Going Nuclear with Nuveen (3/21/23)
Special situations in two Nuveen Closed-End Funds
Today I’d like to profile a developing special situation in two liquidating Nuveen closed-end funds. Explaining the situation requires some background info and history, so get ready to read about Midwestern nuclear plants and public corruption.
Let’s start at the beginning. FirstEnergy solutions was an Ohio utility operating multiple nuclear power plants and coal-fired power generation stations in Ohio and Pennsylvania. The company filed for bankruptcy in 2018, a casualty of excess debt and slumping power markets. As part of its plan to emerge from bankruptcy, FirstEnergy proposed decommissioning three nuclear facilities, two in Northern Ohio and one in Western Pennsylvania.
The Ohio congressional majority and governor were aghast at this plan, and passed legislation subsidizing Ohio nuclear and coal-fired power plants to the tune of $1.3 billion, Ohio taxpayers be damned. FirstEnergy reversed course on the closures and emerged from bankruptcy as “Energy Harbor Corp.” in early 2020. FirstEnergy’s major creditors were the large fixed-income focused investment manager Nuveen Asset Management and private equity/distressed investor Avenue Capital Group. Following the restructuring, the majority of Energy Harbor shares were held by Nuveen and Avenue.
Then, a scandal broke. It turned out the $1 billion and change that certain Ohio lawmakers so generously bestowed on Energy Harbor was not given purely out of a desire to protect the jobs of hardworking Ohioans. Rather, it was a quid pro quo for $61 million in donations that FirstEnergy had given to an organization controlled by Ohio Speaker of the House Larry Householder. The organization, called “Generation Now,” spent lavishly on the 2018 election favoring candidates friendly toward coal-powered generation and nuclear subsidies. And what an “investment” it turned out to be, paying off >20x! But the scheme came crashing down in June 2020, and five members of the Ohio Congress were indicted by US Attorneys. In March 2021, Ohio repealed the nuclear subsidies. Just weeks ago, Larry Householder was convicted of racketeering. A good summary the entire affair can be found here.
I first became aware of Energy Harbor in late 2020 when I noticed a strange new security trading over-the-counter with the ticker ENGH. I purchased a token number of shares. At the time, shares were trading in the $20s. There wasn’t any public investor relations site, just an inbox were one could request access to a company dataroom. Which of course, I did. The dataroom revealed a profitable and cash-generating company with a great deal of cash on hand. At say, $27, the company was trading at an EV/EBITDA ratio of around 3x, and it been busy repurchasing blocks of shares. The only worrying aspect was the company’s language around the nuclear subsidies it had been receiving. If, as expected, the subsidies went away in short order, the company’s profitability would be materially reduced. I spent a few months thinking about Energy Harbor, but ultimately decided not to buy more shares. I couldn’t come to a firm conclusion about the company’s long-term prospects or normalized profitability, so I held off. The September 2021 SEC rule change on non-reporting securities caused Energy Harbor shares to fall to the expert market, making transacting in the shares far more difficult. Shares traded rarely, but they gradually trended upward. The passage of the Infrastructure Bill, with its price floors for nuclear power generation, heartened investors and sent Energy Harbor shares into the $70s.
The strong performance of Energy Harbor shares actually wound up creating a headache for Nuveen. Many of Nuveen’s muni bond CEFs continued to hold Energy Harbor shares received following the bankruptcy proceedings. Last month a Bloomberg article came out detailing the potential risks. The article pointed out how unusual it was for these stodgy closed-end municipal bond funds to hold such a large allocation to a highly illiquid equity security and the difficulty that Nuveen might encounter in attempting to sell its Energy Harbor holdings.
Back to Energy Harbor. Earlier this month, Vistra Energy announced it would acquire Energy Harbor, creating a power generation giant with a national fleet of renewable power assets. Energy Harbor would be acquired for a combination of cash and stock in a new Vistra subsidiary, “Vistra Vision.” Nuveen and Avenue would receive a combination of cash and a 15% interest in Vistra Vision, while all other Energy Harbor shareholders would receive around $85 per share in cash.
Here’s where the special situation comes in. Once Vistra buys Energy Harbor, Nuveen CEFs holding Energy Harbor shares will receive cash and their proportional interest in Vistra Vision. So Nuveen will achieve a partial monetization of its Energy Harbor holdings. (While Energy Harbor shares are functionally impossible for Nuveen to sell, Vistra Vision interests are even less liquid as interests in a private business. However, they will likely produce yearly cash flow as Vistra Vision distributes earnings back to the parent company and minority holders.) I don’t know why Nuveen couldn’t negotiate to be paid entirely in cash rather than receive a partial interest in a private company. It doesn’t seem to leave Nuveen investors much better off. At least with Energy Harbor there was always hope of an eventual IPO or cash buyout to achieve liquidity. With Vistra Vision, it could be a decade or longer before they can cash out. Unless, perhaps, Vistra intends to list a portion of Vistra Vision at some point? They have not indicated they will, but it’s a possibility.
Anyway, there are two Nuveen CEFs that are liquidating in short order. Each has a meaningful proportion of its assets in Energy Harbor shares, and each trades at a discount to liquidation value. Let’s take a look at each.
