NEW YORK, NY — (MARKET WIRE) — 02/09/10 — Prospect Capital Corporation (NASDAQ: PSEC)(“Prospect”) today sent to the Board of Directors of Allied CapitalCorporation (“Allied”) the letter set forth below:
February 9, 2010Board of Directorsc/o John M. ScheurerChief Executive Officer and PresidentAllied Capital Corporation1919 Pennsylvania Avenue N.W.Washington, D.C. 20006
Ladies and Gentlemen:
We write in response to your letter of February 3. While we would havepreferred to have engaged with you in a constructive process designed todeliver enhanced value to your shareholders, you obviously have no interestin doing so at this time. Instead, your apparent zeal to complete yourhastily-conceived merger with Ares Capital Corporation (“Ares”), no matterwhat, has led you to engage in speculation and disseminate misstatementsabout Prospect Capital Corporation (“Prospect”) in a transparent effort todisparage our proposal and divert attention from the flaws in the Aresmerger.
Incongruously, Allied Capital Corporation (“Allied”) has spent more timecriticizing Prospect than answering the most important question: Why isAllied intent on rushing to give away to Ares its portfolio for inferiorvalue, when it does not need to do so? Under the circumstances, and so thatyour shareholders may know the truth, let us share here facts debunkingmany of the incorrect and misleading assertions and innuendo that abound inyour letter.
1. Your Deeply Flawed “Process” Lacked Any Competition. By now it shouldbe clear even to the most casual reader of the preliminary joint proxystatement/prospectus (“Proxy Statement”) filed by Allied and Ares CapitalCorporation (“Ares”) that Allied did not run any kind of a competitiveprocess in order to maximize value for its shareholders. Instead, the ProxyStatement reveals that Allied cut a one-on-one, exclusive “back-room” dealwith Ares that skewed the playing field for all other potential bidders,without any market test to ascertain what other interested suitors mightpay before entering into an agreement with Ares. How many prudentfiduciaries would voluntarily speak to only one potential buyer of theironly asset, a multi-billion dollar portfolio?
We cannot understand how you can believe your actions (or lack thereof) canmaximize the value of Allied for its shareholders or comport with yourduties of care, loyalty and good faith. For example, by asserting that youasked your “financial advisors” to meet and have “discussions” withProspect, your letter attempts to convey the misleading impression thatAllied actually engaged in meaningful dialogue with Prospect. In fact,despite our repeated requests to meet with you to discuss our proposal, onFebruary 1 at approximately 5 p.m. — a little over a day before youpublished your letter rejecting our proposal, your financial advisor (whichis hopelessly conflicted as it is also the lead bookrunner for Ares in its$254 million share offering last week, and a lender to Allied) requested animmediate meeting with Prospect, on barely an hour’s notice. Prospectobliged and provided all the information requested at the brief meeting.Far from a dialogue, we did not receive even a single question, phone callor email from Allied or its advisors related to the information we sent. Inkeeping with your lack of process throughout, we also did not receive aresponse to our offer to make a presentation to the Allied board.
We do not believe that a single perfunctory meeting between your financialadvisor and our management can resuscitate your flawed process, and wedoubt that you do either. In retrospect, it is clear this “meeting” with uswas just a box you expediently wanted to check to include in your letter,and was simply a ruse like the way you brushed us off when we firstapproached you last Spring and Fall.
Your continued support of the Ares merger cannot be explained or justifiedby any supposed Allied “financial crisis.” Having repaid several hundredmillion dollars of secured debt since September 30, 2009, Allied today isfacing no liquidity crisis, and has no debt due in 2010. Allied appears tohave, net of cash on hand, just over $400 million of debt due in 2011 andjust under $200 million of debt due in 2012, or just over $600 milliontotal of institutional debt (net of cash). This debt total is far less thanthe Allied debt when Allied accepted the Ares bid months ago, andsignificantly less than the $2.2 billion of Allied assets which you reportin your letter (with the value of such assets having potentially increasedby a substantial amount since September 30, 2009). In addition, your stated$2.2 billion of asset value for Allied implies an equity value of as muchas $1.2 billion for Allied, or nearly $7 per share, which is nearly twicethe value of the Ares offer.
