Apple's Competitors: Unexpected Success?

HP's new slate is so back-ordered, new buyers are not promised delivery until next year. Blowout sales, right? Everything's relative. When your production run is but 5,000 units (that's not thousands of units, but units), orders under 10,000 units stagger your capacity to deliver.

By contrast, Apple's first iPad production run was in seven figures, and sold out before it shipped.

Keeping the market Apple has captured will require continued vigilance in maintaining Apple's competitive advantages, and maintaining the features users think they need. Toward that end, I expect Apple to invest in its next generation of Apple-branded CPUs and a mechanism to ensure that users can print without being subject to print-based denial-of-service attacks. Since Apple's only recently seemed to have hired anyone worried about security, and lost its last batch of chip gurus, these things may take some time.

Flash: Bad For Your Battery?

Apple has removed Flash from the default configuration of the new MacBook Air, and no wonder: adding Flash reduces batter life by two hours if you have the wrong web page open – apparently, even if the offending page is out of sight in the background.

There have been enough posts here about the Apple/Adobe catfight over Flash and its relevance to the world that I wonder if Flash needs its own tag ....

Still, it's clear why Apple would want people to have to opt in to Flash instead of getting it without informed consent.

ACAS Accretes NAV, Earnings; Diminishes Debt

The call won't be on until tomorrow morning, but the news is out: ACAS enjoyed $59M in NOI (+84% q/q), $149M in "net earnings" (+$72m over q309), over $300m in cash proceeds from realizations, and $407m in debt repayment. NAV increased $0.44 over the quarter to stand at $9.59 per share, more than $2 higher than the after-hours share price printing at the time of writing. Net unrealized appreciation on portfolio investments swelled with the improving economy, and the realization of losses on investment exits, combined to drive the quarter's unrealized portfolio appreciation to $158m.

ACAS' investment in ECAS, about which readers have heard here before, is now valued at $0.5B while its own NAV stands at $0.8B, implying hundreds of millions in discounted valuation that would not exist if ACAS were to dissolve the corporate fiction of ECAS and hold the company's portfolio investments directly. The $300M discount baked into ECAS is thus an artifact of FAS 157, and the likelihood that selling the whole portfolio in a corporate wrapper would involve a NAV discount similar to ACAS' own NAV discount. While this makes perfect sense from the standpoint of FAS 157, of course, it boggles the mind: if a dollar bill is worth $1, but is worth only $0.63 hidden in a wallet, it's worth $0.44 if the wallet is first tucked into a purse. Got that? Good. You are getting the theory of how ACAS is valued under FAS 157 in light of the NAV discount.

So, how many of those purses you want?

ACAS' balance sheet should strengthen with any broader economic recovery, as its portfolio is diverse and capable of catching updraft from any direction. Improvements at portfolio companies flow to ACAS' bottom line. They also improve valuation metrics (earnings being an input into valuation formulas) which boost ACAS' NAV.

ACAS is currently $107m away from lowering the interest rate on its outstanding debt. Part of the $407m in debt repayment was on secured debt due in 2013, intended to make sure that ACAS doesn't have another liquidity crisis inspired by another default scare. ACAS is looking out more than a quarter ahead, which I like to see in management. Avoiding liquidity crises and improving the cost of debt are both solid strategic moves. The Jaded Consumer approves.

One thing worth noting is the improvement in the loan portfolio on non-accrual. Last quarter, non-accrual loans stood at $308 of "fair value" (8.5% of all loans at "fair value"), but this quarter the number has slid to $265m of fair value and a less upsetting $7.8% of all loans at fair value. As portfolio companies get their footing and resume payments, ACAS' NOI and the valuation of the loan portfolio should both improve.

I wasn't particularly happy to read that the $305m in cash proceeds involved sales at an average of 2.9% below last quarter's FAS-157-compliant "fair value" -- after all, the portfolio was going up, right? -- but I'd rather have the cash out of dogs. New investments of $63m are good news: ACAS is cherry-picking the best deals available across a broad range of sectors, and I want as many of those good deals in my shopping cart as we head toward the register.

I also like to see 5% per quarter in NAV increase. ACAS doesn't make a return on its share price, it makes a return on its investment portfolio. Watching that portfolio swell is better long-term news to me than a share price uptick. The portfolio and the NOI it generates is real.

I'm interested to get more color on the company's outlook from tomorrow's call, but it may be a few days until I get a chance to hear it. In the meantime, I like what I see.

Apple 0wn2 Tablet Market

Or for those not following l33+sp33k: "Apple Owns Tablet Market"

Apple's iPad, launched to a welcome of "but there's no market for that", owns 95.5% of the market for tablet devices. Given that the market consumes millions of the devices, it's not trivial – at least, not for Apple. Apple has some firm views (audio linked here, with some comments) on the mistakes of competitors and their apparent errors, and Apple's likely ongoing advantages in the market.

Apple could own this one.

ACAS Passes 7 Ahead of Earnings

It's sometimes hard to work out whether price moves result from slipping secrets or irrational speculation. American Capital Ltd. is set to announce its quarterly results this afternoon following the close of trading. (Well, after the close of regular trading. After-hours trading will probably be very exciting for a few minutes while the numbers are freshly revealed.) In the days ahead, the shares have flirted with and passed $7 a few times, and at this writing the stock stands at about $7.06 or so. (Okay, $7.08. I'm not typing fast enough.)

For shares that were on sale for less than $0.60 in the first quarter of last year, this hasn't been a bad start to the shares' recovery. The shares' NAV remains well above the shares' price, and the quarterly announcement should provide the world with a new view of the shares' discount to NAV. The trend has been increasing NAV, and this quarterly announcement will serve an important function in illustrating the extent of that trend.

Although ACAS has been paying down its refinanced debt, we haven't yet heard an announcement on the company's goal of reducing the debt past the interest-rate lowering threshold. Information on the timing of that milestone – an event that will improve NOI by reducing the cost of the debt with which ACAS finances its investment portfolio – should be in the earnings call even if the announcement isn't that it's been completed.

I for one will be interested in looking at ACAS' NOI, average interest rate on debt, and any announced transactions. I prefer to see ACAS making money through NOI than to see it relying on selling portfolio companies at a time they are likely undervalued. With debt-refinancing expenses a thing of the past, many millions per quarter will be brushed from the bad column and net should be buoyed by the vanished nonrecurring expenses associated with the long-running refinancing effort.

Although ACAS has some interesting exits planned – like the Mirion IPO – I am much more interested to see what ACAS is buying while the world of illiquid portfolio companies is on sale.

Apple's Mac Not Yet Irrelevant

A friend and Microsoft engineer asked me a few years back why Apple bothered to make anything but music players. They really had something with the iPod, after all. But what could Apple manage in computers now that the platform war was over?

I tried to suggest that he misunderstood Apple's product by mentioning that Apple built multiprocessor rack-mounted servers that were highly-regarded for their maintainability. I wanted him to understand that Apple supplied a fairly complete line-up from lightweight laptops to massive supercomputer clusters ranked in the top 500 computer systems worldwide. He didn't get the picture, but instead wondered: why did they bother? Not getting Apple was apparently common at Microsoft. (Apple still bakes high-performance computing support into Macs, incidentally.)

The answer becomes clearer with each passing quarter: Apple sells a lot of computers, and makes good money on them. Recently, Apple stood ranked as the #4-ranked PC vendor in the US by volume (higher by profit) and was a shockingly small number away from the #3 position. Although iPads and music and software are all hot sellers, Macs have better margins and they are a growing market. The more powerful the hardware becomes at a lower price, the cheaper Apple will be able to build outstanding products and the larger will be its addressable market. Competitors who can't offer Apple's differentiating features will be forced into a classic commodity pricing competition and will compete their profits toward break-even. Apple, which owns quite a bit of the intellectual property in its products and spends less per unit licensing technology from third parties, has a margins advantage at any price point at which it sees fit to compete.

MSFT: HTML5 for Compatibility

Microsoft's server president Bob Muglia confirmed that although Silverlight was the primary development platform for Microsoft's phone platform, and that MSFT viewed Silverlight as having good prospects for some applications, the company's broader cross-platform efforts would rely on HTML5.

At MSFT's "Professional Developer Conference" there were no Silverlight sessions and few mentions, but lots of discussion of HTML5. In Microsoft's depiction of Ballmer's remarks at the PDC, for example, the word "Silverlight" appears one time (the other two times on the page aren't in the remarks, but in links outside the remarks), whereas "HTML5" appears 32 times.

Adobe's position on Flash as the standard for cross-platform development grows increasingly less credible with each defection. Shocking though it may seem, some standards even Redmond has accepted.

