, has not allowed due diligence access to Pengana to review details of the CD funds, and is not currently participating in active negotiations to complete a deal.

However, virtually all significant investors in the CD funds (the Directors are not) and the majority of shareholders would be seeking their Directors to actually represent their interests:

- Proactively facilitate merger bids from all interested parties in a transparent, competitive way. We want to leave E&P's incompetent management!

- Provide due diligence access to suitable bidders like Pengana as the value of the portfolio companies, cash holdings and current fee arrangements (CD1 and CD2 paying no GP or performance fees) can only improve the bid value.

- Maintain friendly negotiations with all potential bidders with a firm view to finalising a merger proposal with whoever has the best offer, as 75% of shareholders still have to vote for it. Then leave it up to us shareholders to decide!

2. Brief comments on the Pengana proposal and E&P response

In sections 4-6 below you can read full details of the AFR articles and Pengana's and E&P's announcements. But below are my summarising comments:

Pengana Capital has outsourced PE1 private equity management to GCM Grosvenor a very experienced U.S. middle market PE manager. The CD Funds operate in the same space so this is a serious proposal and worthy due diligence eye on valuations. With PE1 trading at any premium to NTA (which it generally does), it is NTA-accretive to PE1 shareholders to scrip-merge the CD Funds, especially given the CD Funds would be assimilated at some discount to their NTA.

Indeed, the fact that PE1 continues to trade at a premium to NTA despite facing much the same macro and valuation lag factors as the CD Funds indicates that the greatest proportion of the CD Fund discounts is due to their being managed by E&P.

E&P are being completely disingenuous in most of their reasons for rejecting the proposal or due diligence:

a. "There is no cash alternative..."

There is no possibility of any significant cash alternative in such proposals. The best way to cash out is to sell the scrip (shares) in the acquiring fund and get the maximum value relative to NTA in the deal - something which is done by offering the full value of the captive capital a closed-end fund provides. This is precisely why WAM often pays premiums to NTA when taking over other LICs (e.g. PAF, WIC, OZG). It is paying up for the value of the captive capital.

b. "The Proposal represents a significant change in the nature of investment to CD2 unitholders..."

This one is particularly galling given E&P just tried to mash up CD1, CD2, CD3 and CD4 and also change them into an evergreen fund. CD Fund investors would be much better off with the on-market liquidity of a Pengana-run fund than the abysmal situation under E&P's current management.

c. "Long term exposure to PE1 trading price which may fall"

The 12 and 18 month lock-up incentives are intended to minimise PE1's price temporarily crashing if most CD Fund investors try to cash out in the same short time period. Moreover, each early exit is NTA-accretive to remaining PE1 shareholders, so there is a natural countervailing balance. I suspect Pengana would readily negotiate on the proportion of shares locked up and the time periods if it can still obtain the aim of a more stable PE1 share price (relative to NAV) while it tries to increase demand for the much bigger PE fund.

d.  "For unitholders seeking near-term liquidity, the structure of the Proposal does not offer a sufficient premium..."

The current Pengana offering is not generous to CD Fund owners but the structure of the proposal (part of the scrip being delayed and time-restrictions on selling) is clearly open to variation and negotiation. It's not a reason to reject the proposal outright, not propose improvements, and not use due diligence to improve confidence around valuations and thus the proposal value.

e. "The split of value is too much in favour of PE1..."

Again, this is what negotiation and due diligence is for. If ongoing discussion on the proposal is actively facilitated, due diligence allowed, and proposals from other parties encouraged (e.g. WAM, WMA), it is easy to see the value to CD Fund investors increasing one way or the other. The current discounts are extreme and any attempt by acquirers or arbitragers to build stakes directly will quickly see them reduce. Once again, E&P and current Directors are acting contrary to investor interests. E&P continues to obfuscate critical information like how the proposal value was being calculated precisely so it can opaquely characterise it in the way that most suits E&P interests not investor interests.

Finally, I should note that as long as E&P is facilitating a transaction (rather than blocking one), time is on the side of CD Fund investors. Future realisations will certainly be much closer to current holding values than the current deep share price discounts, and these will be paid out as distributions, reducing the potential gain for the acquirer or making it have to bid higher. The steady drawdown of the CD Funds captive capital is all the impetus needed to get a deal done.