Absent any liquidity-driven or valuation-driven urgency to close a dealwith Ares, why are you intent on continuing your headlong rush to depriveyour shareholders of significant value when you do not need to do so?Allied might be fatigued as a result of the way it managed the 2007-2009credit crisis that Prospect successfully navigated, but Allied need notrush to complete a below-market deal with Ares when greater value canreadily be achieved through Prospect.
Last year, when Prospect purchased Patriot Capital Funding, Inc.(“Patriot”), another public company, which our team completed by winning anauction without the need of an external financial advisor or publicrelations firm due to our collective decades of experience in mergers andacquisitions, we had to compete with dozens of other potential suitors.Unlike Allied’s exclusionary process designed to surrender Allied tomanagement’s preferred bidder, Patriot’s financial advisor contacted 133parties, resulting in 51 executed confidentiality agreements and 22 lettersof intent. Unlike Allied, Patriot was facing an imminent liquidity crisisand needed to close a deal with someone quickly to avoid running out ofcash. We believe our terms were attractive for Prospect and Patriotshareholders alike, but we still had to compete to win the deal, whichincreased the value received by Patriot shareholders. In sharp contrast,Ares has competed with no one for Allied. Had the first bidder for Patriotnot been required to compete with anyone, Patriot might well have been soldat a price below market, just as Allied is being sold below market to Aresnow.
Given the experience you and your advisors have with financial companies,where precise valuations are impossible without access to the books andrecords you have denied us, your departure from accepted practice is evenmore egregious. As you undoubtedly know, by withholding detailed financialinformation from Prospect and any other potential bidder, you have made itdifficult, if not impossible, for anyone but Ares to assess the highestavailable value for Allied.
2. Prospect’s Dividend Has Outperformed Ares’ Dividend. Similarly lackingany factual basis is your contrived concern about Prospect’s dividend,while conveniently ignoring Ares’ actual track record on dividends, whichshould have been of great concern to you before entering the Ares merger,and should be now. The Prospect merger proposal (as revised pursuant to thelast paragraph of this letter) would provide Allied shareholders with a proforma quarterly dividend of approximately $0.181 per share of Allied commonstock, based on Prospect’s proposed exchange ratio and most recentquarterly dividend, which is nearly 60% higher than the pro forma quarterlydividend of $0.114 per share of Allied common stock under the proposed Aresmerger. Because Prospect’s proposal on a pro forma basis would provideAllied shareholders with nearly 60% more dividends than they would receivepursuant to the Ares merger, Prospect’s dividend rate would need to dropprecipitously before it ceased to provide greater value to Alliedshareholders than they would receive from Ares.
Equally disingenuous is your professed concern about Prospect’s ability togenerate net investment income to cover its dividend. You ignore that inthe vast majority of quarters over the five years ended September 2009Prospect has earned net investment income in excess of its dividend, whileAres has not reported net investment income in excess of its dividend in asingle one of those 20 quarters. On a cumulative basis over that timeperiod, Prospect has reported net investment income that is $0.46/sharegreater than dividends paid, while Ares has reported net investment incomethat is $1.15/share less than dividends paid. These critical facts wouldlikely be of significant interest to Allied’s shareholders, but areentirely omitted from your letter. You dodge the issue in your ProxyStatement as well where you note as a risk factor that there is “noassurance” that Ares will be able to pay future dividends at current levelsand that Ares has paid dividends to its shareholders “out of assets legallyavailable therefor,” without disclosing that such dividends haveconsistently exceeded Ares’ net investment income. In short, your professedconcern with the security of Prospect’s dividend appears pretextual andunfounded. Given Ares’ dismal historical record not producing netinvestment income sufficient to cover its inferior dividend, it isdifficult to understand how Allied’s board could have executed the Aresmerger agreement and even harder to comprehend why it has selectivelyattacked Prospect, which has a superior record, on this basis.
The dividend coverage “analysis” in your letter also fails to account forany synergies related to cost reductions or discount to par accretion,despite your featuring synergistic benefits in the Proxy Statement. Further,Prospect has been using more conservative accounting standards in valuingAllied assets than the accounting standards we understand Ares is proposingto use, based on a review of the Proxy Statement. We believe that Ares’accounting method involves immediately writing up Allied assetssubstantially above the purchase price. Such method is more aggressive thanthe method used by Prospect to value the Allied assets close to thepurchase price, and we believe that without such accounting Ares’ leverageratio would be even higher than indicated, putting pressure on creditratings and lender covenants, and possibly bringing Ares close tononcompliance with 1940 Act leverage limits, thereby possibly threateningAres’ tax free status as a Business Development Company. These risks arenot adequately described in the Proxy Statement.