Apple Advances Again

Apple's cell phone unit volume has passed that of Research in Motion to take the fourth slot in cell phone unit sales worldwide. Advances in Apple's performance metrics haven't been confined to growing phone share.

Apple, which earlier this year passed Microsoft in market capitalization, just passed Microsoft in revenue in the third calendar quarter of 2010. With Microsoft failing to pull developers onto its new mobile phone platform, Microsoft won't be catching up with revenues from phone operating system licensing. The gross revenue number isn't identical to profitability, but it's an important metric with which to gauge the companies' ability to attract customers' funds. It's a relevance-ometer. Apple's revenues have been growing briskly in recent years, and its ongoing product rollouts in its many markets offer grounds to expect continued growth in the immediate future.

Apple's high-growth trajectory has taken it into an area few would have predicted only a few years ago. The company remains a volatile holding, but its absolute performance and its growth suggest that its share price is backed by a real and growing relevance in the markets in which it competes. Apple is unquestionably a quality provider in its relevant markets, and it markets for profit rather than window-dressing metrics such as profitless unit share (remember the beige-box races for the top slot in PC sales?). Apple isn't squandering precious resources chasing phantoms, it's building and innovating and creating a future for itself and its customers.

Apple: Still Growing

Last year, Apple co-founder Steve Jobs appeared on an earnings report to announce that Apple had had its first quarter that annualized to a $50B/year revenue rate. This year, Jobs is back. Apple's first $20B quarter isn't a Christmas quarter, it's the back-to-school quarter of 2010.

Apple has increased advertising expense, but revenue growth actually caused Apple's advertising expense to decrease as a percentage of revenues. Apple announced that its margins would be lower in the future, but it's made that prediction before. Apple's "low" margin areas of operation include its online stores for downloaded content (iTunes and the App Store), in which Apple takes 30% of gross, and against which it charges lots of advertising and datacenter overhead. Apple's new portable devices, which are themselves portals to the online stores, offer more hardware for the dollar than some of Apple's higher-margin computers. Apple always runs the risk that recalls, parts costs, and other contingencies might eat into margins. Apple's margins decline has worried some folks.

Apple isn't losing margins because it's being forced to compete in a commodity market: Apple has priced products to attract buyers. Neither Dell nor Acer can get the margins Apple does out of hardware; Apple is clearly still selling a differentiated product. Apple's pricing strategy appears to be a deliberate effort to leverage consumer appetite for electronics by pricing products to move volumes rather than to maintain an artificial per-unit margin. The result is clear from the iPhone experience: price it correctly, and the world is Apple's. Apple's profits have continued to increase, and profit hasn't eroded as a result of Apple's new product initiatives, the profit has grown.

Of significant interest to the Jaded Consumer in this regard is Apple's re-imagination of the iTV. Oh, sorry: the AppleTV. AppleTV is now no longer a set-top console, but an Airport Express that supports video and allows, for example, Netflix subscribers to get content onto their HDTV sets wirelessly from their computers. At $99, it's almost an impulse buy. When you buy it, you get another portal into Apple's online store.

Apple doesn't talk about future products, but Apple now competes with netbooks on size, even if not stooping to their typically abysmal performance.

ACAS Chizles Debt

At the time ACAS refinanced its debt, ACAS was $300m away from repayment to the level it would enjoy a lower interest rate on its entire outstanding debt. ACAS announced at the last conference call an intention to pay down the debt to that extent by year-end.

According to the bird chirping in the Jaded Consumer's email box, ACAS' prepayments have reached $200m. Assuming that ACAS intends to realize the benefit of the debt interest reduction, management has some incentive to make the remaining payment toward the beginning of the last quarter so as to obtain the benefit of the lowered rate for the majority of the period. This would help demonstrate the impact of ACAS' lowered debt rates and the effect of ACAS' widened spread.

The other possibilities are interesting: ACAS desires to show it can make payments, but it wants to conceal the effect of spread widening in order to leave an unturned card in its hand as it deals with analysts who might be tempted to claim ACAS is out of room to maneuver. The Jaded Consumer has not previously noticed ACAS' management exercising such gamesmanship, and doubts this alternative. When times were bleak, ACAS' management expressly stated it would consider even such things as changing its corporate structure and tax treatment if needed to rescue the company. I don't expect detail about ACAS' business at the level of individual portfolio companies, but I sense that what we hear from management is straight dealing rather than ongoing gamesmanship. Another possibility is more likely: ACAS is keeping cash around for investment purposes, and consuming cash to make great deals. I like the idea, but the number of quality deals is likely finite. Look at ACAS' previous publication on the number of pitches required to find one to swing at.

ACAS' more likely reason to delay debt spend-down, if it is delayed, is to keep cash on hand as a buffer against risk (ACAS can't borrow any more under its debt agreements to address surprises; those lines of credit are now a one-way street to the lenders). Yes, ACAS would like to borrow up to its ears while the going is good, but ACAS has learned a harsh lesson about debt-to-equity ratios in the crazy world of FAS 157 and illiquid investments. ACAS is going to be more conservative going forward in choosing its financing options, and will be matching debt against borrowing so that as asset values decline, so too decline the values of liabilities.

The world has changed, and ACAS with it. The explosion from $0.58 to over $5 suggests some serious mis-valuation of ACAS, including some over-estimation of the business' risks. Shares' steep discount to NAV suggests that some of that risk over-estimation is still lingering with ACAS' observers. ACAS won't be in the dividend-stock business for over a year in light of its loss carryforwards regardless what it does, so ACAS' marketing machine is not geared to retail investors but institutions and deal participants.

Focusing on deals – that is, structuring the portfolio for future gains – is exactly what long-term shareholders need. ACAS has a discount that could easily be set to evaporate over the next couple of years, even as NAV increases due to multiple expansions in a more broadly normalizing market. ACAS' wholly-managed AGNC, for example, pays a fat dividend and trades at a premium to NAV. When life normalizes at ACAS, management's success in providing premium-worthy results can be expected to pay off.

The short term? Let's see if ACAS has enough cash rolling in to beat its debt pay-down timelines, and see how spread widening impacts NOI. Depending when ACAS pays down the debt, we may not see this until the results of the following quarter. This quarter, though, we'll see the results of the elimination of default-rate interest and the reduction in overhead associated with the debt refinancing program. Regardless what happens with the timing of the debt pay-down, it'll be a quarterly result to watch.

Teotihucan's: Iced Tea Done Right

I met a friend and some business acquaintances for lunch at the Teotihucán Mexican Café.

Shortly after receiving an excellent salsa and a basket of nice, fresh chips, I was served the iced tea you see below:


Note that it comes with a lemon, a spoon that is an iced tea spoon, and a straw for those who, unlike me, don't discard them immediately.

The only downside was that on refill – and I note that refills were readily obtained the whole lunch – the servers tended to slowly pack the glass with ice so it became hard to stir sugar.

Great food with the tea, by the way.

GRADE: A

China Stix Doesn't Get Iced Tea

I ducked into China Stix* for dinner for starving children and learned that thousands of years of expertise in making tea doesn't help some Chinese fast food vendors to deliver a decent experience to iced tea customers.

(1) Overbrewed and bitter.
(2) You don't get refills but have to chase them yourself, which means that if you're with children you're S.O.L.
(3) They will hear you and nod to you when you ask for a tea spoon, but after three tries with different employees you still won't get a spoon suited to stirring tea into the plastic glasses they dispense for cold drinks. You will eventually end up trying to stir your tea with a knife (see photo).
(4) You will run out of little rice-flour pancakes for your honest-to-goodness Chinese dish – like the mu shu dish you read about in the review – and when that happens, the staff will nod like when you asked for a tea spoon but will, in fact, completely ignore your pleas for help.
(5) You will leave unhappy.

It is literally more convenient to brew it yourself. Only approach if dehydrated and traveling far from home.
Grade: F.

* --> There's apparently a restaurant by this name in California, which apparently won some local awards and whose web site reflects no connection to the Houston fast-food joint. My advice to the proprietors: sue for impairment of your valuable trademark.

Sex and Religion: Poor Analysis Criticized

The Jaded Consumer was surprised to read, in an article entitled "How Christians spoil sex", that "[p]assionate, toe-curling sex isn’t normally associated with Christianity or even spirituality in general."

