Oaktree Specialty Lending : and Oaktree Strategic Income Corporation Merger Conference Call Transcript

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Oaktree Specialty Lending Corp and Oaktree Strategic Income Corporation Merger Agreement - Conference Call

EVENT DATE/TIME: OCTOBER 29, 2020 / 4:00PM GMT

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OCTOBER 29, 2020 / 4:00PM GMT, Oaktree Specialty Lending Corp and Oaktree Strategic Income Corporation Merger Agreement - Conference Call

CORPORATE PARTICIPANTS

Armen Panossian Oaktree Specialty Lending Corporation - CEO & CIO

Mathew M. Pendo Oaktree Specialty Lending Corporation - President & COO

Michael Mosticchio Oaktree Specialty Lending Corporation - IR

CONFERENCE CALL PARTICIPANTS

Finian Patrick O'Shea Wells Fargo Securities, LLC, Research Division - VP and Senior Equity Analyst

Kevin Fultz JMP Securities LLC, Research Division - Analyst

Ryan Patrick Lynch Keefe, Bruyette, & Woods, Inc., Research Division - MD

PRESENTATION

Operator

Welcome, and thank you for joining OCSL and OCSI merger conference call. Today's conference call is being recorded. (Operator Instructions)

Now I would like to introduce Michael Mosticchio of Investor Relations, who will host today's conference call. Mr. Mosticchio, you may begin.

Michael Mosticchio Oaktree Specialty Lending Corporation - IR

Thank you, Kate, and hello, everyone. Before we begin, I want to remind you that comments on today's call include forward-looking statements reflecting our current views with respect to, among other things, the timing or likelihood of the merger closing, the expected synergies and savings associated with the merger, the ability to realize the anticipated benefits of the mergers and our future operating results and financial performance. Our actual results could differ materially from those implied or expressed in the forward-looking statements. Please refer to our SEC filings for a discussion of these factors in further detail. We undertake no duty to update or revise any forward-looking statements.

I'd also like to remind you that nothing on this call constitutes an offer to sell or solicitation of an offer to purchase any interest in any Oaktree fund. Investors and others should note that Oaktree Specialty Lending Corporation and Oaktree Strategic Income Corporation use the Investors section of their respective corporate website to announce material information. The companies encourage investors, the media and others to review the information that they share on their website.

With that, I would now like to turn the call over to Matt.

Mathew M. Pendo Oaktree Specialty Lending Corporation - President & COO

Thanks, Mike, and welcome, everyone. We appreciate your interest, and thank you for joining us today. With me are Armen Panossian, our Chief Executive Officer and Chief Investment Officer; and Mel Carlisle, our Chief Financial Officer and Treasurer. This morning, we issued a press release announcing that Oaktree Specialty Lending Corporation and Oaktree Strategic Income Corporation have entered into a merger agreement pursuant to which OCSI will merge with and into OCSL. We also posted a presentation outlining this transaction on the Investor Relations page of both company websites.

On the call today, I'll provide you an overview of the merger and our strategic rationale for pursuing it. Armen will then discuss what each vehicle brings to the combination, recognizing that some of you on the call today may not be familiar with both OCSL and OCSI. And then he will share details about the combined portfolio.

We believe that now is the opportune time to merge the two companies. Since taking over management of OCSL and OCSI over three years ago, we have steadily executed on our plan to reposition both portfolios by exiting non-core and underperforming assets and rotating into opportunities that align with our overall investment philosophy. Those efforts have largely been completed, and the portfolios are in excellent shape with very strong credit quality, which we believe bodes well for this merger.

The merger will create a larger, more scaled BDC with over $2 billion in total assets, investments in nearly 150 portfolio companies and

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OCTOBER 29, 2020 / 4:00PM GMT, Oaktree Specialty Lending Corp and Oaktree Strategic Income Corporation Merger Agreement - Conference Call

over $1 billion of net assets. We expect the increased size of OCSL will lead to greater trading liquidity, making the stock more attractive to institutional investors and might also lead to broader equity research coverage. In addition, the merger creates efficiencies and expense savings.

Let me now touch on the key terms of the merger, which can be found on Slide 4 of the presentation. Under the terms of the agreement, OCSI shareholders will receive an amount of OCSL shares based upon the net asset values of each company at the time of closing as determined shortly before closing. In essence, this will be a NAV-for-NAV exchange, which will result in an ownership split of the combined company proportional to each of OCSL's and OCSI's respective NAVS.

For illustrative purposes, based on June 30, 2020, net asset values and excluding transaction costs and any tax-related distributions, OCSL would have issued approximately 1.39 shares for each OCSI share outstanding, resulting in a pro forma ownership split of 77.5% for current stockholders of OCSL and 22.5% for current stockholders of OCSI.

Importantly, this transaction represents an efficient equity capital raise that is accomplished without significant dilutive effects as a below NAV rights offering and avoids the J-curve associated with raising fresh equity capital as we're able to instantaneously purchase a portfolio that we have been managing.

The combined company will trade under the ticker symbol OCSL on the NASDAQ Global Select Market and will continue to be externally managed by Oaktree Fund Advisors. Oaktree will support the transaction with $6 million of management fee waivers over the next two years, or $750,000 per quarter for the next eight quarters. We feel that a two year fee waiver period is appropriate as we believe it will take us approximately that amount of time to rotate out of OCSI's nonoverlapping, lower-yielding assets into higher-yielding investments that align with OCSL's strategy. Armen will touch on OCSL's future investment strategy and rotation of OCSI's portfolio in just a few moments.