Similarly ignored was the decision of Ares to commence a “rights offering”in 2008, a suggestion made in the past by others to Prospect. We haverejected rights offerings as coercive and unfair to shareholders if otheralternatives are available. Prospect’s track record on dividends andrejection of rights offerings demonstrates that Prospect is far more”shareholder friendly” than Ares, contrary to the assertions in your letter.
We believe the best measure of being “shareholder friendly” is how well wehave helped our shareholders build wealth over time. Over the past fiveyears ended February 8, 2010, Prospect has delivered total returns ofapproximately 43% to its shareholders, compared to only approximately 29%total returns delivered by Ares (and negative returns by Allied). Inaddition, Ares cut its dividend in 2009 by 17% while Prospect has increasedits dividend in each of the 21 quarters since its 2004 initial publicoffering. These facts are also omitted from your letter. Given Ares’ poordividend track record, it is hard to credit your professed concern over”dividend risk” as a sincere reason for rejecting our proposal.
3. Prospect’s Proposal Provides “Superior Value”. In your letter,Allied’s board concedes, as it must, that the Prospect proposal reviewed bythe Allied board in fact provides a premium to Allied’s shareholders overthe Ares proposal. However, in your effort to obfuscate this reality, youspeculate in your letter that the Prospect premium could “vanish” if the”market believed” Prospect would complete the transaction with Allied.Unless Allied’s portfolio is in such miserable shape that Ares, which hashad access to Allied’s books and records, will not realize the manybenefits claimed by its accounting for the merger in the Proxy Statement,simple arithmetic shows that Prospect shares should benefit much more thanAres’ shares have because Prospect has many fewer shares outstanding. Underour revised offer, Allied shareholders would own 56% of the combinedcompany with Prospect, compared to only 30% with Ares, a significantbenefit that should have been examined by the Allied board.
4. Prospect has a Strong Balance Sheet with Low Leverage and isWell-Positioned for Credit Growth. Given your unfair criticisms of theProspect proposal, it is not surprising that your letter said nothing aboutthe risks relating to Ares’ significant amounts of leverage as compared toProspect’s more robust credit profile. A combination with Prospect wouldprovide Allied with a lower leverage profile than the proposed Arestransaction. Prospect currently has a debt/equity ratio of less than 0.1x,which, pro forma for a Prospect/Allied combination, would providesignificant de-leveraging for Allied shareholders. Ares, by comparison, hasa debt/equity ratio of approximately 0.7x, which is seven times Prospect’sleverage ratio and significantly closer to the legal maximum for BusinessDevelopment Companies of 1.0x, as of its most recent quarterly financialstatements. We believe Ares’ higher leverage makes an Ares/Alliedcombination far riskier for Allied shareholders than a Prospect/Alliedcombination. Because Allied’s overleveraging was a significant factorbehind Allied’s recent financial difficulties, we would have expected theAllied board to have paid particular attention to the pro forma leverageratio of the Allied/Ares combination.
Your professed concerns about Prospect’s access to growth capital aresimilarly contrived. Prospect has investment grade ratings on both itscorporate debt and its credit facility. Unlike many of our competitors, wehave expanded our access to credit (with significant undrawn capacity), andhave added multiple lenders to our credit facility over the past yeardespite a tight credit environment. We believe we have excellentrelationships with the lending community, and work diligently with them onan ongoing basis to drive down our cost of capital. Lenders to Prospectinclude some of the largest financial institutions in the world, withcombined total assets of more than $3 trillion. Furthermore, we have raisedcapital at a premium to book in a majority of our capital raises. In 2009,we purchased Patriot at a steeper discount to book than our capital raisesduring the credit crisis for such purpose, thereby accreting value to ourshareholders.