3. Investors must email CD Fund Investor Relations and have it forwarded to Directors

In the absence of shareholder emails to CD Fund Directors, E&P and the current Directors can continue to present their own views as representing CD Fund shareholder interests. Indeed, E&P specifically claims in their response above to be looking after the "best interests of investors."

Investors should email the address below with their views on whether they wish E&P to keep managing the CD funds or see them acquired by Pengana or a better offer.

Feel free to also provide a link to this blog post if in agreement.

Email CD Funds Investor Relations (and ask for it to be forwarded to all Directors)

info@cdfunds.com.au

4. AFR article highlights on Pengana's approach to merge the CD Funds with PE1

> Pengana Capital puts $1b roll-up plan to E&P’s private equity funds

> Characters line up for Pengana, E&P private equity funds battle

<<
Investor sources said Pengana had made several recent offers to roll up the four Cordish Dixon funds in a series of scrip mergers into its Pengana Private Equity Trust, via deals that would create a $1 billion ASX-listed private equity champion.

Pengana’s understood to have offered 30 per cent-plus premiums to the funds’ depressed share prices, however was either rebuffed or ignored because they were still not at NTA and proposed open-ended fund structures.

The bids were made possible by Pengana’s much healthier trading metrics. Its ASX-listed Pengana Private Equity Trust trades at a premium to NTA, so could afford to pounce on bombed-out rivals and still make the deal accretive for its own investors.

David Kingston, renowned activist and former investment banker, is a major holder in several of the Cordish Dixon vehicles, and doesn’t usually like to hear about his holdings not trying to maximise value for investors.
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<<
Pengana confirmed on Friday morning that it lobbed an indicative bid on December 16, and followed it up with a second “enhanced” offer on February 3.

E&P’s funds, run under the “Cordish Dixon” banner, confirmed receipt of the proposals and gave five reasons why they were dismissed.

Three of the four Cordish Dixon funds are listed and trade at gaping discounts to their net tangible asset backing. The responsible entity’s been trying to rectify the problem - albeit not with solutions investors were happy about - and said its door was open to Pengana and other swoopers, should they wish to join in.

It’s pretty clear there’s a deal brewing. Pengana seems serious about merging the funds into its own structure to help create a $1 billion-odd listed private equity fund-of-funds manager. It already oversees Pengana Private Equity Trust, which is listed with about a $500 million market value.
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5. What has Pengana had to say via PE1 Announcements?

On 24 Feb 2023 PE1 posted this announcement: Response to media speculation:

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24 February 2023: Pengana Investment Management Limited (“PIML”) refers to recent press speculation about the proposal to merge the Cordish Dixon Private Equity Funds Series (“CDS”) with the Pengana Private Equity Trust (“PE1”).

 As of today’s date, PIML is not currently in active discussions with E&P Investments Limited (“E&P”) but confirms it previously submitted two conditional non-binding indicative proposals (subject to due diligence) to merge the four CDS funds (CD1, CD2, CD3 and CD4) with PE1 through four separate and simultaneous trust schemes with CDS unitholders receiving PE1 units.

 Following last year’s failed internal proposal from E&P to merge the four CDS funds, PIML submitted an initial proposal on 16 December 2022 and a second enhanced proposal on 3 February 2023, following specific feedback from E&P on a structure that would allow all unitholders of all vehicles (PE1 & CDS) to materially benefit.

 E&P rejected both proposals and did not engage further.

 PIML continues to believe the proposal has significant strategic rationale and would provide compelling value to CDS unitholders if implemented. The indicative exchange ratio of the second proposal represented c.30% premia to the last close unit prices of CD1, 2 and 3.

 Importantly, PIML notes that it would only progress a merger proposal on a disciplined basis such that any merger would be materially value accretive to PE1 unitholders, and in consultation with PE1’s highly credentialed manager, GCM Grosvenor.

 PIML believes this transaction could achieve a true win-win outcome for all unitholders, to deliver substantial premia for CDS unitholders alongside strong NAV accretion for PE1 unitholders.