Nuveen Intermediate Duration Municipal Term Fund - NID
“NID” is a Nuveen CEF with a market value of $605 million. The fund will liquidate at the end of March. Reported NAV is $13.55 and shares last traded at $12.89 for a discount of 4.9%. The last day of trading for NID is this Friday, March 24. As of February 28, shares of Energy Harbor made up 11.6% of NID’s assets. Nuveen valued these shares at $76.58, indicating the fund holds around 962,000 Energy Harbor shares.
Of NID’s $13.55 per share in net assets (the “net” is superfluous as the fund has paid off all borrowings) Energy Harbor shares account for $1.57 in value. Shareholders should expect to receive the non-Energy Harbor portion of NID’s value just days into April. Accounting for maybe 0.5% in trading slippage, that’s $11.92 in cash. Energy Harbor shares will be transferred to a non-traded, non-transferable liquidating trust for the benefit of NID holders. Vistra’s acquisition of Energy Harbor is currently projected to close on October 31, with Nuveen receiving $21.31 in cash per share, plus interests in Vistra Vision valued at $63.69 per share. This works out to another 44 cents per NID share. That’s $12.36 in proceeds. Assuming the $63.69/Energy Harbor share Vistra Vision value is reasonable, that’s another $1.30 per share in value per NID share for total value of $13.66, 6% higher than today. Given the swift (one-weekish) return of 92% of one’s investment, that’s an impressive IRR of 172%.
“But Dave,” you say, “that’s a ridiculous claim. It’s not like anyone can actually sell their interest in the liquidating trust in October. Not for $1.30 per share, not for anything! It’s totally illiquid! Investors are stuck waiting around for the Vistra Vision investment to be sold or acquired!”
And you’re right, of course. Thanks for keeping me humble. Instead, let’s model out the IRR under 3 scenarios: baseline, optimistic, and pessimistic.
Baseline: Vistra Vision is listed on a major exchange/sold back to Vistra/sold to a third party/otherwise disposed of in 5 years. Its value appreciates 5% yearly and it pays a distribution of 6% of its value at the end of each year representing distributable earnings. In this case, total distributions are $14.47 and the IRR is 29%.
Optimistic: Vistra Vision is listed on a major exchange/sold back to Vistra/sold to a third party/otherwise disposed of in 3 years. Its value appreciates 6% yearly and it pays a distribution of 8% of its value at the end of each year representing distributable earnings. In this case, total distributions are $14.26 and the IRR is 40%.
Pessimistic: Vistra Vision is listed on a major exchange/sold back to Vistra/sold to a third party/otherwise disposed of in 7 years. Its value appreciates 2% yearly and it pays a distribution of 3% of its value at the end of each year representing distributable earnings. In this case, total distributions are $14.15 and the IRR is 18%.
Of course, there’s also the disaster scenario under which something goes horribly wrong at Vistra vision and both the potential interim distributions and ultimate realized value are badly impaired. I don’t view this as all that likely given the business model here (baseline power generation and renewables, and all the government support and social zeitgeist behind each) but it is of course a risk.
As with any liquidation play and especially those that rely on a large return of capital very early on, the going-in price is incredibly important. For instance, paying up by 3% versus the current NID trading price crashes the IRR in the baseline scenario to 17%. Taxes are also a consideration. Typically, the transfer of property to a liquidating trust is treated as a taxable distribution, with future distributions of principal exempted from tax up to the value of the property originally transferred to the liquidating trust. But I am NOT a tax advisor so don’t take my word for it.
For investors willing to hold a completely illiquid liquidating trust for a period of up to several years, NID appears to be attractively priced, assuming Vistra Vision is at least middling in its economic performance. Many investors will look at the prospect of holding some weirdo trust and say “Not for me!” and that’s also fine! In fact, it’s what creates the opportunity for the willing.
So that was NID. There’s also:
Nuveen Intermediate Duration Quality Municipal Term Fund - NIQ
“NIQ” is another smaller yet similar Nuveen muni CEF with a market value of $164 million. NAV is $13.01 and recent trading was at $12.48. Energy Harbor shares made up 4.4% of NIQ’s net asset value as of February 28. NIQ will liquidate at the end of June. This liquidation is simpler than NID, given the much smaller allocation to Energy Harbor shares. But since the liquidation date is still >3 months away, it has some interest rate risk that NID doesn’t. The same liquidating trust structure will apply to NIQ’s energy harbor shares. Using the same assumptions I did with NID, I get the following prospective IRRs assuming no change in the value of the NIQ bond portfolio between now and liquidation.
Baseline: total payout of $13.32, 15% IRR
Optimistic: total payout of $13.24, 16% IRR
Pessimistic: $13.20, 12% IRR
Not so juicy due to the lower exposure to Energy Harbor shares, but considerably less uncertainty. As for which situation is “better,” well, that’s a question for each investor to answer for himself or herself. Please keep in mind that my projections around the ultimate disposal of Energy Harbor/Vistra Vision are highly conjectural. It’s possible, if unlikely, that Energy Harbor is somehow disposed of all at once and in short order. It’s also possible that Energy Harbor neither distributes income nor is disposed of for a decade or longer, obliterating IRRs. My assumptions here could be wildly inaccurate. In other words, make your own.
Now for the some recommended reading! Several other Nuveen CEFs hold Energy Harbor shares. Some hold lots of them. No other Nuveen CEFs have yet shared plans to liquidate, but it certainly could happen. Thanks for reading and happy searching.
https://alluvial.substack.com/p/going-nuclear-with-nuveen?utm_source=direct&r=nw7jw&utm_campaign=post&utm_medium=web
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