This is hard to fathom. The association between God and passionate lovemaking is deeply ingrained in the social fabric – especially here in the United States. Especially here, you ask? Think about it. When viewers encounter films that don't show the sex act but want to imply it (not because viewers are Puritanical, but because the MPAA has no regulator and can kill any film before release simply by rating it inconsistently with the expectations of prospective target audiences, or of the expectations of theaters' regarding their target audiences), religious references abound. Exactly what do scriptwriters do to conjure the hot sex in your imagination? More often than the Jaded Consumer can count, the answer is the depiction of some bystander – whether amused, irritated, lonely, or whatever fits the mood of the film – reacting by facial expression to some muffled-through-a-wall dialogue that runs along the lines of: "Oh! Oh! Oh God! Oh, God! Oh God!"

And who is it that's so hot in the popular media? Bad boys are frequently depicted as hot, for sure: addictions, vices, dangerous jobs – "manly" men. But what of the women? What of the objects of men's desire, the characters in films who usually determine who wins the battle for the romantic plotlines?

At the outset, the Jaded Consumer acknowledges that there are sitcoms about women who can't find love in New York, and prove the diligence of their search through an endless line of mostly meaningless couplings, each of which enables another opportunity for a bedroom joke. The Jaded Consumer won't name manes here, but these shows aren't at heart about romantic love, but the relationships between the friends who share the experience that men are mostly dogs, then buy a bag of milkbones because it's what you need to attract dogs. Depicting this can be funny, granted, and the Jaded Consumer doesn't begrudge writers who make a legal living selling humor of this ilk to those who like it, but at the end of the day such shows aren't really about love, or passion, but self-identity and the control of one's life.

Shows that depict love show people lose control, and they celebrate it. When E.R.'s addicted bad boy Dr. Doug Ross (George Clooney) was shown really falling for a girl, it wasn't some whore who was simply taller or leggier or bustier than he'd previously met – bad boys are too jaded on TV to really get into bad girls except as property – but the warm-hearted and Catholic nurse Carol Hathaway (Juliana Margulies). Anyone recalling episodes involving the two recalls her chemistry on screen.

Why did they make Nurse Hathaway Catholic? Because good girls are sexier. Religious girls – and this is a comment not on the truth of the world, but on the social expectation played upon by scriptwriters – are harder to get and more valuable, and their reactions more honest and less jaded, and when they love they love. And real love is hot.

The heat of real love may explain the apparent volume of purportedly "amateur" videos on porn sites. Why would anyone want to see "amateurs" when professionals can show you how it's done? Easy: who believes the "passion" professionals and their vocalizations? People who want to see something more than a pretense of passion – and want to believe they are looking at something "hot" – want to look at something rare, hidden, private – real love. (The Jaded Consumer doesn't want to pretend to be an expert on adult video, and notes that the apparent scale of the industry suggests that lots of viewers are perfectly willing to settle for mechanical, plotless, unbelievable situations simply to view a coupling. However, there are people who want to believe, or need to believe in order to be interested. Hence the complex setups designed to persuade viewers that the performers in professional videos are actually amateurs sharing their genuine affections on camera.)

If people are more drawn into (seemingly) real emotions and (seemingly) plausible interpersonal situations, and people more highly value affection that is hard to earn, then the connection between religion and passion will continue to be inextricably linked as long as religion is connected in the social fabric to values, priorities, and virtue. The hero who gets what he wants in Act I, Scene 1 doesn't leave us with much to be interested in. We want a hero (or anti-hero) who proves his mettle by proving himself through tests that show he is attractive enough in his values and priorities that we want him to succeed in love and experience the blissful but blistering heat of real passion because he's proven he's man enough – vir is Latin for "man" – and by virtue of his mettle deserves the success we all want for ourselves.

The connection in viewers' minds between religion and passion isn't helped by Church sex scandals, which depicts church groupies like rockers' groupies, or financial scandals, which liken churches to banks. Let's not even discuss the child-seduction problem in churches. But stepping outside the failings of particular organized religions and looking at the individuals, there's no doubt that real passion – as opposed to loud pretense and practiced performance – is much more closely linked in the public conception to people's internal struggle to find value and to prioritize the competing demands on everyone's time ... a struggle inextricably intertwined with the struggle to live a practical life in keeping with one's values that requires the same balance as making a personal life function while keeping one's family fed.

This doesn't mean that values and religion are inextricably connected – religions have, after all, given us the sale of indulgences, mass murders of political opponents under the mask of holy war, shelter for sex criminals – but it observes that in America, religion and morals are connected in the media.  Religion is a quick signal to viewers of morality.  It may be inaccurate, but it's a shortcut and in an hour of television how many non-commercial minutes have you got?  So there you are.

In America, it seems, mainstream males don't at the end of the day value and hope to find whores, but mothers. And it's our desire for this that makes good women, reliable women – women with values – such objects of desire.

And that's why good women are so hot.

ACAS: More Profitable Exits Hidden Within

American Capital Ltd. has a wholly-owned portfolio company, bought below book value in an all-stock transaction back when people thought ACAS was about to go down the drain, that specializes in the international markets. European Capital announced today having received £40 million (which is the same as €48 million for those watching at home – haha – okay, over $60 million cash) in prepayments of debt associated with a mezzanine transaction in which ECAS realized a blended return of 13.2%.

ECAS' realizations over the last 12 months now exceed €141 million (alright, $179 million). This, in a portfolio company that (despite having net assets with a "fair value" of $700 million) is listed on ACAS' SEC forms as having a "fair value" of $400 million. (see recent shareholder presentation) Assuming ECAS shares ACAS' objective of investing in exciting deals, the subsidiary would have been originating some exciting new opportunities – or stands on the brink of doing so. New deals with pricing based on post-crash market economics will have pricing more people can understand and trust, and the multiples contraction associated with the market collapse will make those deals extremely sweet as the markets recover. Owning ECAS at less than 60% of the value of its assets is also more mind-boggling when one considers how much of those assets are cash.

So ACAS has a few lessons to teach us: ACAS and its ECAS subsidiary are continuing to exit deals (and to do so at a gain), and the discounts built into ECAS (multiplied by the discount also present in ACAS) make some of these deals particularly exciting from a value standpoint. Panicked income investors who ran for the doors won't be back for maybe two years, if ACAS works hard to put off as long as possible its dividend-paying requirements, and that window will allow some nice fire-sale-priced purchase of a widely-diversified portfolio of companies that are generating a profit that should increase as ACAS' debt overhead drops and its spreads widen. The fact that ACAS gets to realize both leveraged debt return and capital appreciation as we come out of a depression will make shares bought at this level much more attractive down the road.

Since the prior owners – the income investors who used to own for the dividend – will remain on the sidelines for a few years, there could be a while before ACAS shows a NAV premium. However, the irrationality in the severe NAV discount should become evident over the next few quarters as ACAS – which won't face any tax expense or pass any to shareholders due to a combination of its BDC status and loss carryforwards from the depths of the crash – posts continuously-increasing NAV, NOI, ROI, and other metrics of interest to buyers. Oh, and pays down debt.

What's not to like? Cash rolling in, and the books cloud the fact from people reading the top paragraph. Exactly what I like to see: a deal, and a good reason the deal is widely missed.

An opportunity.

I'll be looking at volatility in ACAS as an opportunity to make bullish positions, but won't be trading the share's I've got. The road upward seems like it will continue for a long time – much longer than the horizon for dividends to resume.

ACAS: Another Exit (and More On Horizon)

Recently, a poster suggested that ACAS would have enough funds to make good on its intended debt pre-payment this year, a move that would reduce ACAS' interest rate on its entire outstanding debt and improve its spread on its entire portfolio – an already-announced NOI-enhancing move that, when taken, will have an impact greatly exceeding the size of the modest investment involved.

This week, we receive word that ACAS exited its investment in Innova-Extel Acquisition Holdings for $125 million in cash. The buyer, Hunting PLC, is an oil services company whose energy industry support solutions business has an obvious use for the harsh-environment printed circuit board technology and downhole logging tools, designed for the energy industry, that changed hands in the transaction.

The $125 million sale price isn't all going to ACAS – there are affiliates and managed funds and some senior management at Innova-Extel who will be getting a share. Assuming that the management share is slight, and that the managed funds share is the 30% ACAS transferred to a managed-funds portfolio a few years back, ACAS should be getting something a bit under $90 million in cash.

Considering that ACAS' price point to reduce its interest rate is $300 million, this transaction alone would get ACAS much of the way there if it hadn't already paid the principal back (a timing fact not yet public and not known to this author). Recovering $90 million in capital puts ACAS a long way toward pursuing its announced objectives of prepaying $310 million in debt to reduce portfolio interest (to generate a 12% return on capital) while originating high-quality new investments (using on-balance-sheet securitizations for new debt and targeting a 0.6:1 debt:equity ratio).

