PORTLAND, Ore., Dec. 14, 2011 /PRNewswire/ -- The following is issued by Deschutes Portfolio Strategies:
To: The Board of Equus Total Return (NYSE: EQS)
From: Deschutes Portfolio Strategies (DPS)
On behalf of all other innocent non-insider EQS shareholders, we write to demand the immediate, transparent, orderly liquidation of our company, and a more careful attention by the board to the fiduciary duties it owes to all shareholders equally.
You are as familiar as I am with the history of this company. Over the past 5 years shareholders have suffered a series of nearly unbelievably inept management decisions, accounting statements which are neither self-consistent nor reflective of reality, and large transfers of cash to insiders. Versatile Systems entered the scene two years ago promising to change all that, and, in May 2010, its representatives won control of the board. In that proxy contest, we voted for your representatives because we believed you would be true to your word, and because the direction being pursued by former management was clearly not tenable.
In the year and a half since you took over our company, you have made some progress in an apparent attempt to increase the value of Equus on behalf of all shareholders. We thank you for that. However, you have not changed the fundamental governance and accounting of the company, and you have positioned yourselves to benefit even if non-insider shareholders do not. You have not communicated clearly with shareholders, and you continue to pursue an extremely ill-advised strategy of growing fund assets through a highly dilutive share issuance. All this is unacceptable to our firm, and I believe that the majority of non-insider shareholders agree.
The details of our analysis are laid out in an open letter that can be found on our firm's website: www.deschutesportfolio.com . Below is a brief summary:
Although accounting was worse under the prior regime, our analysis of your 10-Qs demonstrates that extremely poor accounting practices continue at Equus:
The equity portion of this position, which was supposedly worth $1 mln on March 31, close to (ancient) cost, was marked as of June 30 at exactly…zero. Let's check the explanation: "due to lower storage revenues for containers" <page 22>. It strains credulity to assume that reduced revenue alone would cause an equity ownership stake to go from $1 mln to zero in the space of three months! And if the equity is really worthless, then what is the fair value of the 7% SUBORDINATED promissory notes issued by such a company? $.40 on the dollar? $.20? Try $.98! That's where you decided to mark those as of June 30. Again, we have no insider information about ConGlobal's business (if it even exists)… we just know that equity worth ZERO doesn't match subordinated bonds at $.98!
There have been no public trades in Orco bonds, and German broker ODDO has an indicated bid of $.50. And yet Orco bonds are priced at $.66 on the dollar for Equus balance sheet purposes! The valuation of this bond is particularly important because it has so far been your only new investment. We, and other shareholders, will therefore be particularly attentive as to whether Equus insiders receive a higher benefit (or a smaller loss) from this investment than outside shareholders.
1848, London Bridge, Riptide, Big Apple
There needs to be much more disclosure regarding the process of the sale of these investments earlier this year to an entity not initially identified, and identified later only as "Capital Markets Acquisition Partners" (CMAP). Just prior to the sale, you had marked these investments down to $3.4 mln without disclosing your valuation methodology. Whether it was your intention or not, this allowed you to claim the $10 mln sale as a "gain" and, more importantly, allowed John Hardy to earn a large cash bonus.
Needless to say, these investments were not sold at a gain! At the end of the day, EQS shareholders suffered a 50% loss on an original $20 mln loan. Your disclosures so far on this issue raise important fiduciary questions. For example, you say you were "introduced" to CMAP in mid-January 2011. And yet by January 26th you had sold them your entire set of related loans for $.50 on the dollar! This is not enough time for you to have investigated the identity of CMAP, including whether they were related to the debtors. This calls into question whether your sale agreement with CMAP benefited EQS board insiders at the expense of EQS common shareholders.
Cash extracted from non-insider EQS shareholders
Ridiculous board salaries
With his bonus, per the most recent 10-K, John Hardy is paying himself 2% of the fund's current market cap annually! This is clearly not sustainable. Hardy and the other insiders are positioned to benefit if they succeed in increasing the value of Equus for all shareholders OR if they fail miserably! In the 2010 proxy fight, the Versatile candidates railed against MCC and Douglass' self-enrichment at the expense of common shareholders. Now it seems they are doing exactly the same thing. Is it common for someone to buy shares of a company, get himself elected to the board and declared Chairman, then start paying himself a large salary?
Every quarter, the "annual fee of $20,000" paid to each Independent Director gets more and more ridiculous when held up against the actual WORK done by the board, which seems minimal.
Per the most recent 10-Q, Ken Denos, another board insider, receives several hundred thousand dollars PER QUARTER, presumably as compensation for legal services rendered. The two most expensive legal items for EQS recently have been the RNR lawsuit (see below), and the proposed dilutive rights offering.
Lawsuits settled with shareholder money
In June, a Mr. Roy Rimmer filed an open letter indicating that he would be withholding his votes from the Versatile directors at Equus. He laid out a number of the same concerns we've discussed here in our letter. Then, in the second quarter 10-Q, EQS shareholders discovered that Roy had filed a lawsuit against the company and Versatile directors. We found this out because the fund accrued a $200,000 liability for this lawsuit. In our view, it seemed highly unusual that a fund would immediately accrue, within 21 days, a specific amount due to a general-sounding lawsuit. Then, in the most recent 10-Q, we discovered that that $200,000 had been paid out. Why settle so quickly? The most logical explanation is that Versatile directors wanted Roy silenced as quickly as possible. Whether that explanation is correct or not, it is a clear breach of fiduciary duty for Versatile directors to use SHAREHOLDER MONEY to settle a lawsuit directed primarily against them personally!
The Business Strategy
Part of the reason we originally voted for Versatile directors is the verbal assurances they gave that they would carefully consider all options including liquidation of the Fund. And yet, within 6 months they announced plans for a massively dilutive rights offering, the purpose of which could only be the expansion of the Fund's operations.
We believe there is really no other tenable business strategy for this Fund today than liquidation. We believe other non-insider shareholders agree with us. If the Versatile directors wish to make "investments" (like the Orco bonds), we suggest they do so in a straightforward fashion, with their own investment capital. Instead, they have chosen to use the capital of defenseless Equus shareholders to enrich themselves and make ill-advised investments, all with very little communication or transparency.
This fund needs to be liquidated in an orderly fashion by ethical shareholder agents acting transparently for the benefit of all shareholders. In our view, the only way for this to happen successfully is for these shareholder agents to:
-Communicate clearly in a timely fashion their intentions
-Do what they say they will do
-Take no compensation other than the increase in the value of their shares
We intend to do whatever we can to make this happen, and welcome calls from all shareholders directed towards solving the above problems and maximizing the value of our investment in Equus. In the meantime, we urge the board in the strongest possible terms to refrain from any activity that will damage shareholder value. We would view as particularly obnoxious any "side deal" or share repurchase that benefits one group of shareholders over another.
Our current position in Equus, established over the past several years on behalf of various advised accounts, is approximately 2% of the outstanding shares. We and our clients have no connection to the company or its directors or executives except as shareholders. We reserve the right to increase or decrease our position at any time without notice.
-Eric Boughton, CFA
Deschutes Portfolio Strategies
1211 SW 5th Avenue
Portland, OR 97204
(503) 223-2500 ex 13
(503) 333-1560 cell
SOURCE Deschutes Portfolio Strategies