Thursday, September 30, 2010

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.

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