Monday, July 7, 2008

ACAS: Scary Short?

American Capital Strategies, described here and here as a misunderstood stock and an attractive buy at 27 or so, is now in the range of $21.60 a share. Given the announced dividend schedule, the shares sport a dividend exceeding 19%. (In fact, even if you were to discount the announced increases and assume ACAS' dividend doesn't increase at all for some reason, the dividend remains crazy high.)

Earlier posts discuss why ACAS might be mispriced, but I have a new curiosity. According to, the short interest in ACAS has grown to 15.99% of the company's float. (This number may be different when you click the link, as it's a page with routine updating.) Based on the company's average daily trading volume, shorts would require more two and a half weeks of trading days to make an orderly exit. Shorts who entered at 35 may be happy with themselves, but every time ACAS pays another dividend it comes straight out of the shorts' bottom line. This, of course, may explain ACAS' sudden beating: after the dividend was paid last week, shorts may feel they have a reprieve before being subjected to another round of taxation on their trading position.

The institutional interest in ACAS seems steady at 45% according to The insider purchases of tens of thousands of shares in the 30s in January seem encouraging, though there are a few insiders who are on quarterly sale plans. The forecast this spring of good forward profit and dividend increases under an assumption of a recession and a lack of new fundraising is particularly interesting in light of subsequent creation of hundreds of millions in managed assets, which translates into regular management fees. For example, under a 1.25% annual fee schedule ACAS' quarterly payment for management services would be 0.3125% of funds under management, so the new AGNC offering will yield more than $800,000 per quarter in management fees -- before ACAS' dividend income on its 7.5 million shares is counted.

The dividend income for a full quarter of operations at the new REIT isn't known yet, despite MSN's headline that AGNC set a $0.31/q dividend. As described here, $0.31 dividend was for a stub quarter reflecting approximately 27 invested days. Since AGNC's revenues result from payments in connection with agency-backed mortgages, there's little reason to think AGNC's revenues would be anything but regular remissions of quarterly interest payments on real property mortgages. (Here, I note that home mortgages are a financial instrument typically associated with regular monthly payments, and offering little reason to suspect irregular or fluctuating revenues.) Thus, roughly estimating AGNC's quarterly dividend by multiplying the 27-day stub quarter's payment by three (to get a duration nearly as long as a three-month quarter) is a fairly realistic, though possibly understating mechanism to estimate a full-quarter's dividend at AGNC. At $0.93 per share per quarter, ACAS' interest in the company from dividends alone would be approximately $7 million. Adding back the over-a-million per quarter in fees I estimated above, and I'd see AGNC as worth something exceeding $8 million per quarter to ACAS. Since ACAS maintains a dividend policy intended to result in no taxable income (or close to it), these dividends and fees flow to ACAS shareholders along with other operating profits of ACAS portfolio companies.

Based on ShortSqeeze's reported 202,896,718 outstanding share count at ACAS, the AGNC deal alone seems to be worth about 4¢ per (full) quarter to ACAS -- not bad for an entirely new revenue source since the last dividend update. Just the AGNC management fees (that is, just the periodic payment of 1.25% per year of assets under management, which includes none of the dividends ACAS receives on its capital investment) seem to offer over 0.4¢ per (full) quarter to ACAS. ACAS' management fee for AGNC is a flat percentage of assets under management and doesn't involve a carried interest (other ACAS-managed funds may offer upside surprise opportunity as investments are exited for gains). ACAS' developing funds management business seems an excellent mechanism to leverage ACAS' existing due diligence efforts into ongoing revenues, and if AGNC does what I expect ACAS should continue to enjoy solid revenues for the (long) life of the investment. Given that this is a mortgage-based revenue stream that has been subjected to post-subprime-meltdown due diligence, one would expect steady revenues from this collection of investments, offering some quarter-to-quarter stability to ACAS' otherwise fairly lumpy returns.

Incidentally, American Capital Agency (AGNC), which went public at $20 a share earlier this year (and well after things like the subprime situation were well understood at ACAS), is now trading at about $15, for a dividend yield (if my estimates are correct) of about 25%. Folks who believe a real estate recovery will make AGNC more solid by improving the quality of the loans' underlying collateral might be interested in AGNC at these prices. Personally, I like ACAS' ability to take both the dividends and the management fee, and I like the upside suggested by profitable exits from portfolio companies, and I don't mind the shares being terribly mispriced while I'm reinvesting -- but others may have different investment objectives and prefer the higher dividend yield.

The next question is: who are the folks who can afford to short AGNC while it's paying a dividend near 25%? Maybe the announcement of the regular quarterly dividend will have some impact on these folks, in a few months. In the meantime, it's a wild world out there, and shares will continue to be priced on the basis of imperfect information. For my part, I'll happily reinvest these dividends, especially in tax-deferred accounts.

When opportunity knocks, what else is there to do?

UPDATE: ACAS makes a list of stocks that have appeared the most consecutive number of days on an SEC-maintained list of stocks whose short-sellers have failed to deliver securities to their buyers. Folks are selling ACAS shares they not only don't own, but can't find to borrow. My guess? They can't afford to rent the shares. This is an interesting problem: if short-sellers can't even find the shares to borrow when they sell them, there may be a real shortage of shares available for short-sellers. If they were forced to buy in a hurry ... they might get really hurt, the poor things.
As a consumer matter, why should the SEC make a list of stocks with the most consecutuve days on a list of securities short-sellers failed to deliver, rather than just prosecuting out of business the short-sellers who short naked? It is illegal, right?

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