The Steel Partners (SPLP) buyback… or not?
In March 2014 Steel Partners announced a Dutch tender auction for $49 million worth of units at prices ranging from$16.50 to $17.50. Initially the price of SPLP units rose on the news, gradually settling back into the high $16 range as the April 23rd tender deadline approached. But when the results of the tender were announced the unit price fell back, down to around $16 where it is today. The simple reason is that the offer was oversubscribed at $16.50! This means there were a number of large holders that wanted out. Most likely these were original investors in Lichtenstein’s hedge fund (which was forcibly transmuted into the limited partner structure after the 2008/9 financial meltdown) who were waiting for an opportunity to liquidate their holdings without having a devastating impact on the market price.
Remaining unit holders should be pleased, right? After all, 2.97 common units (about 9.6% of units outstanding) were repurchased at a price significantly below Net Asset Value. That theoretically increases the discount to NAV of the remaining units. So why did the unit price not react positively? Well it may have to do with the fact that the offer was significantly oversubscribed at the low-end of the price range, so owners of another 1.5 million units would have been happy to part with these units at the final $16.50 price. This could translate into continued pressure on the market price as those owners try to sell. But, it could also have to do with the filing of an 8-K on May 2nd in which the general partners announced that 1.5 million units of class c units (eventually exchangeable into common units) were issued to management representing incentive awards for 2012 and 2013. So, in effect, there was really only a net 1.5 million unit reduction counting both the Dutch tender and the issuance of these incentive units. The incentive compensation scheme for WL & Co. has been there all the time for limited partners to see, but perhaps it wasn’t until the effects were actually concrete that we realized how much we are paying to the general partner’ skills. The continuing impact of the incentive unit issuance is in all intents similar to a creeping takeunder, and we, limited partners, will eventually be squeezed out, or at least seriously diluted, through the management incentive structure. Yes, more management ownership will align management’s interest with those of the limited partners, but the combination of high incentive pay [automatically reinvested via C shares will] and discounts to market price for incentive units issued to management (ostensibly because of lower liquidity with a lockup period) eventually erode limited partnership interests. Certainly large investors forced to remain in the partnership because of liquidity issues (not a lot of units are traded daily with respect to the number outstanding) might object that the liquidity discount afforded management is out-of-place. I know I think so, even if I’m not a large unitholder. (edit: see Auggie’s comments below)
The positive impact of the Dutch tender was practically negated by the issuance of incentive units, kind of like when management grants themselves options then proceeds with a similar sized share buyback program. In essence the tender offer simply diluted the negative impact of the incentive units. So where does that leave us? As to the unit price, just about where we were at the end of the 1st quarter with the market price at about a 35% discount to NAV. From a confidence in management perspective… significantly lower. We saw some nice gains in NAV in 2013, so management does deserve some credit. How much is hard to say as the market was ‘kind’ last year. Now let’s see what management can do in a sideways or down market. Can they still create value?…. to be continued
Long Term Value Blog 
Aren’t the incentive units paid because the stock price (and implicitly, NAV) has increased? What is wrong with paying management for performance?
I’m not against pay for performance, but… I think the general partner’s incentive compensation at Steel Partners is quite high for a publicly traded limited partnership, especially so since the incentive stock grants are made at a discount to market. First, remember that the incentive fees are a function of NAV not market price of units and NAV is somewhat subjective due to the non-public nature of some of the holdings. Second, the unit incentive compensation is calculated at a discount to the market price at the date of grant, something like 15%, based, ostensibly, on the fact that the C units issued cannot be exchanged into common units for something like 2 years (I’m going from memory here so bear with me if I’m a little off). Thus management is getting units at a discount to the already discounted market price. As long as the pie is growing faster than management’s piece we unitholders are doing OK, but we’re not as well off as we might be if they paid out the incentive in cash. Anyway, it seems to me that they’re not just double dipping here, but triple dipping.
The incentive fees are a function of market price, NOT NAV.
The 5th A&R management agreement spells out the calculation of incentive units in section 9 referencing an “EV per Common Unit”. EV is defined earlier in the agreement as “the equity value of the Partnership as at any measurement date as measured by the product of (a) the volume weighted average of CLOSING TRADING PRICES of the Regular Common Units as reported by the NYSE”.
Here is the management agreement: http://www.sec.gov/Archives/edgar/data/1452857/000145285713000042/ex101fifthamendedandrestat.htm
What am I missing?
Sorry Auggie, you’re absolutely right. I was remembering the incentive units granted two years ago in lieu of management fees for the 2 years prior. Thanks for setting me straight and the link to the management agreement. On rereading it, it looks to me like the 1 1/2% annual management fee is based on ‘partners capital’ which I translate as GAAP book value, but, as you pointed out, the incentive unit grants are calculated at 15% of the unit market price increase, and there is no 15% liquidity discount as I had mistakenly remembered. While this is lower than the ‘2 and 20’ charged by most hedge funds its still quite high for a public company, or in this case a limited partnership. What I also don’t like is the creeping take-under effect as management ‘earns’ a larger and larger piece of the pie, a pie that is undervalued in the market.