Friday, January 16, 2009

ACAS As A Prospective Investment

Nivdung wrote a comment suggesting that (a) ACAS' dividend strategy was a foolish waste of cash, and (b) that share issuance harmed existing shareholders.

Issuance that raises NAV is good for NAV. Issuance that enables high-return investments is good for NOI. The fact that taxable profits are largely returned to shareholders in the same manner as under a REIT does not mean there is not profit, it simply means that profit must be delivered to shareholders.

ACAS' current strategy -- paying dividends as late as the regulations allow -- means that ACAS has for about a year and a half tax-free and interest-free use of gains. This is a positive move for the enterprise and its cash flow even as it is a terrible blow to those who came to ACAS for quarterly dividends.

The idea that ACAS is a poor investment thesis because it has paid nearly $30 a share in historic dividends does not make sense. The investment thesis on ACAS depends on management's success in keeping NOI up, and in protecting NAV. Management's announced initiatives appear directed at accomplishing both.

Nivdung's primary evidence that ACAS is a bad investment is the assertion that (1) equity has come from share issuance and (2) dividends have been funded by taking money from Jane to pay John.

Point (1) is frankly silly: every company's equity comes from the owners. That's why the company issues shares, to get equity. This is only a problem if the equity issued is dilutive. When issuance is accretive as has historically been the case at ACAS (and the stock-swap plan with ECAS, though in theory a below-NAV issuance, is calculated also to raise NAV), dilution requires quite a bit more examination than has been given in the trivial accusation brought in the comment. Presumably Nivdung is upset ACAS can't retain more earnings, but if it retained more earnings it would pay taxes, and then dividend recipients would see their receipts taxed twice: once in ACAS' hands at corporate rates, and once at the recipient's rate for dividend income. The result would be to require quite a bit more risk to produce the same dividend.

Point (2) is disproven by the evidence: Although ACAS is required to distribute more than 90% of its taxable earnings to retain its tax status, ACAS has in fact distributed less than 100% of taxable earnings. This means that ACAS has earned more than it has paid in dividends. This isn't the case with Ponzi schemes that depend on late investors to pay off early investors, which is evidently the assertion intended by this post (linked in his comment here) and this comment.

There may be good reasons to hate ACAS -- Enlightened American bailed on it based on loss of confidence in management, for example -- but claiming that the company didn't earn the money it paid in dividends is just not backed up by the data.

The interesting question going forward is whether the NOI will continue as NAV is hammered by valuation calculus. If the NOI continues, NAV becomes irrelevant: the company will flush with income and shareholders will benefit either because the truth wins out, or because ACAS is required (even if with a substantial lag) to pay taxable profits as dividends to retain its tax status.

The question going forward is whether ACAS' management will invest to maintain income. ACAS' movement up the balance sheet during portfolio company exits, to become debt holders due regular interest payments, seems to suggest ACAS has been interested in obtaining a higher-priority claim on the companies' free cash and to maintain regular income. The move into countercyclical and acyclical businesses (the dental practice management company, for example, is going to get regular money).

Since I've seen NOI maintained, I'm still of the opinion the shares are undervalued. I will be watching NOI as my primary barometer of management performance until the markets move (possibly years from now) into a mode in which portfolio company valuation offers a source of gain.

1 comment:

Nivdung said...