ACAS Conference Call Notes: 2Q2008

This is a list of short notes made on the ACAS 2Q2008 conference call. I'll try to offer analysis later, but I wanted to jot down what I noticed on the call since I had so much trouble getting it. It seemed I had to listen to nearly 15 minutes of silence before listening to a long period of elevator music, and I couldn't skip ahead on the WMA player I was using.

• ACAS' visual aids for the conference call have a number of interesting graphs, including an interesting series on dividend coverage. ACAS management apparently perceives the need to explain why ACAS' dividend is safe, and since 2005 ACAS shows it's covered the dividend with realized income at better than 100% (109% since IPO, and 120% since 2005).
• Depreciation is being recognized because the deals now available in the market are such a serious steal that the mature portfolio investments aren't as good a deal as what ACAS can buy now for the same money.
• The liquidity crunch impacting the market generally increases ACAS' cost of capital, and what ACAS has to invest principally comes from capital returning to play after exits rather than funds raised from equity issuance as in prior years.
• ACAS' 2Q dividend was paid from earnings and long-term capital gains rolled forward from 2007, and ACAS' 3Q dividend is expected to be paid from the at-least-$1.05 in NOI and gains ACAS has forecast for 3Q2008.
• ACAS was able to exit investments in 2Q2008 at the same valuation multiple ACAS used to value the companies in June of 2007, a time some valuations were thought the most outlandish.
• Page 19 of the chart shows $639 million in difference between investments' GAAP "fair value" reportable under FAS 157, and the realizable value ACAS' management believes reflects the real exit value. Curiously, not all the differences show realizable value better than GAAP values: interest rate derivatives are actually more favorable under GAAP.
• When ACAS tries to finance buyers' acquisitions of ACAS portfolio companies (to make exit likelier), ACAS is outbid half the time. This, according to management, is because ACAS demands a steep return on its staple financing. ACAS is thus apparently not arm-twisted into providing staple financing to make deals happen, and isn't being "stuck" with bad terms on staple-financing debt.
• AGNC, a publicly-traded managed fund launched in 2Q2008, turned in a 27% ROE in its first quarter
• ACAS historically trades about 1.4x book value, and recently traded in the range of 0.8x or 0.9x. Management views this as historically low and pitches it as an attractive entry opportunity.
• Despite the recession, ACAS is operating in a steady state, rather than contracting, and is continuing to realize taxable gains.
• In response to a question about slide 19, ACAS clarified what it means by "realizable value." Realizable value doesn't represent what ACAS expects to get on exit, but what ACAS would actually get if forced immediately to sell, so actual realized values should be expected to be better than ACAS' currently-reported realizable values.
• Although ACAS has the power to game timing of loss-generating exits, management urges that observers should look to ACAS' history to see that ACAS does in fact make exits that will cause realized losses. (I note that if the dogs were never sold, then remaining portfolio companies would tend over time to make ACAS' portfolio look like a kennel specializing in scruvy, flea-bitten curs.)
• ACAS de-levered on purpose last year, toward 0.7:1, to keep away from the 1:1 leverage mark. ACAS doesn't see a need to shore up the balance sheet because it's prepared, and ACAS could always direct future liquidity toward leverage management if it seemed prudent. ACAS de-leverage will likely lead to ACAS renegotiating lower lines of credit with banks, in order to reduce fees paid to maintain unused lines of credit.
• Slide 31 shows that ACAS owns about 60% of the funds it manages. Since AGNC is investing billions after raising merely hundreds of millions, it's clear that the "value" being managed involves value net of debt. AGNC's returns appear to be the result of taking modest yield spreads and levering them more than eight times.
• Slide 34: ACAS didn't buy any ACAS shares in Q2 under its buyback authorization. Zero. The written explanation was that ACAS didn't have a trading window under its buyback authorization while shares traded below NAV. The obvious question here is, what factors closed the window most of the quarter? In the Q&A session, light emerged: ACAS' compliance officer establishes the window, based on whatever factors impact his compliance concerns. When the window was open, shares weren't below NAV. Moreover, management took pains to point out, the Board expects ACAS to use the buyback authorization only when accretive relative to other alternatives. A deal with interesting leverage opportunities might be much better than share buyback, particularly given the state of the deals available in the current market and the impact on ACAS' balance sheet. Mere trading below NAV will not trigger buybacks.
• The writedowns earlier this year don't result in tax losses, because they are not realized; since dividends turn on taxable income and not GAAP book value changes, the "losses" don't impact dividend payment requirements caused by ACAS' tax status. Folks looking at Yahoo's summary statistics and noting a "loss" may want to be sure they learn what ACAS' taxable income was, rather than the size of unrealized FAS-157 write-downs, which seem to have taken top billing.
• Managed funds are in the works (to generate fee income growth)
• ACAS thinks it's in a much better position than last time around to weather recession.

Disappointments: the 2Q2008 projected realized earnings of $1.10 turned out to be $0.95, and the plea that observers should mentally add back in $0.12 in realizations from exits that occurred already in Q3, but had been expected in Q2, would be easier to swallow (a) if that didn't still leave management short for the quarter and (b) but you know ACAS will count the $0.12 next quarter as evidence it's covered the dividend for Q3.

Happiness: ACAS' overall dividend coverage is good over the trailing five years and since inception. At the moment, I think ACAS is paying it out of cash flow, and it's safe, but it's not coming out of current profits. The idea that it's coming out of last year's profits may be true, but it means ACAS is handing out funds it had been investing. I do not want to see ACAS eating its seed corn. Nevertheless, ACAS' projections for earnings for the next quarter are reassuring, and the deal flow info looks good. The concern is that ACAS should aggressively find ways to take advantage of current deals if they're even better than share buybacks. ACAS will do outstanding things coming out of a recession if it loads up on good businesses at discount prices, and I'm happy to wait for it. However, I'm not keen to see ACAS miss the boat. The really, really good news here: ACAS management is calm and collected enough that they probably will do a good, stable, conservative, thoughtful job throughout the current economic climate, and my preference to be levered out the wazoo in the face of crazy deals is thankfully something other ACAS investors will not have to live with.

The conference call is worth hearing, and the charts are worth looking at. If you don't hear the call, at least page through the charts to see what management has to say about ACAS' performance. Whatever ACAS may do in the short run (e.g., not lever to the ragged edge to get the most out of the capital, which would risk the company, so it's a good thing they are not tempted overmuch), management has proven that they are fully competent to deliver over the long run.

I'm leaving the DRIP on. I'm also looking for more observations from those giving a hard look at ACAS' reports and filings. Every pair of eyes helps.