The progress toward management's announced objectives is underlined by ACAS' apparent preparedness to sell a major stake in its largest investment in its portfolio, while improving ACAS' liquidity for the non-exited investment: Mirion has filed a new set of IPO papers. The last time ACAS filed MION IPO papers, it pulled the plug on the deal because selling near the last-listed "fair value" wasn't rich enough (the price the street was then willing to pay was about $11, which yielded ACAS only a hair more than the last-listed "fair value" of the portion of MION owned by ACAS). The Mirion pitch (supplying the highly-regulated nuclear segment of the non-petroleum leg of the energy industry with high-tech compliance equipment and services) looks even better after the apparent lack of safety petroleum companies radiated during the BP disaster, and ACAS apparently hopes to cash in. I'm guessing ACAS tries for $14 a share, but IPOs are not a Jaded Consumer speciality and I don't claim any particular basis for this.

ACAS is clearly interested in doing deals and capable of moving on them. Ridding itself of the debt-refinancing concerns and the cloud of a potentially impending bankruptcy filing frees ACAS from a significant distraction. The ratings agencies' clouded view of ACAS – that it proved itself a bad risk based on the view that its lenders were coerced into taking the debt refinance – should give investors some more time to buy ACAS shares while people are still worried about its finances. After a few quarters of business as usual, those days may be gone.

Jobs Right on Flash Quality After All?

The "it plays Flash!" feature of non-Apple smartphones may not be all it's cracked up to be. When users find that Flash loads, they may find the experience to be as technology and telecom reporter Ryan Lawler describes it for for NewTeeVee.com.

And how was that experience?

"Shockingly bad."

The site links a video of a 1GHz Nexus One smartphone on a 25Mbps broadband connection, which should be ideal for showcasing just how wrong Steve Jobs was about the potential of Flash on low-power mobile devices. Instead, the Nexus One video showcases just how accurate his assessment of Adobe's product continues to be: the UI seems to support mis-clicks and links to the wrong content; the waits are significant even when trying to download content on a fast broadband connection; unexpected errors occur and advise trying to experience the pain later; and when you finally find a site that does not result in an error (in his case, a show episode on Fox), there is not even a small segment of smooth video.

Kevin Teufel's assessment:
"That's seconds per frame, not frame per second. . . . I don't know about you, but I could not watch a full episode like that."

The little flag that appears atop your "video" is not encouraging: this video not optimized for mobile. Well, wasn't that what Adobe promised? Provide content everywhere and experience the "full web"? The whole time the video demo is underway, it's crystal clear that the experience one gets isn't the "whole web".

Seeking content from MetaCafé yielded a Hulu video, but Hulu is blocked on Flash mobile devices. MetaCafé, which was more reliable than other sites in yielding working videos, also had a video from an action movie, and the subjective video experience was so bad (the combination of skipped frames and other factors) that the things that were supposed to look quick looked spliced-in, and things that were supposed to be slo-mo looked choppy.

I don't claim 3G video is great on iPhones, but the video above demos performance on a WiFi network attached to a 25Mbps broadband connection. It's not 3G, it's the best case for the Flash/Nexus One combo.

Bleh.

AppleTV: No 1080p

The specs are here. The "TV Compatibility" section says "Compatible with high-definition TVs with HDMI and capable of 720p 60/50Hz".

So, to take advantage of your highest-def content, you need to bypass or work around the AppleTV in your media cabinet? Whose idea was that?

The fact that 1080p isn't widely streamed yet because it's big may explain it, but what about people whose interest in quality leads them to buy those BluRay discs Jobs says no-one will want? Has Jobs just decided that he wants to try to Betamax the physical media in favor of downloads?

If so, it could work – those discs are a nuisance to juggle in and out of players, and anyone with kids knows what happens when they get handled and scratched – especially as transmission speeds make transmission of full-scale content easier over time.

At some point, though AppleTV needs to support the resolution demanded at the high-end, or lose the business of folks who care about seeing the quality for which they bought those big flat screens. At the moment, though, Apple is aiming at the mass market and at the capability easily supported by its existing in-house chip supply.

Next year? New chips, new performance envelope.

The careful student of Apple spec sheets will notice that the device has no user-accessible storage. This isn't the AppleTV of yesteryear, that was basically cross between a Mac Mini and a Time Capsule that played shows on your TV; this is essentially a video-enabled Airport Express. Storage is as big as you like – on your computer, located somewhere else on your network, away from your TV, not cluttering your entertainment center. AppleTV isn't being obsoleted by file sizes; that's a hardware problem for you to work out with your PC vendor. AppleTV is not a stand-alone solution, it's glue in a chain of Apple products.

The lesson? Apple is not trying to build the Lisa any more (intended to be perfect, but ending up overpriced), it's trying to build for the mainstream. Apple has learned from the iPod and the iPhone that a volume business that aims where the demand is now is more valuable to Apple than aiming where the business will be in 10 years (*cough*Newton*cough*).

Apple is growing up – including with product positioning strategy. AppleTV is not a costly part for Apple to build and will involve modest investment in stock; Apple need not sell huge volume to make money on it. Apple is in a position to help Netflix get streamed content to your TV (a problem for Netflix I noticed when I wanted to stream flicks, and ended up watching on a laptop), and makes both your TV and your Netflix account more valuable. Apple is also able to offer ad-supported content from other sources.

Soon, you will be free of your cable bill: you will stream news and you will save the subscription cost in favor of renting the handful of shows you actually watch. That horrid DVR your cable company saddles you with will go back to the land of ugly products with lousy UIs, and your TV will act like an Apple product because Apple will provide the portal to everything you want to watch.

And all for $99.

ACAS' Exits: An Update

In ACAS' recent announcement of its Narus exit (through transaction yielding $21m to ACAS and its controlled funds, including $12m to ACAS' own top line and $3m to ACAS' bottom line), ACAS included a link to a non-exhaustive page of exits. Presumably, this non-exhaustive page of exits reflects the deals that are material and aren't subject to nondisclosure agreements (some buyers may pay for silence), but if you sort the list by date of exit you'll notice that it hasn't been updated since October of 2009.

Earth to ACAS: as of this writing, that list is close to a year out of date. Inquiring minds want to know, and it's an obvious place for folks checking up on the company's results to look. To avoid looking like ACAS is ashamed of recent results, ACAS should publish them.

Reviewing the list, it's clear that ACAS is willing to confess bad bets publicly (the investments in Stein World, Flexi-Mat, S-Tran Holdings, Weber-Nickel Technologies, and Sunfuel Midstream range from 90% losses to genuine 100% loss), but that some of ACAS' biggest listed investments have had attractive internal rates of return (Extream Software at $548m, Axygen Bioscience at $271m, Evans Analytical at $125m, and HomeAway at $120m had IRRs of 22%, 22%, 80%, and 39%, respectively). Some of the investments that involve well-known names haven't been bad: Piper Aircraft's $91m investment produced an IRR of 19%, and Gibson Guitar's $33m yielded an IRR of 16%. But where's Riddell? Maybe Riddell isn't listed because ACAS kept a couple percent, and is therefore not entirely exited.

The vast majority of ACAS' deals aren't on the web site cheat-sheet. Not appearing anywhere investors can see, though, is something even more important: the vast bulk of deals on which ACAS takes a pass (about which one can read here). To make all that proposed-deal volume valuable, ACAS needs effective screening. The fact that there's a huge volume of prospects is valuable only to the extent ACAS can tell gems from duds. The firm's history of buying investments under conditions designed to result in profitable exits even as multiples contract shows a longstanding plan for conservative purchase, but the recent downturn has rattled confidence in management's ability to pick winners.

Continued exits from investments – especially loser investments – places ACAS in a better cash position (a) when a few hundred million cash will reduce ACAS' interest rate on its entire debt, and (b) just at the time that private companies unable to access capital from gun-shy banks and other sources of funds are even more on-sale than normal due to the P/E multiple contraction, and presumably therefore offer some of the most promising prospective investments. And then there are distress opportunities, in which ACAS has been apparently investing already.

While the risk of double-dip recession remains frightening, the ability to get good deals in purchases of solid businesses seems very attractive: with so few equity buyers, ACAS may be the only game in town, so to speak. The more deals ACAS can review, the more likely ACAS should be to find outstanding winners.

I'm off to do some of my own work, and I'll leave management at ACAS to keep my capital there hard at work while I'm otherwise occupied. The dividend won't exist for another couple of years, I expect, and this cash retention will help ACAS grow NAV and, as the capital base grows, ACAS' profits. I like the long term now as much as ever.