5. Allied’s Account of Prospect’s Approach to Allied is RevisionistHistory. Given Allied’s flawed “process” and the low value you areattempting to foist on Allied shareholders, we are not surprised that youdistort beyond recognition Prospect’s multiple expressions of interest in2009 to combine with Allied. Let there be no misunderstanding — yourassertion that “Prospect was unwilling to provide basic information” andthat “at no time… did Prospect make an offer to acquire Allied” ismisleading. We clearly stated that any potential financing sourcesproviding capital should any be needed in addition to our own could, andwould, be disclosed after a mutual confidentiality agreement was executed.
Last April, after Graham D.S. Anderson, a member of the Prospect board ofdirectors, met in Washington, D.C. with William L. Walton, Chairman of theAllied board, to discuss a potential transaction between Prospect andAllied, Alex Fine, an executive of Allied, then sent Mr. Anderson aconfidentiality agreement that Mr. Fine stated was “to be executed byProspect and Allied prior to engaging in any preliminary discussions.” Oneday later, Joseph Ferraro, Prospect’s General Counsel, sent his comments onthe draft confidentiality agreement to Mr. Fine. When we inquired as to thestatus of the agreement, Allied indicated that it wished to postponeexecution of a confidentiality agreement because Allied was focused oncompleting its debt restructuring.
We now know from the Proxy Statement that on the very day that Prospect’slast efforts to finalize a confidentiality agreement were being rebuffed byMr. Walton, Allied’s board met to, among other things, receive an update ona potential transaction with Ares, and that shortly thereafter Ares andAllied entered into a mutual confidentiality agreement. It is worse thandisingenuous for Allied to suggest that “Prospect was unwilling to providebasic information” to Allied when Allied was unwilling to exchangeconfidential information in the conventional (or any) manner with anyonebut Ares.
Last September, after the Allied debt restructuring was complete, Prospectfollowed up again with Allied, communicating through an Allied ManagingDirector to John Scheurer, Allied’s Chief Executive Officer, indicating ourinterest in acquiring Allied. The message back from Mr. Scheurer wasresoundingly clear– Allied preferred continuing as an independent company. As the world nowknows from the Proxy Statement, Allied was instead having secret mergerdiscussions with Ares, and only Ares, at the time. The factual record couldnot be clearer.
6. Prospect has a Partnership Approach to Business. We are disappointedto learn that Allied regards the leaner size of Prospect and its interestin retaining Allied employees as a negative. We would think most boardswould consider these factors to be strong and important positives,especially given our understanding that Ares may not be offering employmentto more than a small number of Allied’s current employees, if that. We alsosee no “cultural” divide with the Allied team. Unlike Ares, who has made nopublic statements about their willingness to keep Allied staff members, ourproposal has expressed interest in significant retention. We believe thatthe retention statement by us is an important sign of strength, and astrong positive, as we recognize that the institutional memory and skillsets of many Allied team members, some of whom have shown consistentloyalty to Allied over many years, is not something to be lightly dismissed,as your letter seems to do. Further, your assertion that Prospect’smanagement platform is inferior because Ares’ manager, Ares Management LLC,has over $33 billion under management (of which only approximately $2billion is actually for Ares Capital Corporation, the prospective buyer ofAllied) ignores the immeasurable benefits to Allied from Prospect’s abilityto focus on its core business without conflicts or distractions. The Aresmanager, we believe, is distracted managing a number of other potentiallycompeting funds beyond Ares Capital Corporation. The Prospect manager isfocused on Prospect Capital Corporation and our shareholders as its primarybusiness.
7. Prospect Has Reduced Execution Risk. We indicated in our previousproposal that we could work with existing merger agreement documentation,and efficiently complete due diligence in only 15 business days, moreimportant facts ignored in your letter.
8. Financial Information in the Ares-Allied Proxy Statement is Outdatedand Potentially Misleading. On March 26, 2010, Allied hopes to be askingshareholders to vote based on outdated financial information in the ProxyStatement that will be almost six months old, that will not reflect (i)substantial Allied debt reductions, (ii) a December 31, 2009 valuation ofAllied’s portfolio, or (iii) a December 31, 2009 third-party audit report.Based on these factors, in light of our experience in this business, webelieve that the Proxy Statement may substantially understate Allied’svalue. Over the past several months, the S&P/LSTA Leveraged Loan Index hasincreased, and we believe this suggests correlatively that there arepotentially significant increases in Allied’s book value since theSeptember 30, 2009 valuations.
