FS KKR Capital Corp (FSK), FS KKR Capital Corp II (FSKR) to Merge
FS KKR Capital Corp. FSK and FS KKR Capital Corp. II FSKR recently entered into a definitive merger agreement to form a combined entity. The merger was announced by FS/KKR Advisor, LLC, a partnership between FS Investments and KKR & Co. Inc.’s KKR subsidiary, KKR Credit Advisors.
The transaction, already approved by the boards of both companies, is still subject to shareholders’ approval. The deal is likely to close during the second or third quarter of 2021.
The combined entity is expected to create one of the largest business development companies (BDC) in the country. On a pro forma basis, as of Sep 30, 2020, it will have $14.9 billion in assets under management, $7.2 billion in net asset value and more than $3 billion of committed capital, second only to Ares Capital Corporation ARCC.
Following the announcement, shares of FS KKR Capital Corp. and FS KKR Capital Corp. II gained 1.2% and 5.8%, respectively, during Tuesday's trading session.
Michael Forman, chairman and chief executive officer (CEO) of both companies, said, "The merger of FSK and FSKR represents a significant step toward our long-term strategic goal of creating a premier middle-market lending franchise and industry leading BDC. The combined company will have a well-diversified investment portfolio and enhanced access to the investment grade debt markets. The combination will also result in reduced overall expenses and a stronger dividend profile."
Deal Terms & Other Financial Details
Per the terms of the agreement, shareholders of FS KKR Capital Corp. II will receive FS KKR Capital Corp shares in proportion of the NAV of the FS KKR Capital Corp. II shares held. Fractional shares will be paid in the form of cash. Following the merger, FS KKR Capital Corp. will be the surviving entity and FS/KKR Advisor will continue to manage its operations.
Further, the board of FS KKR Capital Corp. has approved a change in the advisory agreement of the combined entity. With the merger conclusion, the combined entity will reduce its income incentive fee to 17.5% from the present 20%, while the hurdle rate will remain at 7%.
Additionally, the look back provision in the advisory agreement will be removed. Besides, FS/KKR Advisor will waive incentive fees worth $90 million. The waiver will be spread evenly over the first six quarters following the closing.
The combined company will continue with its investment focus primarily on senior secured debt investments. As of Sep 30, 2020, the combined companies' investment portfolio comprised about 72% of senior secured debt investments, on a pro forma basis.
The combination is likely to accrue benefits for both companies in terms of increased balance-sheet size, scale, cost synergies, liquidity and visibility. As of Sep 30, 2020, its investment portfolio will comprise 216 investments across 23 industries.
Furthermore, a larger balance sheet is likely to lead to improved access to the capital markets. Also, reduced duplication of function is expected to result in about $5 million of annual synergies in the near term.
Before the merger is closed, FS/KKR Advisor currently expects both FS KKR Capital Corp. and FS KKR Capital Corp. II to continue with quarterly distributions, subject to board approval.
Rating Action by Moody’s
Following the announcement, Moody's Investors Service has affirmed the long-term issuer and senior unsecured ratings of FS KKR Capital Corp. at Baa3. Nevertheless, the outlook remains negative for the company.
The rating agency believes that the effects of the proposed merger will be "balance credit neutral" for FS KKR Capital Corp., with positive impact on the pro-forma debt-to-equity leverage, investment portfolio diversity and earnings power. This will be partially offset by the risks to creditors from slightly higher secured debt reliance and encumbered assets.
Our Take
The combined BDC behemoth is likely to enjoy synergistic benefits and enhanced access to capital. It will also likely witness efficiency of operations with streamlining of processes and enhanced earnings capability.
In the past six months, shares of FS KKR Capital Corp. and FS KKR Capital Corp. II have appreciated 19.6% and 17.2%, respectively, compared with the 17.1% rally of the industry it belongs to.
Currently, both FS KKR Capital Corp. and FS KKR Capital Corp. II carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.
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