The next couple of quarterly reports should be interesting as we see ACAS' activity to continue improving debt cost and directing its attention away from its own finances and toward the books it needs to review to make good deals. And that, folks, is where I want ACAS' attention directed.

Consumer Update: Bank of America

After having spent over a week getting Bank of America to begin automatic, recurring payment of a home mortgage recently bought by Bank of America, I have an update:
Nice, eh?

I discovered this while on the phone with a customer service representative who called me in response to by scathing feedback in one of several surveys I was invited to take in response to my multiple, fruitless contacts with Bank of America to set up automatic recurring payment of the mortgage. After 14 minutes on hold, she tells me that (a) according to the mortgage department it is set up to pay the mortgage automatically every month and (b) if I will write down a host of access numbers, pin numbers, etc. I can make my next call quicker and the options offered by the automated phone system more relevant. What she says in (a) may be true, but the BS meter goes offscale on (b).

Much more of this and I'll refinance with another bank just to be rid of the bastards.

Bank of America: Don't Bother

After deciding not to borrow from Bank of America, I ended up with Bank of America's "service" anyway: they bought my loan.

So, to avoid the SNAFUs I foresaw with Bank of America screwing up ordinary transactions as I'd seen in the past, I decided to make timely payment of the loan Bank of America's responsibility: I decided to set up automatic recurring payment of the loan. The steps to reproduce my experience are:

(1) Go through the dance to set up an online ID for managing Bank of America accounts. There were several steps, involving emails and snail-mail instructions, but this was ultimately accomplished without incident. Ameriprise Bank could learn something.

(2) Search diligently for evidence of how Bank of American invites users to accomplish payment online. This can take a while. The online information does indicate that setting up what Bank of America calls a "pay plan" – the automatic recurring periodic payment of an amount due under a loan payable to Bank of America – can be accomplished online. Searching for the mechanism to accomplish this will take longer than your patience endures, however, because establishing automatic payments of amounts due under mortgage agreements has not been possible since last October. This last but critical fact is not disclosed online, and is entirely inconsistent with – in fact, directly contrary to – the instructions advising users they can establish pay plans online.

(3) Call for help.
(a) This part is tricky because the numbers to which mortgage customers are routed tries very hard to steer you into making a one-time payment, and there is no recurring payment mechanism available by phone. This mirrors the situation online, but it's easier to identify on the phone because the options are fewer in number. When you try pressing "0" to get a human, a voice warns you that using a human can lead to higher fees. It is possible, using contact numbers buried in the web site, to get a human without facing the phone queue and its fee threats, but this is probably not the experience you'll have from the outset.
(b) Let's say that after an hour of trying to follow web instructions that don't work, you eventually get a phone number that leads you to a human. This is where, in hindsight, things really because irritating. The human was obviously consulting notes in giving his instructions, which lent an air of authority: he wasn't making this up, he was guided by printed materials to keep everybody giving accurate information. He instructed me that I needed to set this up online. You are going to see the punch line coming long before I did on this one, but bear with me. I was carefully led through a laborious process of associating my external "pay from" account with my online mortgage account so I'd be able to set all this up, and even informed that I was just one step away from completing the automatic payment setup.
(c) I entered bank info online so BoA could pull cash from my account at will, and I looked for a way to ask it to start. The helpful guy told me that, of the options I read him, I needed "verify" – that this would clear the account to start automatically paying the mortgage bill.
(d) Over the next days, I read from my account at a real financial institution that Bank of American had deposited $0.43 and $0.63 into my external "pay from" account. I dutifully logged into the BoA site and entered these numbers in the account verification boxes. My external "pay from" account was now verified! Hurray! I was done! And only three days of effort!
(e) Or was I? I tried to find evidence the account was actually going to be charged. The confirmation information simply said the account had been verified and that it was ready for making payments, not that any were scheduled. The online system included a make-a-payment link for folks who wanted to pay from an external account (or another BoA account), so it was quite plausible that nothing was set up at all. I began hunting for evidence of how to start the automatic payments. See Step (2) above. After patience failed, I began Step (3) again, looking for a human to finish what was obviously half-done.

(4) Get Help For Real. The same phone queues I accessed in (3) above tried to direct me to make one-time payments and actually hung up on me. In my last call, after 37 minutes of alternately being interrupted by agents trying to tell me that "bill pay" can't be used on a mortgage (BoA has a product called "bill pay" that is used for something else) and being placed on hold waiting for someone able to speak intelligibly about the bank's products, and being placed on hold waiting for someone authorized by BoA to confirm I intended to authorize BoA's payment of the mortgage from the account I verified online and from which BoA presumably would allow me to make an unlimited number of payments in any amount I chose, I finally was told the mortgage bill was set to be paid on time every month without one of the fees BoA charges for many of its payment options (the payment scheme is dizzying, and every tier has a different fee).

All told, it was about a week to get the account set up to pay the mortgage loan automatically, a half-dozen calls, numerous trips to the web site, and lots of mistaken online and human-provided instruction. An enormous waste of time.

I'll be looking for alternatives to end up in business with a different bank. As for you: borrow from someone else. Try to make sure you borrow from someone who'll be servicing the loan, not just originating it. You may save some middle-man fees that way, too.

On ACAS following 2Q2010

Thanks for the Anonymous post trying to point out the weak parts of the ACAS story – the more people have to think about, the better. ACAS' 2Q2010 presentation is worth looking at – the slides, at least, if you don't think you have time for the whole presentation.

I do not suggest ACAS should refinance immediately – refinancing was, after all, an expensive undertaking and I expect ACAS to enjoy being out of the refinancing market for some time. However, over the long run, it's an issue that will recur due to the restriction in the new debt limiting the use of funds raised by subsequent debt. I don't see this being an issue before the 2012 time frame. I see this being an issue when ACAS is wanting to be more levered than it is. At present, achieving ACAS' maximum allowable leverage doesn't involve de-levering.

ACAS won't worry about that soon. Looking at 2Q2010 presentation slide 15, ACAS also plans achieving leverage in the future using on-balance-sheet securitizations, a strategy with which ACAS' management has apparently had both experience and success at its publicly-traded controlled fund AGNC. Thus, ACAS may seek future leverage with investment partners on terms that are more attractive than generally available from banks.

Cash flow isn't operating income. ACAS' realized losses washed out its NOI while providing positive cash, preventing a dividend-related liquidity crisis in the near term, but the accounting profits (taxable income) at portfolio companies that lay behind the NOI figure should not be mistaken for positive cash into ACAS. ACAS is paying lots of interest on the debt whose nonpayment is still mounting. To combat this, ACAS plans improving its margins by dropping its interest rate another percentage point by the end of the year through repayment of secured debt. (see 2Q2010 presentation slide #15) (Note that Anonymous seems to overstate the restriction on repayment; the make-whole payments protect only a small subset of the new debt, most of which is subject to repayment at will without penalty, and some of which has a mandatory repayment timetable within the time frame described by Anonymous. If ACAS makes its planned early repayment, it will do so without penalty.) NOI is just coming off cyclical lows, and should improve – and with it, the internal metrics of the companies providing the NOI.

On the other hand, although nonpayment is worse sequentially – nonpaying loans have grown from $671m cost at the end of 1Q2010 to $686m cost at the end of 2Q2010 – non-accrual has improved y/y from $996m cost on non-accrual in 2Q2009. "Past due" loans stand at $57m (cost), down from a peak of $209m at 3Q2010. The benefit to ACAS of having a non-accruing loan that isn't past due seems somewhat mysterious to me just now, though. The fact that ACAS makes a deal for forebearance to allow a portfolio company to reinvest instead of pay interest doesn't mean ACAS ends up with either operating income or interest payments; it means ACAS is helping portfolio companies to avoid the vortex they're circling. It might promise some better odds of future recovery, but from where we stand out here it's hard to measure that benefit. Still, ACAS' focus on organic growth within portfolio companies and in supporting add-on acquisitions suggests that ACAS' efforts to support portfolio companies in their time of need has a strategy beyond improvement in the prayer life of executives. (See 2Q2010 presentation slides 20 & 23).

I note that although 2Q2010 has significantly more NOI than 2Q2009, its NOI was sequentially down from the 1Q2010 quarter. The NOI decrease could be partially explained by the increase in non-accruing loans over the quarter, but this isn't all of it.

The upside is in two hard-to-predict parts: recovering investment values and evaporating NAV discount. This is necessarily a lumpy ride. Depending on the economy (operating results) and the markets (multiples), we could have some significant backward movement while we're underway. Comparing the realized earnings to the FAS-157-compliant SEC-reported "earnings" shows ACAS negative except in improvement in unrealized gains.