Prior to closing, the OCSL and OCSI Boards of Directors intend to declare and pay the ordinary course quarterly distributions that would have otherwise been paid on or about March 30, 2021. Additionally, the OCSI Board of Directors intends to declare a special distribution that will represent any previously undistributed taxable income. This distribution will help ensure that OCSI maintains its RIC status and avoids paying excise tax.

The merger is expected to close in March 2021, subject to shareholder approval and satisfaction of other closing conditions as outlined in the merger agreement.

Importantly, this combination is expected to be accretive to net investment income for shareholders of both companies. We project the merger will generate approximately $1.7 million of operational synergies as certain fixed cost of OCSI will be eliminated and interest expense savings will result from a streamlined capital structure.

Longer term, we anticipate further accretion as we rotate OCSI's lower-yielding investments into higher-yielding proprietary investments, which should lead to increased net investment income. Our belief is that this could translate into additional growth in NII over time.

We expect the combined company will also have greater access to more diverse, lower cost debt sources and may provide OCSL with a better opportunity for further debt optimization. Additionally, OCSI benefits from OCSL's investment grade credit ratings and unsecured leverage. And thus far, our lenders have been very supportive of this transaction. We have already received consent from OCSI's lenders, Citibank and Deutsche Bank, as well as its joint venture partner, the Glick Family Office.

In addition, we have spoken with OCSL's lead banks who have indicated they are supportive of the merger. And in fact, just yesterday, we expanded the size of our revolving credit facility by $75 million due to the utilization of its accordion feature.

The target leverage ratio for the combined company will be the same as OCSL's existing target of 0.85 to 1.0. We anticipate that we will be within this leverage target at closing, albeit at the lower end of the range based on June 30 debt levels. We believe the combined entity will have strong liquidity and capital to deploy as opportunities emerge.

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OCTOBER 29, 2020 / 4:00PM GMT, Oaktree Specialty Lending Corp and Oaktree Strategic Income Corporation Merger Agreement - Conference Call

Finally, this transaction represents a merger between two portfolios that we are quite familiar with. Oaktree's Strategic Credit investment team has been managing both portfolios since we acquired them over three years ago, which helps to give us confidence in our financial expectations and our ability to facilitate a seamless portfolio integration. I want to conclude by reiterating this merger benefits shareholders of both OCSL and OCSI through scale, portfolio diversity and expected earnings accretion.

With that, I'll turn it over to Armen.

Armen Panossian Oaktree Specialty Lending Corporation - CEO & CIO

Thanks, Matt, and hello, everyone. I'd like to reiterate what Matt said. We are very excited to be moving forward with this merger as we believe that the combination will create value for shareholders of both OCSL and OCSI through a larger, more diversified investment portfolios and the opportunity for increased profitability through both cost savings and continued portfolio rotation. We believe that now is the right time to move forward. Both portfolios are in solid shape, and our transition out of non-core assets, that we have been working on since 2017, is nearly complete.

Before getting into the details of the combined portfolio, I would like to provide a brief overview of each company for those investors who may not be familiar with both OCSL and OCSI. I'll start with OCSL, which is the larger of the two and will also be the surviving company.

OCSL's mandate has been to provide customized and highly structured capital solutions to middle-market borrowers across the sponsor and non-sponsor finance markets. Our investment objective is to generate both current income and capital appreciation by targeting businesses or industries that are difficult to understand or have been overlooked by the traditional capital markets.

As a result, many of our new investments have been in the form of directly originated private placement transactions where we have co-invested alongside other Oaktree funds. By leveraging the extensive firm-wide resources and expertise of Oaktree for originations, due diligence and credit selection, we have been able to structure a diverse portfolio with high conviction investments positioned to generate attractive risk-adjusted returns across market cycles.

Ever since we took over management of OCSL, we have felt that we were in the late innings of the credit cycle, so we have been focused on defensively positioning the portfolio by lending to businesses that we believe will be resilient through a recession. We have been systematically rotating out of non-core investments and redeploying capital into larger, more diversified businesses with little exposure to cyclical industries.

As a result, our non-core investments at June 30 represented approximately 9% of the portfolio, down from 63% when we first took over management in 2017. And while nobody could have predicted the onset of the COVID-19 pandemic, our portfolio positioning over the last two-plus years has enabled us to navigate the current challenging environment very well. Overall, we feel good about the quality of our portfolio and the health of our borrowers as only 0.2% of our debt investments were on nonaccrual status as of June 30.

At the same time, we have been able to identify interesting opportunities in companies with attractive risk/reward profiles and have made over $500 million of new investment commitments in the March and June quarters.

At June 30, OCSL had $1.6 billion of investments across 119 portfolio companies. 81% of investments were senior secured, of which 61% were first lien. The remainder consisted of 7% unsecured debt, 5% equity and LP interests and 7% investment in the Kemper joint venture, which primarily invests in first lien broadly syndicated loans.

Turning to OCSI. OCSI primarily invests in first lien loans to performing middle-market borrowers in both the private placement and the broadly syndicated loan markets. Its investment objective is to employ a conservative investment approach with an emphasis on generating stable and current cash income. Like OCSL, we have been focused on defensively positioning OCSI's portfolio since acquiring it in 2017 by lending to businesses that we believe can successfully navigate through an economic downturn. We have increased the overall size of our average borrower, focusing on larger, more diversified businesses with little exposure to cyclical industries.

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