Given the obvious materiality of current asset values to the fairness ofthe proposed transaction, we believe Allied shareholders should be givenaccess in the Proxy Statement to updated financial information about Allied(information that Ares no doubt already has) so that Allied shareholderscan cast a truly informed vote on the Ares merger proposal.
Conclusion
Despite the serious flaws in the process, and your attempt to obfuscate theactual relative merits of the Prospect proposal, we remain convinced thatthe price offered by Ares falls far below the actual value of Allied andthat a Prospect-Allied merger would create synergies and unlock significantvalue for the mutual benefit of our shareholders. While we continue tobelieve that Prospect’s last proposal which you have rejected was asuperior and compelling proposal that would provide Allied shareholdersgreater value, we are now prepared to make our best and final offer,subject to due diligence. Accordingly, we hereby increase our offer toacquire Allied Capital Corporation to 0.4416 of a share of Prospect commonstock for each share of Allied common stock. The implied value of this bestand final offer is now 25% greater than the implied value of Ares’ offer toAllied shareholders, based upon closing prices of Ares and Prospect commonstock on February 8, 2010. This offer expires on Wednesday, February 17,2010 at 5:00 p.m. Eastern Standard Time unless you have indicated to us inwriting prior to that time that you wish to engage in discussions with usrelating to our offer.
Very truly yours, Prospect Capital Corporation Name: John F. Barry III Title: Chairman and CEO
ABOUT PROSPECT CAPITAL CORPORATION
Prospect Capital Corporation (www.prospectstreet.com/) is a closed-endinvestment company that lends to and invests in private and microcap publicbusinesses. Our investment objective is to generate both current income andlong-term capital appreciation through debt and equity investments.
We have elected to be treated as a business development company under theInvestment Company Act of 1940 (“1940 Act”). We are required to comply witha series of regulatory requirements under the 1940 Act as well asapplicable NASDAQ, federal and state rules and regulations. We have electedto be treated as a regulated investment company under the Internal RevenueCode of 1986. Failure to comply with any of the laws and regulations thatapply to us could have an adverse effect on us and our shareholders.
Forward-Looking Statements
This press release contains forward-looking statements within the meaningof the Private Securities Litigation Reform Act of 1995, whose safe harborfor forward-looking statements does not apply to business developmentcompanies. Such forward-looking statements may relate to us and/or ourindustry and address matters that involve risks and uncertainties.Forward-looking statements reflect our current views and assumptions withrespect to future events, operations, business plans, business andinvestment strategies and portfolio management, the performance of ourinvestments and our investment management business and the economy. Theseforward-looking statements are not historical facts, but rather are basedon current expectations, estimates and projections about our industry, ourbeliefs, and our assumptions. Words such as “intends,” “intend,””intended,” “goal,” “estimate,” “estimates,” “expects,” “expect,””expected,” “project,” “projected,” “projections,” “plans,” “seeks,””anticipates,” “anticipated,” “should,” “could,” “may,” “will,” “designedto,” “foreseeable future,” “believe,” “believes,” “currently anticipates,””currently believes” and “scheduled” and variations of these words andsimilar expressions are intended to identify forward-looking statements.Our actual results or outcomes may differ materially from those anticipated.Readers are cautioned not to place undue reliance on these forward-lookingstatements, which speak only as of the date the statement was made. Weundertake no obligation to publicly update or revise any forward-lookingstatements, whether as a result of new information, future events orotherwise. These statements are not guarantees of future performance andare subject to risks, uncertainties, and other factors, some of which arebeyond our control and difficult to predict and could cause actual resultsto differ materially from those expressed or forecasted in theforward-looking statements, including without limitation:
-- our future operating results;-- our business prospects and the prospects of our portfolio companies;-- the impact of investments that we expect to make;-- our contractual arrangements and relationships with third parties;-- the dependence of our future success on the general economy and its impact on the industries in which we invest;-- the ability of our portfolio companies to achieve their objectives;-- difficulty in obtaining financing or raising capital, especially in the current credit and equity environment;-- the level and volatility of prevailing interest rates and credit spreads, magnified by the current turmoil in the credit markets;-- adverse developments in the availability of desirable loan and investment opportunities whether they are due to competition, regulation or otherwise;-- a compression of the yield on