The BLTs don't seem to be performing as planned at all. Repayment of debt associated with the superior debt classes issued by the BLTs is something I haven't measured, but the "half ACAS' cash" conclusion may indeed be the number. The opacity of ACAS' CDO investments prevents me from making any intelligent statements about them, but I notice that management has long since stopped using the CDOs as an example of how FAS 157 misprices ACAS' assets. Conclusion: management agrees that the CDOs (like the commercial mortgage-backed security investment once touted as expected to perform through maturity, despite being valued poorly as residential CDOs were collapsing) are essentially worthless.

To the extent ACAS needs cash, ACAS will be depending on exits. Fortunately, ACAS has been strong on making exits. Moreover, ACAS' focus on debt and securitizeable mezzanine business going forward would, if successful, result in quicker exits and less equity exposure. (see 2Q2010 presentation slide 18) With respect to "earnings" though, ACAS' reversal of unrealized losses and its increases in unrealized gains will likely keep it (and its NAV) looking good in its quarterly reports. However, as pointed out by Anonymous, most of ACAS' writedowns have been in equity. Most of the exits, however, have been in debt: of $351M of 2Q2010 cash realizations, only $45M came from equity. The rest has been debt. Retaining equity that stands a fair prospect of turning around with the economic recovery is attractive.

As depicted on 2Q2010 presentation slide #9, the sale of assets has been near recently-reported fair values. 2Q2010's exits at 7.7% above NAV are better than the within-2%-of-fair-value amounts that have characterized exits since 3Q2008, and it'll take some time to ascertain whether this represents a fluke or a trend. In the immediately prior quarter, exits were 3.7% below last-reported fair values. Both numbers are likely pulled off parity by a small number of outlier exits, and may be useless to shareholders in estimating the value of likely future exits, other than to reassure them that exits are plausible near reported fair values. Since management wants more than reported fair values from some of its investments, management will likely hold on to some well-performing investments for some time.

On the other hand, some of that equity isn't coming back: it died. ACAS borrowed money and lost it in deals that went south, and will have to repay it with the profit from its surviving deals. We won't be seeing $40 shares of ACAS any time soon.

But, as suggested by Anonymous, seeing $15-$20 in a handful of years is plausible. In my view, it will turn largely on macro-economic conditions that impact the entire market's profits and multiples. Considering that ACAS' 22% growth in NAV came after the effect of dilutive issuance, and that ACAS continues to hold a significant fraction of equity (including well-below-NAV-valued ECAS), the prospect for significant equity-driven return seems good – provided ACAS manages its liquidity concerns.

Reducing average leverage to 0.6 to 1, dropping interest rates to their lowest tier available under the newly-refinanced agreements, and lowering the principal on which debt will be paid will all reduce forward risk and improve forward margins. Raising new managed funds will enable ACAS to realize fee income without holding risk, allow ACAS to leverage due diligence overhead and internal resources to develop income beyond that achievable with ACAS' own funds, and enable ACAS to contract to enjoy potential upside like upside participation when return goals are met. Securitizeable mezzanine finance will both shorten the investment cycle and de-risk the portfolio. Focus on growing existing investments organically will allow ACAS to invest in what it knows, picking well-understood known winners for add-on investment in anticipation of preparing them for resale as they come off cyclical lows both in internal metrics and in terms of external multiples. Although ACAS is currently free under its debt agreements and the BDC Act to declare and pay dividends, the lack of an apparent need to declare a dividend this year or next will allow ACAS to maintain and recycle capital on hand for the near-term future.

In the more distant future, ACAS may market itself as an income stock, but in the meantime it's a holding company with no tax expense and I look forward to observing its performance improving book value. I'm optimistic that NAV improvement will continue as the economy avoids further collapse, and as ACAS proves its capacity to do profitable business over time its NAV discount may dissipate. Even if it doesn't, recycling funds into high-value new opportunities created by the economic collapse will offer returns by which ACAS will reward shareholdes with (ultimately) statutorily-mandated ordinary income distributions in the form of annual dividends.

ACAS: 2Q2010

American Capital recently announced its results for the second quarter of 2010, and those results are encouraging. In reading them, consider that American Capital spent the quarter threatening a bankruptcy filing to encourage creditors to accept a debt refinancing deal, which meant that in addition to suffering ongoing distraction at the top of ACAS as it renegotiated its debt, ACAS also had to spend money hand-over-fist on bankruptcy specialists so that it could, on immediate notice in the event deadlines lapsed, file in a bankruptcy court to prevent creditors from asserting acceleration and other rights held under the old debt agreements, under which ACAS was to have maintained a net asset value that proved implausible as the financial markets imploded in 2008. The expense of these renegotiation tactics was $17m over the quarter (up from $7m in the year-ago quarter). The end of the debt renegotiation battle means (a) less distraction for top management, and (b) decreased expenses.

Expense Reduction = Income Increase
To grasp the significance of the decrease in expenses, one should consider ACAS' net operating income (NOI). This is the income gained from operations either because portfolio companies profit (which profits would flow to ACAS' bottom line in the case of the mostly-owned portfolio investments), or because ACAS receives payments on debt extended to portfolio companies (ACAS profits to the extent of the net of its debt income and its debt expense; much of ACAS' lended funds are themselves borrowed). NOI includes everything but investment performance (that is, the change in market value of what ACAS owns); it's the income ACAS makes standing still and doing no deals. And what was that NOI in Q2 of 2010? ACAS' NOI was $29 million over the quarter. Doing nothing else to ACAS' business and merely dropping the debt renegotiation expense, ACAS' NOI would increase over 58% to $46m. This gives one an illustration how significant the elimination of the debt refinancing problem is to ACAS' ongoing operations.

ACAS' NOI hasn't been standing still, though: the current NOI represents a 45% increase over the NOI it posted in Q2 of 2009. As the economy behaves in a more normal fashion, ACAS' portfolio companies will be able to operate in a more normal fashion, and the results of those normalized operations will flow through to ACAS in the form of resumed debt repayment and improved business operations within portfolio companies. The Jaded Consumer has long advocated looking to NOI for an indication of the success of management in picking winning investments, and it's good to see that number moving up -- and looking to continue moving up.

The downside on the NOI is that at $0.09/sh, it is exactly where it was a year ago – that is, share issuance served to dilute NOI performance per share back to its year-ago levels. But there's an upside: even as NOI has stayed the same, ACAS' performance other than in operating income has moved forward.

NAV As Barometer of Management Performance
Even as ACAS posted $0.09 in NOI, it has grown net asset value more than the $0.09 one would expect in the absence of a dividend. NOI increased $0.17/share to $9.15, a 2% increase from the prior quarter. Compared to the NAV announced at the close of 2Q2009, ACAS is up over 23%. That might sound good, but the truth is better. Most companies grow their assets by posting profits on which they accrue tax liabilities. ACAS has achieved its recent results while making investment exits at a net loss – protecting it from being forced to disgorge assets either to the government as taxes or to shareholders as dividends. (As a BDC, ACAS' dividend payment is statutorily set within a range that is a function of ACAS' taxable profit; since FAS 157 and the SEC-reported "income" isn't taxable profit, those aren't the numbers one looks to either for tax liability or for dividend payment. ACAS will have no need to lose valuable cash to dividends for the near future, and will have no tax liability either directly or as passed to investors.) Since much of ACAS' portfolio is valued on the basis of things like price-to-earnings multiples (that are constrained under current markets, and would be expected to expand over the long term as macroeconomic conditions make investors more excited about equities as compared to fixed income investments) and earnings themselves (that are adversely impacted by things like unemployment and spending reductions that accompany the current economic cycle, but are cyclical and absent business failure would be expected to recover), the re-inflation of ACAS' NAV is likely only just begun. As ACAS begins turning in taxable profits, ACAS' loss carryforward will stave off tax liability for maybe another year or so.

When Earnings Aren't Earnings: What to Look For in ACAS
In the year-ago quarter, ACAS' FAS-157-compliant "earnings" were ($2.52) per diluted share (2Q2009), but the newly-announced quarter shows a gain of $0.84/share. Again, this emphasizes the disconnect between FAS 157 and the real world of taxable gains: ACAS is allowed (nay, required) to tell the IRS it lost money (and owes no tax, and has a loss carryforward that is growing so as to prevent near-term dividend issuance), but at the same time must report to the SEC (and to you and me) in accordance with FAS 157 and proclaim it's made 84¢/sh for the quarter, which at recent prices of $5.30 or so a share, suggests a miniscule multiple of price to earnings.

