MCG Capital should immediately move forward with HC2. If that deal cannot be closed, then MCG Capital should invest 100% of their cash assets into the Vanguard Admiral S&P 500 Index fund, which has an annual management fee of 5 basis points.A publicly traded MCG Capital, invested entirely in the Vanguard S&P 500 index fund with more than $233 million in capital loss carryforwards, would likely trade at a premium to NAV and would offer MCG Capital shareholders an investment option far superior to the Pennant Park transaction. The company would also have outstanding liquidity, because this investment could easily be sold with 24 hours notice to Vanguard. No such liquidity is available with a portfolio of floating rate business development loans. The Vanguard S&P 500 Index is preferable to the Pennant transaction even without the carryforwards. The potential to use some or all of the carryforwards make it that much more compelling. Assuming a 30% combined effective tax rate, the $233 million in capital loss carryforwards could be worth a nominal $70 million, before discounting that amount back with a net present value adjustment. Assuming a 50% net present discount, those carryforwards could produce up to $1 per share in additional value to MCG Capital shareholders over the next 4-5 years. This is a viable and excellent strategy. It is low cost and prudent, and it provides an extremely attractive alternative to the MCG Capital transaction with Pennant Park. We would also have the ability to buyback shares in this publicly traded entity, if for some unlikely reason, the shares traded at a discount to NAV. The company can also place ownership restrictions moving forward if necessary to protect our loss carryforwards. A completely liquid investment in the S&P 500 is far more attractive than owning 46% of a floating rate business development loan portfolio. The proposal by HC2 offers an 8.215% yield, an 11.5% premium to the Pennant proposal, and meaningful upside via the conversion option in the preferred security being offered.
The Board of MCG Capital is concerned that HC2 won't close on the transaction. I suggest the Board can move forward without 100% certainty with HC2. This is because an even better alternative than the Pennant Park deal is readily and immediately available in the event HC2 cannot close. As an owner of 2% of the outstanding shares of MCG, I ask that you consider this strategy as outlined.While MCG Capital was created to provide income to its shareholders, the Board should not move forward with an inferior offer in an attempt to provide dividends to shareholders. The HC2 offer provides both income and capital appreciation, and the Vanguard S&P 500 alternative provides outstanding tax sheltered investment opportunities. The Pennant Park transaction is a far distant third choice. MCG Capital should take HC2's $20.5 million and work toward closing a transaction with Mr. Falcone. If you can't close with HC2, an outstanding alternative is available to the MCG shareholders. I trust you will give this your full consideration. Sincerely, Charles FrischerGP, LF Partners