Wednesday, November 4, 2009

ACAS' 3Q2009

ACAS' 3Q announcement contains two major pieces of news:
  1. Unrealized appreciation increased (to the tune of over eighty million dollars, dwarfing NOI) rather than decreased over the quarter, for the first time in nine quarters; ACAS is no longer losing asset value. The charts plotting unrealized appreciation and NOI against indicators of the general economy suggest that as the US economy improves, that ACAS (as previously suggested here) will likewise benefit.
  2. Management believes a deal to end the default status of its debt obligations is near, and will close by year-end. The deal apparently involves turning the unsecured creditors into secured creditors, with ACAS' investment portfolio as collateral, and includes a principal repayment schedule over the next several years. In effect, the deal closes the unsecured revolving credit line and leaves ACAS free to open another unsecured line later on as credit conditions and ACAS' performance enable ACAS to negotiate a better deal. The result is that ACAS will make (as predicted here) the minimum dividend legally allowed to maintain ACAS' tax status, will pay down the principal, and will face a declining interest rate as ACAS continues to reduce its debt balances. In the meantime, there's no effort to force ACAS into a bankruptcy or other situation that would place ACAS in the position of a forced seller, and the impending deal looks like an invitation to continue ordinary business with the single change that the credit line will end up looking like a series of secured notes with specific maturity dates rather than an open-ended unsecured line of credit. The doomsday preached by some looks unlikely.
Initial response to the news was good: shares spiked by over $0.50 (scared shorts fleeing? interested longs rejoining now that the scare is over?), but this declined and shares now trade near $3. The repayment schedule calls for hundreds of millions in repayments, but the initial repayment chunk can be made from cash on hand and the future repayments appear nonproblematic based on ACAS' history of recovering principal through maturities, exits, and so on.

The third interesting point is this: ACAS' exit volume has improved. Although ACAS has enjoyed well over a billion dollars in exits from the beginning of the recession, the deal volume, though it dwindled over the last few quarters, has now grown. The third quarter offered $463m in proceeds. According to conference call comments, exits were at higher multiples than ACAS' entrance, but given the economy's impact on EBIDA, this doesn't mean exits were profitable; it just means that ACAS' management was able to get good value out of its inventory. ACAS' exits generated realized net losses over the quarter. Realization of losses means ACAS' unrealized losses accordingly decreased; however, the reader will note that unrealized appreciation of $86m was much larger than the $41m from reversals associated with sales, and further that these associated sales were within 1% of prior-quarter "fair value".

What of earnings? NOI, which was hammered last quarter by reversal of PIK income, was hammered this quarter by "make whole payments" -- expenses incurred as part of ACAS' effort to mollify creditors whose ACAS-owed debts entered technical default due to breach of net asset covenants. While NOI per share this quarter was down 84% compared to the year-ago quarter, it was up 33% (on a per-share basis, which is important considering the significant issuance of shares in connection with this year's dividend) compared to the $0.09 of NOI posted last quarter. Compared to the year-ago quarter's net income of negative $2.63, this quarter's net income of positive $0.30 definitely evidences something going right. Management unsurprisingly attributes this to a combination of the economy's improvement and the work of ACAS' operations team. Without "penalties" like $22m in make-whole payments, ACAS' NOI would have been closer to $54m than to the $32m reported in 3Q2009. Ignoring these default penalties (which were one-time settlement payments to avoid threats associated with asset covenant breaches, and were unrelated to ACAS' payment performance or ACAS' business income), ACAS had NOI over 68% higher than reported, for a NOI of about $0.20/sh. This is more than double last quarter's reported NOI, though of course that quarter had its own special issues in the form of PIK reversals. (The $22m in "make whole payments" were incurred, and they were an expense in the quarter, but since they are associated with an asset covenant breach that occurred last year it seems strange to consider them as an income event in the current quarter -- though, of course, they must be so considered for accounting purposes even though it paints a misleading picture of ACAS' "normal" income-producing capacity. The $0.20 number isn't presented here to discount the fact ACAS was forced to cough up money to mollify frightened creditors, but is instead offered for consideration of ACAS' current power to generate income without tapping asset sales.)