The tax loss means that dividend-paying requirements are pushed further into the future, which is good because ACAS pays good money for all its cash, and should be making a return on that money whenever possible instead of mailing it to speculators. I'd rather see the share price upward, thank you.

Overview
What does the 2Q2010 announcement tell us?

(1) NOI is set to rocket. NOI will swell with the decreased debt expense, which is not reflected in 2Q2010 even though the refinancing closed in the quarter. This is because the deal closed so late in the quarter that NOI reflected chiefly the default-rate interest ACAS was paying prior to the refinance. Because NOI includes ACAS' spread between its debt expense and its interest receipts, dropping its debt expense by reducing the principal by over $1B and by lowering the interest rate from the double digits to the single digits has a multiplicative effect on ACAS' NOI. NOI will also just stop being dampened by things like debt refinancing expense. Add in the elimination of the $17m debt refinancing expense, and it's clear NOI is sitting on a rocket for the next quarter.
Well, barring financial catastrophe that would affect portfolio companies' capacity to repay debt.

(2) ACAS won't be paying a dividend soon. This good for investors who want ACAS to get the most return out of its interest payments; why pay interest on money it has to distribute to shareholders and stop getting a return on?

(3) With rocketing NOI and no requirement for a dividend, ACAS will be generating lots of investable cash that (a) will lower ACAS' debt/equity ratio, (b) will have no interest expense, and (c) will multiply ACAS' returns as management seeks out more opportunities that are as mispriced as ACAS' own shares.[1]

And just how mispriced are ACAS' own shares? ACAS now trades at something like $5.30. At the end of the quarter, NAV stood at $9.15 and rising. This implies a NAV discount exceeding 40%. That means that if ACAS stopped working and focused its efforts on conducting an orderly liquidation, ACAS' shareholders would end up with a gain over current prices of over 50% (shares bought at $5.30 would result in a final dividend on dissolution of over $9, nearly $4 gain on a current investment). Since ACAS has positive operating income and is set to grow that operating income, the case for maintaining a NAV discount seems weak. The overhanging bankruptcy scare is long gone, and the future looks bright.

What kinds of opportunities does ACAS have to increase NAV? For an obvious example, let's look at ECAS – the European arm of the business that ACAS took private in early 2009. The NAV of ECAS is $0.7B, but ACAS claims it has a FAS-157-compliant "fair value" of $0.4B, or a $0.3B discount. The $0.4B given under FAS 157 is again discounted in the hands of ACAS buyers, who get their share of ECAS at a 42% (or so) discount, valuing ACAS investors' ECAS ownership at a total of $0.23B (or thereabouts). Would you buy ECAS for $0.23B when its NAV is $0.7B? What if you heard some of its portfolio companies were being given harsh discounts under FAS 157 and were worth a lot more than appeared on the books? Considering that ACAS has spent most of its publicly-traded life trading at a premium to NAV, the prospects for a multiplying effect as NAV discounts evaporate is an exciting and plausible prospect.

With respect to buying mispriced assets, ACAS founder Malon Wilkus said this:

We are now focused on originating high quality investment opportunities while continuing to improve our balance sheet. We have generated a 27% return on equity since the second quarter of 2009 and believe we will continue to generate strong book value growth for our shareholders as we recover from the recession.

The President of ACAS' Specialty Finance and Operations, Gordon O'Brien, spoke more specifically about this:

The quality of the portfolio continues to improve. Our investment and operations teams have made good progress in improving many of our troubled companies and the pace of new troubles developing in the portfolio has slowed significantly. We are pleased to now be able to turn our focus to making new investments. History has shown that the most attractive investment opportunities are made during the recovery from a recession and we believe that will continue to hold true.

ACAS expects to hunt down the most attractive investment opportunities exposed by the economic chaos and the recession, and use cash to pluck illiquid and discounted middle-market companies from the hands of exiting owners for the benefit of shareholders. This is exactly the reason I liked ACAS in the first place: it gets to cherry-pick the best deals in a field thin with buyers and flush with sellers.

Keeping Up With the Jonses
Normally, I don't spend much time worrying about what other people are doing with their investments (except to the extent I think they are creating an opportunity, like overselling ACAS or underestimating AAPL). However, there seem to be quite a few funds betting on the rationalization of ACAS' share price. ACAS maintains a list of major stockholders, and quite a few funds seem to hold a tenth of a percent of ACAS' outstanding shares or more as of their most recent filings. Among them are Paulson & Co. (which bought in a private placement in April), Vanguard Group, Dimensional Fund Advisors, and BlackRock – each of which reportedly holds over 3% of ACAS' outstanding shares. Well, in Paulson's case, over 12% of ACAS' shares outstanding. These are some big, ten-million-plus share bets.

They aren't making these bets because it looks like a crapshoot or because the anticipated return looks lame. I think they're recognizing that buying ACAS under these conditions is shooting fish in a barrel, or fishing with explosives: you can't hardly miss.

===
[1] Eventually, ACAS will have enough assets that will look to refinance its debt because it wants terms that improve its ability to leverage up when the investment cycle suggests that leveraging up makes sense. That will be a few years off, though. For now, we have lowered interest expense, lowered need to lobby lenders not to exercise acceleration and related default rights, and lowered need to reimburse lenders for legal expenses in connection with debt enforcement under oppressive debt agreements that force borrowers to bear lenders' legal expenses. (You laugh; as the fireman said in Ghostbusters, I have seen shit that would turn you white. I'm betting some of that $17m was reimbursement of lenders' legal expenses.)

iPhone 4: Don't Expect A Recall

Unless you've been living at the bottom of a well sided in RF-resistant stone, you have seen several volleys of iPhone4 signal-reception complaints, criticisms, defenses, reviews, "analyses", explanations, translations, refutations official-sounding corroborations, and commentary. The highlight may be Consumer Reports' swift reversal from giving the iPhone the highest rating it gives any phone (if you don't have a subscription, trust me: max rating is 76 the day this was written, and that's the iPhone4's CR rating), defending the phone's reception issue as "not unique" and possibly unimportant, then suddenly refusing to endorse the iPhone4 on the basis of in-house RF testing.

The latest in this running gunfight is the latest entry on the blog of electromatic engineer Bob Egan that derisively explains that Consumer Reports' methodology was poorly designed and its conclusions were incapable of being supported by the claimed evidence. For only a couple more iPhone4s, Bob offers to produce real RF testing using a shielded room and a proper experimental design intended to identify the real source of the observed phenomenon.

The Jaded Consumer hasn't gotten an iPhone4, but it's not because of conscientious objection: there's too much time left on last year's AT&T contract to get another subsidized phone. For the record, I tried using an iPhone without a protective case and decided it was too risky because my hands were often dry and the thing could slip out of my hand while pocketing/withdrawing it, which involves turning it about behind my back while aiming into a pocket or past the pocket's hem. The very people with the greatest risk of accidentally bridging the iPhone4's metal-edge antenna are the damp-handed folks for whom adequate friction has never been a problem, and who are least in need of a protective case because they hardly ever have anything slip out of their grippy fingers. For the most of us, who don't want to drop the phones or prefer they were protected in case of a fall, the Consumer Reports suggestion users band-aid the problem with ugly duct tape is superfluous: we've been using cases that would avoid the bridging problem and would never have noticed it except for Consumer Reports trying to boost traffic with an apparently half-baked iPhone4 criticism.

So, with crisis communications experts calling a recall inevitable, what's Apple to do? The Jaded Consumer's view is pretty straightforward: as long as the thing keeps flying off the shelves, and holds Consumer Reports' top phone rating, Apple is clearly selling what the people want and what the critics like. (Well, Mossberg isn't recommending it unless you think AT&T is adequate, which given the rest of his commentary isn't so much a dig against Apple's product as against AT&T's service.) And Apple usually end up selling a phone case, too.

The Jaded Consumer says: Keep up the good work! And don't hold your breath for a recall unless you have medical assistance standing by.

The Jaded Consumer expects the folks who sell adhesive shields for phone screens to be out soon with a product for people who don't want a case, that covers the metal edges so that sweaty-palmed users have a grippy but non-conductive but largely invisible layer protecting the iPhone 4's three external antennae sections from being bridged. Just like some folks pay a few bucks to have the usually unscratchable screen protected from keys in a purse or pocket, and do so without a public outcry for recalls despite the importance of a screen to a modern smartphone, some folks will be willing to pay for similar treatment of the phone's edges. I expect that the fraction of folks using the phones au naturale will have been low enough that there's no serious rebellion among users (there are, after all, no widespread reports of returns despite that Apple waived the restocking fee), but that the large number of iPhone4 users combined with the press on this issue will make protective devices a competitive market.