our investments and the cost of our liabilities, as well as the level of leverage available to us;-- our regulatory structure and tax treatment, including our ability to operate as a business development company and a regulated investment company;-- the adequacy of our cash resources and working capital;-- the timing of cash flows, if any, from the operations of our portfolio companies;-- the ability of our investment adviser to locate suitable investments for us and to monitor and administer our investments,-- authoritative generally accepted accounting principles or policy changes from such standard-setting bodies as the Financial Accounting Standards Board, the Securities and Exchange Commission, Internal Revenue Service, the NASDAQ, and other authorities that we are subject to, as well as their counterparts in any foreign jurisdictions where we might do business;-- our ability to manage future growth;-- our dependence on Prospect Capital Management's key management personnel;-- the highly competitive market for investment opportunities in which we operate;-- uncertainty as to the value of our portfolio investments;-- additional risks to which senior securities, including debt, expose us;-- changes in interest rates;-- our need to raise additional capital to grow because of the requirement that we distribute most of our income;-- the lack of liquidity in our investments;-- fluctuations in our quarterly results;-- fluctuations in our net asset value;-- potential conflicts of interest and their impact on investment returns;-- our incentive fee's impact on the types of investments made by Prospect Capital Management;-- changes in laws or regulations;-- risks relating to our operation as a business development company;-- risks relating to our investments and securities-- the integration of Patriot or other businesses we acquire or new business ventures we may start;-- uncertainty as to whether Allied will enter into and consummate the proposed transaction with Prospect on the terms set forth in our offer; and-- the risks, uncertainties and other factors we identify in "Risk Factors" and elsewhere in our filings with the SEC.
Although we believe that the assumptions on which these forward-lookingstatements are based are reasonable, any of those assumptions could proveto be inaccurate, and as a result, the forward-looking statements based onthose assumptions also could be inaccurate. Important assumptions includeour ability to originate new loans and investments, certain margins andlevels of profitability and the availability of additional capital. Inlight of these and other uncertainties, the inclusion of a projection orforward-looking statement in this press release should not be regarded as arepresentation by us that our plans and objectives will be achieved. Theserisks and uncertainties include those described or identified in “RiskFactors” and elsewhere in our filings with the SEC. You should not placeundue reliance on these forward-looking statements, which apply only as ofthe date of such filings.
Additional Information about the Proposed Transaction and Where to Find It:
This press release is not a proxy statement or a solicitation of proxiesand does not constitute an offer to sell or a solicitation of an offer tobuy any securities. This press release relates to a business combinationtransaction with Allied proposed by Prospect, which may become the subjectof a registration statement filed with the Securities and ExchangeCommission (the “SEC”). This material is not a substitute for theprospectus/proxy statement Prospect has filed or would file with the SECregarding the proposed transaction if such a negotiated transaction withAllied is reached or for any other document which Prospect may file withthe SEC and send to Allied or Prospect shareholders in connection with theproposed transaction. INVESTORS AND SECURITY HOLDERS OF ALLIED AND PROSPECTARE URGED TO READ ANY SUCH DOCUMENTS FILED WITH THE SEC CAREFULLY IN THEIRENTIRETY IF AND WHEN THEY BECOME AVAILABLE BECAUSE THEY WILL CONTAINIMPORTANT INFORMATION ABOUT THE PROPOSED TRANSACTION. Such documents wouldbe available free of charge through the web site maintained by the SEC atwww.sec.gov or by directing a request to the contact listed below.
Prospect and its directors, executive officers and other persons may bedeemed to be participants in any solicitation of shareholders in connectionwith the proposed transaction. Information about Prospect’s directors andexecutive officers is available in Prospect’s proxy statement for its 2009annual meeting of shareholders, which was filed with the SEC on October 16,2009. Other information regarding potential participants in such proxysolicitation and a description of their direct and indirect interests, bysecurity holdings and otherwise, will be contained in any proxy statementfiled in connection with the proposed transaction.
All information in this communication concerning Allied and Ares wasobtained from public sources. While Prospect has no knowledge that any suchinformation is inaccurate or incomplete, Prospect has not had theopportunity to verify any of such information.
For additional information, contact:Grier EliasekPresident and Chief Operating Officergrier@prospectstreet.comTelephone (212) 448-0702