Notes:

Based on the closing unit prices of $1.755 for PE1, $0.825 for CD1, $1.10 for CD2 and $1.33 for CD3 on 2 February 2023, being the last closing price prior to the date of the second proposal submitted on 3 February 2023. For CD4, the offer price was based on assuming the same implied offer discount to NAV as CD3 based on the disclosed NAV as at 2 February 2023 (i.e., the NTA announced on 13 January 2023). The ultimate exchange ratio was subject to due diligence.
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6. What was E&P's response to the AFR articles and Pengana's ASX announcement?

On 24 Feb 2023 E&P posted separate announcements for CD1, CD2 and CD3 with the only substantive difference being the calculations of the scrip-for-scrip value being offered for each.

Below is the announcement for CD2:

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E&P Investments Limited, in its capacity as responsible entity (Responsible Entity) of CD Private Equity Fund I, CD Private Equity Fund II, CD Private Equity Fund III and CD Private Equity Fund IV (together, the Fund Series), notes the recent press speculation regarding an approach made by Pengana Capital Group (Pengana).

 The Responsible Entity regularly evaluates various strategic options to maximise value creation for the Fund Series’ unitholders. The Responsible Entity confirms that Pengana made a confidential, indicative, non-binding and incomplete proposal in relation to a proposed transaction with the Fund Series. The Responsible Entity engaged in discussions with Pengana, which resulted in a revised proposal (the Proposal) which is summarised below.

 Key terms of the proposal for CD2 include:

 • Scheme of arrangement requiring 75% approval of CD2 unitholders voting.

 • 85% of the proposed value to be paid for CD2 units would be by way of issue of units in Pengana Private Equity Trust (PE1), which could be traded immediately.

 • 10% of the proposed value in contingent units of PE1, which would become tradeable after 12 months unless the investor sells their other PE1 units, in which case the contingent units would be forfeited.

 • 5% of the proposed value in contingent units of PE1, which would become tradeable after 18 months unless the investor sells their other PE1 units, in which case the contingent units would be forfeited.

 • Based on the structure above and assuming the PE1 price remains at the current price of $1.68 per PE1 unit (closing price as at 23 February 2023) following implementation of the Proposal, the Proposal represents a premium of 17% if PE1 units were sold in the first 12 months, 31% if PE1 units were sold between 12 and 18 months and 38% if sold after 18 months (in all cases, the premium is assessed with reference to the closing price of CD2 units as at 23 February 2023).

 • The pro forma NAV attributable to each unitholder of CD2 would be reduced by a minimum of 12% from current NAV (assuming all contingent units were converted and sold after 18 months and assuming net asset value remains stable in both PE1 and CD2 at current levels).

 Key reasons for the Responsible Entity forming a view that the Proposal is not compelling:

 • The split of value is too much in favour of PE1 and not sufficient for CD2 unitholders. CD2 unitholders receive a minimum 12% dilution to NAV if they hold their PE1 units for 18 months post transaction completion, while PE1 unitholders will receive a minimum 15.5% NAV uplift. The Responsible Entity therefore thinks the Proposal significantly undervalues CD2 units.

 • For unitholders seeking near-term liquidity, the structure of the Proposal does not offer a sufficient premium. For any unitholder who is currently seeking liquidity and sells their PE1 securities in the 12 months following transaction completion, the Proposal only represents a premium of 17%.

 • Long term exposure to PE1 trading price which may fall. The trading price uplift assumes CD2 unitholders hold their PE1 holdings for at least 18 months and the PE1 price may fall during that time, reducing the premium available to CD2 unitholders.

 • The Proposal represents a significant change in the nature of investment to CD2 unitholders. While CD2 currently returns capital to unitholders as underlying funds are realised (20.6% of NAV in the last 12 months), PE1 pays a 4% yield on NAV, with excess funds reinvested in new investments.

 • There is no cash alternative available to unitholders. The Proposal does not offer CD2 unitholders who would like liquidity the option to choose cash for some or all of their investment.

 Therefore, on the basis that the Responsible Entity does not believe the Proposal is in the best interests of investors, the Responsible Entity has not provided access to due diligence. The Responsible Entity remains open to engaging further with Pengana, or other parties, on more favourable terms.
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