Last quarter, ACAS' NAV per share closed at $7.42 following adjustment for the upcoming paid-in-shares dividend. NAV of $7.80 at the end of this quarter, following the share dividend, signifies a material increase over the period even after considering the diluting effect of the larger share base (a NAV increase exceeding 10% of current share prices). Since the debt ACAS owes won't increase as ACAS pays it down, but its investments' values and cash receipts will increase as the economy improves, NAV should be expected to head in the right direction from here forward -- unless the economic improvements turn out to be a head-fake and the whole thing heads into the toilet again.

ACAS' $7m in new investments includes investment in and recapitalization of existing portfolio companies, so ACAS spent more effort repairing the dykes than it did building new infrastructure. Presumably most of its creative efforts went into its exits, operations improvements, and in developing a cure for the default situation. I would like to see ACAS entering some screaming deals, but let's face it: ACAS still has some work to do in its own backyard before it can develop others' lots for sale. The good news is that ACAS' house isn't falling down, it's actually doing well just recently. The improvement seems to track with improvements in the general economy of the United States. Since the general economy of the United States has attracted some smart bulls, one isn't in bad company to conclude that the long-term trajectory of the economy is in the right direction. One is tempted to conclude that the association of ACAS' fortunes to the economy bodes well for shareholders.

Investing and holding ACAS on the theory of improving NAV makes sense, especially with the spectre of overhanging debt issues poised for resolution and actual, observed improvements in NAV. Improvements in deal flow will help with ACAS' future exits, but one would want to see that ACAS has access to new deals to support the kind of explosive growth that one wants to see exiting an economic recession.


Imperator said...

Good signs. With the M&A market along with the generally economy improving, I think these are great signs for ACAS.

Stabilization and improvement of NAV is a good start for reversion of the stock price to NAV. Here in the 3 dollar range, that is a significant percentage gain.

The 024937AA2 public bond price improved substantially, it was trading in the 80s before the earnings release, last trade was 95.

Keep up the good work Jaded!

Anonymous said...

After happily watching the stock explode upwards this week and last, I saw this:

Pre-packaged bankruptcy isn't really a possibility now, is it? I mean, all this is just a formality, right? Right?!!!

Jaded Consumer said...

There's an SEC filing on this here. The filing discusses a voluntary reorganization, not a dissolution. This is consistent with your link, which also addreses Chapter 11 (reorganization) and not Chapter 7 (liquidation). Different sections of the bankruptcy code have different purposes, and what ACAS is offering lenders with the renegotiation agreement is the ability to control how the debt gets repaid instead of having a federal court prevent lenders from destroying the ongoing enterprise.

Since the lenders aren't secured, there's not much they can do either in court or out of court to screw up ACAS' business, on my read of things.

If ACAS goes to court, ACAS' obligation to pay on its debt will be under the discretion of a bankruptcy trustee because the contracts to pay back the money are "executory" -- they haven't yet been fully performed. Lenders don't want the uncertainty of Chapter 11 remedies, they want security that they are getting paid on a schedule they can predict.

Especially as ACAS' NAV and NOI do well, I think delay plays into ACAS' hands. The more solvent ACAS is or becomes, the less likely it is that anyone can make a case for liquidation and immediate payment (Chapter 13), and the more likely it is that ACAS as "debtor in possession" will simply become bulletproof to run its business while protected from collection efforts by the bankruptcy laws.

From my read, Chapter 11 is all in ACAS' favor and should terrify lenders. The deadline game is designed to put a fire under all the lenders' buttocks to make a deal. Chapter 11 gives ACAS breathing room and makes payment obligations less clear.

ACAS could, for example, enter Chapter 11, stop repaying principal, and invest its cash wad in short-turnaround distressed assets. This beats the heck out of the proposal to turn proceeds over to lenders for the next few years, in my book.

Frankly, I think as a shareholder I like the long-term prospects of Chapter 11 better than I like the prospects of missing out on distressed deals currently available. I bought ACAS to get a piece of mispriced little businesses, not to watch the company pay off debt (yawn). From where I stand, Chapter 11 may be the best thing ACAS can do.

Anonymous said...

Excellently explained, thank you. While I agree with you re: paying off debt, if you swallowed hard and bought more at $1 or $2 a share, you were still buying the mispriced collection of businesses. NAV of $7.80 (and realizable NAV of ~$10) is still a nice vault from here.