Tuesday, February 23, 2010

ACAS Reports 4Q2009

American Capital Ltd. announced its results for the fourth quarter of 2009 and for the whole calendar year. First, the good news:
  • NAV up to $8.29/sh, up from $7.80 at the end of 3Q2009 (6% over the prior quarter)
  • Realizations of $476m in the 4th quarter, for annual realizations of $1.1B
  • Unrestricted cash of $835m, up from $445m at the end of 3Q2009 and $500m at the end of October
  • Net earnings were positive in the quarter again, with earnings of $0.38/sh for 4Q2009, up from a loss in the year-before quarter of $8.13. For the year, the net loss narrowed to $-3.77, up from $-15.29 for the prior year. (These numbers reflect FAS 157, and therefore some unrealized changes in value.
Then, the medium news:
  • The realizations were within 1% of reported "fair value"
This is reassuring (valuations aren't low), but also concerning (the investment thesis is that NAV doesn't reflect true value, but sales at NAV suggest that NAV is close to current liquidation prices, which may in turn suggest that real value and NAV aren't far apart).

The bad news is that NOI will be under pressure as interest rates rise, because ACAS owes all the money it borrowed to make its investments – and owes lots of this at a floating rate – but ACAS can only collect on its performing loans. ACAS' effective rate on its private debt portfolio is 9.9%, which is better than prime but nowhere near what ACAS expected when it entered the deals it's got on the books.

Interesting news in connection with the debt restructuring: "we are working towards launching an exchange offer during March[.]" Exchange offer? If this means management is preparing to swap shares for debt in order to bring its debt:equity ratio in line with expectations, this could help confidence in ACAS as a going concern (because it's not in default, because it is in compliance with required ratios, etc.) and help ACAS shares trade without a significant discount to NAV. On the other hand, exchanging shares for debt is terrible: ACAS' portfolio was picked for being expected to perform better than the cost of debt, so trading the debt for ownership of (part of) the portfolio (by issuing shares) works against the whole thesis of ACAS' prior practice of borrowing to invest. I'd like to see the economics of this transaction before passing judgment. At the right price, this might not be bad – but at the wrong price this is a concerning possibility. On the other hand, "exchange offer" might simply mean exchanging one debt for another – making unsecured creditors into secured creditors, changing existing debt holders into holders of debt with updated interest rates and expiration dates, etc. What management means by "exchange offer" is something that needs some understanding to evaluate.

In the past, ACAS has been good (e.g., ECAS, whose ability to realize NAV has improved due to improvements in the status of its credit facilities) about making good deals by issuing shares below NAV. Based on the representations in the proxy statement, I favored this below-NAV authorization, too. Let's look forward to more good things, including more NAV improvement, as the end of the economy's free-fall becomes clearer.

In the meantime, let's look for evidence that ACAS has an effective plan to stabilize NOI and normalize its credit situation.


Anonymous said...

ACAS owns derivatives that protect it somewhat against interest rate increases. Check the portfolio.

Jaded Consumer said...

Also among ACAS' weapons against the risk of interest-rate increase is ACAS' lending at variable rates. I haven't looked at the size of ACAS' hedges, but would expect ACAS would hedge against rate risk on its fixed-rate portfolio, trusting its variable rates to protect it against most of the remaining risk.

Unfortunately, ACAS has had more debt than expected become non-current, which has impacted ACAS' income and the valuation of its affected debt holdings. The hope is clearly that as the economy turns around, so too will the fortunes of companies that owe ACAS money – to the benefit of ACAS' income and its NAV.

In the meantime, increases in interest both (a) threaten still-paying portfolio companies' ability to stay current (to the extent their rates are variable, their ability to keep current will be affected at the margin by the rate applied to the debt), and (b) impact income (to the extent not offset by gains in hedges). The fact that ACAS is hedged against rate risk is good, of course, but the fact that "somewhat" isn't "entirely" means that there's some risk to consider.

Frankly, ACAS' cash position at the moment is such that it could tolerate a lot of trouble and still make interest payments, even at default rates, which is itself a hedge against unexpected risks. Unfortunately, cash isn't a traditional producer of high-yield returns.

I look forward to ACAS being able to make high-quality investment again. I hope ACAS' debt swap does what ACAS needs. Hmm. Might the share issuance authority be part of a debt conversion feature to give lenders an alternative to acceleration?

Any thoughts welcome :-)