The more competitive, the better pricing for later buyers like the Jaded Consumer. Bring it on!

On Recent ACAS Exits

ACAS' recent completion of its debt exchange has freed it to direct its attention on its primary business: making deals in the middle market.

ACAS' subsidiary ECAS has converted some assets from equity and debt holdings in GO Voyages to cold hard cash in the amount of €74m, realizing en passant a double-digit rate of return (16% mezzanine rate and 19% equity rate) including the realization of €10m in equity gains. ECAS exits have been few, as the press release states that the only other ECAS exit in 2010 has been the Spotless Group exit.

ACAS' exits from its non-ECAS portfolio have, by contrast, included a number of smaller, not announced transactions that will be harder for investors to follow. For example, the unreported exit of ACAS from Resort Funding Holdings Inc. in the second quarter was described by an anonymous poster as likely resulting in a $25m loss; in the last-filed 10-Q, ACAS had disclosed its Resort Funding Holdings investment as having a value of $7.4m, consisting of $7.4m in 8.2% senior notes valued at face value, and common stock valued at zero (with a basis of $20.5m). According the poster, the exit occurred in 2Q and the earnings release made later in Q3 will reflect the disappearance of the investment. ACAS has been able to IPO holdings such as RRTS, but withdrew another IPO when pricing did not meet management's standards. Being a patient investor, ACAS can wait for the market to better appreciate interesting alternative-energy technology and compliance plays like Mirion; however, investors have a hard time keeping up with the deals that result from ACAS' investment operations. Unlike Cramer, however, who hates ACAS in part for what he refers to as "opacity", the Jaded Consumer likes that ACAS can do deals under the radar: ACAS can enter deals no-one else has seen, and find buyers who value the secrecy of deals that give it a competitive edge without drawing attention. Selling Naurus to Boeing shows ACAS' capability to find strategic buyers, rather than depending on private investors or IPOs for its exit strategy. Although the details of the Naurus exit aren't yet known, the strategic value of portfolio companies to publicly-traded would-be parents may offer rich valuations: HP previously bought Extream Software from ACAS for $5m over the prior-quarter "fair value". Cybersecurity is valuable, and an aerospace giant like Boeing with international corporate espionage concerns may be willing to pay top dollar for outstanding talent and technology.

ACAS should keep doing deals. Investments in which management has lost confidence should be exited to allow capital to be deployed more productively (and to realize losses that will help ACAS keep down required dividend payments; dividends of BDCs are based by law on taxable income and not SEC-reported "income" that includes unrealized changes in portfolio values). Investments that have succeeded well enough that buyers offer a strong price for a holding should be considered for sale in light of the alternate available investments, the benefit of holding for ongoing income from the portfolio company, and the premium offered by buyers to management's assessment of the investment's true value.

Growing ACAS will allow ACAS easier access to cash when it has payments to make, and returning to business as usual may aid ACAS in returning to the days of NAV premiums as usual. In the meantime, ACAS' operations can't turn on what people will or won't think about ACAS' share valuations. ACAS must look to the long-term returns of its portfolio, one deal at a time, and try to buy excellent companies cheaply and, having grown them with the aid of its in-house operations experts, sell them as dearly as possible.

Warren Buffet's comment is appropriate: In the short term, the market may be a voting machine; but in the long run, it is a weighing machine. Like ACAS' management, we may do best being patient investors. Here at the Jaded Consumer, news of ACAS' results in this arena are

iPad > electronic competitors

Nielson's survey suggests that paper books are easier to read than iPad books: readers of iPad books read 6.2% slower. However, Kindle readers were 10.2% slower than paper readers. Oddly, both the Kindle and the iPad users rated the experience more enjoyably than paper (the iPad>Kindle>paper scores were 5.8, 5.7, and 5.6; it was a close match, and one wonders about novelty effects – the scores were, after all, in order of device novelty, and relatedly but differently, in order of gizmo sexiness).

iPad also gets top marks for making the computer experience a lot simpler than it used to be. This review pretty much sums up why Apple is able to reach people who never were interested in computers: you don't need to be interested in computers, only in your music or your email or your photos the internet or the like. This is virtually the hallmark of a well-designed tool: you don't notice it really when you use it, just the power it lends you.

ACAS Exits CreditCards.com

ACAS' recent sale of CreditCards.com to BankRate frees the company from a property that, as I understood it, didn't live up to its billing and had ended up being primarily a vehicle for obtaining referral fees. The purchase at $145 million is not all going to ACAS (though the preferred redemption feature may make ACAS effectively a bigger owner than just the size of ACAS' control block), but this value is above ACAS' last-published fair value for the company (<$120m), which makes it interesting to wait for the news. (Of course, exiting 13.9% and 19.0% bonds makes it interesting to ask what ACAS would do with the money that's better. Still, realizing an equity loss will help ACAS avoid paying a larger dividend next year, which is important to maintaining its capital. As much as I enjoy having zero tax expense at ACAS, I enjoy reinvestment more. Realizing losses when recovery looks dim is absolutely sensible.)

ACAS' management has always said that it didn't just sell winners, and getting back capital to invest in more promising deals had great value; this exit seems right in line with that thinking. ACAS will get out of a deal that didn't do what management hoped, and help prevent an outsized dividend next year by realizing losses in the current period on its equity investment in Creditcards.com Inc. Since ACAS (as a BDC) is required to pay 90% of its taxable income in dividends, and ACAS can't be sure it will be in a position to raise capital above NAV to pursue interesting deals, avoiding payment of outsized dividends by early realization of losses makes good sense when the price is right.

With the debt restructuring distraction behind ACAS, I hope to see many distressed situation entries – and shedding unexciting investments seems a great way to fund a more exciting future.

The next question is interesting: why is ACAS under $5? Did people expect a non-bankruptcy pop and then exit when they were bored? Personally, I think we need to see next quarter's earnings results to allow the benefit of the debt restructuring to have any likelihood of showing up in the share price.

Apple's Smartphone Competition Thins

The competition for turf fought over by iOS, Android, and the smoothly-named Windows Phone 7 has thinned with the apparent death of Microsoft's Kin platform.

After six weeks and under 10k units, we hardly knew ye ;-)

The unit, led by one-time MacBU manager Roz Ho, will be folded into MSFT's other phone OS unit and presumably decisions and coding will slow accordingly. Daring Fireball points out that the people under Roz Ho aren't just bad at making mobile products. However, Microsoft's acquisition of Danger as a strategy to get a high-quality mobile product was doomed from the outset by politics. The "Windows Everywhere" drones made sure that buying Danger for its superior software would go nowhere.

Do iOS and Android have anything to worry about?

Fitch on ACAS

Fitch assigned ACAS a post-exchange Issuer Default Rating of B+.

However, the headline on this news was that since ACAS restructured its debt by coercion – that is, by threatening a bankruptcy filing – ACAS was getting a D (okay, "RD", but it reads the same).

Of course ACAS restructured its debt by threatening bankruptcy – otherwise, why would creditors have voluntarily ceased taking default-rate interest from ACAS? This coercive restructuring is why Fitch slaps ACAS' hand: ACAS didn't just pay up according to the schedule in the original debt agreements, but forced its creditors to renegotiate. This could bother you if you were looking to lend to ACAS, but the lowered cost of funds and decreased risk of the overhead of a bankruptcy filing is what equity investors are interested to see.

Fitch's comments about ACAS' potential difficulties raising funds are out of synch with the real world. ACAS has had no trouble raising cash for its managed funds. While ACAS trades 35% below NAV, there's no reason for management to be excited about diluting their own interest by issuing shares, but ACAS hasn't had trouble issuing shares when manageemnt thought it made sense (e.g., the accretive ECAS stock swap and the April issuance to Paulson). So long as ACAS' NOI recovers with the decreased interest rate and the decreased principal (paying interest on the $1b+ in cash it had on the books was making my eyes roll something awful), investors should see interest coverage improve, and with improved interest coverage comes assurance that ACAS will be able to pursue its business as usual while the portfolio has time to recover. Parts of the portfolio were entered specifically to take advantage of economic downturns, and other parts of the portfolio will be in a position to improve as the broader economy improves. These things take time, and improved NOI following improved costs of funds will make time easier to handle.

The headline – ACAS Gets A "D" From Fitch – obscures the substance of ACAS' situation following the debt exchange rather than illuminating it. Its authors get an "F".

For shareholders, the question is whether ACAS has improved its situation, and the "Ratings outlook: Stable" and the "B+" seem to be where their answer lies.